Food distribution consolidates further as tax rise pressures margins

Wholesalers are worried. Most already work on minuscule profit margins and they now face a new, powerful retail clientele more than capable of insisting that suppliers absorb part of the 3% consumption tax hike coming in April. The result is a rush to add scale, both in market share and logistics capability. Analysts expect a corresponding rush in wholesale M&As in the next 12 months.

Kokubu, only the third largest food wholesaler even with sales of ¥1.5 trillion, announced a business tie-up with Toyota Tsusho in November. The news comes as no surprise given that Kokubu lost its place as the largest single wholesaler in 2009 due to consolidation of multiple food wholesale interests by Mitsubishi and Itochu. With Mitsui, Sumitomo and Marubeni all major food wholesalers in their own right, Kokubu is the only non-Shosha affiliated company in the top ranking – although it has some minor ties with Mitsui Shokuhin, Mitsui’s main subsidiary.

Kokubu has been looking to consolidate for some time. Toyota Tsusho will provide new access to overseas procurement in both fresh and packaged foods, with the hope of higher margin ranges for sale to Kokubu’s supply network of both large and small retailers. As with all of the leading players, Kokubu has been investing in logistics facilities, for example opening its largest multi-temperature distribution centre in Fujisawa back in September, which already supplies 400 supermarkets in the southern Kanto region.

All of the big wholesale players are worried about the consumption tax increase in April – perhaps even more so than their retail clients. Despite moves by the government to ban retailers from promoting pre-increase prices, the reality is that wholesalers need their larger accounts to survive and most fully expect pressure from retailers to absorb some of the tax by cutting prices. Itochu Shokuhin, Asahi Shokuhin and others are now developing own-branded products for supply to small and medium retailers as exclusive lines, controlling the brand and so reducing influence on prices, but this shift into marketing can only take these wholesaling behemoths so far.

More practically, as with Kokubu’s new logistics centres, the big companies have been frantically looking to reduce costs as the best way to help their retail clients do the same. Tokan, an Aichi based wholesaler, has taken on the running of the first ‘mother centre’ for Uny Group, the dominant retailer in the region. The new distribution centre opened in Komaki in October and is designed to largely replace six other supermarket DCs and a further 26 DCs supplying convenience stores – making it responsible for supplying some 6,500 stores in total. This kind of giant, consolidated distribution facility remains rare in food supply due to the restrictive geography and difficulty of navigating Japan’s crowded roads, but it will help reduce costs, increasing profitability. Other wholesalers are reported to be working on similar projects for other major retail clients.

For wholesalers the issue of profitability and dealing with retailer pricing demands is critical. Even Mitsubishi Shokuhin, the sector’s largest player, had an operating profit margin of just 0.74% last year. Given the 3% jump in consumption tax, absorbing some of the price increase could easily wipe out its profits entirely.

Although few are willing to talk openly, retailers are of course keen to have suppliers take on some of the tax-induced price increase. Retailer power is increasing everywhere – last summer Aeon accepted supply of beer at below cost price from a leading wholesaler. Similarly, a leading drugstore chain commented last month that the easiest way for most retailers to cut costs was to reduce reliance on multiple suppliers – given the large number of wholesalers in Japan, retailers have long split supply right down to a category-by-category basis. Until now only the largest firms have really consolidated their order books – or forced suppliers to work together in order to get product onto their shelves.

All of which presages a further wave of consolidation in food and FMCG wholesaling. Recof, an M&A consultant, recently published data showing that M&A activity within food and FMCG related wholesalers increased markedly when the consumption tax was first introduced and later when it was increased (see Chart). With 43 mergers up to October, it expects the total for 2013 to have broken 50 for the second year running and thinks that 2014 could even set a new record, exceeding the 57 M&As in the sector in 2005.