Fleming Takes Hefty Deductions
From Grocery Suppliers' Bills

Early this year, Oil-Dri Corp. of America drew the line with its longtime grocery distributor : It refused to ship any more cat litter.

Oil-Dri complained that when the distributor, Fleming Cos., paid its bills, it arbitrarily deducted large sums for things such as product placement or early bill payment, even if it was actually paying late. "There are hundreds of thousands of dollars of erroneous deductions that need to be cleared off our account," the company wrote to Fleming.

Deducting a little bit from a bill, usually for reasons such as incomplete or damaged orders, is a time-honored practice of wholesalers and retailers. Suppliers usually accept this annoyance as a cost of keeping the customer. But dozens of suppliers and ex-employees of Fleming say the company -- the country's largest grocery distributor and one with considerable power over customers -- has pushed the practice to extremes.

Some suppliers temporarily stopped shipping to the distributor this year until a deduction dispute was resolved. In other cases, when they complained, Fleming threatened to halt or reduce its purchases from them. Fleming's "relationship with vendors is ugly," says Richard Kochersperger, a food-industry consultant who has worked for Fleming and for a competitor. "They deduct and deduct until a vendor cuts them off, then they pay. Then they start deducting again."

Relations with some retailers are tense, too. Fleming's ties with Kmart Corp., its largest customer, are strained because of service and billing issues. Fleming's stock also has been falling -- plummeting 14% Wednesday -- though not clearly in response to any issue with suppliers.

Fleming denies it has ratcheted up its deductions or takes more of them than competitors. It says its deductions may simply appear to have grown lately because it has been putting them all on one bill. "The fees look different because they're all aggregated," says Fleming's chief executive, Mark Hansen.

The dispute spotlights the fierce tug-of-war that goes on in the low-margin businesses of manufacturing, distributing and selling grocery products to independent supermarkets. This is a largely invisible struggle, hidden in the murky workings of an industry with arcane conventions, such as suppliers' practice of funneling promotional money to retailers by giving discounts to the middleman.

For thousands of food-product suppliers and independent supermarket chains, the issue of Fleming's deductions is crucial. Suppliers can gain access to these independent and smaller grocers only through their distributor. And the grocers rely on their distributor for most of their merchandise, unlike giant chains such as Safeway Inc. and Wal-Mart Stores Inc. that buy direct. The situation puts Fleming in a powerful gatekeeper position, with the clout to unilaterally lower what it pays suppliers for their products.

Yet Fleming, too, is under marketplace pressure. Its big customer Kmart has been closing stores since filing for bankruptcy protection this year. More broadly, the independent grocers Fleming serves are dwindling in a world of retail behemoths with great purchasing power.

At the same time, Fleming has been promising investors it would turn its slow-growth, low-margin business into a faster-growing and more profitable one. Fleming, with about a 10% share of its market, managed last year to record its first net profit in five years, partly by reversing writedowns taken earlier.

The company carries a large debt load, and its cash flow from operations deteriorated in the quarter ended in mid-July to negative $82 million. Wednesday's big stock tumble, to $8, came amid rumors of a possible debt downgrade. Moody's Investors Service and Standard & Poor's said they had no current plan for such a move. Fleming said it will hold a conference call this morning to "correct misconceptions."

As for deductions, Fleming notes that they have long been a common practice in its industry. But as suppliers give a direct-buying giant such as Wal-Mart deals unavailable to independent grocers, Fleming says, deductions become important as a way for distributors that serve the independents to fight back. "We are still 'David' battling 'Goliath,' " says Mr. Hansen. Fleming, which is based in Lewisville, Texas, maintains that its annual deductions are in line with industry averages of about 5% of purchases.

Reports to the contrary come in part from former Fleming employees. One former senior-level Fleming executive says he started hearing complaints from suppliers about nuisance deductions 2½ years ago. He says he shrugged them off until the complaints grew more vociferous and began involving large sums from prominent companies.

The executive says he had his staff do an informal tally. It found that at that time, about 15 months ago, suppliers were disputing $100 million of deductions Fleming had taken from their bills. The executive says he resigned after disagreeing with Fleming about its practices.

Fleming says it believes that deductions currently in dispute total well below $100 million, although it has never tried to keep track. It takes about $800 million of deductions in all each year, the company says.

'Shared Savings'

The executive's tally came before Fleming imposed a novel deduction called "Shared Savings." The distributor invited food suppliers to become "Preferred Vendors," promising that it would then "eliminate nonproductive activities such as deductions" and provide quick resolution "on any deduction, invoice and or administrative errors." Fleming asked suppliers to pay a $75,000 fee for this status, a fee it said it deserved because it was saving suppliers money through a new central procurement system.

When most suppliers balked, Fleming told them in August 2001 it was taking automatic 3% deductions from what it owed them. The idea was that the suppliers saved money by using this new procurement system, and the deduction let them "share" their savings with Fleming. "Congratulations ... !" you are "leveraging the many benefits of Fleming's industry-leading Central Procurement efforts," Fleming began its letter informing these suppliers of the 3% deductions.

The new deduction, retroactive for 12 weeks, surprised and irritated some suppliers. Agrilink Foods Inc., maker of Bird's Eye frozen vegetables, faced $278,000 in deductions it didn't consider justified. An Agrilink official told Fleming he wasn't seeing any "shared savings" at all. "Frankly, the cost of doing business with Fleming has gone up as our representatives seem to need to spend more time chasing unauthorized deductions than building our mutual business," said a letter from Ben Frega, executive vice president of the Green Bay, Wis.-based supplier. Fleming says the dispute has been resolved.

Mr. Hansen says Fleming has stopped taking Shared Savings deductions. "When you institute new programs, there are always some successes and some learnings, and you move on," he says. Fleming says it has resolved all disputes over these deductions, in some cases by canceling them.

But there are other deductions, some of them associated with Fleming's big March 2001 contract to supply Kmart stores that sell groceries. Unilever PLC, the supplier of Dove soap, Lipton tea and many other consumer products, got a $6.8 million bill in May 2001 for what Fleming called Kmart "transition and introduction" costs. Fleming expected suppliers to help it defray costs it incurred in taking on the Kmart business, such as two new warehouses, because the contract meant extra business for suppliers.

Unilever rejected the demand. A Unilever executive says the matter remains unresolved. Fleming contends the issue is between Unilever and Kmart, which isn't how Unilever sees it. Kmart declined to comment.

Former Fleming executives say smaller suppliers with less clout paid these Kmart-related deductions for fear of losing business. Most supermarkets use only one distributor, so a supplier is excluded from them if it can't get along with the distributor.

The Kmart contract prompted another new category of deductions as well. These were deductions for making goods that had been slated for Kmart available to other retailers.

Some suppliers told Fleming they didn't want these products made available to other retailers. Fleming took the deductions anyway, according to correspondence between Fleming and several suppliers. Fleming managers sometimes said they were taking the deductions at the direction of upper management, according to a supplier and to an employee who recently left Fleming.

Suppliers say an administrative deduction of a few hundred dollars per product line might be reasonable to cover the computer changes to make Kmart items available for new customers. But Fleming was charging up to several thousand dollars, invoices show. For instance, for the maker of Swanson frozen foods, Pennexx Foods Inc. in Philadelphia, such fees came to more than $50,000.

Several former Fleming employees say Fleming has also played games with "slotting allowances." These are deductions taken for the trouble of adding new products to inventory. Two former high Fleming executives claim the distributor sometimes charged slotting fees for items it never actually put into distribution.

Oil-Dri, the cat-litter maker, says that too. The Chicago company objected to $55,000 in slotting deductions Fleming took for products that Oil-Dri said were never "slotted," either in Flemings' warehouse or on Kmart shelves. These were part of several hundred thousand dollars in various charges that Oil-Dri disputed in a breach-of-contract lawsuit against Fleming. The suit, in federal court in the Northern District of Illinois in February, was settled two months later on undisclosed terms.

Solo Cup Co. says Fleming took a slotting deduction on paper products that Kmart ordered but canceled before Solo ever shipped them. Solo, of Highland Park, Ill., denied credit to Fleming off and on last year, complaining to Fleming that it had failed to pay bills and taken unjustified deductions. Fleming, in turn, stopped buying private-label products through Solo, cutting in half its Solo business.

Fleming says it is "not aware of any items where we charged slotting and did not make the item available to our customers." It notes that the Oil-Dri case has been settled and says Solo's complaint is a matter between that supplier and Kmart. Solo disagrees. Kmart wouldn't comment.

New Deductions

In the weeks before the April 20 close of Fleming's fiscal first quarter, Fleming's suppliers received letters informing them of a slew of new deductions. Kellogg Co. found that the total amount it considered unjustified had jumped to more than $500,000, even though Kellogg had paid to become a "preferred vendor." The main reason for the jump: a new Fleming concept called an "off-shore funding equalization" deduction.

It was related to the sales-promotion discounts that suppliers often provide to food retailers, which use them to mark down prices during sales. In a peculiarity of the business, the promotional discounts frequently pass to retailers by way of the distributor. Suppliers give the distributor a discount, and the distributor is supposed to pass it on to the retailer.

In explaining its new off-shore funding equalization deduction, Fleming informed suppliers that they weren't providing the same level of promotional discounts for food retailers in Hawaii and the Caribbean as for retailers on the U.S. mainland. So in order to provide more promotional discounts to those offshore retailers, Fleming said it was deducting some money from what it owed suppliers.

A Kellogg executive, Kristin Schweitzer, wrote to Fleming that this was unjustified and violated the preferred-vendor agreement. Kellogg and some others hit with the new deduction contended that promotional discounts were already available to Hawaiian and Caribbean retailers on the same basis as for everybody else.

Fleming says it took the deductions because suppliers were charging lower prices to competitors that serve solely the offshore market. Suppliers were giving them larger promotional discounts, resulting in lower net prices for these competitors, the company contends.

Fleming says its offshore funding equalization letter "had a single purpose: to cause vendors to focus on offshore trade practices that were unfair to us and noncompetitive for our offshore customers." It adds the lower prices resulting from its deductions "can be passed on to [retailers], making them more competitive and, ultimately, allowing them to sell more of the vendors' product."

As for Kellogg, its status as a preferred vendor didn't exempt it from this issue, Fleming says. Kellogg says the matter "was recently resolved to our satisfaction and Fleming continues to be a valued customer."

Fleming's deductions can ripple through the supply chain to supermarkets. Jim McCaffrey, who owns four supermarkets in the Northeast, felt his stores weren't receiving their full allotment of promotional discounts. He says suppliers told him that in some instances they had withheld marketing discounts from Fleming because Fleming owed them money, while in other cases, they had made the discounts available but it appeared Fleming hadn't fully passed them on.

Mr. McCaffrey switched last year from Fleming to a rival distributor, Minneapolis-based Supervalu Inc., and says that since then, his stores have seen $700,000 more in marketing discounts than the year before.

Fleming says Mr. McCaffrey's contract didn't call for marketing dollars to be passed through on an item-by-item basis. It denies ever failing to pass on promotional discounts provided by the supplier. If suppliers are providing local retailers with less in the way of sales-promotion discounts, Fleming says, it must be because the suppliers are shifting their marketing focus to nationwide programs.

Write to Ann Zimmerman at ann.zimmerman@wsj.com

Updated September 5, 2002