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Food For Thought: Are Megastores And Wholesale Clubs Permanently Changing The Way Food Is Bought And Sold In Puerto Rico?

Will supermarkets and local distributors survive? Globalization, technology, and megastores are revolutionizing Puerto Rico’s food industry

By Lucienne Gigante

August 23, 2001
Copyright © 2001 CARIBBEAN BUSINESS. All Rights Reserved.

Where do you buy your groceries? Chances are good that it is not at a corner store. For years we have been stocking up at bright new supermarkets, but even they are beginning to fade.

Local supermarket chains such as Grande, Amigo, Pueblo, and Pitusa, and independents such as Ponce Cash & Carry now compete with stateside giants such as Sam’s Club and Wal-Mart super centers. Coming soon are Costco and expanded Kmart stores with full-line food departments.

As megastores enter the island market and local supermarket chains expand, many traditional <I>colmados<I> (mom & pop grocery stores) are going out of business. Even though total bankruptcy cases in Puerto Rico decreased from 1999 to 2000, bankruptcies of <I>colmados<I> increased 58% during the same period. Many, including the United Retailers Association, blame the multinationals or the so-called megastores for local food retail hardships.

But the challenge faced by <I>colmados<I> and even regular supermarkets are not due to any one thing in particular. Changing market forces are much more complex. They include everything from globalization to consolidation of wholesale distributors, from technological innovation to changing consumer behavior, all of which have transformed the way the food wholesale and retail business is conducted.

As a result, experts predict dramatic consolidations in all market segments will occur in Puerto Rico over the next two to five years.

The trend has already begun.

The local big fish are beginning to swallow some of the smaller fish in the local food distribution pond. In February, distributor B. Fernandez acquired some of Freiria & Co.’s major food brands including McCormick Spices and Libby salmon. In May, V. Suarez purchased Cadierno Corp., acquiring the distribution of major local brands including Casera and Carmela along with one of the island’s largest wine portfolios. V.Suarez now handles 35% of the imported wine market.

In May, Grande supermarket President Atilano Cordero Badillo confirmed that the company is in negotiations with the New Jersey-based, full-line food distribution giant, White Rose, who has been supplying products to Grande for several years. The stateside distributor is conducting negotiations to acquire a major stake of the local 32-store Grande chain.

Fifteen years ago there were more than a dozen large food distributors in Puerto Rico. Today only a few large ones remain, including V.Suarez & Co., B.Fernandez & Hnos., Mendez & Co., Plaza Provision Co., and Ballester Hnos.

"I think there should be additional consolidations among smaller distributors," said V.Suarez CEO Diego Suarez Jr. "Though with the larger distributors, it will be more difficult, but not impossible."

Another link in the food industry supply chain that has almost disappeared in the last 10 years are the wholesalers and cash & carry stores, which have traditionally supplied merchandise to <I>colmados<I> and other smaller businesses. "From the hundreds of wholesalers years ago, there aren’t many left," said Rafi Ortiz, operations manager at Oscar Cash & Carry in Caguas.

"Sam’s Club has replaced the traditional wholesaler and become the No.1 or No. 2 beverage wholesaler in Puerto Rico," said Jose Angel Mendez, president and CEO of B. Fernandez & Hnos. In the hardware industry, Home Depot has taken a similar role and become a supplier for small and medium-sized hardware stores.

"The Home Depot sells merchandise cheaper than what our local suppliers charge us," said a hardware store owner who did not want to be identified.

The megastores can afford to--and make it a practice of–selling certain items at prices below their cost from time to time, just to attract customers to the store and build market share.

The market’s competitiveness apparently moved the Food Marketing Industry Distribution Association (MIDA by its Spanish acronym) to adopt a resolution recently which has been seen by some as anti-business. The resolution calls on the government to immediately adopt a two-year moratorium on the approval, amendment, or renewal of any permit or endorsement for the construction or expansion of any shopping center that would exceed 85,000 square feet.

"The fact that a trade organization intends to place restrictive measures and interfere with a company’s growth sends a very dangerous message to companies interested in investing in Puerto Rico," said Wal-Mart’s spokesperson Federico Gonzalez Denton. "Puerto Rico, especially in these times, should maintain an attractive environment to encourage companies to invest. Besides, the resolution goes against the long-time MIDA-espoused principles of free competition and less government intervention."

Meanwhile, a well-publicized lawsuit between local distributor Mendez & Co. and Grande Supermarkets and U.S.-based wholesaler DiGiorgio Corp. emerged in 1997 to challenge Law 75, which protects local distributors in their relationship with the manufacturers of the products they represent. In a nutshell, Grande began purchasing national name-brand products from a U.S.-based wholesaler, but the same products were exclusively represented locally by Mendez & Co. and other local suppliers. Grande’s orders with local distributors dropped dramatically.

"Local retailers need to compete with megastores, which are buying directly from manufacturers in economies of scale through the huge purchasing power of parent companies so they can offer products at rock-bottom prices," Cordero Badillo said. "We are supposed to have to buy from local distributors who, in many cases, are buying from stateside distributors. We need to access other markets to get better prices."

Mendez & Co. Vice President Jose Arturo Alvarez declined the opportunity to comment to CARIBBEAN BUSINESS due to the ongoing lawsuit. During a 1997 interview (CB Sept. 4, 1997) he said, "I couldn’t sit with my hands crossed and watch my own funeral as a distributor. If other distributors prefer to do so, that’s their prerogative…I realize I’m taking matters to the extreme and am fully aware of the possible consequences if the case is not resolved in favor of my business."

Distributor Plaza Provisions has a protracted lawsuit with Unilever, which came to Puerto Rico to open its own distribution offices after Plaza Provisions successfully marketed the brand.

Although industry sources, including other distributors, say the outcome of the Mendez & Co. case is uncertain, it could lead to possible amendments to, or even the potential elimination of Law 75, which would have a major affect on the food industry in Puerto Rico along with several other industries protected under the law.

Transformation of the markets

In the Puerto Rico food industry of years past, business was simple. The players were mom & pop stores, some supermarket chains, and no megastores.

Local retailers purchased merchandise from local distributors, which had exclusive contracts with manufacturers or distributors abroad. Consumer options for grocery shopping included markets, colmados, Plazas del Mercado (farmers’ markets in downtown areas) and some supermarket chains.

"The way distributors conducted business changed in the 1960s when supermarket chains started to proliferate on the island," said B. Fernandez’ Mendez. "Supermarket chains had the purchasing power to buy merchandise at the same price or a lower price in the States. That was the first challenge for local distributors."

To survive that first wave of chains purchasing stateside through economies of scale, local distributors were forced to change their modus operandi. They began buying in vanloads for a better price scale. A vanload is a 40-foot trailer, loaded, depending on the product, with anywhere from 500 cases of paper towel to 1,000 cases of cereal.

The distributors began to order trailer units of a certain product and notify their customers that X product would be available on X date at X price. The buyer picked up the merchandise at the dock and the distributor earned a commission for the transaction. The price per vanload competes with the price that a retailer can buy from another distributor in the U.S.

"Our change in purchasing structure helped maintain the Pueblos, Grandes, and Amigos of Puerto Rico so that they could continue to purchase from the local distributors," Mendez continued.

Industry sources say that Pueblo supermarkets, because of its purchasing power, was the first to seek better prices and buy product from U.S.-based full-line wholesalers. The company still has a division, Pueblo Wholesale, that sells product to small business mainly in the Caribbean.

As supermarkets grew bigger and their purchasing power increased, others joined the move to purchase abroad. Supermarkets do not buy merchandise directly from manufacturers but from giant food wholesalers such as White Rose, Fleming, and Associated Grocers. Last year, Fleming signed a contract with Kmart Corp. to become its exclusive food distributor.

In the early 1990s, Wal-Mart Corp. continued its global expansion and introduced its discount store concepts, Wal-Mart and mega store food warehouse Sam’s Club, to Puerto Rico. Wal-Mart holdings in Puerto Rico now include seven Sam’s Clubs, nine Wal-Mart stores, and one Wal-Mart supercenter, which consists of a discount store and a supermarket.

"It costs millions a year to compete with these megastores," said a retailer who did not want to be identified. "If a I find a product at a price 30% less than the price the local distributor is charging me and the distributor can’t match the price, I will buy it in the states. Why shouldn’t I, especially if my competition is buying directly from the manufacturer? The manufacturer is the one that should protect its local distributors," he said. "Don’t expect the retailer to do it. We have to get the best price possible to be able to compete."

"Up until now, the behavior of the megastores has been almost the same as supermarket chains. When prices are equivalent, they buy from us," local distributor Mendez said. "However, the clubs asked for larger packages than local supermarket chains usually carry. We had to look for the packaging facilities to accommodate them. So far, if we offer what they can find in the States in terms of price, they purchase from us because of the service we give."

"We buy 50% of our merchandise locally," said Wal-Mart’s Gonzalez Denton. He confirmed the company purchases the other 50% of its merchandise from its central distribution center at the company’s stateside headquarters in addition to other suppliers off the island. Wal-Mart Corp. in the states purchases directly from the manufacturer and sends the merchandise to its stores worldwide, including Puerto Rico, similar to other retailers in the U.S.

Industry sources say these wholesale clubs commonly enter a market and start out buying locally to generate good local public relations. They eventually end up purchasing more products through their stateside headquarters. In Puerto Rico, only time will tell.

Newcomer, wholesale club Costco--which will open its first two stores in Puerto Rico in November--plans to buy more than 50% of its food items locally. "We expect to buy 70% of the food and sundry items in Puerto Rico," said Roger Campbell, Costco’s senior vice president of the southeastern region. When asked if it is cheaper to bring the merchandise from its central distribution center in the states, Doris Harley, vice president of food & sundries said, "Not necessarily."

With more than 400 warehouse clubs in the U.S. and internationally, Campbell expects Costco to have $35 billion in sales this year. The company’s first two stores will be located in Bayamon and Caguas and will employ about 250 people each, more than 50% of those will be full-time positions, noted Campbell, in contrast to its competitors that offer more part time jobs.

Following an aggressive expansion in the U.S. that calls for the opening of 30 to 40 per year for the next five years, Campbell’s strategy for Puerto Rico is to open five or six stores within the next four to five years.

Costco’s entrance to the market is good news for consumers because it will bring tough competition to Sam’s Club, which according to sources, has been increasing prices in recent months.

Distributors support the brands

Distributors say they are essential in the food industry business in Puerto Rico.

"I think that the distributor’s job is extremely important. We create and develop brands in the local market, which include functions such as delivery, pick-up, advertising & marketing, warehousing, as well as job creation," said Diego Suarez Jr. of V.Suarez. "The fact that one imports a brand doesn’t mean it will sell in Puerto Rico," he said. "As a client, someone has to do the job to develop a need in the consumer to acquire a product."

"We are an essential part of the market and Law 75 protects us from the supplier who might wish to take the brand back or give it to another distributor after we invest the money, infrastructure, time, and resources to develop the brand. That’s it," he continued.

"There are many products that now sell in large quantities in Puerto Rico that began with minimal sales through a local distributor," said Mendez. "For instance, we started selling Kellogg’s cereals in 1923 and I assure you we didn’t buy it in vanloads. All the monster products now consumed in Puerto Rico were developed as a brand by a local distributor into a mass market product," he said.

"The focus must be on broader lines [offerings] and branding," said Matteus Reingel, vice president of operations for Hill Brothers. Hill Brothers has undergone its own metamorphosis from a relatively small distributor of produce to <I>colmados<I> and Grande supermarkets to a technology oriented, merchandise based, sophisticated local distributor.

"Our operations have grown by about 30%," Reingel said. No small part of that growth is Hill’s contract to supply Sam’s Club stores with produce. The local distributor met the needs of the wholesale giant with bulk packaging of produce, a first for them.

"Produce is the only non-branded food category in Puerto Rico," he added, "but it [branding of produce] has got to happen."

Developing brands in the local market is an art form among local distributors. B. Fernandez made Clorox a household word in Puerto Rico. But that success brought the Clorox company to its own manufacturing and distribution on the island in 1995.

Enter technology

Some retailers say that technology has changed the business. "Distributors eventually will be obsolete and they will become brand representatives," said an industry source.

Bar codes and scanners have eased the tedious process of inventory control. "I place orders electronically, per store and if I want, per shelf. There is no need for distribution warehouses in Puerto Rico," said Cordero Badillo. "It’s not about keeping inventory, but about rotating inventory." It’s also about service. "I place an order with White Rose and place an order with a local distributor and I receive the White Rose order first," added Cordero Badillo.

Distributors say they assure merchandise is available for small retailers, which do not have the purchasing power to buy in large quantities in the States. Also, local distributors are equipped to react to local natural disasters because they have the food provisions available in local warehouses. When Hurricane Georges wiped out most of the shipping dock cranes in the Port of San Juan, local warehouses provided provisions to the island populace until the unloading cranes could be repaired.

For distributors to be able to offer a competitive price, they need to have relationships with the manufacturers. "The most important element is the distributor’s relationship with its manufacturers," Mendez said. "We have to work with our manufacturers to assure we offer the most competitive prices so as not to give the retailer [motive or] opportunity to go look for the product in the states," he said.

Distributors also offer cost efficiencies. "Because of the large product variety each distributor represents in Puerto Rico, distribution costs are lower than if the manufacturer were to establish an office here," said Mendez. "Except for Procter & Gamble and Clorox because they have a critical mass."

"I think that the key for the survival of food distributors is to maintain a critical mass in order to obtain efficiencies in the operation," he continued. "Mass distribution works for the beverage distributors because volume sales in beverages are much higher."

"If the manufacturer of a certain brand knows that a third party–a full-line wholesaler–is bringing a product to Puerto Rico and the manufacturer does nothing to protect the local distributor’s exclusive contract, [it speaks to the relationship between distributor and manufacturer]," said Mendez. "The solution is to work with the manufacturer to prevent these things from happening. The relationships need to be established so that the manufacturer is awarding the best possible price for Puerto Rico."

In terms of future consolidations, Suarez said, "Everything gets to an end, including the process of consolidation. How many whiskeys, champagnes, and vodkas can I carry as a distributor? As process of consolidation continues, conflicts among brands emerge."

And branding remains the name of the game. Now, even Madison Avenue advertising agencies spend big bucks on traditional brand-building techniques. And while mass media such as cable TV brings those brands into local homes, the example of Coors Light beer’s success (the No. 1 selling beer) in the Puerto Rico market is indicative of the importance of local branding efforts.

This Caribbean Business article appears courtesy of Casiano Communications.
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