Cross-regional Climate Change Impacts and Adaptations – Business Supermarket Sector Case Study – Fresh Produce Supply

1 Executive Summary

For this case study we have focused on fresh produce supply and retail. Limiting the study boundary to fresh produce helps define the market quite narrowly, making it more manageable by excluding the provision of other products and services within the supply chain. This case study was carried out between December 2004 and August 2005. While we believe that the organisations’ policies and practices as reported here were correct at that time they may have changed since. Climate change adaptation is not currently on board agendas and this is probably because it is not a risk that is going to affect supermarket survival within their generally short planning horizons. The board will be aware of climate change, due to legislation, energy and transport issues etc, but this is more likely to relate to mitigation than adaptation. However, the sector has well established mechanisms to monitor, plan for and respond to threats and opportunities in the short to medium-term and a proven track record of adapting to external change in the market place in the longer term. Farmers in the UK have been changing what they do for some years now in response to difficult market conditions and EU legislative changes. The capability to adapt to external challenges therefore exists within the sector, provided the signals for change are recognised and correctly interpreted. Weather influences both consumer demand for fresh produce (products, volumes, ability to purchase, etc) and retailers’ ability to supply (range, volumes, quality, price, etc). Supermarkets have developed a good understanding of the former. On the supply side risk control strategies include sourcing products from a range of growers and locations, spot buying on the world market and to some extent identifying and helping build capacity in new locations. Increasingly supermarkets are beginning to rely on a limited number of ‘first tier’ suppliers to monitor and manage the supply side risks arguing that it is the suppliers and growers who are in the best position to understand these risks and identify and implement effective management strategies. Dedicated supply chains allow traceability to ensure safety, quality, brand differentiation, risk management, and demonstration of ‘due diligence’. The retailers in turn are best placed to understand the demand side risks. Although this trend is driven by other more immediate drivers, it is building a more adaptable and responsive supply chain and therefore should have a positive impact on the sector’s ability to respond to climate change. Factors such as immediate history of grower reliability (including weather related problems), ability to meet quality and ethical standards, the political situation in supplier countries, cost of transport and short term consumer trends will have a greater influence

Risk Solutions Page 1 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B on sourcing strategies than longer term climate trends. Current strategies are, however, proving effective in responding to supply and demand challenges in the short term and there is no immediate reason to believe that these will not continue to be effective in the medium or longer term. This is not to say that climate change poses no risks (up or downside) and that there is not an opportunity to improve resilience. The main risk we see is that sub-optimal sourcing decisions will cause a creeping increase in costs of supply and increasing reliability problems ultimately affecting competitiveness and undermining the basic business model. By considering longer term trends in the weather, and their impact on growers and product supply, sourcing decisions can be made more robust to future change. Climate change considerations should be embedded in routine risk management and decision-making processes to ensure, among other things, that opportunties to build resilience at marginal cost (win wins) are identified. The challenges to making this a reality are: • ‘Selling’ the longer term benefit to decision-makers in supermarkets and, through them and directly, to key ‘first tier’ suppliers • Providing the basic climate change information required to support decisions in a straightforward to interpret and use format.

Much of the supermarkets vulnerability to climate change arises from a need to maintain complex, global supply chains to meet consumer expectations. While we expect to see fresh produce on the supermarket shelves all year round, supermarkets will have to supply them at competitive prices to retain market share. Before solutions are adopted that require customers to accept limited supplies of seasonal product out of season, a concerted campaign of consumer education and awareness raising would be needed about the need for more sustainable sourcing strategies.

2 Introduction

This case study report is structured as follows: • Description of the supermarket sector and the case study organisations − What characterises the sector; the market forces and supply networks etc, − Individual company strategies and the transferable lessons from these − What are the Key Success Factors (KSFs) for this sectors • How might climate change impact on the sector, • What decisions structures are adopted by the sector, how do these impact their ability to adapt to climate change impacts, and • How can the sector improve and build capacity for adaptation; what do others need to do to support this.

Risk Solutions Page 2 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B 3 Approach

The project has used proven risk and business analysis techniques to build up a rich picture of the impacts of climate change, possible adaptations, willingness and ability to adapt, and barriers and incentives to adaptation in two case study business sectors: transport and major food retailing and their supply networks. Information has been gathered through interview and literature review, and a supermarket sector case study workshop on 1 June 2005. In the workshop we explored how the sector, with the support of policy makers can address the risks from climate change and build on its current strengths to improve its adaptive capacity. For the purposes of the case study we have focused on fresh produce supply and retail. Limiting the study boundary to fresh produce helps define the market quite narrowly, making it more manageable by excluding the provision of other products and services within the supply chain. The study examines how fresh produce retailers, suppliers and growers could build capacity in the broadest sense and not at solutions to specific technical issues. We have also concentrated on issues that supermarkets can tackle directly with their suppliers not externalities such as the loss of the national grid due to extreme weather over which they exert little control and that would impact every business in the UK. Managers, however, need to be aware of these risks and have responses in place to mitigate them as appropriate.

3.1 Selection of Case Studie Organisations

Supermarkets are successful local and global businesses, at the forefront of developments in areas such as inventory management, logistics, marketing and supplier and customer relationship management. The sector comprises firms that are large and small, private and public, with UK and international ownership structures. They operate stores of a variety of different sizes and formats, serving a general or a niche customer base and selling a mixture of food and no-food products. An emphasis on shareholder value, innovation and fierce competition has resulted in a blurring of business boundaries, in short planning horizons and a strong focus on reducing cost and increasing market share. Supermarkets are highly adaptive and customer responsive with significant ability to influence their customers and supply chains. It is also a very diverse sector. In particular, the supermarket sector was selected because: • It has a big influence on the UK economy and patterns of societal interaction • Its policies will influence the entire supply chain from packaging to the reduction in the use of chemicals and fertilisers etc. • Its reaction to social amplification issues influences the response of NGOs, the media and consumers alike • It is highly influenced by the weather • It has not been addressed in previous work, and

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• It represents quite distinct business models (e.g. the Asda and the Co-op case studies) but at the same time there are many transferable lessons that apply to other types of FMCG1 supply chains that are faced with similar risks (e.g. those from changing global markets, just-in-time and logistics).

4 The Sector

4.1 Key Features

It is predicted that there will be only 10 major global food retailers by 2010. A similar trend of concentration is taking place in food processing and distribution, matching the scale of downstream players in order to counteract the power of the supermarkets and prevent their profits slipping down the food chain. The UK grocery market was worth £115bn in 2003, with groceries accounting for 13.4% of all household spending2. This makes it the third largest area of household expenditure, behind housing and transport. Whilst non-food sales are becoming increasingly important for the major retailers, food and grocery expenditure accounts for 49p in every £1 of retail spending3. The UK grocery market is dominated by the ‘supermarkets and superstores’4, which are valued at £84.3bn spread across 6,507 units. In contrast, the ‘convenience’5 market is valued at only £23bn spread across a much greater 53,653 units. Supermarket formats generally consist of the following types:

Supermarket Superstores Compact stores – Town centre Convenience Format smaller stores designed to stores, possibly supermarkets serve specific local with extended needs opening hours

Examples The big four: Tesco, Co-op, Tesco Metros, Co-op, Iceland, Co-op, corner shops, Asda, Sainsbury’s, Sainsbury’s Local, Waitrose, M&S, shops adjacent to

petrol forecourts, and Morrison’s Fresh & Wild, Spar, Somerfield, Tesco Metros, small Planet Organic Lidl, Neto and Aldi local chains, Sainsbury’s Local, M&S Simply Food

1 Fast Moving Consumer Goods 2 Market value for 2004 is estimated at £118.1bn and it is predicted to be £133.5bn by the end of 2009. However, much of this growth will be attributable to inflation. [Source: IGD] 3 www.igd.com 4 E.g. 30p in every £1 is spent in the ‘top eight’ - Asda, Iceland, M&S, Morrisons/Safeway, Sainsbury’s, Somerfield, Tesco and Waitrose. 5 The Institute of Grocery Distribution have defined a convenience store as being under 3,000 sq ft, open for long hours every day of the week, retail food and drink for consumption off the premises, and offer a group of 15 core products.

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In the UK grocery market there have been a number of long term trends over recent decades, including: • Increasing commoditisation of products, thus raising the influence of price • Increasing consumer demand for convenience foods • Increasing consumer demand for a wider range of foods • Increasing consumer awareness of food-related safety, ethical and social issues6. At the same time the UK grocery retailers have undergone a number of major changes, such as: • Focusing on efficiency gains along the entire food chain • Increasing the geographical spread of suppliers to seek new/less costly products • Increasing consolidation along the supply chain, with the increasing importance of both purchasing power and a UK-wide store presence. The increased consolidation has resulted in four key effects: 1. Barriers to entry have increased. Any new entrant to the supermarket sector will generally have to achieve the economies of scale required to both deliver products at a competitive price and have sufficient geographical coverage. The sector is now dominated by a very few key companies. 2. There has been a compression of the supply chains to ensure availability and certainty. This has inevitably led to the emergence of a few key players with major market share, and thus economies of scale, is reducing margins across the sector. This is particularly damaging for smaller food retailers, who can not compete on price. 3. The reduced margins in food retail are forcing food retailers to seek alternative (non-food) products and services to protect their profitability. 4. It has driven acquisition costs disproportionately high, making exit from food retail more attractive and easier than entry to the market, especially in an environment of decreasing profit margins. These structure, drivers and key success factors for the sector are discussed in more detail in the following sections.

6 Society is becoming increasingly affluent and customers are becoming increasingly aware of, and concerned with, wider social issues. These can vary from environmental through to ethical topics and are often driven by and/or a consequence of media coverage.

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4.2 Industry Structure

4.2.1 General Picture The key elements within supply chains that we have looked at in this case study include: the consumer, supermarkets/retailers, and key suppliers and to a more limited degree distributors, food manufacturers and growers. A simplified picture of the supermarket supply structure (or the value network) is presented in Figure 1. In this picture value is added increasingly as one moves from the agricultural suppliers, the farmers or growers on the left of the picture, who essentially produce commodities, through to the retailers on the right who deal with the consumer directly and have access to the best information on their expectations and preferences.

Food retail supply structure

Strategic suppliers Supermarkets C

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i s, o , ur r s c e e i g o i g ct Wh & P n F m A st i a i t f r g e o k nu Far r L

a Food Suppl M

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Food & labelling stds; own/BRC quality standards; planning, environmental, competition; & employment laws

Figure 1.

4.2.2 Consumers Customers are now much more demanding and surer in asserting their rights. Our case study organisations tell us that customers no longer forgive failure and the level of competition on the high street is such that they can demonstrate their displeasure immediately. Retailer-supplier relationships within the sector have changed to reflect changing consumer expectations regarding product range, availability, local sourcing, quality and price. Over the past ten years, customers’ perceptions of what constitutes the low and the high ends of supermarket retail have changed significantly. Loyalty based on socio-economic status is on the wane and perceived value, convenience and range are now the bigger drivers. The supermarkets have large amounts of data showing how they loose clients continuously to their competitors and back again. Consumers also now also have the

Risk Solutions Page 6 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B affluence needed to be able to make ethical and environmentally conscious choices. They are informed enough not to accept choices being imposed on them.

Ethical, Environmental and Social Dimensions There are many examples of how supermarkets have applied ethical and environmental considerations to their operations; for instance, in driving the use of ‘greener’ farming systems by their producer suppliers. Supermarkets have learned from and incorporated features of ‘alternative’ suppliers and retailers, as demonstrated by the large market shares of organic, fair-trade and regional foods, and there are examples of quite tough competition between supermarkets for the moral high ground; e.g. the Co-Op has sought to convert whole parts of its product range – such as bananas and chocolate – to ethically sourced material. In these terms stereotypes of mainstream supermarkets are somewhat outdated. Also, not all problems of unsustainability in the food system can be attributed to supermarkets- e.g. supermarkets can only go so far in pushing their customers towards healthy or ‘ethical’ foods, and away from unhealthy or ‘unethical’ options. Some remain very critical of the supermarkets response to the challenges of stakeholder accountability and corporate social responsibility (CSR). There is a view that when supermarkets adopt self-regulation approaches, such as codes of conduct on labour standards or environmental issues, the associated costs and risks may be passed down the chain, resulting in a disproportional allocation of costs and benefits between standards ‘makers’ and standards ‘takers’ such as processors and farmers. Example: Consumers and ethical choice In recent years there has been a concerted campaign throughout Europe in support of the import of bananas from the Windward Islands. This move has traditionally been regarded as an ethical stance to help the large numbers of disadvantaged small holdings and exporters in the Islands compete in a global market, albeit at the cost of having to pay slightly more for the produce. Although these generally small, family run farms employ many people, they are quite inefficient operations because of problems with farming methods, packing facilities, poor logistics and the impacts of extreme weather in the Islands. With large scale investment in infrastructure and education, adaptive capacity could probably be built into the Islands’ agricultural sector to make it more competitive and make good quality bananas available reliably over time. There will also be a need to make wholesale changes to the social infrastructure which may not prove very palatable. However, the Islands remain exposed to extreme weather episodes and this could get worse in the future. The supermarkets remain wary about maintaining a long-term commitment to procuring bananas from the Islands because of the risk of rising costs and reputational damage if supply cannot be sustained in the face of extreme weather events or rising sea levels. An alternative to sourcing bananas from the Windward Islands is to import them from the Cameroon - an equally disadvantaged part of the world that employs around the same number of people in its banana agriculture sector but with far fewer numbers of farms and packers. The farming methods employed are more advanced, there has been good investment in better logistics, packing facilities and educating the local workforce. The risks from extreme weather are also less likely to cause massive disruptions to the quality or availability of the bananas. However, should climate change prove to be an important risk to supplies in the future, adaptive capacity could be developed relatively cheaply because of the consolidated nature of the sector. Asda have chosen to put both types of produce on their shelves and to leave the final choice to the consumer. In our discussions with Asada, they said that although there may appear to be complicated and subtle ethical versus commercial decisions to be made, their customers are now so much better informed and affluent that they can make their selection based on informed choice.

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The Co-op said that they find, through extensive consumer research that although a large percentage of customers say that they prefer to buy produce that has a social and environmental protection dimension associated with it in practice they behave quite differently at the point of sale. The Co-op finds that appealing to only one set of social amplification drivers (e.g. sustainable sourcing) is not enough – the product has to ‘pluck’ at two or more social drivers (e.g. sourced from sustainable sources’, ‘organic production’ or ‘fair treatment of the farmers/suppliers’ and be sensitively priced in comparison with alternatively sourced produce). The Co-op is monitoring the sale of its Fair Trade bananas and will consider replacing their entire line with these if it is proved that sales would not be affected as a result of this replacement

4.2.3 Supermarkets Over the past few years there have been major shifts and structural developments in the grocery retailing sector. In particular: • Tesco’s share of supply of groceries in the UK has increased while that of Sainsbury’s has fallen • Tesco and Asda particularly have broadened their product offer to consumers • Tesco and Sainsbury’s have also been increasing their presence in the convenience store sector • Morrisons has acquired Safeway but the share of the combined operation has fallen to about the level of Safeway’s alone before the acquisition. The supermarket business is characterised by self-service shopping with separate departments for produce, meat, bread and other grocery items under one roof, discount pricing, large-volume procurement and a centralised distribution system. But the sector is heterogeneous. Different supermarket companies in the UK have targeted specific market segments and concentrated on a preferred format, from the convenience and ‘top-up’ segments dominated by small to medium size stores such as Somerfield and the Co-ops, the ‘deep discounters’ such as Lidl and Aldi with a limited range of own-brand produce aimed at consumers in the C2,D,E social classes7, the full range one-stop formats of Sainsbury’s, Asda, Tesco and Morrisons often with large, edge of town stores, and the up- market retailers such as Waitrose. Some of these distinctions are eroding, as companies move towards convenience stores or pull out of saturated or heavily regulated areas. An example of this is Tesco’s 2002 purchase of T&S Stores which allowed it to positions itself in an entirely new part of the market. The dominant players are targeting smaller outlets; capitalising on their existing economies of scale allowing them to offer the same convenience and local presence, but at much lower prices. Some retailers are also broadening their demographic base, such as Tesco’s success in appealing to a broad spectrum of socio-economic groups. The distinctions between grocery, other retailing and food service are getting less marked as the large supermarkets move aggressively into non-food sales such as electronic items and clothing, and into home meal replacements and so-called ‘meals on the go’. These

7 Individuals with the following social ranks: C2-skilled working class; D-working class, and E-those at the lowest levels of subsistence.

Risk Solutions Page 8 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B trends, known as ‘channel blurring’, have mixed implications for access to food, for the survival of independent retailing, and for the structure of the typical high street. Non-food high street retailers are struggling against the rapid move by Tesco and Asda into core areas such as pharmacy, opticians, clothing, and financial services. Ownership is diverse, from publicly traded limited companies (Tesco, Sainsbury’s, Morrisons, Wal-Mart, Somerfield, Marks and Spencer) to private family-owned companies (e.g. Booths), consumer Co-operatives (e.g. Co-operative Group) and employee-owned groups (e.g. John Lewis Partnership, owner of Waitrose). This determines the degree of leverage available to the investment community over retailer strategy, and arguably, the degree of freedom of retailers to promote sustainability even where this acts against short- term financial interests. Geographic concentration is uneven, with Waitrose and Sainsbury’s having a strong presence in the south of England, for example, and Asda and Morrisons (pre-Safeway merger) having strongholds in the north. The existence of national retail chains is a relatively new phenomenon. Tesco is the only real international player, with 20% of its turnover from overseas.

Supermarket Growth Market share is the traditional measure of success for supermarkets. Larger market share allows economies of scale. Savings are sometimes achieved by extracting more favourable terms from suppliers, either through demanding lower merchandise prices, or demanding greater provision of services such as special packaging or third-party food safety certification, or demanding payment of fees. Another measure of success is sales intensity per square metre. Economies of scale and higher sales density deliver lower unit costs and higher net margins potentially leading to a ‘spiral of supermarket growth’ (Figure 2, Race to the Top8, and Burt and Sparks, 2003). Features of this spiral are (a) that absolute costs and barriers to entry for competitors are raised, and (b) growth becomes dominated by a handful of organisations.

8 Stakeholder accountability in the UK supermarket sector. Final report of the ‘Race to the Top’ project. November 2004.

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The supermarket growth model

Lower unit costs, relative to competition Increased sales density, relative to competition Increased sales & relative scale

Increased investment in (1) facilities, (2) price reductions, (3) new products Decreased unit costs Higher net margins

Increased sales density

Increased sales

Figure 2. Savings are achieved through attention to shelf management and evaluation, and to distribution logistics. Moreover, as food retailing has high people costs relative to profits, retailers have paid much attention to managing these, increasing labour productivity and reducing corporate overheads. Supermarkets regard non-food items as an intrinsic component of the business model. In its evidence to the Competition Commission, Sainsbury’s said that ‘they used profits made on non food items to invest in bringing down food prices. This attracted more customers for their food and the greater footfall in turn enabled them to sell more non-food items’.

4.2.4 Key Suppliers Most large UK suppliers are subsidiaries of global or national corporations, whose legal, operational and trading organisational structures vary. The supermarkets’ key supplier lists include may subsidiaries and divisions of subsidiaries. In the UK, the supply chain was essentially limited by what could be grown in the UK and the length of the growing season. The UK grocery supply chain traditionally relied on importers to ensure availability of products, often at an inconsistent quality and/or price. The consequence of this model was that retailers had little visibility, and thus influence, over their supply chain which resulted in both poor efficiency and an inability to consistently meet consumers’ requirements. As a result of consolidation within retailers, and their increased purchasing power, a number of key trends have emerged within the UK-related supply chain: • Competition among UK suppliers has increased as the retailers developed new supply routes; e.g. sourcing directly from farmers and processing under ‘retail own brands’, seeking products from outside the UK, etc.

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• Consolidation among UK suppliers has increased as the retailers’ purchasing power has increased • The UK supply chain has become more susceptible to large scale disruption as products are distributed via retailer national distribution centres, rather than to/from local stores. Closed forms of tightly specified contracts are preferred by supermarkets and their first tier suppliers when sourcing own-label produce. These are now such a large part of the fresh produce industry that it is difficult to identify ‘actual’ market prices. There is a view that the systematic coordination of the supply chain using direct contracting, rather than competitive pricing combined with the use of imports, allows retailers to cap farm-gate prices against gross margin targets. There is a belief that retailers with the largest market share extract much better terms from their main suppliers. A key feature of the modern supermarket model is increased vertical coordination of agrifood chains, with associative rather than arms-length supply relationships. This means that supermarkets have reduced the number of suppliers from whom they source, in part to achieve their quality assurance and traceability objectives but also to build adaptability and responsiveness into the supply chain. This constriction in the supply base is expected to continue. It is obviously a very important structural capability that the supermarkets have for assessing and reporting to their shareholders on whether or not their supply chains are resilient to disruptions from risks such as extreme weather.

Advantages and Disadvantages of Greater Integration along the Supply Chain The advantages of retailers pursuing more associative relationships and greater integration along the supply chain include: • Exposure to fluctuations in quality and/or market prices within an ‘open’ market is reduced • Transaction costs are reduced and responsibility for managing the supply chain can be delegated to the supplier, who is better placed to identify/resolve emerging issues • The long-term supply of strategically important product can be assured due to better visibility of emerging opportunities/threats within the supply chain over the long-term (e.g. the medium to long-term impacts of climate change) • The retailer will be able to exert direct influence on the supply chain leading to a more sustainable structure. • Long-term investment within the supply chain can be supported by the retailer providing expertise, finance and/or less uncertainty regarding future business • The costs of finding/replacing suppliers (standards, new audits, set up costs etc) are reduced. Disadvantages for the retailer include: • Increased exposure to reputation, financial, etc. risk in the supply chain • Incompatible cultures/structures between the retailer and supplier can lead to inconsistent decision-making and conflicting priorities • Diversion of retailer resources and capabilities away from its core consumer-facing activities • Reduced opportunities to fully capitalise on speculative opportunities on the ‘open’ market (e.g. oversupply driving down price)

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• Increased exposure to any weakness in the supplier’s business (e.g. lack of capability, knowledge, etc.) The supplier will benefit from greater certainty and better market information, but the majority of power and leverage will reside at the retail end of supply chains and the larger part of the benefits can be expected to pass to customers and shareholders.

4.2.5 Food Manufacturers Supermarket own-brands return the highest contribution to margin or profit. The market share of own-brand in the UK, at around 40%, is the highest in Europe. Retailers’ brands now compete head on with manufacturers’ brands through shelf placement and packaging. Own label is not only a huge revenue generator, but also key in enhancing corporate image and customer loyalty.

4.2.6 Distributors Distribution is seen as very important in driving costs out, firstly by eliminating the role of the traditional wholesaler through direct supply from primary producers and manufacturers to regional distribution centres, and then to superstores, and latterly taking over parts of the upstream distribution network from suppliers where savings are perceived.

4.2.7 Growers Growers have traditionally considered yield per acre as their most important metric. In the UK supermarket strategies and recent changes to the Common Agricultural Policy (CAP) are changing the nature of the large-scale end of commercial farming, from a group that has supported and benefited from state protection and/or subsidy of agriculture to more free market-oriented agribusinesses with high levels of collaboration with downstream processors and retailers and a keen focus on environmentally sustainable practices. Supermarkets have also been drawing increasingly intense attention and concern from a wide range of interests about their growing dominance of the food system. Friends of the Earth and some farming groups have been particularly critical of supermarkets’ commitment to fair trading and UK produce. Although a subset of farming is profiting from trading preferences within dedicated supermarket supply chains, many farmers – especially mid-sized family farms – feel marginalised by the collapse in the wholesale market9, a lack of alternative markets, the sale of goods below the cost of production, and a perceived disconnection between farm-gate prices and retail prices.

9 The wholesale market now largely represents the price of residual/lower quality production that supermarkets do not use. Farmers who supply wholesale markets, especially in remote or economically marginal areas, are the most endangered sector of UK agriculture.

Risk Solutions Page 12 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B There is a suspicion that supermarkets are earning too much of their money on the buy, not the sell, that is from charging suppliers10 rather than from consumers. This came to a head in the UK in 2001 when a slump in milk prices was not translated into supermarket prices. The cost structures of the supply chains – especially the need for processors to cover their ever increasing fixed costs – have a considerable bearing on farm-retail spread. According to farming groups, supermarkets have also been quick to adapt their business to eliminate technologies that alienate consumers (such as GM foods), but not to practices that alienate suppliers. The supermarkets argue that except for some very short supply chains such as poultry, farmers are often two to four steps away from the supermarket shelves. They also point to high levels of concentration among packer-integrators and processors, and state that retailers have little control over the trading relationship between farmers and the chain intermediaries.

4.2.8 Policy and Regulation Those with responsibility for the relevant areas of government policy have to balance consumer, retailer and supplier interests when creating regulation and policy that affect the supermarkets. It is possible that some of the measures which might be taken to address social, environmental and climate change issues might run counter to short-term consumer interests. Similarly regulating competition and food safety may benefit consumers above those of suppliers. The government departments and agencies that are concerned with the role of supermarkets, the supply of food and the protection of consumer health and interests also have a very important role in terms of communication, awareness raising and education. In the context of climate change adaptation, this is obviously a very important role. UK consumers have been willing players in the relocation of retail from high street specialist shops such as bakers, butchers and greengrocers or doorstep deliveries, to one- stop shopping in supermarkets, especially since the ‘retail revolution’ of the 1980s. Broad public acceptance is part of the explanation why political scrutiny of the sector is relatively light. Another explanation is that supermarkets deliver on the economic ambitions of governments – low inflation and high employment. The one place where government scrutiny has been intense has been in competition policy; for example, the recent buy-out of Safeway prompted a Competition Commission inquiry immediately after another investigation into the sector in 2000. As a result of the Safeway inquiry, Asda was prohibited from bidding for Safeway in order to protect market competitiveness. The process of consolidation in retail is well advanced. The loss of Safeway from the UK retail scenery has increased the 4-firm concentration ratio to around 75%; in other words, three-quarters of the country’s supermarket food shopping is with just four firms – Tesco, Asda, Sainsbury’s and Morrisons. A market is regarded to be dominated by a few buyers when the four firm concentration ratio rises above 50%. Following complaints that profits and food prices were unreasonably high in the UK compared to continental Europe and the US (‘Rip-off Britain’), the Office of Fair Trading

10 Through ‘listing fees’ i.e. charging for shelf space for new products, for ‘supplier rebates’, for ‘over-riders’, or even unilateral deductions from money due or ad hoc demands for cash payments

Risk Solutions Page 13 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B (OFT) referred the issue to the Competition Commission for investigation in 1999. Although, the focus was to be on the consumer, the investigation included the relationship between supermarkets and supplier. This followed initial investigations by the OFT which heard complaints from farmers and growers that they were being threatened by excessive or unreasonable demands of supermarket contracts. The biggest supermarket chains developed their own code of conduct to pre-empt the findings of the Report. The Commission’s report, published in 2000, rejected claims of overcharging customers and making excessive profits, and concluded that the industry is broadly competitive. But as a ‘secondary concern’ the Commission identified ways in which supermarkets are said to have misused market power. This included ‘requests’ for retrospective discounts and promotion expenses, making changes to contractual arrangements without adequate notice, and unreasonably transferring risks to the supplier. They also stated that ‘In a competitive environment, we would expect most or all of the impact of various shocks to the farming industry to fall mainly on farmers rather than on retailers; but the existence of buyer power among some of the main parties has meant that the burden of cost increases in the supply chain has fallen disproportionately on small suppliers such as farmers.’ The Commission recommended that supermarkets should abide by a Code of Practice on their dealings with suppliers – drafted by the Commission and welcomed by many farm groups. Details of the Code were then negotiated between the major supermarkets and the OFT, in order to find something workable given the diversity of the sector. The final Code from the Department of Trade and Industry, which came into effect in March 2002, and which is (on the insistence of the Commission) applicable only to the top four supermarkets, was roundly criticised for having been diluted. A review of the code was launched and the OFT has also recently audited each of the four supermarkets’ dealings with suppliers against the code. This last report was published in March 2005. It concludes that the supermarkets are not currently abusing their position. It does recognise that it is not fair nor legitimate for a retailer to negotiate terms and then unexpectedly and unilaterally to change or cancel those terms; e.g. by unreasonably insisting on additional payments or other commercial favours after the deal is struck. Where a supplier has, on the basis of the terms negotiated, made investments specific to the relationship with the retailer in question, the supplier may be adversely affected by such changes. They also note that in many circumstances, the value of a supermarket’s reputation for fair dealing − in the sense of honouring the terms of deals struck and giving reasonable notice of desired variations − would provide a strong commercial incentive to respect the agreements it makes with suppliers. By not doing so, a supermarket might worsen the terms on which it could transact with suppliers in future, and hence worsen its longer-run competitive position. For ASDA, Sainsbury, Tesco and Safeway they noted that many supplier agreements, particularly for larger suppliers, had been in place for many years, reflecting the long-term relationships that the supermarkets often have with suppliers of their core products.

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5.1 Background

We have examined two supermarket businesses, Asda and the Co-op, and their suppliers’ (English Village Salads (EVS) part of the GEEST group, and Isleham Fresh Produce (IFP) respectively) approaches to fresh produce for this case study. We identified what these businesses consider to be their key success factors and what strategies they have adopted to realise these. We have also included observations with Sainsbury’s approach through our discussions with our Steering Group member from the Sainsbury’s group.

5.2 Asda

Asda’s origins as a food retailer can be traced back to 1950 when, as Associated Diaries, it built its first supermarket in Pontefract. The Asda brand first appeared on a store in 1965 and its origins have traditionally lain in the provision of locally sourced food products at low prices. During the 70’s and 80’s, Asda expanded rapidly into Southern England through a combination of acquisition11 and building new, large supermarkets. In 1999, Asda was purchased by Wal-Mart12 and at the time was the UK’s third largest food retailer, after Tesco and Sainsbury respectively. This was followed in 2000, by the opening of its first out-of-town ‘supercentre’, which was so large that staff were given scooters to get around the store. The same year, Asda overtook Sainsbury as the UK’s second largest food retailer and, in 2004, Asda overtook Marks & Spencer as the UK’s largest clothing retailer. Asda’s market share and geographical spread make it one of the UK’s leading food retailers. Its retail strategy focuses on larger, out-of-town stores based on an efficient supply chain and the supply of products at an ‘Every Day Low Price’ (EDLP); that is, a consistently low price throughout the year, in preference to sporadic promotions such as ‘Buy One Get One Free’ (BOGOF), although these are sometimes used as well. In turn, this requires Asda to instil the principle of ‘Every Day Low Cost’ (EDLC) throughout its supply chain. Asda views its EDLP policy as allowing products to compete solely on the attraction of the value and choice they provide. They regard the EDLP strategy as leading to increased volumes and greater efficiency and avoiding the distortion of competition that can derive from one-off promotions. Its pricing is less reactive to the actions of its competitors, thus allowing it to attach a greater degree of certainty to its forecasting of supplies, etc.

11 E.g. it purchased Gateway in 1989 for £705m. 12 Wal-Mart (the owner of Asda) is the world’s biggest retailer, and also the biggest grocer, with US grocery sales estimated at $57 billion. Asda represents 0.5% of Wal-Mart’s profits.

Risk Solutions Page 15 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B Ultimately sales growth is the most important objective throughout Asda and its different supply chains.

5.2.1 Asda’s Fresh Produce Business The Asda fresh produce business, the subject of this case study, is one of Asda’s five main operating units. It comprises six produce category units, one of which is the whole head salads line. The business is managed very differently from other parts of Asda and Wal- Mart . The EVS relationship is very different to the Wal-Mart model and to many others.13. The fresh produce business unit seeks to work closely with its first-tier suppliers to promote its key objectives along the entire food chain in a very transparent way, building long-term business relationships based on achieving its quality and low price targets and gaining efficiencies throughout the supply chain. Their aim is to work towards becoming the market leader for each individual produce line, achieving the lowest price gained by implementing supply chain efficiencies – over time their competitors having to react in an attempt to try and match Asda’s prices. Asda complements its strategy with Wal-Mart’s ‘country manager’ structure. These country managers do not have sales-related objectives, rather their role includes: preventing different parts of Wal-Mart competing against each other within a region; facilitating infrastructure development; and helping individual suppliers to collectively solve common problems. This matrix structure allows Asda to achieve synergies with Wal-Mart’s wider supply chain (e.g. by relying on economies of scale to negotiate down raw material costs centrally for electricity, orchard nets, pesticide, packaging etc). According to Asda, they now achieve the lowest supply chain costs in the industry by careful management rather than prices paid to its suppliers. Asda’s fresh produce supply chain has undergone significant changes during recent years as the number of its suppliers has been reduced from around 250 down to 27. Its current suppliers handle approximately ten times the volumes supplied by each previously – the downside to this dependence is that Asda may be exposed to significantly more risk from disruptions to the supply of produce. These 27 suppliers are structured around Asda’s product categories, with each supplier being solely responsible for product supply for one or more of these categories. The aim is to develop long-term relationships with these suppliers so that: • As far as is practicable, Asda does not have to purchase product from the open market, over which it has little or no influence regarding price, availability and quality • Asda’s specific product requirements are shared along its supply chain, in particular with its immediate supplier • The suppliers are rewarded with long-term certainty regarding shelf-space and thus revenue; the assumption is that suppliers will then not factor any hidden risks (and thus cost) into their supply relationship with Asda

13 E.g. This part of Asda sources 100% of some of its produce lines from some suppliers. Wal-Mart’s policy only allows 25% single sourcing.

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• Where possible, Asda uses local/UK suppliers to highlight the provenance aspect, and thus perceived ‘freshness’, of its products An example of this approach is the relationship with EVS (see box below). Asda’s seven biggest fresh produce suppliers (accounting for over 80% of sales) are now all operating on the basis of ‘open book contracts’, meaning that both the retailer and supplier are able to share commercial information. Should it wish to, Asda has the power to scrutinise its suppliers’ accounts and check that they are endeavouring as far as possible to cut out any avoidable costs out of their operations. If not Asda can step in and insist that this is done. Asda is now five years into the implementation of its supply chain strategy. The approach is still being developed and it has not yet been developed for the whole supply chain. It aspires to apply this model to all its current fresh produce supplier relationships and estimates that this change may take a few more years to complete. The advantages that Asda sees with this model are: • It focuses the supply chain collectively on Asda’s, and by default the consumer’s, requirements – i.e. to provide a good retail offering as well as a good supply chain to deliver this offering • It creates a move away from short-term trading which creates inefficiency, possible disruptions and thus cost into the supply chain. Asda contrast their approach with the supply chain philosophies of other major retailers (including Wal-Mart), who exploit such short-term trading battles to leverage lower prices from suppliers, arguably at the longer-term expense of the supply chain itself The output of Asda’s supply chain strategy is a blurring of boundaries between the supplier and retailer, which Asda intends to extend to encompass farmers14. Essentially the key supplier acts as an advocate for Asda, sourcing Asda’s requirement for a particular product category(s) both from farmers directly and, where necessary, from importers. Asda recognise that choosing the correct suppliers underpins their supply chain strategy; that is, selecting suppliers with an open culture similar to Asda and who are willing to change their organisational systems and structure to ‘fit’ with Asda15. This ‘change process’ will take several years to embed, and both Asda and its suppliers accept that during this transition stage their relationship will be vulnerable to incidents such as predatory approaches from other major retailers, major supply chain disruption incidents, etc.

5.2.2 Planning and Risk Management Asda’s fresh produce business maintains a five year rolling plan which addresses nine areas of activity and risks that are likely to affect their business. Key issues addressed are: customer requirements, locations, customer expectations, raw materials, manufacturing processes, supplier base (quality/availability). Climate change is not currently considered

14 This is summed up by Asda’s philosophy that ‘the customer is king, the grower is queen’. 15 In fact, EVS committed themselves to not supplying any other retailer once they were selected as sole suppliers for Asda’s ‘whole head’ fruit and vegetables. That is, they intended this gesture of good will to demonstrate their commitment to Asda as a customer.

Risk Solutions Page 17 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B as a single item on the corporate risk log. On the whole it is true to say that growers take the most risk, then importers, and lastly retailers. Asda gather information from growers and suppliers on medium to long-term trends, and emerging risks and this is combined with customer information and corporate needs in order to come up with the key ingredients for joint business plans with the supplier. Together Asda/EVS are becoming much smarter in forecasting demand into the future and both work to the same short to medium-term weather forecasts. A traffic light system is used to grade suppliers’ performance against quality and availability criteria on an ongoing basis. For example, if quality becomes unacceptable over a period (i.e. becomes ‘red’), then Asda will sit down with the supplier and growers to review production and growing processes and agree how best to improve matters. Asda prefers not to get too involved with such decisions; only with how these affect the outcomes in terms of impacts on the quality, price and availability of the produce. Of these, availability is the most important factor – the quality is secondary if the produce is not available. However, if problems with non-availability and the quality of the fresh produce become irrecoverable then a decision may be made to by Asda and its key supplier to switch to growers in other locations. In times of scarcity they also have to avoid or manage the risk of not becoming wholly reliant on a handful of growers who are approached simultaneously by Asda’s competitors for the same product. The business planning and review processes provide potential mechanisms for identifying extreme weather and climate change impacts and to explore possible adaptation options. The vast majority of investment comes from the growers themselves. Asda/EVS usually do not put any significant investment in upfront. Instead they may give a new grower from a new location (e.g. from Morocco or Poland) an idea of the volumes or demand that Asda/EVS may place with them, allowing them to make forecasts for how much produce they will be able to sell each month and throughout a contract. The grower then would use this to raise capital for investing in new farms, green houses etc and for building infrastructure and capacity in general. With new growers Asda/EVS is able to build in its specific requirements right from the start when the supplier/grower is setting up the agri- business, something that is far more difficult to do with existing, long established small growers (e.g. farm cooperatives in Spain).

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English Village Salads (EVS) is a subsidiary of Geest plc (one of the leading fresh prepared foods and produce companies in the UK ). Asda has essentially outsourced its marketing and purchasing activities for whole head vegetables to EVS. Asda and EVS initially agree a joint business plan which includes factors such as sales growth, profit margins, wastage and quality performance indicators. This joint business plan acts as the framework for annual procurement plans, which detail product requirements by regions and sometimes even grower (EVS has a profile of 2 to 3,000 growers). As part of this relationship, all major investment and recruitment decisions are made jointly between Asda and EVS even though Asda does not actually invest any finance itself. This ‘open book’ approach is underpinned by a number of win-win dynamics: - Asda guarantees EVS a minimum profit margin thereby incentivising EVS, through its marketing and its ability to ensure availability at the appropriate quality/price, to maximise sales. - As long as EVS can demonstrate that it is managing the supply chain risks on an ongoing basis against Asda’s success criteria, Asda will bear the cost of any unexpected, adverse events (e.g. extra costs of transport, disruptions due to extreme weather). - To help EVS establish and maintain excellent working relationships with key growers, Asda will support advance payments (sometimes one season in advance) to ‘underwrite’ the crop - Asda’s network of country managers can draw on their considerable purchasing power to negotiate very good prices from agri-suppliers, hauliers, and energy providers. Asda is able to make this facility available to growers so that if in their own assessment they need to invest in extreme weather protection or adaptation options (say) they could do so relatively more cheaply than non Asda suppliers Because EVS is a category champion, Asda rely on them to get the customer safety, hygiene etc standards right. EVS manage the grower base and specifications. The cost of this is invariably passed on to Asda; but ASDA have scrutiny through the open book policy. They have open discussions with supplier/grower regarding what a fair profit is for each to succeed and also to invest into the future. They share relevant information on risk and rely on trust and transparency of decisions concerning risks. In particular, Asda cooperates with its fresh produce suppliers to such an extent that it gives them access to its Retail Link information system, allowing them to retrieve sales data regarding their products. This is unprecedented, even within Asda/Wal-Mart. Asda’s philosophy is that suppliers and growers are best placed to understand and manage the risks to their own businesses from extreme weather so they tend not to intervene on decisions regarding what varieties to grow, where, how much and under what conditions unless it becomes necessary. In turn it makes demand side information available to EVS and their growers so that they could decide what volumes and yields they should be aiming for. In this strategic alliance, there is a merging of the cultures between both organisations, with them referring to each other as ‘colleagues’ rather than suppliers or customers. A very tangible example of this alliance working is the fact that Asda/EVS employ a joint head of marketing. Together Asda and EVS have become much smarter in forecasting demand going into the future. This helps give the suppliers and growers much more certainty about the long-term demand and investment needs which in term allows them to become more proactive in developing innovative farming methods and new products. The EVS/Asda relationship is quite responsive to supply shocks and resilient enough to react appropriately in to extreme weather events. However, there are still quite big differences between the grower and buyer mindsets. Growers are a very diverse bunch, especially between those from different countries and for different types of products. They do not all want or aim to have a sustainable business over the long-term; they may be happy with feast-famine cycles in which they make no provision for the adapting to impacts of extreme weather but just ‘put up with it in the hope that they could recoup their losses in subsequent years.

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5.3 The Co-operative Group

The Co-operative Group (the Co-op) was founded in Rochdale in 1844 on the principle of selling ‘wholesome food at reasonable prices to customers living in its community’. The current Co-operative movement is a vast and complex structure of 45 autonomous societies spanning activities as diverse as food retailing, banking, farming, opticians, insurance and undertakers. These are all either wholly owned businesses of the Co-op. It is the largest retail cooperative in the world comprising forty societies in total. Its focus has always been on local and convenience store formats, of which there are many hundreds, rather than on having many supermarkets or out-of-town superstores16. It has long served its traditional customer base from often lower income or socio-economic groups. The Co-op has been losing market share in the UK grocery sector over recent decades17. Recently published Co-op grocery sales were £4.6bn, spread across 3,104 supermarket and convenience stores. The Co-op has identified increasing concerns about the environment, health, ethical sourcing and sustainability as an opportunity to differentiate itself from other food retailers and to make inroads into previously less accessible segments. Its marketing strategy relies on appealing to the more affluent consumer and bringing them into its stores where once they may have preferred to go elsewhere. They do this by identifying a critical mass of social concerns18, sufficient to support a particular product line or a group of products that incorporate one or more social amplification drivers. The Co-op’s strategy now combines its proactive stance on social issues with its ‘convenience’ format for store locations. It leverages the fact that customers trust the Co- op brand. When it says that its produce is sourced locally and without the use of harmful chemicals it knows that customers could actually trace the product at all stages straight from the farm to the fork. Attracting new demand for innovative products obviously has the potential to increase sales; however, the Co-op recognises that there are also potential risks associated with this strategy: • Whilst customers are prepared to pay a premium for convenience (convenience stores can charge up to 5% more than out of town stores) the Co-op must ensure customers will also pay a premium for those social issues being adopted by the brand • The integration of a particular social issue into a brand must not jeopardise availability of that product, especially if it is a product that the Co-op consider to be a core or essential product as seen by their customers. (The Co-op lists around 50 to 60 staple products as core and ensures that these are available in their stores at all times. These products comprise daily essentials such as sliced bread, milk, potatoes, meat, eggs, flour, etc.) In addition the Co-op now faces increasing competition from the ‘big 4’. For example:

16 As part of this strategy, Co-op recently acquired 603 Allday and 111 Balfour stores. 17 E.g. in 1985, it was the UK’s largest food retailers and in 2000, it was the 5th largest. 18 The Co-op has actually identified six social dimension levers to incorporate: Animal Testing & Animal Welfare; Honest Food; Food Integrity; Environment & Sustainability; Globalisation & Poverty; and Community Support.

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• Although it can achieve some degree of buying power through the role of the CTRG in price negotiations, it still has difficulty in matching longer-term supply contracts offered by some competitors which puts it at a cost disadvantage • Convenience stores are more price elastic because the value proposition/equation is different. None-the-less Tesco can often buy products and put them on the shelf, cheaper than Co-op and are now expanding into convenience stores and aggressively attacking prices at that level • Asda is also attacking the social dimension position held by Co-op; using their size, economies of scale and buying power to compete head-on in Co-op’s chosen space. The key to the success of the Co-op marketing strategy is to communicate to new and existing customers what it is trying to achieve in terms of the social agenda. Because its ‘added value proposition’ is driven more by ethical, responsible and convenience dimensions (rather than cost competitiveness), it could potentially get hit harder if its reputation became tarnished. One of the key challenges that the Co-op faces is therefore to successfully embed its social dimension policies (e.g. the Sustainable Purchasing and Sound Sourcing Policies) into its day-to-day decision-making processes – e.g. for procurement, quality control and employee targets. It has been training its staff to ensure that these newer polices are congruent with other policies and are implemented consistently across the group.

5.3.1 Co-op’s Supplier Relationships The Co-op has developed longer-term relationships with many of its suppliers and co- operatives, some have been in place for over thirty years. The supply network remains very stable although most suppliers these days avoid putting all their ‘eggs in one basket’. It views this approach as an opportunity to overcome its decreasing purchasing power relative to the dominants player in the food retail sector. It promotes its organisational values and culture throughout the supply chain in an effort to develop good relationships with current/potential suppliers and thus help overcome the challenge of having to match the prices and volumes offered by the big supermarket chains. However, because it cannot “guarantee” its suppliers stable volumes or prices over too long a period, the Co-op often has to offer short-term supply contracts which may undermine its ability to develop relationships with new suppliers and/or prevent existing suppliers from switching. In recent years it has also been focusing its supply chain on customer-facing as opposed to non food activities and operations (e.g. developing its Farmcare business in preference to its dairy processing business which it divested). The Co-op strategy focuses on those social issues where customers feel they can make a direct, immediate impact through their purchase19. For example, by being able to purchase one of its Fair-trade products for around the same price as a standard product and of equal

19 The Co-op uses its External Advisory Panel, feedback from its members and in-depth ten yearly consumer surveys to identify emerging social concerns and to determine the relative priorities for the conscientious consumer.

Risk Solutions Page 21 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B quality, the customer perceives that the farmer/producer receives an equitable payment within a relatively short timescale that allows it to invest in more sustainable farming operations. In contrast, by purchasing an ‘environmentally responsible’ product the customer may struggle to link this purchase with a tangible benefit that will be realised over foreseeable periods of time. On the whole, the Co-op experience has shown that appealing to only one social driver may not be a sufficient incentive to make the customer substitute the ‘standard’ product for its new one. Moreover, because it introduces its Fair- trade range (e.g. chocolates and bananas) incrementally onto its shelves, alongside the standard range, it limits the risks of slow or poor sales. In time if the product sells well, Co-op would aim to substitute the entire range in stages. Although it is accepted that growers must take responsibility for their own business survival, wherever possible the Co-op will provide hands-on advice and guidance to some of its less sophisticated or poorly resourced suppliers, who may themselves be cooperatives, on better use of resources, farming methods, and sustainability. This is on top of the requirement that suppliers/growers have to comply with Co-op’s policies in respect to the environment, ethical trading, safety etc. In this way the Co-op cascades its socio-ethical policies throughout the supply chain. The Co-op allows suppliers to use self assessment tools to check their own compliance against various policies and this helps to bring down their costs. For the Co-ops strategy to succeed the product must be of a comparable quality and price to those already on the shelves. The Co-op tries to pass a fair margin down to its suppliers/growers to invest back in its own operations. In Co-op’s experience most farmers do use the profits to reinvest in the business – e.g. to pay for better protection against storms, new seed varieties, irrigation or packing facilities etc. If a case is made for direct investment, the Co-op can and does put its own money in directly, especially if the supplier is providing a very niche product. However, the Co-op Board believes that although delivering the social agenda is the key to success this must be done in a commercially viable manner. The financial returns have to be at least as good as others in the market place (c. 10%) in order to be able continue to operate into the future – otherwise its social agenda would fail. Therefore, managers need to be able to make the case for why particular investments in Fair-trade products or parts of the supply chain are attractive in terms of the risk-reward balance. An example of Co-op’s relationship with a supplier is illustrated in the box below.

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One example of the Co-op’s commitment to developing and maintaining longer-term relationships is it relationship with its supplier Isleham Fresh Produce (a subsidiary of Produce World, the third largest conventional and organic root vegetable and potato supplier in the UK). The Co-op relies on IFP to supply al of its carrots and parsnips throughout the UK. This relationship has existed, in varying forms, for several decades and is largely based on mutual trust as well as a rolling three-year contractual arrangement. The commercial and technical aspects of this relationship are normally negotiated separately between IFP and the respective Co-op functions. As a result there are a number of communication channels between the two organisations, rather than a single point of contact. An example of how the Co-op incorporates its strategy on social and ethical issues into its supply chain, is the Co-op’s request that IFP, and its supplier(s), adhere to the Ethical Trading Base Code, LEAF (Linking Environment And Farming ) and Assured Produce standards (managed by Assured Food Standards (AFS) under the Red Tractor mark). These requirements are requested by the Co-op’s technical function and are audited by the Co-op every 1-2 years. Any costs associated with meeting these requirements are borne by IFP and reflected in the price of the produce, as part of their commitment as an ethical and environmentally responsible supplier. The benefits of this specific supplier-retailer relationship include: • IFP have the confidence to invest both time and money in aligning their own goals and priorities with those of the Co-op • IFP can adopt longer-term time horizons and try to align both themselves and their supplier(s) with externally recognised ethical and environmental standards • By selecting a supplier, which is willing and able to align itself with the Co-op’s goals and priorities, the products supplied have an added value to both the Co-op and its customers.

5.4 Supermarket Key Success Factors

UK grocery retailers generally have a common hierarchy of key success factors20 underpinning their business strategies. These are as follows: • Availability and range – irrespective of the quality and price of the product, it should be available on the shelves when required by the customer. Despite trends towards more efficient, consumer-focused supply chains availability still remains a major issue to safeguard for UK retailers. − For Asda this KSF means attempting to make available to its customers as diverse a range as its main competitors but not at any price or at the expense of compromising quality. For example, grapes used to be sourced from ten different countries but not all of these were ideal places to grow grapes. This affected both the quality and price of grapes. Asda, has now moved from having grapes on the shelf for 52 weeks to having the best quality grapes sourced from the most reliable locations. If Asda runs out of something they prefer to leave a gap on

20 i.e. Those specific outcomes that the organisation must strive to get right, first time and every time.

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the shelf for operational reasons. This does not look good with customers but they find if they are honest and explain why the gap is there - e.g. quality problem, weather problem - they get a very good response from customers. Asda is very keen to source as many of its produce locally (provenance) from UK producers as it can. − For the Co-op this KSF means concentrating on providing 50-60 core products that provide around 80% of total sales. Their customers have different expectations of convenience stores - they do not expect to go in to get the full range of products that they may get in superstores. However, if you do not have milk and bread on the shelves, they will walk out. The Co-op is also very keen to source all its produce locally. • Quality – products will have both ‘must have’ quality attributes (e.g. safety, non- exploitation, taste, etc) and aesthetic attributes (e.g. attractive and informative packaging, organic, etc) − For Asda this KSF means ensuring that the basic hygiene and ethical factors are a given and the same as the competition − For the Co-op this KSF means meeting the basic hygiene and ethical standards plus the addition of more advanced social dimension policies • Competitive price – this is driven both by internal requirements to achieve specified profitability benchmarks and the need to respond to competitors − For Asda this KSF means achieving its ‘Every Day Low Prices’ strategy − The Co-op aims to offers customers ‘wholesome, unadulterated food at a fair price’. For the Co-op its prices have to be competitive in comparison to other local convenience stores, within walking distance of its traditional customer catchments. • Location – this KSF is shaped by retailers’ approaches to how they intend to develop a UK-wide or regional geographical presence, combined with the store formats that best fit their strategies. Store layout is important not just in terms of customer appeal but also efficiency gains. For example one downside of having large stocks in store is the cost; in-store warehousing is achieved at the expense of selling space. . − For Asda this KSF means having large stores at strategic locations - larger stores and out-of- town shopping developments offer wider ranges and sufficient car parking spaces. Location diversity and formats is now the key to Asda’s strategy because increasing the number of out of town locations is no longer an option. − For the Co-op this KSF having means local top-ups or accessible convenience stores within walking distance of socio-economic groups who may have less mobility

5.5 Supplier Relationships to Support Delivery of the KSFs

We have identified five general types of retailer-supplier relationships that are used to help deliver these key success factors. The supermarkets may adopt any one of these depending on the nature of the product (i.e. how critical is continuous availability) and the nature of the supply chain (i.e. its long-term sustainability). The five types of procurement relationships are: 1. e-procurement based upon purchasing short-term (e.g. 28 day auctions) supply contracts against minimum quality specifications. This approach is used for unbranded commoditised products, where volumes and prices are formally agreed

Risk Solutions Page 24 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B for the contract period with many competing suppliers (e.g. Sainsbury’s 28 day auction procurement approach for commodity products, where the retailer promotes keen price competition between suppliers. Suppliers bid against a specification and standards. This approach is applied where the retailers can accept some risk to supply or when there are availability shortages) 2. Annual contracts - e.g. Supermarkets’ core and branded product strategies, where the retailer may only have a few suppliers producing and labelling its “own brand” products, but promote limited competition to ensure value-for-money 3. Long-term (5 year) open book contracts with tier 1 strategic partners, working in partnership, providing the supplier and in turn the growers with a predictable and fair operating margin, reliable demand forecast, and a transparent mechanism (open-book) for sharing information on retail, supply and farming production risks (e.g. the Asda/EVS type strategy, where both parties make a major commitment in time/resource to a long-term strategic relationship) 4. ‘Paternal’ model, consisting of very long-term relationships with small scale suppliers, usually producing very differentiated products. The retailer would often work with the grower directly to help them improve their production and farming methods, investing time and money in the process. Some of this investment is indirect (e.g. through providing better margins and reliable demand predictions) and sometimes direct investment. The rationale for this type of relationship is that the retailer cannot afford to have these niche suppliers fail because the costs of restabilising this specialist part of the supply chain would be very prohibitive or if the retailer decides to abandon the supplier its reputation could suffer Therefore, the retailer will decide to work with them to help them manage the risks to their business better (e.g. Co-op’s Fair-trade type of approach, where retailer makes a major commitment in its supply chain but with some competition between a pool of suppliers) 5. Vertical integration where the retailer actually owns and manages the ‘supplier’. This type of relationship is deemed suitable for strategically important and/or highly profitable products (e.g. Co-op’s relationship with its wholly-owned fresh produce supplier Farm Care Ltd, Morrison’s relationship with its packers etc)

6 Climate Change Impacts

6.1 Climate Change Variables

Over the coming century we expect that in the UK: • Temperatures will increase • Winter rainfall will get heavier • Summer rainfall may reduce considerably • Sea levels will rise.

Risk Solutions Page 25 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B As well as changes in seasonal average climate, there will be changes in extremes, such as very hot days and intense downpours of rain. There may also be more storms, and possibly more violent storms crossing the UK, although there is still uncertainty about their frequency of occurrence. Extreme events are by definition rare, but they often have the most significant impacts. They are also difficult to predict, so information on future climate extremes is still largely uncertain. Climate varies naturally too – at any given point in time these natural variations could add to or act against the climate change effect. In order to identify the impacts it is important to consider: • Average climate, such as seasonal temperature and rainfall, • The effects of extreme weather, such as heavy rainfall, coastal flooding, droughts, very hot days, and freak storms, and • Whether there are critical thresholds in a system that may be exceeded as climate changes, causing significant impacts. Because fresh produce supply is a global industry, we need to understand, in outline, how global changes in weather patterns predicted by climate change might impact fresh produce supply. A detailed analysis of specific changes and impacts is beyond the scope of this case study – we have described in this section the broad trends and some specific examples of their potential impact. In general terms, globally higher temperatures will contribute to higher summer heat indices and shorter return periods for heat waves. Increased aridity is likely to translate into greater risk of wildfires and droughts in some regions. Meanwhile, global increases in winter precipitation, particularly extreme rainfall events, would have obvious implications for flooding and land loss as will increases in sea levels. Crop destroying hailstorm and high winds may also increase. The nature and severity will vary among regions, but the ability of scientists to project changes in many types of severe weather, such as wind and hail storms is limited for long term forecasts. Warm weather hastens crop development and brings harvest earlier. Dry weather causes drought: soil moisture reserves are depleted until crop demands for water cannot be fully met, leaf function becomes reduced or impaired, and growth is slowed. Thus warmth and dryness both act to reduce final crop performance, warmth by reducing the duration of growth and dryness by reducing the rate of growth. For some crops however (e.g. cereals), warm dry conditions are not necessarily disadvantageous because bright conditions often enhance crop growth rates and yields. By advancing flowering, warm weather overcomes soil moisture depletion during the post- flowering period by bringing yield formation earlier in the year, before soil moisture reserves have been exhausted.

Risk Solutions Page 26 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B The key impacts of climate change for fresh produce supply in the UK are therefore likely to be: On the demand side: • consumer demand for products (e.g. increased sales of salad vegetables in hot weather) On the supply side: • the crops that can be grown (e.g. vineyards in Southern England) • the yields and cost of production: • the impact of pests and diseases • the availability of water • the extent of storm damage (hail, high winds etc) • loss of land for production due to flooding

Although changes in extremes have the potential to increase damage at the margins, the major consequences of severe weather on future economic and public health will be the socio-economic factors that control the exposure of people, property and agricultural land to extreme events. The relationships between climate variables and socio-economic variables and supply and demand are complex. In the following section we introduce influence diagrams which provide one way of attempting to illustrate and explore these relationships.

6.2 Influence Diagrams

6.2.1 What are they?

Winter Summer temperatures temperatures

Temperature range

Production of different crops

Risk Solutions Page 27 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B Influence diagrams are pictorial representations of complex systems. They allow people to systematically describe a system and how the different aspects of the system interact with one another. In an influence diagram the key variables that are related to each other are represented by ‘nodes’. A node is related to other nodes by ‘links’. Where two nodes are linked, this indicates that the state of one node directly influences the state of the other node. An arrow shows which node acts on which. For example, in the figure below, there are four nodes, linked together: The orange nodes in the figure represent climate variables. In the future, winter temperatures may become colder or warmer. Summer temperatures may become cooler or hotter. Both these nodes are linked to a yellow node, representing the effect of these climate change variables. In this case the combination of winter temperatures and summer temperatures will influence the likely temperature range experienced during the year. This in turn influences the farming community in terms of which crops can be grown. Other variables, such as rainfall, type of land, likely market etc. will also influence the crops that will be grown, and the diagram can be expanded to include these. The value of representing the various factors, variables and influences on a diagram such as this is that it allows people to see and communicate how a complex web of influences, such as those associated with climate change, can either directly or indirectly impact on their lives and businesses. The key influences can be followed through logically. An influence diagram can be used either qualitatively or quantitatively. In this study we have focused on qualitative values, although we have explored how the diagrams could be used quantitatively. It will be seen below that even the qualitative diagrams can quickly become very complex, and in the form shown here are probably likely to be of most use to risk management specialists who are familiar with this approach to laying out information. However, they can be used as the basis for developing simpler checklist based tools for application by non specialists.

6.2.2 Development of Influence Diagrams for the Supermarkets Case Study We have used the influence diagram as part of the case study to demonstrate how climate changes can impact supermarkets through the supply chain. For this exercise it rapidly became clear that not only climate variables but also socioeconomic variables were of great importance to the future evolution of the sector. This is equally true of other retail sectors. Placing the supermarkets and their supply chain onto an influence diagram with both socioeconomic and climate variables proved to be a complex task. For this reason two separate diagrams were developed, initially, one illustrating the socioeconomic side of the picture, and the other the climate and weather-related side, and later the two diagrams were combined. Clearly over the long term climate and socioeconomic variables will themselves interact, but in the shorter term it is reasonable to consider them separately to tease out the individual effects. We drew on the UKCIP02 tools for both socioeconomic and climate changes, which do not address interactions between the socioeconomic and climate change scenarios but produces eight separate scenarios, four each for climate and socioeconomics. We were guided by the variables developed within these tools to form the starting point for the case study influence diagrams.

Risk Solutions Page 28 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B We have not generally represented in detail factors external to the system, for example electricity supply, which itself could be strongly influenced by the effects of climate change, and threats which railway managers would need to understand. Such wider external impacts would deserve an entire study to themselves. Instead we have represented such factors through costs of production nodes, which will be influenced by the wider outside world.

6.2.3 Interpreting the Supermarket Case Study Influence Diagrams

Socioeconomic Effects Figure 3 shows the socioeconomic influences. At the top of the diagram, the grey nodes represent the socioeconomic influences. We have included a wide variety of socioeconomic variables. At the very top there are variables such as the level of EU subsidies available to farmers, import restrictions against goods from outside the EU (or even outside the UK), the level of competition experienced in the market, the level of GDP and population growth in the UK, the attitude of government to intervention in markets, and the attitudes of consumers to: new technology (for example GM crops), environmental protection, animal welfare, food and health, and social welfare. In turn, these top level socioeconomic variables affect variables in the next stage down the page. For example: GDP growth, population growth, the attitude of the government to intervention and the attitude of consumers to social welfare all influence the way wealth is distributed in society (more evenly distributed or with greater disparity between the richest and the poorest). Moving further down the diagram again, the blue nodes represent the demand side of the demand/supply equation that supermarkets are aiming to meet. The supply side is represented by the green nodes. Consumer demand can take a variety of forms, from the overall level of demand for goods and services through to specific demands for different types of products. Here we have characterised demand according to the following factors: demand for premium products, ‘value’ products, organic products, new products (driven by changes in weather and tastes). We have also included the demand by consumers to know the provenance of the products they buy, which is currently considered an increasing trend. These different aspects of demand are influenced by the type of society envisaged, and therefore by the socioeconomic variables we have captured. For example: the attitude of consumers to the environment will influence the level of demand for organic products; the way wealth is distributed in society will affect the levels of demand for premium and value products. All these demand variables together feed into a node titled ‘Acceptability of Produce’. This variable stands for how all these different consumer attitudes and demands translate into how acceptable consumers find the offering of the supermarkets. On the supply side again the top level socioeconomic variables have a direct influence. For example the cost of transport is influenced by the pattern of settlements (it may be more dispersed or more concentrated), which in turn is influenced by population growth and planning regulations. Cost of transport may also be affected by the level or type import restrictions in place. A rather different example may be in the area of food packaging. The availability of new technology, for example processing or packing

Risk Solutions Page 29 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B technology, and the level of food safety regulation, both influence the packaging methods used. This in turn influences the cost of food processing. The purple nodes at the bottom of the diagram represent the key success factors that supermarkets must achieve in order to build sustainable and successful businesses. Here we can see how both the supply and demand variables influence how the supermarkets can meet their key success factors of: availability, range, quality, price, and store location, which in turn influence their level of sales growth and market share. Supply side variables feed into the costs borne by the supermarkets, for example the cost of transporting produce has a direct influence on the overall costs of the supermarket’s supply chain. Together price and cost influence profitability. Profitability and market share together influence the overall level of profit achieved by the supermarkets. For completeness, we have included a single white node to represent supermarket policy. In reality, supermarkets can have influences at many points in the diagram, and part of the purpose of such a diagram is to illustrate where actions might be taken that would help supermarkets and their supply chains to adapt to socioeconomic and climate changes. However a very direct influence of supermarket policy is in the positioning of a particular chain within the market place. From our case studies we have identified different business models for supermarket chains that are be characterised by different mixes of, or emphases on, the key success factors of: quality; range; price; and store location. Supermarkets set a strategy that takes into account these key factors, and it is this major policy decision that we are capturing with the white node.

Climate Change Effects Figure 4 shows the climate change influences. The very top orange node is a general ‘Global Climate Change’ node. This represents the four UKCIP02 climate change scenarios. Depending on which scenario is considered, this would influence the likely values for the climate change variables below. At the next level down in the diagram, the orange nodes represent the major climate change variables that are described by climate change models. These are: winter temperatures, summer temperatures, levels of precipitation, cloud cover, levels of wind (duration and speed), and sea level rises. In turn, these climate variables impact directly on ambient weather and environmental variables (yellow nodes) that have an impact on agriculture and on demand for produce. As on the socioeconomic diagram, the green nodes represent the supply side and the blue nodes the demand. The climate change and weather variables will have a major influence on the supply side, specifically on the ability of farmers to produce, process, store and transport their produce. We have allowed for a wide range of potential changes and responses to climate change. For example: if winter and summer temperatures are altered, this could influence the length of the growing season. This, coupled with changes in levels of rainfall, and the overall ambient temperature range over the course of the year, could allow farmers to produce different crops that are not currently viable or economic to produce in the UK. It could also change the distribution of farmed lands (availability of land for farming). Changes in winter temperatures and levels of precipitation could affect winter humidity. This would influence the keeping properties of grain, and therefore the costs of grain storage. It would also influence the types and levels of pests and diseases, along with factors such as the summer rainfall, length of the growing season and the arable

Risk Solutions Page 30 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B production methods used, which in turn would affect the risk of crop damage and then the overall level of crop production. Further down the diagram, the supply factors together influence the overall level of food production, the costs of the raw materials for food processing and the costs of other supply inputs. At the bottom of the diagram, once again, we have the purple key success factor nodes. These are identical to those on the socioeconomic diagram. The main difference is that this diagram illustrates how climate change (rather than social change) can have an impact on the supermarkets’ ability to meet their key success factors and operate sustainable businesses into the future.

Combined Diagram Figure 5 shows the entire picture, with both climate change and socioeconomic variables together on a single diagram. There are several nodes that are influenced by both sides of the diagram. For example, the availability of land for farming is affected both by the prevailing weather and climate (as well as sea level rises), and also by settlement patterns. The risk of animal diseases is affected both by humidity and temperature, potentially allowing new vector-borne diseases to take hold in the UK for example, and also by animal husbandry methods that may be influenced by the attitudes of consumers to animal welfare.

6.2.4 Development of the Influence Diagrams Ultimately, influence diagrams can be quantified to allow modelling of ‘what ifs’ to be followed through a network of possibilities. To illustrate how the influence diagrams could be used to explore a specific example, we have used data from an analysis of the hot summer of 199521 and from more recent work as part of the EC’s CAFE programme22 to look at the potential directions and magnitudes of impact of climate change on summertime demand for and production of fresh produce (e.g. salads) to develop a semi- quantified influence diagram. This is shown on Figure 6. This figure illustrates the impacts of a hot, dry summer on production and demand for fresh produce, and ultimately on the supermarkets bottom line. In this diagram red lines have been used to indicate an expected increase in the value at arrow head end, as a result of a change in the influencing node. Blue lines have been used to indicate an expected decrease. Black lines indicate no expected change. The width of the lines has been used to indicate the expected magnitude of the change - a thicker line means a bigger/ more material change. At the top of the diagram we have assumed that global climate change leads to an increase in summer temperatures and a decrease in precipitation (summer, specifically). The higher

21 Economic Impacts of the Hot Summer and Unusually Warm Year of 1995. Published by UEA, at the request of the Department of the Environment. 22 Mike Holland, Alistair Hunt, Fintan Hurley, Stale Navrud, Paul Watkiss (2005). Final Methodology Paper (Volume 1) for Service Contract for carrying out cost-benefit analysis of air quality related issues, in particular in the clean air for Europe (CAFE) programme. Published at: http://europa.eu.int/comm/environment/air/cafe/activities/cba.htm http://www.cafe-cba.org/

Risk Solutions Page 31 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B summer temperature, in turn, is expected to result in an increased temperature range, higher summertime ozone levels (due to photochemical smog production), greater crop growth for some crops that benefit from increased sunshine and much higher costs of refrigeration. The length of the growing season is also expected to increase (starting earlier, and finishing later in the year). The lower precipitation leads to lower summer rainfall overall, but higher frequency of heavy rainfall events - when it does rain it tends to be in heavy bursts rather than regular showers. The lower rainfall also results in increased costs for irrigation. The increased risk of pests and diseases, coupled with increased ozone pollution, results in increased risk of crop damage and consequent decrease in crop quality. Crop quality may also suffer due to reduced levels of nutrients such as gluten in wheat, which may be affected by hotter, drier summers. Increased crop growth may offset this to some degree, but overall the cost of raw produce is expected to increase and the overall level of food production may decrease. On the demand side the overall level of consumer demand is expected to decrease. This is based on research21 which shows that in hot, dry weather people tend to spend less time shopping and to spend less when they do shop. Although overall consumer demand is likely to decrease, demand for fresh produce such as fruit and vegetables and lighter alcoholic drinks and soft drinks is expected to increase during hot summers. Supermarkets may be able to take advantage of such a trend by devoting more shelf space to fresh produce at the expense of less popular items, and thus maintain sales to some extent. However costs are likely to increase, and profitability and profits may be affected. Much has changed since 1995; for example the current study has identified the following relevant changes in supermarket supply trends: • The move to 24 hour opening might reduce the seasonal trends, because consumers have more options to shop outside peak leisure time. This is likely to be a significant mitigating factor in hot weather, i.e. we might expect consumers to alter the time of day of retail purchases, at least for supermarket purchases. • Supermarkets have moved towards year round availability of produce, e.g. of salad and vegetables, sourced from global supply networks. This reduces seasonal fluctuations in demand. It will also reduce supply issues with fruit and vegetable production. This is may reduce the susceptibility of production to temperature extremes – although supplies from other countries may also be disrupted by weather events. • Supermarkets hold much less stock than 10 years ago, with supermarkets themselves having very little capacity. This has been associated with the growth in large central distribution warehouses. This might exacerbate shortages, if short term supply issues did arise. • Supermarkets have the capacity to predict weather (there are numerous commercial prediction organisations) and have become much more efficient in matching likely demand for certain goods to seasonal and short-term temperatures changes. Viewed in this light, temperature extremes will represent an opportunity for supermarkets, by maximising the shop space given to summer consumables, fruit and vegetables, etc during hotter weather.

Risk Solutions Page 32 Climate Change Impacts and Adaptation: D5119 D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B

These changes are not reflected in the diagram, which also does not include other socio- economic drivers. Bearing in mind these reservations, on the basis of this diagram, we can conclude that if the climate changes as predicted, costs are likely to increase (a major contributor is expected to be refrigeration costs) and, while demand for fresh produce is expected to increase, overall the impacts on profitability will be negative. However, the improved flexibility and responsiveness of the supply chain does present opportunities for improved efficiency.. The diagram might be developed further to look at different crops in turn and to estimate how, for example, the cost of production and profitability of a particular product, sourced from a specific region, is expected to vary over time if no special adaptive action is taken. The most value from these diagrams is likely to be derived simply by sitting down with the people responsible for making sourcing and related decisions and using them as a way to think through the various issues related to the decision in a structured way. To be a useful tool for the non expert to apply some more explanation of the nodes and linkages would be required. Quantification of influence diagrams can be a time-consuming process, but can in the first instance be attempted through expert workshops.

Risk Solutions Page 33 Climate Change Impacts and Adaptation: Cross-regional research programme D5119/ Case Study Report - Supermarkets Issue 1 Defra ref: B

Socioeconomic Effects Le ve ls of Attitude of import consumers – Le ve ls o f I nte r ve ntio n ist EU restrictions te ch no lo gy vs. laissez faire UK subsidies govt Population growth

Attitude of consum ers – Attitude of Le ve l o f GDP environment consumers com petition growth Attitude of – social consum ers – Support for welfare fo od & he a lth new te ch no lo g y

Societal Le ve l o f wealth environment/ distribution planning I ntr o d uctio n Dispersed vs. regulation of new concentrated technology settlem ent pa tte r ns Standards of Le ve l of foo d animal safety welfare regulation Availability Cost of of land for tr a n spor t fa rm ing

Use of new arable Adoption of Food production GM produce labelling/ methods Production sourcing of different requirements New animal crops Cost of husbandry other inputs methods Risk of (fertilisers Demand for animal etc) ‘va l u e ’ Risk of Risk of diseases products pests/ crop crop D iffe re nt Demand for Change in diseases damage fo od Demand for organic crop growth labelling premium products D iffe re nt food Different food products packaging packaging Different food Demand for methods materials Overall level processing provenance of consumer methods of products demand Costs of food processing Acceptability Demand for Le ve l of foo d Costs of food Su bstituta b ility Supermarket of produce new production raw materials of produce Policy products

Flexibility of supply chain Competitiveness of supply chain

Availability Range of Quality of Store of offering offering offering Price of Lo ca tio ns Costs offe r ing

Sales growth Profitability

Market share

Profit

Figure 3

Risk Solutions Page 34 Climate Change Impacts and Adaptation: Cross-regional research programme D5119/ Case Study Report - Supermarkets Issue 1 Defra ref: B

C lim ate C hange Effects

Global climate change

Summer Winter temperatures Cloud cover Precipitation temperatures Wind Sea levels

Le ngth o f Frequency of growing Temperature heavy season Frequency of range Summer snowfall Winter heavy rainfall r a in fa ll events humidity events

Quantity of G ust speed rainfall (wind)

Availability of land for Cost of other fa r m ing inputs (fertilisers, Demand for Costs of irrigation) Costs of ‘va l u e ’ fo od/ gra in fo od products Use of new storage processing Demand for arable Demand for organic production premium products methods products Costs of Risk of Demand for refrigeration Demand for pests and provenance Production new diseases of products of different products Change in crops crop growth

Risk of Risk of animal crop Cost of tr a n sp or t diseases damage Overall level Acceptability of consumer of produce demand

Costs of food Supermarket Level of food raw materials Policy production Su b stitu ta bility of produce Flexibility of supply chain

Competitiveness of supply chain

Availability Range of Quality of Store of o ffe r ing o ffe r ing o ffe r ing Price of Loca tions Costs o ffe r ing

Sales growth Profitability

Market share

Profit

Figure 4

Risk Solutions Page 35 Climate Change Impacts and Adaptation: Cross-regional research programme D5119/ Case Study Report - Supermarkets Issue 1 Defra ref: B

Climate Change Effects Attitude of Socioeconomic Effects Leve ls of Global climate consumers – EU change Leve ls of technology subsidies import Inte r ventionist restrictions vs. laissez faire govt UK Population growth Winter Attitude of Support for Attitude of consumers – Cloud cover temperatures Precipitation Leve l of new Summer consumers competition GDP environment temperatures technology – social growth Attitude of welfare consumers – food & health Wind

Frequency Societal Le ngth of Sea levels wealth Frequency of he avy growing distribution of heavy Winter r a in fa ll season snowfall humidity events Intr oduction Dispersed vs. Le ve l of events Gust concentrated of new environment/ Summer Quantity speed te chnology settlement planning Standards of r a in fa ll of rainfall (wind) patterns Le ve l of food regulation animal safety Temperature welfare Cost of regulation range Availability tr a nspor t Use of new of land for arable fa r m ing production methods Food Production Adoption of labelling/ of different GM produce sourcing crops Cost of requirements New animal other inputs husbandry (fertilisers methods etc) Demand for ‘va l u e ’ Risk of products animal Different Demand for Risk of diseases food Demand for organic Different food Change in pests/ labelling premium products diseases packaging products crop growth Demand for methods D ifferent food Risk of new packaging Different food Demand for Overall level crop processing provenance products materials of consumer damage methods of products demand Costs of refrigeration Costs of food Acceptability Level of food Costs of food processing Supermarket of produce production raw materials Substitutability Policy of produce

Flexibility of Competitiveness supply chain of supply chain

Availability Range of Quality of Store of offering offering offering Price of Loca tions Costs offering

Sales growth Profitability

Market share

Profit

Figure 5

Risk Solutions Page 36 Climate Change Impacts and Adaptation: Cross-regional research programme D5119/ Case Study Report - Supermarkets Issue 1 Defra ref: B

Climate Change Effects, Fresh Produce Example

Global climate change

Precipitation Summer temperatures

Summer rainfall Le ngth of growing Ozone season Temperature pollution Frequency of range heavy rainfall events

Risk of pests and Quantity of diseases r a in fa ll Costs of refrigeration

Risk of Change in crop crop growth damage Demand for new fresh Overall level produce of consumer demand

Costs of food Leve l of food raw materials Crop production Cost of other quality inputs (fertilisers, irrigation) Acceptability of produce

Supermarket Policy Substituta bility of produce

Flexibility of supply chain

Competitiveness of supply chain Key Change in the value at arrow head end, as a result of a change in the influencing node: Availability Range of Quality of Price of Store of offering offe ring offe ring offe ring Loca tions Costs an expected increase an expected decrease. no expected change.

Sales The width of the lines has been used to indicate the expected growth magnitude of the change - a thicker line means a bigger/ more Profitability material change.

Market share

Profit

Figure 6

Risk Solutions Page 37 Climate Change Impacts and Adaptation: D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B

7 Capability to Respond to Climate Change

While climate change adaptation is not currently on supermarkets’ strategy agenda the sector has well established mechanisms to monitor, plan for and respond to threats and opportunities in the short to medium-term and a proven track record of adapting to external change in the market place in the longer term. Farmers in the UK have been changing what they do for some years now in response to difficult market conditions and EU legislative changes. The capability to adapt to external factors therefore exists within the sector, provided the signals for change are recognised and correctly interpreted. Weather influences both consumer demand for fresh produce (products, volumes, ability to purchase, etc) and retailers’ ability to supply (range, volumes, quality, price, etc). Supermarkets have developed a good understanding of the former. On the supply side there appears to be an increasing trend to relying on a limited number of “first tier” suppliers to monitor and manage the supply side risks arguing that it is the suppliers and growers who are in the best position to understand these risks and identify and implement effective management strategies. The retailers in turn are best placed to understand the demand side risks. Therefore, the trend is towards the different sides forming strategic alliances where each would share the best information on risks and costs in an open and transparent way. Although this trend is driven by other more immediate drivers, it is building a more adaptable and responsive supply chain and therefore should have a positive impact on the sector’s ability to respond to climate change. Some of the current, short-term, solutions adopted to ensure that produce remains available at the right quality and price include: • Monitoring and the early identification of potential problems/opportunities • Maintaining a minimum stock holding (some products only)Controlling demand (pricing strategies) • Sourcing products from a range of growers and locations • Additional capacity/redundancy built in to systems to cater for business disruption (alternative hubs, distributions etc) • Switching to the open market at short notice (other international/UK suppliers) and paying the going rate, and to some extent • Identifying and helping build capacity in new locations (e.g. Morocco to supplement Spain). Factors such as immediate history of grower reliability (including weather related problems), ability to meet quality and ethical standards for a given price, the political and economic situation in supplier countries, cost of transport and short term consumer trends will have a greater influence on sourcing strategies than longer term factors such as climate trends.

Risk Solutions Page 38 Climate Change Impacts and Adaptation: D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B

Examples of sourcing decisions A few years ago the unavailability of iceberg lettuce from mainland Europe (due to poor weather conditions) meant that all retailers had to buy and fly produce in from a few farms in the USA. This led to big increases in prices for that year. Consequently, more US farmers anticipated an even bigger demand for the following year and devoted their farms to growing lettuce. However, the supermarkets went back to their European suppliers again when iceberg lettuce became available, putting some of the US farms out of business. Until recently, the sector sourced almost 80% of its winter tomatoes from the Canary Islands. After experiencing a few problem years, where quality was affected severely partly due to weather, the sector made a conscious move to become less dependent on the Canary Islands, and established an alternative and more diversified supply chain, sourcing tomatoes from a number of different locations.

Other risk control strategies are aimed at reducing the impact on reputation and customer loyalty of a failure to supply including: • Promotion of similar/substitute products (i.e. communicating why there is scarcity with honesty and recommending alternatives to consumers) • Focusing on availability for key retail outlets Efficient demand planning, sourcing, sound logistics, good inventory management, and distribution using advanced technology (IT, EPOS systems, materials resource planning etc) all help manage the risks. These strategies are proving effective in responding to weather related and other supply and demand challenges in the short term and there is no immediate reason to believe that these will not continue to be effective in the longer term. But, this is not to say that climate change poses no threats or opportunities or that there are not opportunities to improve resilience at low cost. The main risk we see is that sub-optimal sourcing decisions will cause a creeping increase in costs of supply and increasing reliability problems ultimately affecting competitiveness and undermining the basic business model. By considering longer term trends in the weather and their impact on growers and product supply, sourcing decisions can be made more robust to future change. The current trend towards longer term relationships with fewer suppliers could help support adaptation through: • Early identification of weather related concerns, longer term trends • Improved planning for new varieties/crops with individual suppliers • Improved planning to maintain the product portfolio • Providing direct and indirect investment to reduce the cost of adaptation to supplier/grower (e.g. access to crop protection technologies, materials at lower price; R&D into new varieties, crop technologies, processes) The challenges to making this a reality are: • ‘Selling’ the longer term benefit to supermarkets and, through them and directly, to key ‘first tier’ suppliers • Providing the basic climate change information required to support decisions in a straightforward to interpret and use formats.

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• Before solutions are adopted that require customer to accept limited supply of seasonal product out of season a concerted campaign of consumer education and awareness raising would be needed about the need for more sustainable sourcing strategies and changing expectations about seasonal availability.

8 Building Adaptive Capacity

A key concept developed by UKCIP is the development of ‘adaptive capacity’. This is the ability of an organisation to adapt to the variety of circumstances it might face in the future – tackling its current weaknesses and building on its perceived strengths. Building adaptive capacity is a way for organisations to safeguard themselves against major uncertainty, and could involve developing skills, reviewing decision-making systems and processes and increasing organisational flexibility. The particular areas for consideration include: • Awareness, understanding and commitment to tackling and adapting to the impacts from climate change • Data and information (both related to climate change and the response of a company’s assets to weather related events) • Decision-making tools (the systems and processes) to support a more detailed understanding of the nature and magnitude of climate related risks, time horizons for planning, and development of business cases for change in the face of high inherent uncertainty etc • Skills development and resources needed to use and apply the tools Superior management of climate change risk through building adaptive capacity into the organisation and its supply chain could be a source of long-term competitive advantage, because better risk management and adaptation means better management of contingent costs. The consequences of doing nothing or delaying adaptation to the impacts of climate change include: • Permanent loss of the supply chain infrastructure • Loss of reputation and public confidence • Decline in performance and cost to UK plc • Increased costs But note that it also provides the potential to save on wrong or unnecessary adaptation. We have seen that climate change adaptation is not currently on board agendas and this is probably because it is not a risk that is going to affect supermarket survival within short planning horizons. The board will be aware of climate change, due to legislation, energy and transport issues etc, but this is more likely to relate to mitigation than adaptation.

Risk Solutions Page 40 Climate Change Impacts and Adaptation: D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B

Given the supermarkets’ current, very robust capabilities to react to extreme weather it is legitimate to ask whether there is really a need to put climate change adaptation on the board agenda when they have many more important short-term risks? The answer to this is probably yes, because of the risk of becoming uncompetitive over time due to adopting suboptimal solutions and incremental cost increases. While these risks are probably best identified and managed by decision-makers at lower levels in the organisations (e.g. when making sourcing decisions) it may require board action to ensure that it becomes embedded in routine risk management processes. Much of the supermarkets vulnerability to climate change arises from a need to maintain complex, global supply chains to meet consumer expectations. While we expect to see fresh produce on the supermarket shelves all year round, supermarkets will have to supply them at competitive prices to retain market share. There is some evidence that awareness of climate and environmental issues is rising and that customers will accept the occasional empty shelf especially where explanations are provided, nevertheless it is unlikely that a retailer would adopt in isolation a strategy of seasonal supply for those products considered ‘core’. Policy instruments that affect all retailers, such as transport or emissions taxes, will drive change across the sector but may disproportionately affect the smaller, more marginal, or specialist retailers. A more fundamental solution, but the greater challenge, would be to educate and change consumer expectations and behaviours at source. We discussed specific actions industry stakeholders and policy makers should/could do to build adaptive capacity and enable appropriate adaptation responses during the 1 June workshop and at the case study interviews. The results are summarised in the table below:

CC The Sector (supermarkets, suppliers, Policy makers requirement growers etc) Awareness and Awareness of the need to consider Government should continue to work with commitment climate change when making weather the sector, to raise awareness of climate (including related decisions needs to be raised change adaptation (as opposed to resources) through out the sector. This may be mitigation), sustainability and broader facilitated by communicating the potential environmental issues across the sector and impacts in terms of: with the public. • Opportunities • The impact on the bottom line i.e. in X years as a result of not doing the right things now the cost will be Y. Data, models Marketing, supply chain planning and Climate change data needs to be provided and methods distribution tools exist but these do not in an easily digestible format that can be currently support assessment of climate used by businesses both to help develop change effects. Businesses need to be able business cases and communicate sector to understand: where key vulnerabilities specific issues. Global climate change and exposures lie, UK and globally; the information is required. time scales over which problems may

develop; likelihoods; and the potential solutions.

Risk Solutions Page 41 Climate Change Impacts and Adaptation: D5119/Case Study Report - Supermarkets Issue 1 Cross-regional research programme Defra ref: B

CC The Sector (supermarkets, suppliers, Policy makers requirement growers etc) Systems, Current internal structures, processes and The current system of subsidies and structures, systems may not be suitable for structures may not support climate change people and addressing longer-term issues such as adaptation and at worst may present a processes climate change. barrier to it. Climate change considerations should be embedded in routine risk management Where there are opportunities to move the and decision-making processes to ensure, supply chain to the UK (e.g. new varieties among other things, that opportunties to may become increasingly viable) build resilience at marginal cost (win consideration should be given to providing wins) are identified. support structures to fledgling industries at Adaptation responses should be looked at a regional level. in the round. Response to climate change

should be considered alongside the need to adapt the businesses and their supply chains to government energy and transport policies, new planning requirements, building regulations etc. Longer term strategic decision-making needs to consider management of risks along the whole supply chain and needs to take a longer perspective (appreciating that climate is changing and that past weather patterns may not be representative of the future). Assumptions about weather, transport and storage costs etc made when developing, for example, sourcing strategies should be kept under review. Current business case methodologies and decision structures should be re-evaluated to ensure that the impacts of long-term, benefits can be assessed realistically alongside more short term costs and benefits.

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9 Annex A: People interviewed and information sources

Organisation Interviewee and position Date Asda Mike Snell 15 December 2004 Co-op Kevin Barker 11 January 2005 Co-op Becky Toal 11 January 2005 Co-op David Croft 8 February 2005 Asda Paul M. Farrell 22 February 2005 Asda Paul Farrell 22 February 2005 EVS Kate O’Shea 22 February 2005 EVS Keith Hinchcliffe 22 February 2005 IFP Charlotte Faulkingham, Technical Manager 7 May 2005 NFU Jo Hughes, Environmental Specialist 21 June 2005 Institute of Grocery Distribution (www.igd.com) Competition Commission Report into Safeway (2003) Race to the Top (2004)

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