Struggling in the golden state

California is generally considered a national trendsetter. It would be wise for retailers in the other 49 states to pay close attention.

Nearly 150 years ago Horace Greeley, the editor of the New York Tribune, was credited with coining the phrase, “go west, young man,” to Americans looking to find their fortune. If he were around today he would likely say, “Go west, but stop before you get to California.”

The nation’s most populous state, with more than 37.6 million people, had been viewed as a land of economic promise from the Gold Rush through the emergence of Silicon Valley. However, in recent years California has been experiencing a number of problems—including high taxes, high unemployment and high home foreclosure rates—that have triggered a fiscal crisis that outpaces the rest of the country.

With an annual deficit estimated at $20 billion to $30 billion, times are certainly tough for California residents. It is no easier for California-based businesses. A recent report by the Tax Foundation claims that the California business tax climate is the third worst in the nation. While some dispute the accuracy of the report, there is no denying that doing business in the Golden State comes with its challenges—and no companies faces more challenges than those in the grocery industry that call the state home.

To be sure, California is still an economic force. Taken alone, the state produces the eighth largest economy in the world and Californians enjoy a higher standard of living than most Americans. But, some say financial issues, as well as union conflicts, congested highways, intense competition and changing ethnic demographics, make it hard to do business in the Golden State.

Taxes take a toll

Taxes and government bureaucracy are at the top of the list. According to Pat Davis, vice president, state government relations for the Washington-based Food Marketing Institute (FMI), this year California owes the federal government an estimated $300 million in unemployment interest alone. Next year that number is expected to be closer to $400 million. In an effort to recoup these payments, he says the state has devised a plan designed to tax businesses on a per employee basis.

“This is a per employee rate,” says Davis. “For every employee hired in California, there is going to be a sizable fee attached. So that is one giant disincentive to hire people. As the grocery industry is one of the biggest employers in the state, this clearly affects it in a negative way.”

In the past, when California had a Republican governor, the grocery industry had a realistic chance to fight this type of legislation. However, now with Democratic Governor Jerry Brown in office—along with a Democratic state assembly and Senate—most industry observers believe one party controlling the state will enable officials to enact the tax increases that they seek. The regulations do not end on at the state level.

“All grocers are struggling with higher taxes,” says Burt P. Flickinger III, managing director for the New York-based Strategic Resource Group. “The industry is overregulated, it has high energy costs, high utility costs, and these rising costs are not only coming from the state capital. They are coming from every county, city and town government as well.”
For example, Los Angeles officials recently passed the Grocery Worker Retention Ordinance. This ordinance requires a company that purchases a grocery store of 15,000 square feet or larger to hire only the predecessor company’s employees within 90 days following the close of a sale. Purchasers are also required to hire all predecessor employees with six months tenure and are only allowed to fire those employees for cause during the 90-day period.

The ordinance was challenged by the California Grocers Association (CGA), which contended that it was pre-empted by the National Labor Relations Act (NLRA). This past July the California Supreme Court upheld the law, ruling the NLRA does not pre-empt the ordinance. The U.S. Supreme Court recently refused to hear the case, thus the law stands.

“Here is a classic example of the grocery industry being targeted while other industries are not,” says Erik Lieberman, regulatory counsel for FMI. “So, yes, it is harder to operate for the grocery industry in California. The industry is in the state’s crosshairs. The law speaks for itself. The state seems to have certainly targeted our industry because we are a large employer.”

Unions wield power

Some observers say this law was a union-driven effort to keep stores unionized in a state that has a strong labor influence. “This does nothing more than discourage a non-union store from building or purchasing in the city,” says Dave Heylen, spokesperson for the Sacramento-based CGA. “When there is a strong labor influence and an economy that is in very bad shape, that makes it very difficult to do business.”

Obviously, union officials have a different view of the power the union wields. “You can go back hundreds of years saying unions have too much power,” says Ron Lind, president of the San Jose, Calif.-based United Food and Commercial Workers Local 5. “Maybe when we represented 40% of the country’s work force we had too much power. Now the problem is whatever power unions have has been mitigated by the weakening of labor laws and [non-union] companies undercutting labor laws. We also have an obligation to weigh in on public policy in regard to grocery sales.”

Another law that many in the grocery industry say was helped along with union support was the ban on purchasing alcohol at self-checkouts. The bill was initially touted to curtail underage drinking and eliminate the sale of alcohol to the visibly intoxicated. On the surface most would agree it seems like a law of this nature makes complete sense. Some say a closer look shows that the law was likely not needed.

FMI’s Davis says that the self-scan alcohol ban is a bad law that could have been easily averted. All that needed to be done, and what was being done by retailers, was assign a store employee to monitor the self-checkout lanes and when alcohol is purchased they would be able to verify age and other issues.

Heylen says state officials told him that they did not see an issue with the self-scanning of alcohol and do not expect to see a significant decrease in underage drinking. So the question becomes, why was the law so important?

Some suggest that there was a hidden agenda by the union in an effort to preserve jobs by eliminating Fresh & Easy stores—which only offer self-checkout lanes—from California.

“This was the third time this particular bill was brought up,” says Heylen. “The two previous times the unions were quite vocal in supporting it. One time it died in committee. The other time, the Governor vetoed it. This third time the unions backed out of being present with the bill but they brought in Mothers Against Drunk Driving (MADD) and law enforcement officials to make it more of an emotional issue and it passed.”

It passed even though most legislators Heylen has spoken with on an individual basis say it was bad legislation. Unfortunately, observers say this has become standard operating procedure in California. In the past, the CGA would be able to oppose legislation and there would not be enough votes to support many bills. Today they have to figure out ways to best work with the situation at hand.

“Sometimes legislators and local elected officials don’t really understand [that retailers operate on thin margins] and costs are passed on to consumers,” says Heylen. “They think they pass these laws and ordinances that will impact businesses and cost is just absorbed.

They either don’t realize or don’t want to make it public that in reality they are increasing the costs for grocers but also for consumers who are going to be forced to pay more.”

Pricing pinch

As prices at grocery increase, consumers are more likely to shop around. And as more and more outlets—not to mention the availability of food and other products often purchased in supermarkets such as diapers, paper goods and OTC medications on the Internet—get into the retail food business, grocers are feeling the pinch.

Predominant, healthy chains such as Raley’s, Fresh & Easy Neighborhood Markets and Save Mart have all been forced to close stores in recent months. Fresh & Easy, owned by British giant Tesco, closed seven California locations in January. Company spokesperson Brendan Wonnacott says there just were not enough sales and customers to warrant keeping the stores open and that the economy has hampered some of the company’s plans, particularly in the Los Angeles area.

In Northern California, Raley’s closed two stores while Save Mart closed one. Raley’s spokesperson John Segale says the Raley’s closings were needed to reduce costs to better compete with heightened competition from non-union retailers that can pay lower wages.

In Save Mart’s case, Steve Junqueiro, president and COO for Save Mart Supermarkets, says the lease ran out on the closed store and because of the economy, keeping it open was no longer viable.

As closings have increased, the state is not seeing many new openings either. “In this economy the opportunity for new stores and expansion are limited,” says Junqueiro. “For us that may actually be good news. We have really taken the opportunity to look at our stores, reinvest in our stores and look at opportunities for conversions to other formats, all in an effort to be relevant to our customers.

“It is so important for us to be relevant with our customers,” he adds. “And the customers’ needs change with the times. We are very focused on that, making sure we provide the value equation that works for them. That’s the only way we will be able to compete and operate in this environment.”

It is an environment that most believe is not going to get better any time soon. While it seems the nation seems to be coming out of the recession, albeit slowly, some in California say the economic strife in the Golden State may get actually get worse.

“I think I read somewhere that California is typically 18 months behind the rest of the country anytime we come out of a recession,” says CGA’s Heylen. “Some people say we are starting to creep up, but we may not have even reached rock bottom yet.”

The coming elections in November will likely be of no help to grocers either. Most expect the Democrats to gain a super majority in the state assembly, which means there would be virtually no way to stop future legislation.

“Unfortunately the laws and regulations always add problems,” says Junqueiro. “We can’t quite seem to get the cooperation and collaboration to help us. In most cases it just seems to hurt our ability to do business.”

Western unions

By nature, the management-employee relationship is adversarial. However, union leaders want to make it clear that they understand that in order to keep its members working, grocers need to be successful.

“There are so many non-union competitors out there, with much lower compensations than our stores,” says Ron Lind, president of the United Food and Commercial Workers Local 5, based in San Jose, Calif. “We have to be open-minded and work with them and try and find ways in which we can compete.”

Lind says much of the grocery industry’s struggles in California can be attributed to an over saturation of stores. And while some may say the unions exert too much influence in California, Lind says getting involved with public policy is really in the best interest for the entire industry.

“How many [retailers] is too many?” he asks. “Does [adding a new store] make sense from a land use or traffic perspective or respect to urban blight? It is no secret we get engaged, along with other community partners to try and stop these big super centers coming into certain areas.”

Lind says that the pitch to city councils that are starved for tax revenue is that the super centers are going to provide jobs and sell groceries at discounted prices. “The reality is there are no taxes on groceries in California so they are not creating more tax revenue. More importantly, for every store a Walmart opens two or three traditional grocery stores close. So all they are doing is replacing good, full-time middle class jobs with benefits with low wage, low benefit part-time jobs, causing a race to the bottom.”

Saturating the deserts

Obesity and food deserts are epidemics in the U.S. The California FreshWorks Fund (CAFWF) is making strides toward eradicating both in the Golden State.

The CAFWF, based in Oakland, Calif., is a $264 million public-private partnership loan fund created to increase access to healthy food in underserved communities, spur economic development that supports healthy communities and inspire innovation in healthy food retailing.

“The fund is modeled after the successful Pennsylvania Fresh Food Financing Initiative,” says Tina Castro, director of impact investing and strategic partnerships for Los Angeles-based The California Endowment, an activist investor in the fund. “We decided to essentially build a similar model in California.”

Since the launch of the fund one store has been opened in City Heights, in San Diego, which is considered a food desert. The operator of the store, Northgate Gonzalez Market, has a series of stores that it is planning, including one in Englewood, California. In February First Lady Michelle Obama showed her support of the project, visiting the site, which is scheduled to open with CAFWF funding.

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