Costco gets creative to meet shoppers’ huge appetite for organics
by Janet I Tu, published on the Seattle Times, on April 1, 2016
To boost its supply of organic foods, Costco is trying something new: It’s working with farmers to help them buy land and equipment as it struggles to keep pace with customer demand.
At Costco’s recent shareholder meeting, CEO Craig Jelinek touted the vast amounts of food the company sold last year, from 83 million rotisserie chickens to $6.1 billion worth of produce.
As for organics, one of the fastest-growing categories in food sales and one in which Costco has become a major player?
“We cannot get enough organics to stay in business day in and day out,” Jelinek told the gathered investors.
What Costco is doing to build its food supply
Among the initiatives:
• Lending money to farmers to buy land to grow organics
• Raising chickens at its poultry plant in Alabama
• Working with Mexican vendor to get wild shrimp
• Contracting with Nebraskan farmers to raise cattle on organic fields
So to boost its supply, Costco is trying something new: It’s working with farmers to help them buy land and equipment to grow organics.
The effort is still in its infancy. So far, Costco is working with just one partner, loaning money to help San Diego-based Andrew and Williamson Fresh Produce buy equipment and 1,200 acres of land in the Mexican state of Baja California.
But Costco is looking at expanding the initiative. The idea is to ensure a greater supply of organic foods at a time when demand is soaring but supply has not kept up.
While other retailers might have loan programs for suppliers to upgrade equipment or offer financial incentives such as advance payments or long-term contracts, helping farmers buy land to grow organics appears to be unusual in the industry.
The nascent program joins a list of other Costco food initiatives that try to ensure the warehouse giant can meet the voluminous demand of its customers.
The Issaquah-based retailer, for instance, has a poultry plant in Alabama dedicated to raising chickens for the fresh meat and rotisserie chickens it sells.
It started working with a Mexican vendor two years ago to get wild shrimp from the Sea of Cortez, allowing the retailer to diversify from relying on shrimp caught in Thailand, where human trafficking and slave labor in the fishing industry are pervasive.
And in the last year, Costco bought cattle and is contracting with owners of organic fields in Nebraska to have ranchers there raise the livestock to ensure supply for its organic ground-beef program.
“A few years ago, Craig [Jelinek] came to me and said: ‘Fresh food — we need to have sustainable lines of supplies into the future,’ ” said Jeff Lyons, Costco’s senior vice president of fresh foods.
Behind each of the initiatives, Lyons said, are the questions: “What do we see down the road that could be a challenge in terms of supply? And what can we put in place today to grow that particular scarce resource?”
Organic food is one such scarce resource, its supply limited in part because the transition from conventional farming to organic farming takes several years and is costly. Virgin land that is ready to grow organics is scarce or prohibitively expensive.
Demand, meanwhile, has leapt with sales of organic food jumping from $11.13 billion in 2004 to $35.95 billion in 2014, according to the Organic Trade Association, which represents the supply chain from farmers to retailers.
“Demand is increasing. But we’re not seeing the same level of farmland,” said association spokeswoman Angela Jagiello.
While organic-food sales reached nearly 5 percent of total food sales last year, organic farmland makes up only about 1 percent of U.S. farm acreage.
“We’re not seeing the level of growth we need in domestic supply to meet demand,” Jagiello said. “It’s the No. 1 strategic issue facing the industry.”
So stretched is the supply chain that some organic packaged-food companies, such as Nature’s Path and Pacific Foods, have bought their own farms or are raising their own chickens, according to The Wall Street Journal. Restaurant chain Chipotle Mexican Grill, meanwhile, began providing financing to help farmers shift from conventional to organic food, the newspaper reported.
For Costco, the idea of loaning money to longtime supplier Andrew and Williamson Fresh Produce (A&W for short) took shape when Lyons took a tour of A&W’s Baja operations.
The supplier had heard about 1,200 acres of land in San Quintin, Baja California, that seed company Seminis wanted to sell.
The land had lain fallow for years, so it could be used immediately to grow organics, said Ernie Farley, one of A&W’s owners.
A&W, which had experience growing organic strawberries, raspberries, blackberries and tomatoes, told Lyons it wanted to pursue buying the land. The availability of this much land, not to mention that it could grow organics right away, was rare along the Pacific Coast, where acreage is often grabbed by developers.
But money was an issue. A&W didn’t have all the cash on hand it would need to buy the land outright.
And more recently, A&W has been dealing with fallout of a salmonella outbreak linked to cucumbers produced in Baja California and distributed by A&W that infected 888 people in 39 states, hospitalized 191, and resulted in six deaths in four states. (Costco says that outbreak would not have affected cucumbers it sells, since it carries only hothouse cucumbers; the ones linked to the outbreak were field grown.)
Lyons was supportive of A&W’s desire to buy the land, Farley recalls, and said that it made sense strategically for Costco to get involved, given the growing demand for organics and Costco’s desire to attract and retain customers over the next decades.
Costco ended up loaning A&W money to buy the land — neither company would say how much — and the deal is being completed.
Going forward, Costco will have first right to everything that meets its requirements that comes off that land.
In addition, Costco loaned A&W money to buy equipment to grow organic raspberries on another piece of land, also in San Quintin, that A&W is leasing.
“By helping them with financing, we got access to and purchased about 145,000 cases of organic raspberries that we normally would not have access to,” Lyons said. “Because they normally would not have done the deal or could not have done it. Or, if they could have, we may not have gotten first dibs.”
Costco is considering doing something similar with other companies, including a large group with operations in Chile and Mexico.
“There are lots of discussions going on,” Lyons said. “The challenge for the farmer is: ‘We may go down this road and what happens if something bad happens?’ We have to make sure we don’t get them in a position of financial trouble. We need to make sure the loans are totally secure. If it doesn’t work out for them, we want to continue to buy conventional from them to make sure they’re A-OK.”
Part of the reason the supply of organic foods is so limited is that it’s onerous to transition from conventional to organic farming.
“Traditional ag is the way it is because it yields more, which leads to less expensive food,” said Will Rodger, director of policy communications with the American Farm Bureau.
Transitioning to organic farming takes three years — the window set by the U.S. Department of Agriculture for pesticides and other nonorganic substances to wash away from the soil. The switch often also requires new equipment and new processes to grow and manage the crops.
“The difficulty is that in this three-year window, you’re using organic methods but you’re only getting conventional prices for what you’re selling,” Rodger said. “The margins right now are better on organic produce. But you have to take that three-year hit.”
Some natural-food retailers have their own programs to help suppliers or to preserve farmland.
Whole Foods, for instance, has had since 2006 a loan programto help its local producers grow their businesses. About $18 million has been lent so far, for everything from helping farmers buy equipment to building greenhouses and packing facilities, according to the company.
PCC Natural Markets, meanwhile, supports preservation of farmland through PCC Farmland Trust, which the Seattle-based co-op founded in 1999.
The trust is independent of the co-op, though PCC’s annual support for it exceeds $100,000. The trust has worked to conserve more than 1,600 acres of Washington farmland, according to PCC. Some of the crops grown on those lands end up being sold by PCC, but that is not a requirement.
Aside from Whole Foods and now Costco, “it’s very uncustomary in the [food] industry for retailers to provide capital to suppliers,” especially given the industry’s thin margins, said Burt Flickinger III, retail analyst with Strategic Research Group.
And he’s not heard of any that provide loans for land.
Doing so “secures Costco a long-term supply, rather than having that land be developed or have that farmer or food producer be selling to Costco competitors,” Flickinger said. “This way, Costco strategically locks in a long-term, high-quality source of supply which its competitors will not have access to.”
That’s important because Costco has become one of the nation’s biggest sellers of organic food.
Beating Whole Foods?
In 2014, for the first time, conventional retailers such as Costco, Wal-Mart and Kroger bested natural-food retailers, including Whole Foods, in sales of organic foods, according to the Organic Trade Association.
And last year, after Costco said its sales of organic products exceeded $4 billion annually, one investment bank surmised the warehouse giant may have surpassed Whole Foods to become the nation’s largest organic grocer.
Flickinger says that, at the least, Costco is the top seller nationwide of the types of organic foods it carries. Other retailers, though, carry a broader range of products.
Still, Costco’s increased focus on organics is significant and comes at a time when organic food is the fastest-growing food category, increasing at 8 to 11 percent a year, versus 2 to 2.5 percent for food sales overall, he said.
That Costco is working on increasing its supply of organic foods is good news to Letitia Chapman, who was shopping recently for organic fruits and vegetables at Costco in Seattle.
A few months ago, the sales rep from Seattle decided to start eating more organic food as part of a lifestyle change. While the longtime Costco shopper liked the organic produce she found, sometimes Costco simply doesn’t carry enough organics, she said.
“I tend to end up going to Whole Foods,” she said. “If Costco could get more, that would be awesome.”