ECN CoverE&C Commissary News

Editorial Comment — July 2015

We Do Not Believe

Looking at military resale activities solely as retailing operations instead of as part of an overall compensation package is bound to highlight “opportunities” that might noticeably improve their business performance, but the same approach can drastically reduce their ability to fulfill their intended purpose as benefits.

So those familiar with repeated attempts to reinvent military resale and morale, welfare and recreation (MWR) benefits uttered a collective groan when a “confidential draft” executive summary of a work-in-progress review of the commissary system by the Boston Consulting Group (BCG) surfaced last month.

No doubt BCG’s report will be amended and tweaked before being presented to Congress; it is important to note that this summary is only a draft. The glimpse of the report it provides leans heavily upon “we believe” instead of “experience has shown,” and generally offers anecdotal observations in place of the hard data that is expected in a final report. That glimpse is disappointing.

The Pentagon has taken the opportunity to piggyback a quick study resuscitating a favorite topic, consolidation of the three separate military exchange systems — also recommended by the Military Compensation and Retirement Modernization Commission (MCRMC) — upon the Congressionally mandated review of the commissary system.

Not surprisingly, the report recommends “some degree” of eventual four-way consolidation of exchanges and commissaries, involving organization under one “independent” leader of a vast array of complex and highly nuanced military-mission-support retail enterprises and their supply chains. That would be a perilous path for customers’ resale benefits and service branch mission support, on which a misstep or two could plunge the entire conglomeration into an abyss of insolvency and ruin.

First, however, regarding the commissary system, BCG parrots earlier Pentagon proposals to convert the Defense Commissary Agency (DeCA) to a nonappropriated fund (NAF) entity, adding six other actions it labels “win-win opportunities” without specifying who the two sets of winners are. Among these suggestions, BCG proposes that DeCA introduce private label products; reduce cost of goods sold, partly by increasing local sourcing, and goods not for resale; cut capital expenditures; “improve merchandising” and “improve store operations.” These actions, BCG estimates, would reduce the agency’s APF funding by between $335 million and $525 million a year.

The review rejects the at-cost commissary sales model that is partly funded by those dollars, proposing instead that DeCA establish variable pricing, the “framework used by all private sector grocers,” a framework found to be unsuitable for the commissary’s purpose when last examined 11 years ago in a study led by Dove Consulting Group.

Focusing on the system’s constraints, BCG fails to acknowledge how the current model keeps DeCA leaner, already encouraging and relying on extensive private industry participation, thereby alleviating DeCA of a portion of staffing costs. It could be said that the current system offers an optimized form of privatization in well-balanced equilibrium, attested to by multitudes of military shoppers still patronizing commissaries despite force reductions that have considerably reduced the customer base over the past few years.

Congress, wake up and smell the coffee! This whole NAF conversion-variable pricing-privatization construct is a shell game aimed at funding the largest part of patrons’ earned resale benefits by taking money from the military family’s own pocketbooks.

And after all that, the draft concludes that a nominally NAF DeCA will still need “some level of appropriated funding … even if all of these opportunities are secured.”

While conceding that the “complexity” introduced in combining DeCA with the three military exchange systems “would likely exceed any value created,” BCG disregards its own cited research of a few years ago that two-thirds of all mergers “destroy value” and that retail mergers are among the least likely to succeed, finding no difficulty in consolidating the exchange systems themselves, basing its conclusion on the fact that they are “similar.”

The BCG summary fails to make the exchange consolidation case on numerous counts that members of Congress would do well to consider in their deliberations.

Although the summary points to a series of so-called quick wins and efficiencies from merging resale activities, some of them are illusory. The separate exchange operations have little geographic or customer overlap with each other; and commissary assortments differ dramatically from those of exchanges in both type and size, with hardly any items in common. Alone, these two factors make it nearly impossible to derive the perceived cost benefits either from merging or from economies of scale in buying.

Oddly, one very important factor completely ignored in the BCG summary is the exchange systems’ access to credit. Each exchange system is subject to regulatory and credit agency oversight, and a planned merger could reduce the system’s credit rating, causing interest payments to rise dramatically, calling into question any of the system’s economic futures and drastically undercutting its access to favorable credit terms — especially if the system were required to take on the liabilities of other parties.

DoD could also be pressed to fund MWR operations entirely with appropriated funds instead of just partially. One nuance of exchange dividends, which are relied on by all service branches’ MWR organizations, is that they depend on sales reaching a critical mass to cover operating costs and recapitalization before MWR funds can be paid out. If retail is detail, and BCG seems to believe it is, stock assortment categories is one area that does not bear excessive tinkering with. The effect on exchanges of siphoning off key traffic drivers — for instance, beer and wine — to DeCA, would be devastating to the exchanges’ viability, as would diversion of any MWR dividends toward funding DeCA operations.

Although the summary recognizes the branding differences among exchanges, it glosses over the importance of the vertical and horizontal integration of the exchanges within their respective service branch structures and mission support. Each exchange engages in multiple activities outside the normal scope of retail — school lunch programs, lodging, ship’s stores, community services, telecommunications services and other operations. If the goal is to produce the most complicated and risky multi-channel retail entity in the world, BCG is on the right path.

Most importantly, an exchange merger would alter the way exchanges interact with and respond to service branch priorities when it comes to serving troops downrange and afloat. Currently, this is conducted in a way that responds immediately and directly to service branch needs. Under a recommended unified resale command structure that prioritizes things based upon how well they reduce APF funding, disconnection from specific service branch needs is inevitable.

We haven’t tracked down how much DoD spent for the Boston Consulting Group review, or how much it may have allocated for follow-on work, but we do know that the firm doesn’t provide product at Goodwill store prices. We were disappointed therefore that there appears to be little that is new in the work-in-progress circulating at press time — other than its conclusions, which differ considerably from numerous preceding studies on the same topics.

Most of the BCG recommendations we have seen so far have been dusted off from the recycle bin. Dusting them off has not improved them.

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