Demand for organic food is growing every year, but frozen food specialist Iceland got the cold shoulder from its customers when it tried to go 100% organic last year. The experience offers lessons for all food retailers, not just where organic sales are involved, but also in terms of the essential need to give customers enough choice.

Iceland really went for organics in a big way. In June 2000 the supermarket chain announced a £9m investment designed 'to bring organics to all'. This included £1m to support the National Trust's existing Whole Farm Planning programme promoting a pro-organic approach. The other £8m was for subsidising Iceland's organic food offerings through reduced margins, enabling organic items, which cost around 15%-20% more to produce, to be sold at the same price as ordinary own-label items. As Iceland's then chairman, Malcolm Walker, said of the commitment: 'This is the biggest move in the organic industry so far.'

Iceland was convinced its customers wanted more organic produce on the shelves, but not at inflated prices. 'This is why we're willing to put our money where our mouth is and we are investing to convert major ranges of our own-label food to organic,' Walker said. 'It's our aim to stop organics being a niche market and make it accessible to all income groups.'

So great was Iceland's increased demand for organic supplies that over 80% of its frozen vegetables were to be sourced from overseas, mainly from the US and continental Europe. In fact the supermarket said its buying team had 'secured nearly 40% of the world's organic produce'. They had also set up long-term contracts with suppliers which were intended to 'assist sustainability, by enabling growers to develop new organic acreage in a way which will be commercially viable in the long term'.

This was a brave move into an organic new world order, but one that dramatically failed to deliver.

The City was given an initial hint of problems on 22 January this year when Iceland issued the first in a series of profit warnings; analysts duly cut their profit forecasts for the 15 months to 31 March 2001 from around £135m to £120m. Just over a week later, on 31 January, new chief executive Bill Grimsey, who had only been in charge since 2 January, had to warn of a further severe deterioration in profits. He announced that profit before tax and exceptionals was likely to fall to £62m for the 15-month period, a sum less than half the City's original expectations. In addition, there were likely to be exceptional costs of around £34m.

At the same time the supermarket announced the resignations from the board of both Walker, who had co-founded Iceland 30 years ago, and Andrew Pritchard, the retailer's finance director until early January, when he had moved internally to become managing director of the food retailing business.

The resignations and this latest slump in profits was chilling news for investors, but worse was to come. In March Iceland released its second interim results for the 12 months to 30 December 2000 and the expected outturn to 31 March 2001. Expected profit before tax, amortisation of goodwill and exceptional items for the full 15 months had now slipped by another £22m to just £40m. Meanwhile, exceptional costs to 31 March were now expected to rise to £66m.

What caused the collapse? Bill Hoskins, who took over as Iceland's finance director from Pritchard in early January, having previously worked with Bill Grimsey at DIY retailer Wickes, says that the organic policy was 'not a major part' of the profit before exceptionals shortfall. There were certainly more significant causes, as the retailer's interim accounts detail: higher than expected costs accounted for £33m, lower than anticipated savings from last August's merger with cash-and-carry company Booker accounted for £12m, reduced gross margins accounted for around £23m and accounting policy changes cut profits by a further £2.5m.

However, lower than expected sales accounted for another £10m of the profit shortfall, and the organic policy must take considerable blame for that. Iceland's March comment on its current trading and prospects specifically referred to the 'flawed implementation of the organic food proposition'. Iceland's website expands on the point: 'Sales performance in the second half last year demonstrated that the conversion of complete Iceland own-brand ranges to organic, with no conventional alternative, was not what our customers wanted. We will continue to sell organic products, but will reintroduce non-organic alternatives in those ranges (such as frozen vegetables) which have already been converted.'

Tom Gadsby, a retail analyst at Williams de Broe, says that Iceland's insistence on offering own-label organic produce or nothing at all was 'quite key in the decline in sales - probably the one biggest factor'. He says that Iceland misjudged its customer base. 'Organic is very nice in Islington or Hampstead or Notting Hill, but that's not really where Iceland's customers come from,' he says. 'Iceland have got to keep offering the “value” produce, but where they couldn't offer organic [Iceland own-label] produce, they offered nothing. People began going elsewhere for their entire shop. Iceland leapt on the organic bandwagon without really thinking how this was going to affect the customer base. They weren't really offering the [necessary] choice.'

Although Walker is recognised as being sincere in his support for the organics cause, he led Iceland too far, too fast down the organic path. 'He was massively committed to organics and wanted to persuade Iceland customers that organics were the way forward,' says Simon Wright, founder of The Organic Consultancy, which advises food producers and retailers on organic issues. 'The major mistake Iceland made was that it gave them no choice - it took away the non-organic option - and that wasn't right for the customer base. Other supermarkets offer a choice and then market their organic products, which is a more sophisticated way of persuading people to buy them. The other mistake Iceland made was trying to sell organics for the same price as non-organics. That's not a sustainable policy.'

Apart from the impact on profit before exceptionals, Iceland's commitment to purchasing organic products is to blame for the largest single element - £20m - of the £66m expected total exceptional costs. 'The company has surplus stock of organic vegetables in the supply chain which it needs to clear at reduced prices,' says Hoskins. Despite this immediate profit hit, the damage will still take some time to unwind fully; Iceland expects the cost of its organic contractual commitments, so eagerly announced in June last year, to have an adverse impact on operating profits to the tune of around £8m in 2001/02, £4m in 2002/03 and £2m in 2003/04. 'Iceland is committed to buying some organic vegetables until 2003/04 at prices which are above the normal cost of conventional products,' explains Hoskins.

Despite Iceland's problems, there is growing demand for organic produce. The Soil Association's Organic Food and Farming Report 2000 reported that the total UK retail value of organic food sales grew by 55% to £605m in 1999/2000, up from £390m the year before. Over 65% of UK households made an organic food purchase during the year, compared to 37.2% two years previously. In 1999/2000 the frequency of purchases also rose, by 13%, while the average spend per shopping trip increased by 15%.

Demand for organic produce continues to be fuelled by high-profile food and farming scares. 'At present UK consumers are very concerned about the safety of the non-organic food supply,' says Wright. 'Consumers are looking for ways of trying to avoid the highly-publicised problems. They see organic produce as healthier for them, tastier.'

Interest in organic produce is mirrored by concern about genetically modified (GM) food, and most supermarkets, including Iceland, have responded by taking a strong GM-free approach (see panel). Although Iceland is modifying its organic policy, it remains committed to selling food free of GM ingredients and artificial colours and flavours.

The growth in demand for organic and GM-free items clearly does create opportunities for supermarkets. At Sainsbury's, for example, sales of organic foods have increased 40-fold since 1996 and now run at over £3m a week. However, organic items remain a tiny percentage (no more than around 3%) of total UK food sales. 'It's important that supermarkets should have it [organic food] as part of their offering, but we don't regard it as particularly key and we don't strip out what percentage of their sales are organic,' says Gadsby.

Iceland's organic offer is officially still under review, but the supermarket is publicly optimistic that it will get profits back on track. Hoskins says: 'We are confident of the fundamental strength of the Iceland and Booker brands, and the advantages we can derive from our unique mix of businesses…Together these provide us with a strong platform for the creation of shareholder value in the years ahead.

Asda began offering organic foods in September 1999 with a fairly limited range of mostly branded products. However, in February 2000 it launched its own-label organic range. The retailer now offers 400 products (branded and own-label) from all its stores.

Asda believes it was one of the first supermarkets to start talking to suppliers about avoiding GM foodstuffs. None of its own-label items now contain any GM ingredients.

Safeway was the first major supermarket to introduce an organic food range, Organics, in 1981. The supermarket now offers a total of 500 organic lines, across a wide range of categories.

Safeway's own-brand products have been reformulated to contain only non-GM soya and maize ingredients and derivatives. The supermarket says its aim is 'to offer poultry, pork, lamb, beef, eggs and dairy products originating from animals reared on non-GM animal feed as soon as possible'.

Sainsbury's started selling organic food in 1986 and now offers over 1,000 organic products from 100 UK-based suppliers, which source products from the UK and overseas. Sainsbury's was the first supermarket in the UK to have an own-label organic baby food range.

Sainsbury's eliminated GM ingredients from all its own-label foods in July 1999. Since then it has been addressing animal feed, and now offers five products from animals fed on a non-GM diet - free-range chicken, eggs, a pork range, outdoor real bacon and traditional beef.

Tesco's policy is to extend its organic range to such a degree that customers will always have the choice between conventional or organic. In September 2000 the range was extended from 500 to 800 items.

Tesco claims to be GM-free, with the exception of animal feed. However, the supermarket wrote to suppliers in January and asked them to start sourcing GM-free animal feed. Tesco aims to be completely GM-free in all products, including animal feed, by June.