After several years of aggressive cost-cutting and a focus on improving margins, U.S. food companies are back to spending in an effort to reignite growth and compete with crafty, more nimble upstarts.
While executives remain laser-focused on keeping expenses in check, their attention is shifting toward innovating their portfolio through new offerings or building a product's offering within a specific region. They are honing in on how they reach consumers both online and in-store, and investing in or purchasing faster-growing brands that are reflective of changing consumer preferences and consumption habits.
During the annual Consumer Analyst Group of New York conference in Florida last week, top officials from companies including General Mills, Mondelez and Kellogg said cost cutting has left them better positioned to grow their businesses in what is an increasing competitive and challenging environment for legacy CPG manufacturers.
At the same time, there is concern that continuing to focus too much on costs and not growth could leave them in an even more difficult position to compete by weakening their brands' relevance with shoppers — a factor Kraft Heinz exhibited on Friday with a cascade of bad news that sent its stock plunging 28%.
"We’re starting to run the business in a fundamentally different way," Luca Zaramella, Mondelez's CFO, told analysts. "As we continue pivoting to a more growth-oriented model, we will benefit from work over the last few years that has strengthened our base and platform."
Mondelez executives said the company will benefit from strong tailwinds in snacking — an area in which its portfolio of gum, chocolates, biscuits and candy collectively grew 2.8% in 2018, compared with 2.1% a year earlier. But the Chicago-based company will spend more money on growing local brands — like Chips Ahoy in the U.S. and Lacta chocolates in Brazil. Mondelez also plans to increase innovation in globally recognized products like Oreo to boost sales.
Zaramella said at least half of the savings Mondelez generates going forward will be invested back into the business.
"We have compelling margins, a highly efficient cash conversion cycle, and unique and scalable capabilities," he said. "We are now making (a) conscious decision to act on opportunities that will generate growth, including more focus on increasing profit dollar, making investment in higher growth channels where we are underrepresented, and focusing on broader snack adjacencies."
Kraft Heinz starts a trend, then stumbles
Few companies are as iconic to deep cost cutting as Kraft Heinz, the maker of its namesake ketchup, Oscar Mayer cold cuts and Kool-Aid, that is majority owned by Brazilian private-equity firm 3G Capital Partners and Warren Buffett's Berkshire Hathaway.
In the four years since Kraft and Heinz merged, the combined company has cut thousands of jobs, closed plants and wrung out other inefficiencies, giving it the highest profit margins in the U.S. food industry. But it came with a cost. While 3G excelled at the financials, it had less expertise building brands and growing sales, especially in the face of the rapid shift by consumers toward healthier, fresher and natural brands that clashed with many of the offerings in its portfolio.
This was further thrust into the spotlight last week after Kraft Heinz slashed its dividend, issued weak guidance, disclosed an investigation into its procurement accounting policies by the Securities and Exchange Commission and wrote-down the value of its Kraft and Oscar Mayer brands by $15.4 billion.
Erin Lash, a director of consumer equity research at Morningstar, said before the announcements, which were part of the company's latest earnings report, that Kraft Heinz has "impaired their brands ... and they've lost shelf space with leading retailers because they aren't investing sufficient resources behind (them)."
Kraft Heinz said sales rose in 2018 following several years of declines, but it had to spend more to reverse the trend, causing profit margins to suffer and reducing the value of the brands it oversees. David Knopf, the company's CFO, said during Kraft Heinz's earnings call that it may sell some brands that have low profit margins or “no clear path to competitive advantage.” The divestitures and cut to the dividend will improve the company's finances for consolidation that are "necessary and will happen" in the food industry, CEO Bernardo Hees told investors.
"Our industry has been and is likely to remain challenged on several front, continued fragmentation of consumer demand, a general lack of affordability to reinvest in brands, retail competition where assortment is likely to grow in importance and, finally, in the short term, ongoing cost inflation," Hees said. "We could focus on maintaining or expanding margins, but risk forfeiting commercial growth and market share."
Lash and other analysts interviewed at the conference said cuts at the packaged food maker initially spurred its peers to engage in their own bout of cost-savings efforts. Trimming spending — and shoring up business on a company's own terms — also makes the operation less vulnerable to an advantageous buyer seeking to benefit financially from the changes. The practice also was a way to quell uneasy investors who at the time had been pointing to improvements at Kraft Heinz — seen as a new way to run a food business in the current climate.
'Too far, too quick, too deep'
Brittany Weissman, an analyst at Edward Jones, told Food Dive it remains to be see whether the focus on sales growth among big food companies will remain a priority beyond 2019. For now, manufacturers realize there is more to driving profitability than lowering costs if they want to keep themselves competitive with consumers or have any heft to pass a price increase on to retailers without adding some incremental value to the product, she said.
"The companies cut too far, too quick, too deep," Weissman said. "You start seeing pieces of your business start to decline a couple percent and that negates everything you're doing on the cost side of things, so you couldn't hide behind the cost-cutting anymore."
Jeff Harmening, chief executive of General Mills, said his company is optimistic that recent spending on brand building, innovation and expanding distribution — despite challenges in its bar, cereal and yogurt segments — will eventually drive low single digit organic sales growth. For now, organic net sales for its 2019 fiscal year are projected to be flat to up 1%.
"We know that over the long run, sales growth is the single biggest contributor to value creation and it happens to be the lever that's been the most difficult to achieve for our industry and for General Mills in recent years," Harmening said at the investor conference. "While we’re pleased with our progress, we know that there is still work to do."
At Kellogg, the cereal and snack maker has made some "big investments and major changes to get our business back on track," Chris Hood, the president of its North American division, told people attending CAGNY. In some cases, it has required patience. Kellogg, for example, has resisted the temptation to pull back on spending, such as when new packaging creates additional costs or inefficiencies before demand has sufficiently ramped up for the new item.
"The companies cut too far, too quick, too deep. You start seeing pieces of your business start to decline a couple percent and that negates everything you're doing on the cost side of things, so you couldn't hide behind the cost-cutting anymore."
Analyst, Edward Jones,
The Michigan company focused first on its five key snacking brands, which represent 60% of snack sales at retail for Kellogg. It rolled out its first ever national advertising campaign for RXBAR and turned a social media craze where consumers stacking different Pringles flavors together before eating them into a Super Bowl ad with customized digital messaging during the game.
While cereal remains disappointing, it showed some signs of life. Kellogg managed to gain market share for its top six brands by highlighting the wellness attributes of Raisin Bran and Mini-Wheats and the taste and fun aspect of Fruit Loops and Frosted Flakes. With sales slipping 1% to 2% annually, Kellogg still has work to do return to growth in cereal, but the rebound has given executives confidence they are making progress and further overhauls will be equally successful.
Similar to Kraft Heinz and other food companies, Kellogg is pruning its portfolio to jettison slow-growing or under-invested brands. The company announced in November plans to explore a sale of its cookie and fruit snacks businesses, including Keebler and Famous Amos, to focus on the core breakfast, snacks and frozen foods that make up 80% of Kellogg's North American revenue.
"We're confident that our total company portfolio can deliver low-single digit net sales growth over time" after stabilizing a multi-year decline in 2018, Steven Cahillane, Kellogg's CEO, told the audience at the conference. "Now, don't get me wrong. We are not doing a victory lap here today. Nobody is celebrating this type of growth."
Lash said the last few years have shown Big Food that "you cannot cut your way to growth." The growing influence of social media platforms and e-commerce penetration, she said, has leveled the playing field with smaller and mid-size operators who have proven more agile in responding to changing trends and been better at cultivating a more personal relationship with their customers, leaving food companies no choice but to respond.
"It's necessitating that these large established brands really up the ante as it relates to their own brand investments or risk losing out," she said.