Food industry veteran and advocate Phil Kafarakis is president of the Specialty Food Association, an umbrella organization representing 3,700 innovative, entrepreneurial member companies in the food and beverage industry. The second article in this five-part series can be found here.
“I nsanity: Doing the same thing over and over again and expecting different results.” - Albert Einstein
Every day brings more news of major food conglomerates floundering and frantically reaching to regain their lost followers. In the last few weeks alone, the Wall Street Journal has covered Kraft-Heinz’s inability to grow its own legendary brands; the flailing of Kraft, Campbell’s Soup and J.M. Smucker as they face pressure to innovate healthier meals and snacks; and Nestlé having its worst sales year in 20 years, shining the spotlight on its inability to innovate. It's quite clear that the same problem is plaguing all of these big manufacturers — they are failing to develop and distribute the types of products that consumers want today.
With that in mind. accelerators and incubators will likely be the best weapons for the next crop of Big Food CEOs. As big food companies continue to onboard senior leadership from the outside, the expectation is that these leaders will inspire new thinking and leave legacy practices and processes behind. In this new environment, the evolution of traditional big food company R&D departments could take on unprecedented and radical transformational change.
Currently, these R&D departments function under a centralized, methodical, stage-gate decision-making model focused on testing and retesting, where they’re trying to get the future 99 percent right. What big food R&D departments now need to embody is a decentralized, entrepreneurial, fail-fast-fail-early model. And in doing so, they will send classically trained marketing and product development leaders scurrying to find a place on these innovation teams, because that’s where things will really be cooking!
Taking on a venture capital mindset and leveraging resources normally plowed into traditional R&D to approach innovation in a new way gives an ironic twist to the current Big Food company way of thinking. It requires a process that methodically dedicates resources to an idea that might not make it, and patiently nurture it to a point where it can get into the marketplace to prove itself. Or not. The other alternative is that it jumps into a fast startup scenario by investing in an idea and moving it into the marketplace quickly to determine its viability, albeit the idea has yet to prove its merit.
While the objective is clearly to create a sustainable competitive advantage, either of these unconventional paths will play havoc on any new CEO’s nerves, not to mention test their board’s support and confidence in managing resources. It will not just be about the reallocation of resources; it will be about a tremendous shift in values and cultural mindset, starting with R&D and marketing teams, who are accustomed to owning the innovation process.
With millions and millions of dollars on the line — usually 2 to 3% of net revenue (source: McKinsey & Forbes) being spent on traditional R&D — the pressure to deliver results has never been greater. Several sources have reported over the last decade that approximately 67% of R&D investments made contribute to “maintenance” of a product rather than a breakthrough to something original and truly new. At the same time, about 26% of that investment provides a competitive advantage. The time for disrupting the current approach in R&D labs across big food companies has finally come.
Last year, more than a dozen investments were reportedly made by Big Food brands in either an incubator or accelerator strategy. With separate resources and decentralized teams, Campbell Soup created Acre Venture Partners, a $125 million venture fund investing in food and agtech startups; Kellogg’s funded Eighteen94 Capital with $100 million to take minority stakes in startups; and General Mills has 301 Inc. focused on early-stage startups beyond their core product portfolios.
These signs of old habits changing do come with huge risk, and it does not appear that traditional funding of R&D practices have concurrently gone down. Kellogg still spent $182 million in 2016 on R&D, albeit down from its 2012 levels of $206 million. Campbell also spent more than $100 million in R&D in 2016 and 2017, while General Mills continues to spend approximately $200 million a year, going back to 2011.
Companies that already spend 2 to 3% on traditional R&D won't be able to sustain that plus an additional 2 to 3% on innovation. As historical net profit margins in food processing decline — from an average of 5.2% in 2015 to breakeven and even into the negative range in 2017 — organizations will have to address their ROI given their lost market share and the lower volume and stock values they are producing. The top 10 big processed food brands have lost 4% of market share in the past five years, according to an IRI “Times and Trends” report published in early 2016.
So, what’s a new CEO to do?
“It is during our darkest moments that we must focus to see the light.” - Aristotle
Collaborating with adjacent competitors and other institutions, whether government or academic, is one possible solution to getting ahead of the direct competition. In a couple of unique instances last year, competitors and local governments came together to till a fertile ground for young upstarts to blossom.
While it’s important to experiment with pursuing an incubator or an accelerator path, it will be even more important for CEOs to evaluate whether they currently house the human resource competencies and talents required to support either. Both require degrees of risk that traditional programs have never been able to wrap their minds around, and it seems that the safer bet would be to execute an acquisition strategy while developing and acquiring the talent required — at a time when accretive top-line growth may be secured. The challenge with that path remains the scale, scope and complexity brought by an acquisition.
More of the smaller, consumer-preferred new brands will be driving M&A activity in 2018 and beyond. My bet for the best model to follow is Kellogg’s recent purchase of RXBAR, even as new industry minds come into the food business and figure out how to more effectively increase share of stomach while getting big enough to make a significant difference to EBITDA and P/E ratios over time.
To my mind, and this is critical, throwing millions at innovation is not the solution unless the big companies can figure out what the small entrepreneurs are getting right, and find a way to replicate it at their level. Rather than thinking about permutations of new products, use permutations of market and customer needs and desires as their guideline. In other words, just as with the new entrepreneurs, there has to be a purpose and a raison d’être to what R&D is doing for big food companies. For the small upstarts, this is part art, part passion, and the recognition that so many successful new products have grown out of a particular need. And remember, these fast-growing entrepreneurs got there on a tiny fraction of any big food company’s R&D budget.
Will the big food companies reach that lifeboat in time? It will be interesting to watch, as the food world transforms.