Is Big Food in Trouble?

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Source: Hartman Group

Author: Dave Donnan,Randy Burt,Laurie Demeritt,David Hokens

The industry’s major players are struggling as smallercompanies gain a competitive edge. Staying on topwill require shifting the focus toward consumers’preference for “real” food.

Small Firms Taking a Bite Out of Market Share

Large food manufacturers are losing the growth game. The top 25 food manufacturersin the United States have ceded 300 basis points to small and medium-size competitorssince 2012 and have grown revenue at 1.8 percent compared with 11 to 15 percent growth forthe smaller companies. US consumers are voting with their wallets to leave the establishedlarge food companies. Changes in consumers’ core values—amplified by social media,celebrity chefs, and a myriad of food experts—are rewarding small and medium-sizecompanies with above-average growth and slowing the growth of the top 25 food andbeverage (F&B) companies (Food and beverage companies with annual revenue of more than $4 billion) .

The top 25 food manufacturers in theUnited States have grown revenue at1.8 percent compared to 11–15 percentgrowth for the smaller companies.

After decades of making food safer, more accessible, and more affordable, some of these largecompanies might not survive in this new “real” food marketplace. Forward-thinking firms willchange direction to recapture lost share and return to a profitable growth trajectory.

Consumers’ Growing Influence on Food

Today’s consumers are more passionate about the food they eat, and their appetites arecreating dynamic shifts in the grocery aisle. Viewpoints and products that once were thedomain of co-ops and local health food stores have gone mainstream. The market has shiftedfrom previous decades’ focus on diet foods to a focus on real food as a way to maintainhealth. Most people now view food—particularly food with benefits—as the key to goodhealth (Shopping for Health study, Organic Life magazine, 2016). More foods are being launched that go beyond basic nutrition to support hearthealth, digestive health, and higher energy levels. Consumers are rewarding retailers that, byinvesting heavily in private-label lines, offer high-value products at lower prices than brandedalternatives. They are embracing free-from segments (non-genetically modified, organic,and gluten-free), which collectively have a projected growth rate at a CAGR of 21 percentover the next five years. Fresh food departments and formats are growing in popularity atthe expense of center store and processed foods. Locally sourced foods with a direct-to-consumermodel are becoming more attractive; the demand for transparency in foodsourcing, production, and labeling is gaining traction; and consumers are discovering novel,foreign ingredients such as quinoa. Figure 1 highlights the trends that are roilingthe branded marketplace.

A 2015 study by The Hartman Group indicates that for the first time, consumers believe theirpurchasing decisions have a much greater impact on society than their voting decisions ortheir involvement in their local community (see figure 2) . (Transparency 2015), The Hartman Group Millennials and Gen Xers—significant consumers for future grocery sales—have especially strong feelings about theimpact of their purchasing decisions.

Figure 1

Changes in core consumer values are impacting the food landscape

Key trends to watch

Trends for awareness

Note: CAGR values are from 2014–2019, except for Functional (2012–2017) and Local (2014–2018).

1.Ken Research;2.Statistaƒ;3.Food Dive, SpecialtyFood Association, Nutrition Business Journal, Food Navigator, Statista;4.Willard Bishop;5.A.T. Kearney

Source: A.T. Kearney analysis

As consumers—led by Millennials and Gen Xers—continue the shift from a traditionalproduction-driven food culture to a more modern demand-driven food culture, they willcontinue to press companies and retailers for more information and accountability abouthow ingredients are sourced and processed, how “real” their food products are, and howresponsive they are to consumers’ desire for choice and customization. This growinginfluence has major ramifications for the future of big food.

Figure 2

Consumers now believe their purchasing decisions have a greater impact on society thantheir voting decisions.

Base: All consumers, 2013 (n=1,842);2015 (n=1,779); Core (n=243); Inner Mid-level (n=552); Outer Mid-level (n=490); Periphery (n=262†); Millennial (n=480);Gen X (n=401); Boomers (n=898).

Source: A.T. Kearney analysis

Big Food: Bigger Issues

As a result of these trends, the top 25 US food manufacturers’ share of US food and beverageretail sales has declined from 66 percent in 2012 to 63 percent in 2015 (Top 25 is based on revenue) . While the overallmarket has grown 3.4 percent, the top 25 have shown a CAGR of only 1.8 percent over the pastthree years. Meanwhile, medium and small companies have driven market growth with 11 to15 percent CAGR from 2012 to 2015 and $14 billion of added revenue, catching up with the bigfood companies that grew their total revenue by $16 billion over the same period (see figure 3) . (Medium-size companies have $1 billion to $ 4 billion in annual revenue; small companies have $ 0.5 to $1 billion.)

Big food companies have beenevaluating strategies, improving theircore businesses to accelerate growth.

In addition to big food’s loss of market share to small and medium-size companies, big-foodearnings growth slowed to 4.8 percent from 2012 to 2015. During this same period, marketcapitalization has grown by 8.1 percent—begging the question of whether current valuationsare sustainable and implying that the large food manufacturers need to step up top-line andearnings growth from current trajectories (see figure 4). For many larger foodcompanies, the declines are coming from their core businesses. With the market betting onfuture growth, big food companies have been evaluating strategies to improve their corebusinesses along with other options to accelerate growth.

Figure 3

Small and midsize companies grew at 11–15 percent CAGR and added $14 billion in revenueover the past three years

Food manufacturer revenue ($ billion), ratio vs. big food by segment(1)

1.Data set consists of 12midsize and 15 small food and non-alcoholic beverage companies.

2.Food processing.com Top lists about 50 midsize companies, indicating about24% coverage in sample.

Sources: Company annual reports and SEC Filings, Foodprocessing.com; A.T.…Kearney analysis

Campaign for Sustainable Growth

Based on industry projections, big food can tap into a $70 billion opportunity in overall F&Bmarket growth over the next three years. Recognizing slow growth in their core businessesand mounting pressure to align their brands with consumer tastes, big food companies needa systematic campaign to rebuild loyalty and win back consumers. They need to rigorouslyevaluate their portfolios, create strategies to reduce costs and enable investment in growthactivities, pursue expansion into trending categories, and participate in joint ventures tonurture potential acquisitions. Recapturing profitable growth will hinge on finding the rightmix of three strategies.

Strategy 1: Take advantage of cost take-out and divesture to enable investmentsin growth activities

In 2008, 3G Capital purchased Anheuser-Busch for $52 billion and used an aggressive approachto remove unnecessary costs. Some of the measures included slashing 1,400 jobs (75 percent ofwhich were at the St. Louis headquarters), replacing existing management with external people,bringing in talent from 3G, implementing zero-based budgeting, and instilling a merit-basedpayment system that rewarded promising young people. The turnaround proved successful:Anheuser-Busch InBev’s EBITDA increased by 31 percent, margins reached 39 percent (whileSAB Miller was at 23 percent), and stock prices shot up by 150 percent. ( EBITDA is earnings before interest, tax, depreciation, and amortization.)

Figure 4

Market cap exceeded earnings growth for the top 25 producers, indicating overvaluationby investors

Food manufacturer EBITDA vs. market cap by segment(1)

1.Does not include currently private companies (Mars, Bimbo Bakeries, Land O’ Lakes, HJ Heinz, Kraft, Smith­ield Foods) included in Top ƒ„25 sample

Sources: Yahoo Finance, annual reports; A.T. Kearney analysis

Venture funds allow F&B companiesto engage with entrepreneurs.

Selected divestitures have enabled big food to refocus capital on promising growth opportunities.ConAgra, for example, divested its private-label business because of stagnant sales, whichhelped consolidate 32 manufacturing facilities, and the company will focus more on higher-marginbusinesses. General Mills divested Green Giant, a frozen and canned vegetable producerout of step with accelerating trends toward fresh foods and produce, and J.M. Smucker divestedcanned milk because of stagnant sales.

Strategy 2: Use controlled acquisitions of smaller, established players and externalventure capital development to add trending categories to a portfolio

Controlled acquisitions could include one or two small public competitors with about $550 millionin 2015 revenue and 7 percent CAGR until 2019, or two to three companies each with $250 millionto $350 million in 2015 revenue and 13 percent CAGR until 2019. Examples include Kraft, HillshireBrands, MOM Brands, Krave Jerky, and Applegate. Alternatively, companies can launch fouror five high-growth products (equivalent to $100 million valued start-up) with potential for100 percent CAGR until 2019. Examples include Soylent, Quinn Popcorn, and WikiFoods.

Early this year, General Mills acquired EPIC Provisions, a two-year-old maker of bars and othersnacks with meat in them. Prior to that, General Mills acquired Annie’s for $820 million toexpand its US natural and organic food category. In addition, the company has a new businessdevelopment and venturing unit called 301 INC to provide capital, knowledge, and expertiseto entrepreneurs and early-stage food companies. Investments have been focused on naturaland organic foods. As a result, General Mills achieved 4.3 percent CAGR from 2011 to 2015,which is significantly above the big-food average. Today, the company has seven organic ornatural brands with net sales that exceeded $570 million in fiscal 2015.

Strategy 3: Create venture funds to invest, seed, and grow nascent brands, products, andtechnologies that could position companies to take advantage of consumer trends with alower entry cost

By creating a venture fund, F&B companies can engage with entrepreneurs whose ideas may betoo risky for acquisition or who are uninterested in giving up complete control of their business.This also allows F&B companies to invest in promising start-ups early on rather than paying a heftyacquisition cost later. One good example is General Mill’s acquisition of Annie’s at a multipleof 27 times EBITDA where the industry norm is between eight and 10 times. Figure 5 shows the keystart-up investments by large F&B companies’ venture funds.

Figure 5

In efforts to create small-company growth prospects, manycompanies are looking to invest in new business models.

• Multiple food and beverage companies have created “venture funds” to invest, seed, and grow nascentbrands, products, and technologies that could take advantage of trends.

• Venture funds provide the opportunity to engage with an entrepreneur whose idea may be too risky foracquisition, or who is uninterested in giving up complete control of his or her business.

Sources: General Mills, Unilever, Coca-Cola;A.T.ŽKearney analysis

Winning with Big Food

Over the past decade, acquisitions have been the primary means by which many F&Bcompanies have attracted and retained consumers and quickly created value for shareholders(see figure 6).

Although many of these acquisitions have driven some top-line growth, they expanded largefood manufacturers’ scale in stagnant categories, not emerging ones. This relentless search forsustainable market-share growth will have winners and losers. Ultimately, the landscape of bigfood will change as there will not be enough large acquisition opportunities to keep investorshappy. To succeed, larger F&B manufacturers need a focused acquisition strategy to expandinto growth categories paired with a more robust internal innovation model.

With a focused strategy, big food canconvince consumers to stay.

Along with M&A-driven growth, larger companies need to build their internal competenciesin two ways. A culture of innovation enables a willingness to take risks and enter newcategories or pursue novel ideas at leadership levels as well as throughout the organization.

Figure 6

Benchmarking accretive impact of acquisitions on earnings per share (EPS)

1.Estimated impact of acquisitions (Krave, Allan, Golden Monkey) is $0.03-0.05­.

2.EPS estimated to increase from 3.32­ (FY 16†) to ­3.†60 (FY 17‡) with accretive value being generated due to the merger

Sources: Broker reports, press releases; A.T. Kearney analysis

Financial forward-thinkinghelps build budgets based on future needs versus historical onesin order to cut unnecessary costs and drive growth along with willingness to sacrifice short-termhigh margins and return on investment to maintain share.

To win in this space, the large established food manufacturers will need to give consumers realreasons to remain loyal. This includes providing innovative products that meet consumers’needs, delivered when and where they shop and with transparency in sourcing, production, andmarketing. With a focused strategy that balances strategic acquisitions and forward-thinkinginvestments, big food can convince consumers to stay.

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