Into the wind

by Keith Nunes
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Food industry executives have resigned themselves to the fact input inflation related to energy, raw materials and ingredients will pressure financial results for the foreseeable future. Addressing the effects of these cost "headwinds" was a common theme throughout many of the presentations at the Consumer Analyst Group of New York annual meeting in Scottsdale, Ariz., Feb. 19-23, with many executives outlining initiatives they have implemented to reduce costs and enhance margins.

"We look at it as being more systemic," Jeff Ettinger, president and chief executive officer of Hormel Foods Corp., Austin, Minn., told Food Business News. "The key driver for us is corn and more recently soy meal, following it up with some questions about acreage. Unlike a single year equation, where corn is being driven by weather or carryover stocks, we see all of the ethanol plants coming on line, and we don’t see any signs of a wavering in terms of national policy as far as subsidizing ethanol facilities, So we feel we need to run our business prudently, and we need to factor that in how our pricing needs to be going forward. We anticipate costs to be at the level we have today."

Taking advantage of pricing is a priority for Flowers Foods, Thomasville, Ga., as well. Between 2005 and 2006 the company saw its costs rise 6%, said Jimmy Woodward, senior vice-president and chief financial officer.

"When you look at ‘06 to ‘07, given the current hedges that we have in place, we’re looking at some 10% cost increases in those items, with things like flour and high-fructose corn syrup being significantly higher," he said. "We’ve taken pricing, and we’ll look for pricing to offset those costs."

Cost headwinds have been a factor for Del Monte Foods Co., San Francisco. During fiscal 2005 and 2006 the company experienced $120 million and $150 million in incremental year-over-year inflationary pressures, respectively.

"These cost pressures are from four major areas, packaging, which is around 25% of our operational cost; logistic synergy and transportation related costs, which is around 15%; (and) the rest is about split evenly between raw materials and related costs, as well as labor, benefits, and other," said Dan Meyers, executive vice-president of administration and chief financial officer, Del Monte. "Looking ahead, post fiscal ‘07, we are seeing both favorable and unfavorable cost trends, which are expected to impact the consumer packaged foods industry.

"We expect that some industry cost trends, including energy and fish, will be favorable. Countering some of these improved industry trends are inflationary trends in corn and meat byproducts, logistics driven by anticipated increases in trucking and rail rates, and tinplate, driven by consolidation and continued global demand for steel."

To offset rising costs, Del Monte has focused on pricing. Between fiscal 2005 and 2006 the company took an average of 200 to 300 basis point pricing.

"We have additional pricing impact in 2007," said Rick Wolford, chairman, president and c.e.o., Del Monte. "That will tend to be more of an impact in the back half of the year and these have achieved their goal of helping mitigate our cost increases. These prices, in our view, are well set in the marketplace … and accepted by our customer."

David Mackay, president and c.e.o. of The Kellogg Co., Battle Creek, Mich., echoed Mr. Wolford’s comments during his presentation.

"In 2006 we saw a big ramp-up in inflation above the norm, nearly $170 million above what we would normally expect to see in a given year," Mr. Mackay said. "Our view as a company is that corn will stay at relatively high levels for the foreseeable future. We think the government’s push to ethanol is one that is potentially right for the country, but it’s certainly one that they’re not going to back off of. And therefore, the price of corn and other grains is going to stay high."

To offset the rising costs and enhance margins, Mr. Mackay outlined two strategies Kellogg is pursuing: geographic expansion and nutrition. Kellogg is pursuing opportunities in high-growth markets where the company currently doesn’t compete, like Central and Eastern Europe, Russia and Asia. The markets are growing across a basket of food products double-digit relative to most of the developed markets, which typically are very low single-digit, he said.

"In health and nutrition, I think when you look at cereal today it still resonates as one of the best ways to start your day for breakfast," Mr. Mackay said. "And as we think about the changing environment in which we compete, what’s going on with the overarching growth in health and wellness, the issues of obesity, there are a number of things that we are looking at and doing.

"A lot of our innovation is skewing toward healthier, more nutritious offerings. Our overarching belief is we will need to offer choice, and we have great choice in the market. But innovations will play a part as we continue to grow and evolve our portfolio going forward."

Managing product mix, supply sources
For General Mills, Inc., Minneapolis, profit growth in 2004 and 2005 was pressured by sharp increases in input costs. The company has continued to see inflationary pressure, but has offset it with new price realization and increased productivity, said Ken Powell, president and chief operating officer.

"In 2006, operating profit growth was slightly faster than sales growth, and through the first half of this year, both sales and profit growth have accelerated in spite of continuing pressure from input and energy costs," Mr. Powell said. "We’re driving this performance with the same strategies we have been following for many years. But we are executing them in new ways.

"For example, spurred by input cost inflation, we are taking a much more comprehensive approach to margin expansion. And we have taken this approach because we believe margin expansion is the only way to support both top-line initiatives and bottom-line profit growth. So our teams are actively using all of the levers in our business model to drive margin expansion."

Managing product sales mix throughout the company’s divisions has become a key part of General Mills’ efforts.

"Innovative value-added new products can be a great contributor to positive sales mix, too," Mr. Powell said. "For example, Betty Crocker Warm Delights are a unique offering in the baking aisle. Consumers are willing to pay more for these convenient, single-serve desserts that are ready after just 3 minutes in the microwave. Every day shelf prices and merchandise prices for Warm Delights are higher than established items in this category."

He added that s.k.u. (stock-keeping unit) rationalization has benefited both sales mix and cost of goods.

"We have held our s.k.u.s to higher standards in recent years and cut slower-turning, less-profitable items," Mr. Powell said. "Across U.S. retail there are similar rationalization efforts under way, and at the same time, we are introducing new products with higher margins than the items eliminated, which drives positive mix and increases our in-store distribution. So we have more distribution with a lower s.k.u. count — that is a profitable combination."

Other efforts under way to control costs and increase margins include efforts to simplify the ingredient lists for some of its snack products. For example, General Mills was using 14 different shaped pretzels in its snack mixes. But when the company surveyed consumers, they found few cared about the different shapes and were more interested in different flavor varieties. The company also reduced the number of pasta shapes included in its Hamburger Helper line for the same reason.

"Simplifying our ingredient list is another way to improve cost of goods," Mr. Powell said. "And we continue to believe global sourcing will be an important component of margin expansion for General Mills. In the future a larger portion of our raw materials will be sourced outside of the U.S. On the ingredient side, we have already found that on products such as fruit purees, nuts and beef, we are able to lower our costs 10% to 25% by looking globally. Packaging materials are another area where we are finding significant savings."

Looking beyond North America for cost reduction opportunities also was discussed by Richard H. Lenny, chairman, president and c.e.o. of The Hershey Co., Hershey, Pa.

"Our products are sourced mainly in the U.S. and Canada with only 6% of our volume produced in other markets," he said. "We are missing out on the cost opportunities that exist outside of the U.S. For example, labor cost versus the U.S. indexes at 10% in Mexico and 5% in Asia. Other inputs can also be sourced more efficiently. Raw material outside the U.S. is available at a 10% discount to U.S. prices. As we focus on over $2.5 billion of cost of goods we see significant opportunity for improvement.

"To unlock these savings, last week we announced a global supply chain transformation project. This will rationalize our current manufacturing network, reducing the number of production lines in the network by over one-third. Low value-added items will be outsourced and low-cost flexible capacity will be added in a new facility in Monterrey, Mexico. We will be implementing this project over the next three years with annualized savings on an ongoing basis of $170 million to $190 million by the year 2010."

The end result of the global transformation project will be a more globally dispersed network with Mexican and Asian production, including China, said Mr. Lenny. The company will outsource manufacturing for products that do not provide it with a unique advantage in the marketplace.

"Labor cost per pound should be down by more than 20%," Mr. Lenny said. "Our capacity utilization should jump by more than 20 points as we realign the network. We anticipate U.S. and Canadian production would still represent over 80% of our volume but outsourced volume and international production will figure more prominently in our plans."

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