Market volatility alters food industry strategies

by Eric Schroeder
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An increasing number of food and beverage companies are going to market with a message centered on high quality, a direct result of heightened attention on food quality issues, while battling to overcome rising commodity and labor costs. That was the finding of a new survey conducted by Grant Thornton L.L.P., a business advisory organization.

The survey, "2007 Survey of U.S. Food and Beverage Companies," was conducted between November 2006 and January 2007 using an on-line questionnaire and involved 131 food and beverage companies.

In addition to food quality, the survey found most food and beverage companies are aggressively marketing foods to baby boomers and Generations X and Y. Approximately 55% of the companies indicated they were most likely to be impacted positively by process improvements in product development and research and development.

"Driven primarily by competitive pressures, increased market share and profitability challenges, food and beverage companies are frequently looking to R.&D. initiatives to drive growth and manage costs," said Stan Babicz, Grant Thornton’s Midwest region practice leader, R.&D. tax credit services. "From test kitchens and R.&D. laboratories to the plant floor, R.&D. remains an important component of the business plan of successful food and beverage companies. If a company’s strategy is to launch into emerging markets, most new product development activities are the result of a company’s long-term work in R.&D."

Focus on health and wellness

According to the survey, a focus on health and wellness remains a key revenue driver for the food industry. Fifty-four per cent of the companies surveyed said the "better-for-you" category was the food group that offered the most potential for revenue growth, up from 42% in a previous survey, which was conducted in 2005 and included responses from 95 food and beverage companies.

Organic foods were cited by 44% of companies as offering the most potential, up from 15%, while high-end/premium foods (a new category to the survey), was cited by 43%.

The trend toward health and wellness and organics is evident in a variety of new product offerings introduced in recent months, ranging from a cholesterol reducing, fat-free milk introduced this month by The Kroger Co., Cincinnati, to a line of U.S. Department of Agriculture-certified Organic Toaster Pastries from Nature’s Path Foods, Inc., Richmond, B.C., launched in April.

Several companies also have used health claims as a way to capitalize on the wellness trend. Tropicana Products, Inc., a division of Purchase, N.Y.-based PepsiCo, Inc., earlier this year launched the first national orange juice to include omega-3s. Omega-3s fall under the qualified health claim for reduced risk of coronary heart disease.

Energy, fuel prices dampen sales

Although several smaller food and beverage companies were able to post significant sales growth during 2006, the food and beverage industry for the most part felt the impact of rising energy and fuel prices. According to the survey, the industry’s sales growth level topped out at about 10%, a figure it is expected to duplicate again in 2007.

Approximately 88% of the food and beverage companies surveyed said logistics costs rose last year, with 41% claiming costs increased by more than 5%. Sixty-nine per cent of those surveyed expect logistics costs to rise again in the next 12 months, with 17% of those expecting costs to increase by more than 5%.

George Deese, chairman, president and chief executive officer of Flowers Foods, Inc., Thomasville, Ga., in a June 5 conference call discussing first-quarter results, expressed optimism that proper steps were being taken at his company to address the rising logistics costs.

"Strategically, we have been looking at where do we need these locations to cut down on the transportation costs, and you’re beginning to see that," Mr. Deese explained. "One of the huge improvements was relocating our snack operation distribution facility right near our Crossville (Ga.) big volume producing plant. It has really helped out tremendously."

On the energy side of the equation, volatility is reflected in data showing 86% of companies said energy costs rose in 2006, with 50% reporting costs increased by more than 5%. Survey respondents expect to see some relief next year, although 72% said they expect energy costs to rise in the next 12 months. Twenty-six per cent said they expect costs to rise by more than 5%.

According to a July 10 article in The Wall Street Journal, McDonald’s Corp., Oak Brook, Ill., plans to cut its energy use by using a networking system to more efficiently monitor and control operations. McDonald’s, which spends more than $1 billion a year on energy worldwide, hopes the system, developed by Echelon Corp. of Palo Alto, Calif., will reduce kitchen energy use at least 10%, The Wall Street Journal said. Widespread implementation of the system is not expected for several years.

Labor costs again an issue

Like energy and fuel prices, labor costs continue to weigh on food and beverage companies. According to the survey, 71% said labor costs rose last year, with 10% reporting costs increased by more than 5%. An additional 75% expect labor costs to continue to rise in the next 12 months, and a quarter of those companies expect costs to rise by more than 5%.

"Firms with annual sales of less than $10 million spend an average of 24.6% of revenue for the most recent fiscal year — a percentage higher than both medium-size companies (22.5%) and larger firms (13%)," the Grant Thornton survey said. "Of interest is that firms with higher annual sales and those closest to market-leader status were most likely to have higher labor turnover (the high percentage of large firms among market leaders likely affects this data), according to Grant Thorton. At firms with employee training (where employees work in tandem to help devise a better way of completing a task) and empowerment programs, turnover was a median 6.8% versus 10% at firms without such programs. Adoption of employee training did not correlate with lower labor turnover."

Earlier this month, Cott Corp., Toronto, a soft drink provider, merged several roles and integrated business units to reduce costs. The personnel changes are expected to result in a charge of approximately $8 million in the second quarter, but will result in similar savings over a 12-month period.

Likewise, Chicago-based Sara Lee Corp. in March laid off nearly 1,700 employees as part of a reorganization plan to increase business performance. The layoffs took place at the company’s pork processing and FlavoTech spice production plants in West Point, Miss.

Rising costs mean rising prices

In many cases, food and beverage companies have addressed rising costs by implementing higher selling prices, according to the survey. Approximately 71% of companies raised prices in 2006, with 14% increasing prices more than 5%. During the next 12 months, 76% of respondents said they would raise prices, with 12% indicating price hikes of more than 5%.

Although companies with higher sales volumes or market-leader status were deemed less likely to plan large price increases in the coming year, at least a few large companies have taken such steps.

Late last month, Minneapolis-based General Mills, Inc. began shipping new, smaller boxes of Big G cereal. Although smaller in size, the new prices average to a low single-digit increase per ounce. The move will involve one-time costs of approximately $30 million, but is expected to deliver annual costs savings of $20 million once in place.

On July 2, General Mills said higher dairy prices would lead the company to implement a mid single-digit price increase across its Yoplait line of yogurt.

Higher commodity costs have been blamed for most of the price increases, the survey said. More than 85% of respondents said commodity costs rose last year, with 31% indicating costs increased by more than 5%. Approximately three-fourths said commodity costs should rise again in the next 12 months, with 15% expecting an increase of more than 5%.

Dean Foods Co., Dallas, recently lowered its expectations for earnings in fiscal 2007, citing an unusually broad set of challenges across the dairy group portfolio, not the least of which was commodity costs.

"Conventional milk prices have risen rapidly and forecasts for the back half of the year have increased significantly as foreign and domestic market forces have combined to put significant pressure on the U.S. dairy industry," said Gregg Engles, chairman and chief executive officer, Dean Foods. "As a result, it has become increasingly likely that conventional raw milk prices will reach all-time highs by the third quarter."

Steve Lyman, a partner in Grant Thornton’s business advisory service practice, said food and beverage firms "are in danger of being overwhelmed by rising costs with many expecting further increases in the coming year."

"Companies that increase selling prices to cover these costs risk losing market share to companies who are effectively managing them," Mr. Lyman said. "Companies that do not increase prices face eroding profit margins."

A final aspect of the Grant Thornton survey found average spending level for sales and marketing across all companies was 10.8%. However, smaller companies with sales of less than $10 million spent an average of 16.2%, representing the second highest expenditure level, trailing only labor costs. Nearly 73% of smaller companies conduct sales and marketing using in-house resources, the survey found, while nearly 45% of medium-size companies outsource this function and more than 40% of larger companies outsource.

This article can also be found in the digital edition of Food Business News, July 24, 2007, starting on Page 53. Click here to search that archive.

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