Innovation on hold

by Josh Sosland
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New product introductions, long thought to be the lifeblood of food company growth, has slowed markedly, Wall Street analysts interviewed last week by Food Business News said.

The analysts applauded the retrenchment … at least for the near term.

"I can’t give you a statistic to corroborate that, but I’ve definitely heard companies put aside some new product development because they don’t expect consumers to be very adventurous in this environment," said Mitchell Pinheiro, an analyst with Janney Montgomery in Philadelphia.

"I think most companies are talking about promoting value as opposed tomix improvement via innovation," said Eric Katzman, an analyst with Deutsche Bank AG, New York. "That makes sense given the current economic environment. Because the consumer is under pressure, they are less willing to try new products with very valuable household dollars. Companies are more risk averse in this kind of environment."

Compounding this aversion has been the notable degree to which consumers have been especially reticent around areas that had been sources of growth and innovation in the recent past, Mr. Katzman said.

"I think if you look back over the last few years, areas where consumers would spend more on new products were categories such as natural, health and wellness and convenience," he said. "You could argue that all three subcategories of the industry have been susceptible to the macroeconomic situation to a large extent. So areas that had been driving growth have been hurt for the moment."

If food companies are reluctant to invest in new product introductions generally, innovations that could be described as dramatically different are even less likely to be rolled out in 2009, said Robert Moskow, a food industry analyst with Credit Suisse, New York.

"Most of these food companies are spending more time talking about cost savings in their presentation and less time on describing the array of new products that is going to drive growth," he said. "I believe packaged food companies are more cautious than ever about high risk projects. They recognize the consumer is less willing to try new things, even at relatively low price points. If I’m a consumer and am trying to save 10% or 20% at the supermarket, one way to do that is to avoid the ‘next new thing.’"

Even food companies with pipelines rich with new products should hold back if they want to maximize the chance a particular new product will succeed, a dicey proposal in any economic environment.

"Unless you had something that was meaningfully innovative and differentiated to introduce, I think you might lose the introductory bang for your buck," Mr. Pinheiro said. "It will cost more to get people to sample it.

"It isn’t as though we are lacking for variety. We have an outrageous number of food products and forms at our disposal. I would probably imagine packaging might be where innovation currently is most focused — value packages with more quantity for the same dollar. Or perhaps thinner carbonated soft drink plastic, which is greener."

Raising the bar still further for new product introductions is an increased focus on stock-keeping unit reductions by leading retailers, Mr. Pinheiro said.

"You will see third and four tier brands and line extension lose shelf space to best-selling products and private label," he said. "That will put a near-term crimp on new products."

He predicted the drought in new product introductions will last as long as consumer confidence remains depressed. That hole is a deep one.

The Consumer Confidence Index stood at 39.2 in April. While up sharply from 23.7 in February, the latter figure was the lowest level since the index was created in 1967. Calculated against a 1985 base of 100, the April figure of 39.2 compared with 62.6 12 months earlier. The April 2008 figure, in turn, was a 26-year low, down from 85.6 in April 2007.

Mr. Moskow warned that while patience may be appropriate given the current state of consumer conservatism, gains in private label pose a meaningful threat to the financial health of branded food companies. Additionally, he said the current decline in new product introductions follows a period during which innovation was not especially impressive.

"The risk on the other side is that if you don’t innovate and differentiate your products, you leave yourself increasingly vulnerable to private label and market share loss," he said. "I think innovation has been weak in food over the last four or five years. The trend has been toward flavor variety instead of true innovation. From an investment perspective, it worries me, definitely. Yes, it’s true that you can still grow 3% to 4% without new products if you’re sharpening your ability to market your existing products. It’s possible. Ultimately, though, branded companies must come up with creative ways to differentiate and keep raising the bar from a technological capabilities standpoint."

Mr. Katzman agreed about the importance of innovation over the long term and expressed optimism that the situation would change.

"I do believe innovation is key over the long term, and companies will go back to innovating along the lines of health, convenience and organic etcetera," he said. "But for the moment those are on the back burner and value side is key. Look at what Frito-Lay is doing as an example — adding 20% more product."

Another way value has emerged as a theme in innovation may be seen in the coffee category.

Mr. Katzman said the Dunkin’ Donuts brand of coffee, marketed at supermarkets by The J.M. Smucker Co., has been "growing at a very rapid rate." Smucker gained the rights to market Dunkin’ Coffee as part of its Folger’s acquisition from Procter & Gamble Co.

Smucker is not the only company looking to parlay a successful food service brand into a supermarket success, Mr. Pinheiro said.

"Starbucks is coming out with their instant coffee," he said. "It isn’t a company I cover, but in most consumers minds the idea of Starbucks and instant coffee are opposites."

Mr. Katzman said that in assessing prospects for success between Starbucks and Dunkin’, at first blush he’d give the nod to Dunkin’.

"It seems to me given the macro environment, the consumer of Dunkin’ is probably more price sensitive than at Starbucks," he said.

Generally speaking, the analysts were hard pressed to identify impressive successes in new products introduced over the past 12 to 18 months.

"Look at Kellogg, which is taking the approach of fewer, bigger and better," Mr. Moskow said. "They were particularly bruised by Cereal Straws, which were aggressively unrolled and did not work out as hoped. It looks as though the company now is trying to go with singles instead of doubles.

"One indicator for what’s going on is looking at McCormick, which is a supplier to these companies. McCormick said new product activity is down, and that has hurt their volume growth."

Kraft Foods Inc. stands out as a company that has enjoyed several successes, Mr. Moskow said.

"They have had more winners than losers," he said "Cakesters, Bagel-fuls and frozen pizza were good successes, pretty unique offerings that seemed to resonate."

As a platform, high-fiber products are an area that has enjoyed good growth, Mr. Moskow said.

"The Fiber One platform has been very successful for General Mills," he said. "The line is based on inulin as a key ingredient, fiber source. Fiber resonates with consumers. They want ways to feel more satiated after they eat. They aren’t using it for regularity. They are using it because they want to feel full."

Mr. Katzman described the Bliss line of The Hershey Co. as a moderate success.

"The Bliss product line has done relatively well," he said. "It is a slightly more indulgent chocolate with a couple different s.k.u.s. I think it’s doing well due to a couple of things. They produce lower priced, mass market chocolate, and the consumer in this economy has been moving from higher end, European style toward more mass market. Also, the Mars-Wrigley combination has resulted in that company becoming a little more internally focused."

While hardly effusive about prospects for the packaged foods industry, Mr. Katzman said 2009 is unfolding better than he had expected.

"Our current bias is to be a little more optimistic," he said. "So far this quarter, which was supposed to be one of the worst, companies are reporting better-than-expected results. They are managing the input environment relatively well. Combined with keeping margins on track, most consumer packaged categories are growing as customers move from out-of-home eating to in home.

"Trade deloading and pantry deloading, which were disruptive late in 2008 and early in 2009, seem to be moving into the background. Given all that, plus the valuations, things seem more optimistic."

This article can also be found in the digital edition of Food Business News, May 26, 2009, starting on Page 1. Click here to search that archive.

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