A Recipe for Growth in Packaged Foods

Major U.S. food and beverage companies are experiencing anemic volumetric growth, according to The Hartman Group’s analysis of Euromonitor data. It revealed that from 2012 to 2013, more than half of the top 14 branded food and beverage companies grew their U.S. retail revenue slower than 1 percent inflation.

The implications are troubling for those at the helm of food and beverage companies with large exposure to the U.S. retail food market:

• Demand is tapping out for many legacy branded food products, as these businesses can no longer count on population growth as a basic guarantor of top-line growth.
• Innovation from many legacy brands continues to produce short-lived top-line hits, not sustained and/or large accretions.
• Innovation successes (i.e., large first-year hits) are not necessarily making up for volume losses elsewhere.
• Brand portfolios are becoming segregated into decliners, flatliners and a small group of power brands, creating turf struggles over marketing/innovation investments

During three days of sessions at IRI’s recent “Winning the Race to Growth” summit in Orlando, ironically, the mood seemed fairly upbeat, despite the unimpressive performance of the industry. The default assumption at the summit was that the industry’s problems are related to macroeconomics, stale go-to-market strategies and/or inefficient marketing/promotions.

In other words, the reasoning is that everything will be solved when GDP picks up and when companies use better data to plug distribution holes and reach consumers with better targeted digital promotions.

The Hartman Group has a different theory: It’s about the food.

In three days of conferencing, rarely did the subject of product or product design come up as part of the recipe for growth. That’s mystifying, given the relentless double-digit growth of disruptive upmarket food retailers that sell highly differentiated foods curated to a contemporary set of quality criteria. Even the management consultants on hand commented on the market-share growth of small brands.

The biggest long-term challenge facing the U.S. food industry is that taste preferences are changing. This is most apparent among highly urbane and educated consumers, where the arbitrary boundaries of “too sweet” and “too fatty” are altering in ways inimical to the core food science paradigm of the U.S. food and beverage industry.

The U.S. food industry routinely serves crude flavor profiles associated with the unsophisticated farm cuisine of Middle America: heavy on salt, dairy and animal fat and, in the past half century, sugar. Fattiness. Sweetness. Saltiness. These are the primary flavor triggers the American food industry knows how to engineer and incorporate into branded processed foods. And it is very, very good at it. For years, there was growing demand for these flavors in all sorts of foods, primarily because U.S. preferences were not changing.

Now they are. The increasing multiculturalism of the U.S. population plus the globally well-traveled, savvy upper-middle class have created a large population of consumers intentionally seeking complex flavor profiles imported from much more sophisticated food cultures.

In addition, overconsumption of traditional fatty and sweet foods became associated with rapidly rising rates of obesity, heart disease and diabetes. More educated or health-conscious consumers are readjusting their boundaries around fattiness, saltiness and sweetness, especially the latter. Subtle sweetness, targeted saltiness and moderate fattiness are now spreading as the new norm for modern U.S. consumers. While new preferences will not eliminate our desire for the "old stuff," these recalibrations are capping growth in many legacy brands that cannot simply reformulate to the new taste profiles without losing their brand identity (e.g., low-fat, low-sodium Cheetos?).

A perplexing twist is that upmarket consumers are simultaneously driving growth in high-fat-content categories such as olive oil and high-sweetness categories such as honey. The apparent contradiction is part of the complexity of upmarket shifts in food culture. Unprocessed sources of fattiness and sweetness are allowed a backdoor pass. It’s a cultural truth that’s hard for mainstream brands to act on, because these kinds of natural, pure sources of fat and sugar lose their acceptability halo once transformed into heavily processed foods.

The shift from a traditional, all-American diet based on crude flavor profiles to a multicultural one that includes subtle, global flavor profiles is naturally leading consumers to new foods (e.g., Greek yogurt, hummus) and to the emerging brands that herald their arrival.

As U.S. food preferences have changed, large industry players have been slow to react. The tendency is to use marketing, trade promotions, big data and digital media to plug the leaky bucket. But we are confident the industry can catch up with consumers.

Here’s our take on how senior executives should respond:

• Battle big for growth categories, not just for existing category share. Many legacy brands face a much bigger problem than the age of their brand or its “relevancy.” They are competing for share of declining categories in food culture (Hint: Don’t invest in Worcestershire sauce).

Yet, out of a sample of nearly 300 product launches from top food companies followed by The Hartman Group since 2012, less than 1 percent involved food categories introduced recently (i.e., in the past 20 years) to Americans. The inability of major packaged food companies to broaden their view of where to grow in the store continues to benefit their retail partners, innovative supply-chain companies and entrepreneurs.

The situation is even more perplexing when large companies buy emerging brands in these growth categories but fail to develop them.

• Follow the lead of upmarket entrepreneurs. Entrepreneurs have created fast-growing premium segments across the grocery store, because they have higher risk tolerance, are closer to unmet consumer desires at the edges of the market and display far more nimble, scrappy go-to-market strategies to steal share. Natural Products Expo West 2014 broke all records in terms of scale; everyone wants in on the premium food and beverage market. Midmarket grocery chains have staff scouring the country for cool new brands to bring into their stores.

What these small players intuitively understand is that we no longer need to worry about economical calorie supply. The future is about making trends in food based on desire, play and possibility made possible by unprecedented affluence at the upper end of the market.

After five years of focusing almost exclusively on pricing down to boost value perceptions among the disadvantaged end of the market, food executives are just beginning to sense that the upmarket entrepreneurs may have a point: Why not upsell consumers who want to be upsold?

Restructure to allow for upmarket innovation and investments. The majority of packaged food and beverage product launches are low-risk, mainstream extensions not generating more than temporary share grabs. They do not succeed, because they offer little of interest, even to a brand’s heavy buyers. The last decade of top first-year launches in food produced few sustainable businesses, despite their eight-figure runs out of the gate.

This is because, to obtain large first-year success, you must pander to established mass-market preferences with distribution and brand as your primary weapons. The problem is that these mass-market preferences are the same ones your competitor targets, and the demand curve behind them has flattened in food culture (i.e., too many products chasing the same traditional flavors/textures/benefits).

The most successful long-term lines of new business in food in the past 20 years have come from early-stage companies birthed upmarket. However, unless you have a track record of investing in upmarket brands or own legacy brands (e.g., Cheerios) with substantial upmarket consumer purchasing, it can be difficult to tap into this lucrative area.

Investing in upmarket acquisitions and innovations generally requires a separate entity to incent the pursuit of multiple small bets, long-term wins and a different set of consumer demand assumptions than the base.

• Let go of legacy brand bias. Few companies are becoming brand-agnostic enough to “let go” of yesterday’s cash cows and focus a portion of their base profit dollars on investing in huge upside opportunities. The dispassionate gaze of the blended fund manager is one that senior management should adopt rather than the overenthusiasm of today’s brand evangelists. If a brand won’t respond to sensible investments but is otherwise stable, stop overinvesting in it.
• Permit new revenue and margin models for upmarket launches. The dominant revenue models of today’s packaged food companies are not suited to launching, or investing in, the new growth engines (e.g., fast growth, lower initial gross margins). Why? Upmarket product design often involves lower initial gross margins, with profit scaling as the business grows and costs come down on non-traditional ingredients that are essential to differentiation.

The value in upmarket growth engines like these is that, if done well, the profit stream is continuously growing along an S curve of 10 to 15 years (before flattening out) with less marketing investment than required to generate low-single-digit growth in larger cash cow brands.

• Build new supply chains. Tapping into evolving food preferences upmarket cannot avoid radical supply chain issues. Some of the biggest hurdles are getting organizations to aggressively pursue economical sources of super-premium ingredients that often drive the growth of new categories (e.g., hummus, non-GMO).

• Invest in separate consumer demand analytics from base consumer insights. Traditional consumer insights organizations are oriented to defense, not offense: studying core users and brand-switching behavior or identifying slivers of market share to grab for small, often unsuccessful, line extensions.

Years of training reinforce assumptions and habits that will not help drive strategic upmarket investments, a process where default, mass-market assumptions about consumer behavior are unhelpful and misleading.

The key is to develop a talent for studying the edges of the consumer base, the consumers who are most dissatisfied with your current products. These non-customers have underserved needs your organization will not see by studying legacy brand heavy users. Deep, niche ethnography and nuanced analysis of the less measured channels are key components that are systematically underutilized.

Not all of this advice is easy to implement without a strong CEO insisting that the upmarket opportunity be prioritized along with stabilizing the base. Leadership at the top is the most critical tool for catching up with rapid shifts in American food culture.