A quick survey of the exhibit hall for the Food Marketing Institute's (FMI) annual conference and exhibition, which was held in May, shows just how mighty Kraft Foods has become in the U.S. food industry: Its exhibit space literally towers over everyone else's. Kraft's reputation on Wall Street casts a similarly long shadow.Yet things have been unraveling fast for the food industry's finest in recent months due to events both within and beyond Kraft's control. A legal ruling in tobacco litigation against parent Altria Group (the cigarette maker formerly known as Philip Morris Cos.) resulted in credit rating downgrades for Altria and Kraft and significantly raised the latter's borrowing costs. Then two key executives left in July -- Irene Rosenfeld, president of North American Businesses, and Michael Polk, Kraft Foods North America Group (KFNA) vice president as well as president of Biscuits, Snacks and Confections, which include Nabisco. Polk left to become senior vice president of marketing and chief operating officer of Unilever Bestfoods, which is struggling with problems of its own. The next stop for Rosenfeld, who left only nine months into her job, hasn't been disclosed. A week later, another shoe dropped when Kraft reported it missed second-quarter earnings expectations and reduced its sales and earnings outlook for the balance of this year. Suddenly, a company that nearly could do no wrong in the eyes of Wall Street was reeling amid widespread downgrades and harsh appraisals by analysts. Kraft co-CEOs Betsy Holden and Roger Deromedi, who blamed competition from private labels and the failure of some key products for the mess, pledged to spend an extra $200 million on marketing through the end of 2003 to shore up core businesses such as cheese and biscuits.In a July conference call, Holden blamed Kraft's disappointing performance on a host of factors. "We incurred higher promotional spending in certain categories, including cheese, coffee and cold cuts, to narrow price gaps versus private label and price-oriented competitors," she said. "Disappointing results on certain new biscuit items, including Chips Ahoy [Ooey Gooey Warm & Chewy cookies], generated significant product returns [from retailers]. And finally and most significantly, we expected our top-line growth to be stronger and [our] product mix to be more favorable."A "private" problem Inventory de-stocking by retailers, particularly of higher-priced items, as well as a poor worldwide economy also hurt results. Consumers traded down to private labels after Kraft raised prices on cheese and its private-label competitors didn't follow suit.Notwithstanding problems with its Ooey Gooey product, which occurred when original microwave instructions had to be adapted for differing climatic conditions, resulting in cookies with iffy consistency, most products launched by Kraft this year have met or exceeded expectations, Holden said. These include Altoids breath strips, Lunchables Fun Fuel, Uh-Oh Oreos and Kraft Cheese and Cracker Cups. Developing markets also posted a solid 4.8 percent increase in the quarter, one-third of which came from acquisitions, she said. But analysts think that Kraft's problems may be simpler , yet deeper , than Holden and Deromedi describe. "Kraft is first and foremost huge and in a mature industry," says William Leach, analyst with Neuberger Bergman. "Their core categories, which are coffee and cheese, are frankly just one step above commodities. If you look back at the promises they made all through their [2000 initial public offering], it looks ridiculous in hindsight. And they were clearly guilty of cutting their marketing spending to make their earnings. Now they're paying the price for it. They've gone from one of the best in the industry to one of the worst."Several marketing services vendors to Kraft say the company has increased pressure on them to cut costs in the past year. And market research vendors say Kraft even proposed retroactive rebates on services already performed and billed for those wishing to keep Kraft's business. Research vendors shouldn't have been surprised, Kraft spokeswoman Kathy Knuth noted. "It had been previously discussedThey knew this was something that was coming."We have a responsibility to our shareholders," she added, "to have the best services for the least cost.""Over-promised and under-delivered" While squeezing marketing spending has hurt growth, Leach believes that over-promising on the IPO -- notably projected annual earnings increases of 15 percent -- ultimately set up Kraft to fail. "It was the second biggest IPO in history, and they had 16 underwriters," he says. "They just hyped it to death. They over-promised and under-delivered."Plans to spend more to support brands are overdue, Leach says. "But the fact is they're just never going to be a 15 percent grower. In reality, a company like Kraft is really a 2 to 3 percent grower."Tim Ramey, analyst with D.A. Davidson & Co., agrees that Kraft's growth projections have been overstated. At this point, he says, it would be prudent for Kraft to make more realistic projections instead of continuing to spend heavily to meet the old ones."The solution is to be realistic about your expectations and not try to exceed your natural growth rate," Ramey continues. "I know that sounds like heresy. But if you saw the discounted cash flow model on the $200 million [in increased marketing spending] they're going to do for the rest of the year, I bet you wouldn't do it with your own money. You'd think the risk-adjusted returns were just too low."Kraft's biggest problem is that the innovation that helped it rise above much of the industry just isn't there as it had been, says Eric Katzman, analyst with Deutsche Bank Securities. "The basic criticism against Kraft is that it's in commodity-oriented categories, whether it be coffee or cheese or meat, but over the past several years, that was obscured or offset by some pretty impressive innovation," he says. "You can point to Oscar Mayer Lunchables or sliced cheese with added calcium, or the takeover of Starbucks' license in retail coffee. That put competition in a tough spot, meaning Kraft was able to get a premium for those brands and products. Now it appears that the consumer isn't giving those products a premium vs. the competition."Simply tossing money at the problem isn't going to solve it, Katzman says. "The long-term solution is to continue proving to investors and consumers that they have differentiated products that will keep the competition at bay."A lesser problem, Katzman believes, is a lingering integration issue from Kraft's 2000 merger with Nabisco. "I think this warehouse-driven company is having a little more difficulty than it thought dealing with the complexity of the [direct-store delivery] network." "These things have cycles," Katzman says. "The company went through a few years where their innovation was ahead of the competition. And now they seem to be in a trough. But at some point they'll come out of it. It's too big and strong of a company; its management depth is too great for them to remain down forever. How long that takes is the $64,000 question."Sidebar The cookie crumbles? Through no fault of Kraft's own, "issues of protein-based diets, trans fats and so forth have probably put a crimp in the growth of many company categories," says Eric Katzman, analyst with Deutsche Bank Securities. Whatever the reason "shareholders don't care," he continues. "Kraft spent the capital, and [now it has to] lead the category and convince consumers that eating cookies is OK."Just a few weeks before its earnings meltdown, Kraft sought to do just that, unveiling a sweeping anti-obesity initiative that includes smaller portion sizes for snacks and kids' Lunchables meals and increased emphasis on lower-fat, lower-calorie products. The initiatives were well received by consumers, according to an online poll by PlanetFeedback.com. Some 47 percent of respondents indicated that "Kraft is taking a major step and should be applauded." By comparison, only 4 percent believe "Kraft needs to do more."The problem is that getting consumers to eat less isn't necessarily a growth strategy, and leading analysts wonder if Kraft can both combat obesity and hit its 2 to 3 percent volume-growth targets. "It's hard for a lot of people in the United States to eat 3 percent more," Prudential Securities analyst John McMillin noted on the conference call. "You're going to try to grow your volume 2 to 3 percent domestically it's almost gotta make us fat.""I think you need to think about share of stomach," said Kraft CEO Betsy Holden, who noted that despite its size, Kraft accounts for less than 5 percent of U.S. packaged food sales. "So there's a significant opportunity for us to improve share of stomach. And people clearly need to eat, and we provide a lot of products that provide very good nutrition, [just as] we provide a lot of products that provide alternatives, whether it's sugar-free, reduced fat, et cetera."Whether it attempts to trim fat or fatten its wallet, one thing is certain: Kraft has its work cut out for it.