October, 1999

From the Editor

Giant Mistakes

The buzz on Wall Street is that food industry consolidation is “inevitable” – which means it will probably happen. But does it make any sense?

The sense of inevitability is dictated by the food manufacturing industry’s inability to satisfy the stock market’s thirst for increased profits. For all the enormous expenditures on marketing in the food industry, the industry has generally failed in getting people to eat more food. Instead, most of the marketing battles are really market share battles.

But without increased food consumption, big branded product manufacturers are going to fight one another to the last nickel to hold onto market share, so increased profitability has to come from price increases. But the boom in private label has made this a self-defeating strategy even for the most concentrated of retail categories: Boost prices to increase per unit profits and see total unit sales decline as the fixed volume switches to private label products.

Adding impetus to the notion of food producer mergers and acquisitions is the haunting reality of retail consolidation. The Top 10 retailers already account for over 50 percent of U.S. grocery sales. And with predictions that the top five retailers will zoom well past this number in the near future, the expectation is that these behemoths will use their heft to pressure manufacturers into bigger discounts and higher promotional expenditures. The assumption is that only giant manufacturers can stand up to giant retailers.

Finally, many large manufacturers haven’t the foggiest idea of how to boost sales and profits except through mergers and acquisitions. Nowadays, the idea of a “great product innovation” is coming out with a new size of an established product or a new flavored line extension destined to draw 2 percent of the sales of the main item.

These are all reasons for mergers and acquisitions. Particularly, reasons if you are an investment banker looking to do deals. But none of these “reasons” come close to a compelling rationale.

The problem with mergers and acquisitions in the food business is that most of the great efficiencies have already been realized. Within any given product line – coffee, cereals, ketchup, etc. – the food business is highly consolidated right now. So what all this M&A stuff does is to bring together food conglomerates of even greater size.

Yet the truth is that this just doesn’t produce much in the way of efficiency or benefits. A while back the talk was that Best Foods and H.J. Heinz were talking merger. The deal fell apart but may, one day, be revived. Of course, what the advantage is in being a giant in both ketchup (Heinz) and mayonnaise (Best Foods) is a mystery.

There are minor savings – head office, media buying, etc. – but even theoretically it is hard to make a case for substantial benefits to having all these products under one umbrella. And practically, it is even harder to find examples of favorable synergies. Quaker Oats was supposedly going to do great things with Snapple because of the tremendous power of Gatorade. About all they were able to do is lose a tremendous amount of money. Kellogg’s is a mighty company, but being the king of cereal just doesn’t have much to do with selling bagels, and so that acquisition is now being divested. And, of course, everyone in the food business recalls how helpful it was to Borden that it could market both ReaLemon and Cracker Jack. The once proud company restructured itself into oblivion.

In fact, not only don’t these big conglomerates serve any particular purpose in the food business; they regularly destroy fine companies and good brands.

Supermarkets, and particularly, differentiating departments such as deli, make a big mistake by focusing only on operational efficiencies as opposed to merchandising effectiveness. There may be some minor advantage to being able to have all 10 divisions buy from the same supplier, but it is unlikely that these advantages are sufficient to outweigh the loss of merchandising variety and marketing specialization that dealing with smaller suppliers can produce.

Indeed, the growth of retailers in size should create a whole roster of new opportunities for smaller, more specialized, more innovative manufacturers. When retailers were small, they had to depend on giant manufacturers to provide market research and merchandising support. But Wal-Mart doesn’t need manufacturers to do that. Wal-Mart can do it better than most of the manufacturers. With retail consolidations, this is fast becoming true of all the big global retailers that will be dominating the retail food trade.

What these giants need is what giants aren’t good at. New and innovative products, fresh foods that retail competitors don’t have, an ability to be a little ahead of the trend and, most of all, an ability to be different from what that other global retailing behemoth down the block is presenting.

But big food manufacturing conglomerates are big companies just like those retailers, and thus apt to be awful at all this. That’s why it is Starbucks, and not Maxwell House, that convinced Americans that paying $3.50 for a cup of coffee is a great idea.

It is easy for a deli to just buy the biggest name and carry that line. It also is a terrible mistake. The deli is one of the few departments that can really help the giant retailers of today to become different than the competitive store down the street. That can’t happen if everyone carries the exact same brand.  DB