Rooting for the underdogs: Why the little guys are taking over the food industry.

By Jonathan DeVito, Principal | jdevito@pivitasresarch.com

 

Rise of the small firms.

The food industry is poised for change. Once dominated by giant, invincible manufacturers, the landscape is becoming scattered with emerging firms that are absorbing market share. And while the definition of a “small” company may vary, the general industry consensus appears to be that industry growth is skewing towards the bottom end (as in company size, not price or quality) as opposed to the top.

What does the rise of niche firms mean for the future of the food industry? The answer is complex.

On the one hand, small firms benefit for consumer preference for relatable, often story-driven brands. On the other hand, the demand for small brands means that scalability may be inherently limited. This may lead to an industry that looks more like a mosaic: an industry scattered with small brands that collectively control an increasingly big piece of the pie. It remains to be seen whether or not large players can get adapt to this new environment by buying smaller firms or changing their existing product lines.

On top of the onslaught of the little guys, private label is another threat for large, mainstay food brands at retail. This is an interesting development because mainstay food brands are being squeezed at both ends. On the one hand they are losing to small players that have plenty of “soul”, but also are often priced at a premium. On the other hand, share is also being taken by private label players that are often “soul-less”, but can compete at deflated price points.

The following dives into how the food industry is evolving and why. It also provides predictions for the future and strategic recommendations.

 

People don’t like big business.

A recent study found that 80% of Americans distrust large enterprises. It is the polar opposite of small business, a segment that is viewed favorably by 80% of Americans.

This general dynamic appears to apply not just to retail, but the entire food industry. In addition to consumers’ increasing preference for small brands at retail, in foodservice independents tend to be rated higher than chains.

Looking at the b2b landscape, a similar trend exists, albeit for reasons typically unrelated to consumer preference.  Independents often view large suppliers as being untrustworthy and transactional. Historically, this has been due to big brands’ preference for chasing large chain accounts while ignoring the other ~70% of restaurant locations that are comprised by independents. Aside from this, distributor sales representatives tend to enjoy better relationships with independent operators than manufacturer sales representatives, largely owing to the former being more frequently visible.

You have to bring something to the table to win.

A strike against the big guys is that they have simply become too comfortable with their own success. Many firms are living off of legacy brands, underinvesting in product development or reinvention, and attempting to boost profits through operational cost-cutting strategies. In fact, don’t take it from me, you can get it from the horses mouth. Here’s a quote from Keith McLoughlin, past interim President and CEO of Campbell’s, as featured in the firm’s 2018 annual report:

Soup is a great business, and Campbell’s is an iconic brand. However, the business has been over-relied upon to generate earnings, while being under-invested in. In recent years, we pushed the business too hard on pricing and margin. And, we did not do enough to keep our soup products and brands relevant with consumers.

Further compounding problems is that big firms’ legacy brands and products are now consumer staples. This is a nice way of saying they have become commodities that are in desperate need for a facelift. Compared to small brands that give consumers a warm fuzzy feeling, and private labels that provide value, traditional branded products are losing on both ends.

It should also be noted that food retail is arguably more competitive than it has ever been. Combined with retail’s shrinking proportion of the American food spend, it is also experiencing price compression. For the better part of the past decade, food at home inflation has actually trailed overall CPI. In a hyper-competitive environment with deflationary influences, you need to have a stand-out product, have the right marketing, and/or be a price-fighter. You can’t have a legacy product that is both expensive and undifferentiated.

Diversity in the landscape.

One of the key factors at play is that if small sells, growing means potentially losing the appeal of being small. In the banking industry, some businesses are “too big to fail”. In the food industry, some firms may be “too big to win”. The reasons for the limits of scalability in the food industry have three primary dimensions:

Consumers are becoming more apprehensive of “big business” and are shifting their preferences to smaller, more relatable brands. This means that becoming a big firm often comes with the obvious consequence of losing the branding benefits of being small.

→ Many local or regional brands offer products that have appeal for consumers living in their respective locations. Growing beyond a local or regional base may be met with failure due to fundamental differences in customers and the attributes they are seeking.

Niche and/or regional products can quickly outgrow their supply chains, putting strains on the ability to distribute finished products and source the ingredients used to make those products.

The implication of the above factors is that we may be seeing an industry that is continuously fragmented. As opposed to a consolidated market, the new reality might be a sea of smaller suppliers, with few of these suppliers being able to grow large enough to dominate a portion of their respective markets.

Strategic perspectives.

It is important to highlight two points. One is that food is a highly localized business. The insights in this article are high-level, but dynamics may differ dramatically across regional or micro-markets.

The other point to mention is that the dynamics highlighted in this article primarily apply to the United States. International markets may produce entirely new elements. Although some food brands may be lagging in the US, they may be experiencing substantial growth in emerging markets.  Moreover, international markets may not follow a US-type cycle where firms scale only to lose appeal once they become too big for comfort.

With the above in mind, the US does have a disproportionate influence on the global business of food. The US comprises nearly 25% of global GDP and a disproportionate share of sales many major food companies. For example, in 2018, Nestle a truly global player that isn’t US-based, derived almost 28bn CHF from its total 91+bn CHF in global sales (~31% of sales) from the US.

… Now back to the perspectives:

Adapting to the mosaic landscape: Large firms may need to move away from seeking “home run” acquisitions. In a world of limited scalability, the runway for each individual firm may have diminished growth horizons. Limited scalability also means that acquiring firms may need to maintain portfolios comprised of increasing numbers of small firms. While there are firms that have unilaterally disrupted an entire industry (like Chobani becoming the biggest yogurt firm in the US), this is the exception rather than the rule.

Recognizing that small may not be all that bad: One of the reasons behind the rise of private label is lack of brand differentiation. Private labels have essentially picked off categories by replicating features and offering lower prices. It’s a functional play and probably represents the moat surrounding core consumer staples’ businesses has simply begun to dry up. However, holding a broader portfolio of smaller businesses with local appeal may provide points of defensibility that are less subject to price competition.

Resisting MBA-itis: Another factor at play is perhaps more anthropological than business-oriented. Large farms may need to learn to keep their hands off their acquisitions. Specifically, this may entail resisting the temptation to “corporatize” acquisitions and/or reengineer management, thereby killing what made some of what made these smaller firms “innovative” in the first place. This is highlighted by the decline of Kashi once Kellogg’s began to exert increased corporate control over the company in the late 2000s.

Reviving mature categories through product marketing: The unavoidable reality is that many large firms do have substantial amounts of their eggs in a small number of baskets. For example, although Kraft-Heinz has numerous products, 26% of its sales (on a global basis) are still derived from the condiments category. What this means is that many large firms are still going to work with what they have. Products like ketchup, hot dogs, breakfast cereal, and carbonated soft drinks aren’t going to disappear anytime soon despite declines. However, many of these brands can probably benefit from a facelift. In particular, mature brands may be able to leverage nostalgia to gain share and win back the affections of consumers. In some ways, nostalgia or cultural-driven marketing may actually be more important than products’ healthfulness or cleanliness of labels. For example, both Twinkies and Pabst Blue Ribbon have been able to resurrect themselves through brand repositioning. In the former case, nostalgia has been the driver and in the latter case, the hipster-ification of the brand has proven successful. These cases also show that mature brands can still succeed in markets that are facing overall headwinds. For example, Pabst Blue Ribbon has thrived despite demand challenges facing the beer industry.

Recognizing the key differences between foodservice and retail: Suppliers should recognize the key differences in drivers between retail and foodservice. Both channels have vastly different purchase drivers. Marketing may be able to provide more lift in retail than in foodservice. The reason for this is that in retail, consumers interact with the manufacturer’s brand whereas in foodservice, the restaurant’s  brand is the primary focus. Unless a food brand offers notable performance benefits or can help restaurants elevate their own brands, branded products in foodservice stand to lose share to private labels. On top of all of this, the push towards “fresh” may further deflate some branded suppliers’ relevance in foodservice. The reason for this is that “fresh” often implies a move towards scratch cooking, meaning that basic food staples are preferred over value-added products. In short, the amount of wiggle room in foodservice may be contracting.

Final thoughts.

Legacy brands are getting squeezed on both ends. On the one hand, small firms are absorbing market share due to the demand for small, relatable brands. On the other hand, private-labels are taking advantage of established brands’ maturity by picking off market share through price competition.

Players will have to rethink their strategies. This may require charting into unfamiliar and often uncomfortable territory. Perhaps most notably firms may need to start reevaluating the long term viability of their legacy brands while also recognizing that “home run” acquisitions may be harder to find than previously thought.

Yet, being uncomfortable isn’t an excuse to stand still. As the old adage goes, “time and tide wait for no man”. The industry, and consumer demands, and changing, whether we like it or not. Those that are open to adapting to these new realities will have a distinct advantage. And many of those that don’t will inevitably be left behind.

 


About the author:

Jonathan DeVito: Jonathan is a food industry analyst and Principal at PIVITAS. He works with food industry clients to help them make informed product, market, and growth strategy decisions. Jonathan maintains tactical industry expertise by spending weekends picking up restaurant shifts in Chicago.

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