Reinventing Big Food

A revolutionary leap in the way people think about, buy, and consume food is forcing Big Food companies to radically transform themselves and their product lines. The largest packaged food manufacturers are undergoing a crisis of lost relevance as consumers switch their preferences to fresher, healthier, and less processed food and snacks. Without change, Big Food companies are facing thinner profit margins and declining market share.

This has all been well documented, and ranges from Nestlé experiencing its worst sales year in two decades to Kraft Heinz’s troubles with rebuilding its own iconic brands, and declining performance at Campbell Soup and Smucker. This is one reason we are seeing so many changes in leadership at these companies. Among the top 10, Coca-Cola recently went through a CEO transition; General Mills’s CEO, as well as Tyson’s, have had a tenure of only five or six years; and Hershey’s, too, is in a state of flux.

As with these recognized market leaders, virtually every other Big Food company is seeking a new path. The emerging crop of CEOs coming in to lead these food companies will need to regain lost market share. And I know from my own 35 years in this world that when faced with turning around the ship, one of the hardest things is to focus on the innovation side of the business.

That said, I believe that Big Food companies can reinvent themselves by effectively aligning themselves with, and riding on, the new market forces. To understand the potential solutions, it is useful to take a quick look back at the business forces that brought us to this point.

The Twinkie era of feeding growth with mass-produced, highly processed food isn’t coming back. Big Food CEOs must now compete in a consumer market that has clearly stated its preference for specialty, local, creative, and non-mass-produced products. And as consumers shifted toward a health and wellness consciousness, Big Food was subjected to tremendous pressure to improve earnings.

We are coming out of a decade of consolidation when Big Food companies—focused on building their brands—felt that to be top of mind for the consumer, they needed to get bigger and stronger. As these large and larger organizations struggled to grow market share, capital firms like 3G Capital stepped in to offer more immediate results through production efficiencies and managed costs.

Changes in the retail environment caused the Big Food companies to rethink their strategy. Over the last five years, they have been living out the philosophy of 3G: being mono-focused on creating value for shareholders and adding efficiency and effectiveness to the mandate to be big and powerful. This phase has been characterized by a need for Big Food companies to financially engineer their earnings. For example, Kraft consolidated, then merged with Mondelez; finally, it split the company because of antitrust pressure.

Distracted by CEO departures and efficiency plays, Big Food had not been paying enough attention to innovation and the massive changes in consumer preferences. Meanwhile, thousands of small brands have been amassing on the horizon, taking over market share. These small players are innovative, passionate about their product, fleet of foot, and totally focused on evolving consumer wants. Indeed, many big brands have acquired innovation by buying up some of these small brands, although, as yet, acquisition does not seem to have been the best strategy for these companies: the culture of the acquirer seems to be sapping the innovative, entrepreneurial spirit out of the acquired company.

As an alternative, big companies have been investing in incubators or forming separate companies within the big companies to accommodate the incubators. Or, as with Chobani, the companies are becoming accelerators, giving capital to small start-ups. Beyond investing in their own brands and business for future growth, the big companies are also guiding emerging entrepreneurs to build and grow new companies.

As I see things, these incubators and accelerators are going to be the best weapons this next crop of food CEOs can use to regain some of their companies’ lost traction. They will also need to leverage technology, particularly because this is the way to get closer to the consumer and the e-commerce environment.

Initiatives to innovate at the big companies come at a hefty cost. Innovation comes in many forms, but for the purposes of this discussion, there are two main types. One is the highly controlled, expensive process that you might find in a pharmaceutical firm. In the food industry, this might mean literally being in the lab, with “lab-grown” tuna (such as Finless Foods) or “clean meat” companies (like Impossible Burger). The other type of innovation—the passion type, if you will—is your neighbour coming up with a tasty vegan cookie that just takes off. Both routes can benefit from incubators and accelerators—and Big Food companies can, too.

So what are incubators and accelerators, and what is the difference?

An incubator is a space for experimentation created by a third party, either an academic institution or a research facility. The incubator offers start-ups a source of funding that includes test kitchens and the ability to leverage technology, so those with an idea have the resources to get their idea started by developing a prototype.

The accelerator develops this idea further, taking the prototype and subjecting it to a specific model to prove it. For example, a start-up could create a baklava ice cream cone in an incubator’s test kitchen. They do some consumer testing of the product and begin to receive feedback. They have researched what kind of equipment would be required to produce these cones, and this helps them formulate a business plan to make their idea into a viable product and brand. The start-up has taken the idea and formulated it; they have left the incubator nest; and now they have gone into an accelerator. Someone with money—perhaps a strategic partner, perhaps a private equity firm—welcomes them in, maybe funding part of their company… and that is the beginning of the start-up’s financial rounds.

As you might imagine, Big Food companies already make hefty investments in research and development—on average, this takes about 2 to 3 per cent of their total budget. The innovation strategies we have been discussing may be at least as important in light of the changing market, and they take about the same 2 to 3 per cent of the budget. It is not too much of a stretch to see that, with thinner and thinner margins, companies already spending 2 to 3 per cent on traditional R&D will not be able to add an additional 2 to 3 per cent for innovation.

Last year, Big Food brands made more than a dozen investments in either an incubator or accelerator strategy. With separate resources and decentralized teams, Campbell Soup created Acre Venture Partners, a US$125 million venture fund investing in food and ag-tech start-ups; Kellogg’s funded Eighteen94 Capital with US$100 million to take minority stakes in start-ups; and General Mills established 301 Inc. to focus on early-stage start-ups beyond General Mills’s core product portfolios.

As net profit margins in food processing decline—from around 5 per cent in 2015 to breakeven and even into the negative range in 2017—big companies will need to address their return on investment in light of their lost market share and the lower volume and stock values they are producing. The top 10 big processed food brands have lost 4 per cent of their market share in the past five years, according to an IRI “Times and Trends” report published in early 2016.

However, throwing millions at innovation and new entrepreneurial paths is not the solution, unless big companies can find a way to reproduce what small entrepreneurs are getting right, at scale. In particular, innovation in Big Food companies, far from being an abstraction, needs to first replicate the passion of the small food specialty companies. Rather than thinking about permutations of new products, they should look at how permutations of market and customer needs reverse back into a product. In other words, establish that new product’s purpose and the need it fills, rather than invent the product and try to match it to a market. This is a radical transformation in thinking for these big companies, who have been accustomed to selling shiny and colourful new food products through massive advertising campaigns.

Just as with start-ups, Big Food companies’ R&D strategies need to have a reason for existing. This is part art, part passion, and an overarching recognition that so many successful new products have grown out of a particular need. And let’s not forget, these fast-growing entrepreneurs got there on a tiny fraction of any Big Food R&D budget.

Independent and specialty food companies have already taken over some 15 per cent of market share across retail and food service. This figure is projected to climb to 20 per cent by 2020. They must be doing something right; isn’t it time that Big Food companies started thinking like them?