The 1980 founding of Whole Foods Market is as good a point as any to mark the beginning of a major inflection point for the food business. That is, a major trend away from packaged, processed food with scary-sounding artificial ingredients toward fresher, more "natural" foods that have the allure of being healthier.
You see it in a rise in prominence (and profitability) for the periphery of the supermarket, where you find the fresh produce, deli, bakery, sushi bar, butcher counter, takeaway food … and so on.
The rules of the game used to be pretty simple for large food companies: Make massive quantities of tasty and inexpensive (if not particularly nutritious) food products, create memorable brands around them, and use their market clout to get them within arms' reach of the everyday consumer. For my mother's generation the germ-free, safe and convenient access to packaged and processed food was a boon.
All those boxes and cans of stuff in the straight aisles in the middle of the store are increasingly being bypassed. Or when people do visit, they are as likely to pick up Annie's Cheddar Bunnies as they are to buy Pepperidge Farms' Goldfish — even though it's now a General Mills-owned brand, its halo of being healthier has stuck.
Kraft Heinz has tried to escape the dead zone — for instance, with its $200 million 2018 acquisition of "better-for-you" brand Primal Kitchen — but it's still pretty much anchored there.
Big Food — the iconic companies that operate globally and have been a darling of investors like Berkshire Hathaway founder and CEO Warren Buffett — are facing a growing loss of relevance. Kraft Heinz is Exhibit A. In February it wrote the value of its Kraft and Oscar Mayer brands down by $15 billion, posted a $12.6 billion loss, cut its dividend by 36% and announced an SEC investigation. Not a good day. Kraft then replaced its CEO in April.
Replacing a CEO is nothing out of the ordinary in the food sector: The flurry of acquisitions aside, packaged-goods food CEOs are a breed at risk. Some 15 of the largest have been shown the door since 2016. But what happened at Kraft does reveal some specific mistakes made by the company, rather than spell the end of Big Food companies.
3G Capital, the Brazilian-based investment firm that took Kraft private and engineered the merger with Heinz with backing from Buffett has a playbook. Identify a fat-and-happy company with well-known brands. Implement the "3G way," a system that includes zero-based budgeting, transparency about performance and intense competitiveness. Also, get rid of a lot of employees and long-serving managers. Oh, and load up the company with debt. As of 2019, Kraft Heinz was carrying $31 billion in long-term debt.
It works, as company advocates will tell you. Just look at how well they did with beer giant AB InBev (that is where Kraft's new CEO comes from), Restaurant Brands' Burger King and even Kraft in the early days of the acquisition. Critics say the approach creates great margins but underfunds innovation. 3G, they say, hides the lack of innovation by finding more companies to buy with more efficiencies to create. In stable conditions, fair enough. But the practice stops working if the world is changing and you're not investing in keeping up.
As if this wasn't controversial enough, big food brands are also engaged in an epic power struggle with retailers. Consumers have adopted private label and in-store brands with a vengeance. That gives retailers more pricing power. Kirkland Signature, Costco's house brand, is less than 30 years old and sold almost entirely at Costco. Yet Warren Buffett — whose right-hand man Berkshire vice chairman Charlie Munger is a big Costco fan and board member — bemoans that consumers spent 50% more in 2018 on Kirkland products than on all Kraft Heinz products. Worse, power players like Walmart and Costco can credibly threaten to drop Kraft Heinz brands if they aren't happy with the prices offered them, squeezing margins. And that is not even to mention Amazon, which now owns Whole Foods (when Buffett got out of what had been a big, longtime stake in Walmart a few years ago, he cited Amazon).
In fact, the competition from the tech sector is hitting category after category and not just from the behemoths like Amazon. Upstart companies that are "born digital" have pioneered new business models in which brands dispense with retailers altogether. Examples include Harry's and Dollar Shave Club in personal care, Bonobos (recently acquired by Walmart) in men's clothing, and Rent the Runway in fancy clothes, among many dozens of others.
In food, we find meal-kit providers like Blue Apron and Plated and food-delivery companies like FreshDirect. And then we have the intermediaries like Seamless, PostMates, GrubHub and other food-ordering platforms that intermediate between food preparers (like restaurants and take-out places) and customers.
These businesses have had mixed performance as publicly traded stocks, but the larger point is that they are training a generation of consumers to expect to meet their every need with a few taps on a smartphone as well as meet their desires for healthier options. Indeed, a Nielsen report found that 49% of households shopped for consumer packaged-goods products online. Most of these companies are still small, but there are an awful lot of them. And even nibbles out of Kraft Heinz' market share can have a disproportionate impact on a company bearing a big, unforgiving debt burden.
The large food manufacturers were not caught entirely by surprise by these trends, but changing their fundamental business models to ride through the inflection point has proved challenging. For many, acquisitions were part of the answer, including making acquisitions of disruptive companies that had sprung up to capitalize on the trends. While acquisitions should certainly be part of these companies' growth strategies, they shouldn't forget about homegrown innovation.
Transforming a company, particularly one that is already struggling, isn't easy. Warren Buffett said earlier this week on CNBC that he has confidence in the new Kraft Heinz CEO and, if any mistake was made, it was that Berkshire and 3G simply paid too much for the stock.
Kraft Heinz has one big advantage, and it is one that 3G seemed to have forgotten. More than anything else, Kraft Heinz needs to rekindle a passion for innovating to meet customer needs. Its iconic brands may be a tad tired, but they are still beloved by many. Leveraging that affection would be a great place to start.
But it is time to stop it with the nostalgia-as-business-strategy approach. Put your best minds on discovering the next generation of better-for-you-and-the-environment food. Reconsider convenience: Millennials might not open cans of tuna, but they could well buy fresh tuna salad. Use your incredible manufacturing prowess to go from huge volumes of standard stuff to greater variety of niche-oriented products. Digital can really help here. And stop using earplugs when listening to critics — they may be telling you something vitally important.
Your employees might have some telling information to provide, too. Kraft Heinz has come up short as an attractive employer. Unilever, which Kraft Heinz tried to buy in a failed unsolicited takeover attempt in 2017, has a great corporate culture. They were horrified at the very idea of the merger. In a survey of Glassdoor reviews of consumer products companies, Kraft Heinz came out dead last on a number of key measures. Only 29% of its employees said they would recommend it to their friends – that's under a third! Compare that to the same question asked of Nestle (70%) and General Mills (75%).
While Big Food is facing some big problems, successfully surviving the revolution in the ingredients business is possible. Just look at Danone, Unilever and even Pepsi. They have put customer-focused innovation at the very center of their strategies and been rewarded accordingly.
—By Rita McGrath, Columbia Business School professor and director of its Leading Strategic Growth and Change program. Her book, "Seeing Around Corners: How to Spot Inflection Points in Business Before They Happen," will be published in September.