Kraft to cut costs, up brand investment

Kraft to cut costs, up brand investment

Kraft Foods Group, the US$18.7bn North American grocery giant that will emerge when it is formally spun-off from the firm's global snacks business today (1 October), is a powerhouse of brands operating in the world's most profitable grocery market. According to Kraft Foods Group management, going forward the company's mandate is clear: it must improve efficiency and increase investment behind its brands in order to grow sales and beef up shareholder returns. However, Katy Askew suggests, the task awaiting the newly-formed food group could prove quite a challenge.

"Today, I have the honour to introduce a new Kraft, one with the spirit of a start-up and the soul of a powerhouse," the soon-to-be chief executive of Kraft Foods Group Tony Vernon told analysts earlier this month.

Ahead of Kraft Food Group's planned spin-off from Mondelez International, which will retain Kraft's portfolio of international snacks brands, Vernon outlined his vision of the direction that the newly-formed North American grocery business will take.

Kraft Foods Group will be the third-largest food group in North America behind Nestle and PepsiCo. Its portfolio of everyday staples will be made up of brands ranging from Planters nuts to Oscar Mayer meats. Its focus will will be primarily placed on the centre of the grocery store and Kraft has indicated it will target "universal penetration". The majority of the group's sales come from grocery and dairy.

"Our aim is to be North America's best food and beverage company," Vernon insisted.  

A laudable ambition indeed. However, by Vernon's own admission, a number of challenges await Kraft as it looks to remodel itself as a lean, dynamic, forward-thinking, cash generating machine.

Vernon said Kraft needs to address cultural issues, such as its overly bureaucratic decision-making process. He insisted that one of his primary tasks will be to remove layers of inefficiency and foster stronger links between pay and performance.

"You have referred to Kraft as having a post office mentality, rife with bureaucracy and entitlement... There will be no more automatic incremental post office compensation," Vernon pledged in his bid to win investor support. "

On an operational front, Vernon insisted that Kraft must become more efficient and revealed that work was already being undertaken to trim the fat from "bloated" organisational structures, stripping back "layers of inefficiency".

"I want to have the leanest overheads in our industry without sacrificing quality and to be the lowest cost producer in each category," Vernon explained.

Kraft management said the breadth of the group's portfolio - which has frequently been cited as a weakness - will be turned into an advantage.

The firm will "strategically allocate resources" to "best leverage" the breadth of the portfolio, which ranges from peanut butter, to dairy, to coffee and convenience meals. As an example of this strategy in action, Kraft highlighted its recent link-up with sales agency Acosta. This, Kraft said, has expanded in-store merchandising and realigned its incentives to focus on net revenue growth and profit dollars.

According to Nikoleta Panteva, senior analyst at IBISWorld, cost control will be key to growing profits at Kraft.

"Cost control is important, part of which is wage cuts. Automation is the way forward for many manufacturers," Panteva tells just-food.

Likewise, Panteca sees some benefits arising from the link-up with Acosta. "A third party broker could analyze individual markets better than Kraft's in-house team, placing products in the most attractive spaces to minimize costs/losses and maximize profit," she suggests.

However, cutting costs out of the business can only go so far. If Kraft is to generate solid long-term growth the company must re-engage with consumers, addressing the issues surrounding its typically under-invested brands.

According to the assessment of Kraft Foods Group management, for years the North American grocery business has been the workhorse that has funded the group's expansion in emerging markets.

"The choice between focusing on growth in China versus Oscar Mayer, anyone would make that call," Vernon acknowledged.

But, while money was invested in high-growth markets, the firm's domestic business did not receive its share of spending. The result was that Kraft has been left with under invested brands, a marketing spend that lags its peers and a weak product development pipeline, the chief executive-elect conceded.

As the North American grocery business forges out alone, all this looks set to change.

Vernon said Kraft plans to reinvigorate its innovation pipeline, moving from "worst to first" in R&D. He highlighted the steps that Kraft has taken in this direction, such as the introduction of Philadelphia cooking crème and MilkBite milk and granola bars, which, Vernon claimed, have created "new" grocery categories.

However, Vernon was quick to balance this enthusiasm for NPD and emphasised that the company would not bet all its chips on big product launches. "Big bet new products must meet new standards covering purchase intent, margin and sustained profitability."

In addition, Kraft will be ramping up its investment behind established products and brands. And its portfolio of iconic brands, including Philadelphia, Jello, Miracle Whip and Oscar Mayar would seem to offer a good platform for growth.

Kraft's marketing investment has trailed its peers for a number of years. The company spent 2.9% of sales on advertising last year, compared to an industry average of 4.5%. While management stopped short of detailing just how much it plans to spend on advertising, it is evident that the company will look to grow sales of household brands by upping consumer communication. "There is no such thing as a mature brand, just tired marketers," Vernon suggested.

Morningstar analyst Erin Lash concurs that Kraft should be able to grow sales of mature brands by upping its ad spend.

"Although the market is mature, Kraft has shown over the recent past that by investing behind product innovation and marketing support for core brands sales growth can accelerate," she tells just-food. "Kraft competes in a very competitive marketplace both due to other branded players as well as private-label offerings. We have been encouraged that the firm's brand spending appears to be resonating with consumers."

However, as the group increases ad spending it will become increasingly more difficult to grow margins, particularly given the weak consumer sentiment in the US.  This makes Kraft's ability to generate cost savings ever more significant, Lash says.

"If the firm isn't able to generate cost savings, additional brand investments could hinder profits assuming commodity cost pressures fail to subside," she comments. Nevertheless, Lash continues: "Investing in core brands is necessary in this highly competitive environment. What is equally important is making sure those investments are resonating with consumers - so for instance, launching new products isn't necessarily a value-enhancing activity if consumers don't see the value-added in those launches."

Kraft indicated that it will target fast-growing categories, such as nuts and coffee, as well as those driven by demographic factors, such as health and wellness products and hispanic foods.

Turning its weaknesses into opportunities for growth, Kraft Foods Group management has set out a stable of ideas that it hopes will improve its fortunes in the years to come. The mantra of reducing the cost base while investing in innovation and marketing may be familiar. However, it is one that has been neglected at Kraft and a renewed focus on its core brands could reap benefits for the firm.

Click here for just-food's profile of Mondelez International and an analysis of how the global snack group is looking to emerging markets for growth.