Co-manufacturing is a common way of doing business in the US food sector but the practice is less prevalent in Europe. In his debut column for just-food, Jefferies consumer goods analyst Martin Deboo wonders whether interest in co-manufacturing will start to grow among Europe’s food majors.
Two unrelated events, both occurring at the back end of 2016, have contrived to put the hitherto-unheralded activity of ‘co-manufacturing’ under the spotlight.
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The first was in November with Greencore’s GBP750m acquisition of Peacock Foods, the Chicago-based purveyor of frozen breakfast sandwiches, lunch and salad kits to the likes of Kraft Heinz, Tyson Foods and Dole Food Co. Then, in December, came an announcement from Unilever at its annual investor seminar to the effect it is looking to increase the proportion of outsourced manufacture from the current 15% of sales to 25%.
Unilever’s announcement implies something like EUR5bn (US$5.5bn) of potential new business is set to go out of house – a potential pump primer for what has been something of a Cinderella activity outside the US.
But what is ‘co-manufacturing?’ The reference point is the more familiar activity of supplying own-label products to the big retailers. This is now a mature industry in Europe, driven by penetration rates for own label exceeding 50% of the grocery market in some countries. The associated ecosystem is one of focused strategic suppliers (Greencore, Bakkavor), big branded players supplying own label opportunistically (Unilever, Premier Foods plc) and a myriad of smaller players, which often lead a hand-to-mouth existence.
Co-manufacturing, as the Americans would define it, is the parallel activity of undertaking production on an outsourced basis for the big branded players (‘CPG’ in US parlance). Such activity is typically in key categories where the client lacks scale and/or expertise and typically on the basis of a longer-term, more ‘strategic’ relationships. Peacock, the origins of which lie in provisioning for the US Army, counts its key client relationships in the decades.
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By GlobalDataPeacock operates a collaborative, ‘co-investment’ model with these big CPG clients. Typically, Peacock will build and operate the physical facility (it has seven in the US, with 2m sq. ft. of manufacturing space). The customer frequently owns the production equipment. Margins are low (4-5%) reflecting the customer’s economic return being passed back in pricing. But high asset turns mean pre-tax return on capital is around 30%. Nice work if you can get it.
This feels like a different world to the low-returning, precarious existence of the typical, small, own-label supplier in Europe. An existence that reflects what are generally arms-length, fractious relationships with retailers, short-term contracting and marginal cost pricing.
Co-manufacturing makes sense for the customer, too. One critique of the food industry has been it has remained too asset-heavy, for too long. In a world where the likes of Apple manufacture virtually nothing and where industries like automotive thrive on the back of complex, outsourced supply chains, European Food plc/NV/SA/GmBh would appear to be addicted to insourcing. Arguably something of an anomaly when the likes of Unilever tend to define marketing as their core competence and differentiator.
But there are signs that might be changing. We have already highlighted Unilever’s move. Over in Vevey, Nestle highlighted at its investor seminar last year improved returns on invested capital were a priority; a topic that can be expected to be the subject of increased focus under new CEO Ulf Mark Schneider. Both Nestle and Unilever now have ‘ROIC’ writ large as a medium/long-term KPI. Over in the US, the direct influence of 3G Capital on Kraft Heinz and its indirect influence of the rest of the industry can be expected to provide a spur to increasingly judicious ‘make or buy’ decisions.
The economic and strategic logic underpinning ‘make or buy’ is that specialisation should deliver superior cost and quality to what the client can achieve in the chosen category, as a result of economies of scale and learning. The fruits of this can then be shared equitably between customer and contractor. But this is only likely to be achieved in a climate of mutual commitment.
So the question going forward is whether the likes of Unilever can get to where the likes of Ford and VW got to years ago: to start to treat their suppliers as strategic partners, contributing not just dedicated manufacturing capacity but also product development expertise. If they can, then perceived-as-dowdy co-manufacturing is set for a bright future.
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