FMCG

by Greg Thain

  2006

  Kellogg celebrated its centenary year with a 7% sales increase (both reported and internal) to reach $10.9 billion. Unfortunately, operating profit lagged behind, with a 4% internal growth and a measly 1% reported. This knocked an entire percentage point off the operating profit margin, down to 16.2% - energy, commodity and marketing costs being the causes. With the exception of Asia-Pacific – flat once again – the rest of the business performed well.

  The North American Retail Snacks unit was once again the powerhouse of growth. It increased internal sales by 11%. The leaders were Special K Bars, which benefited from new variants, and Go-Tarts, introduced as an on-the-go version of Pop-Tarts. In fruit snacks, a category the company had entered only three years previously, Kellogg had built a 30% market share; and both the cookie and cracker businesses grew, thanks mostly to innovation. The Frozen and Speciality Channels business grew to reach $500 million in sales.

  Here, the most notable innovations were the extension of the Kashi cereal brand into frozen entrées and the launch of Eggo Pancakes. The North American cereal business posted a 3% growth and a 0.2% share gain, with many new products launched. The most interesting was Smart Start Healthy Start, a brand with strong cholesterol- and blood pressure-lowering claims; and the introduction of organic versions of Rice Krispies, Raisin Bran and Frosted Mini-Wheats. One benefit of having some very strong cereal businesses overseas was demonstrated with the running across several countries of a “Pirates of the Caribbean” promotion. The high costs could be amortised across markets.

  Elsewhere, the European region, under the most competitive pressure from CPW, returned to sales and market share growth, driven by Kellogg’s two largest businesses, the UK and France. The Turkish market was targeted, with the formation of a joint venture with a Turkish company to sell co-branded products. A multi-year project was initiated, to reconfigure the company’s European manufacturing infrastructure with the goal of making better use of its biggest and most efficient plant in Manchester. Kellogg also was the first company to introduce nutritional labelling on the front of the packages in most European countries. The momentum in Latin American cereals and snacks continued, with a further 8% growth. The troubled Asia-Pacific unit declined slightly, mostly because of problems in Australia, the size of which dominated the performance of the region.

  2007

  The new strategy implemented in 2000 was continuing to pay off. The company recorded its seventh consecutive year of sales growth, up another 8% on a reported basis to $11.8 billion. But stripping out the currency exchange effects reduced that rate to 5.4%. This broke down into a somewhat sluggish 2.1% volume increase, with another 3.3% coming from pricing and positive mix changes – nice if you can get them and make them stick, but not as dependable as organic growth. To be fair, the company had kept on increasing its advertising, breaking the $1 billion barrier for the first time. More worrying was promotional expenditures, which was a mostly price-related activity. That had by now crept up to nearly 30% of sales – a key factor, along with energy and commodity cost increases, for the operating margin to decline again. The latter was down to 15.9%, despite the more than healthy price increases taken during the year.

  Within the divisions, North America grew internally by 5.5%, of which more than two-thirds came from price/mix. Cereals grew by 3%, helped by the usual slew of new products - plus the venerable Rice Krispies brand was kick-started back into life with new lines and a ‘Childhood is calling’ themed advertising campaign. All-Bran and Kashi also had good years. The Snacks business continued to outperform cereals, posting a 7% increase. This was not least due to the competitive edge provided by the DSD system, which was rated the best in the snack industry by the Advantage Group Performance Monitor. In the Frozen sector, the Kashi brand was extended further into waffles and pizza.

  On the international front, a headline sales increase of 12% was predominantly due to currency movements. The underlying growth rate was 5%, with Latin America, as usual, leading the way. It grew by nearly 9%, of which two-thirds was due to volume increases. The Mexican business exceeded Australia to become the company’s third-largest operating unit behind the US and the UK, helped by introductions such as All-Bran drinks. Europe was still chugging along, driven by high single-digit increases in Spain and Italy and cereal share gains in the UK and Ireland. The Turkish joint venture was off to a flying start, increasing Kellogg’s market share from 2% to 22% in just two years. The Asia-Pacific market continued to be sluggish, reflecting too great a dependence on the Australian and New Zealand markets. There a poor year more than wiped out the benefits of growth in markets such as Korea and Japan, where the company launched its wholesome snacks brands.

  The fact was that Kellogg was getting virtually nothing out of the emerging markets boom in that region; the entire Asia-Pacific region was contributing only 5% of company sales and even less in operating profit. Something had to be done. Company acquisitions were still mostly small-scale and North American. Bear Naked, Inc. – a premium granola company – and the Wholesome and Hearty Foods Company – an American vegetarian food manufacturer – were both purchased in the year. Not before time, the company’s eye was turning towards emerging markets to look for acquisitions.

  A very significant announcement was a global commitment to adjusting how and what the company would market to children under the age of 12. Kellogg had established a global nutrition standard (Nutrient Criteria), which would be applied to all the products marketed to children worldwide. Products that failed the criteria would either be reformulated to comply, or not marketed to children. This was a reflection of the pressure that had been building for some years on companies involved in children’s food categories. The days of launching brands like Sugar Smacks and advertising them with popular cartoon characters were long gone.

  2008

  Everything was looking rosy, with a 9% reported sales increase in a year when the economic crisis was beginning to bite. In fact the going was getting tougher for the company. Of the 9% sales increase, less than 1% came from actual volume growth. Prices had been ramped up, adding 4.5%. Acquisitions added another 1.8%, and a 53-week accounting year chipped in another 1.7%. Ever-increasing cost pressures drove the company margin down even further to 15.2%, not least to promotional expenditures. These now represented a staggering 40% of 2008 net sales. Most if not all of the list price increases was dealt back, as retailers refused to contemplate pushing up in-store prices while their shoppers were feeling the squeeze. Even the Latin American growth machine hit the buffers, with volumes down nearly 3% as prices were pushed up by nearly 7%. It was only a somewhat belated return to growth in the Asia-Pacific region that kept the company in positive growth territory.

  Looking to the future, the company made three significant acquisitions in its Asia-Pacific region. In Russia, OJSC Kreker (United Bakers), a manufacturer of commodity cookies, crackers and cereal was acquired; not for its brands but for its six manufacturing facilities and broad distribution network. In China, the company purchased a majority interest in Zhenghang Food Company Ltd (‘Navigable Foods’), a manufacturer and distributor of cookies and crackers in the northern and northeast regions of China. Kellogg also bought out one of its longstanding contract manufacturers of crackers, cookies and frozen-dough products in Australia. After these acquisitions, the company now had 32,000 employees and 59 manufacturing facilities in nineteen countries, servicing 180 countries where over 1,500 products were distributed.

  2009

  In 2009, there was no disguising. All was not well on Planet Kellogg. The company reported a 2% decline in sales. Even the internal growth figure of 3% was more than made up of price increases, as opposed to actual volume growth. Global volume declined by 0.7% and only moved forwards in the Latin American region. On the plus side, operating profit increased by 10% owing to a series of cost savings and productivity initiatives. The latest was the company’s ‘K-LEAN’ (Lean, Efficient, Agile, Network) assault on
its manufacturing complexity. Undoubtedly, the global economic slowdown had affected sales performance, but cereal and snacks were two of the most recession-resilient categories, and both were still growing globally. Two-thirds of the company’s net sales still came from North America, where a modest cereal volume increase was achieved. Snacks’ volumes, previously a big driver of growth for the company, were static. The Frozen and Speciality Channels division declined, as it operated in sectors and channels hit harder by the slowdown.

  The company was still doing good things in building for the future. Its main R & D facility, the WK Kellogg Institute for Food and Nutrition Research, was expanded to enable more rapid prototyping across simultaneous project streams. It also continued to invest in an open innovation programme. Media spend was maintained at over $1 billion, in the face of media cost deflation to increase the number of consumer impressions. Advertising and research agencies were consolidated and aligned. Based on a global research study, which showed that adult females shared much the same concerns across different cultures, the Special K ‘Moments of Truth’ marketing campaign was rolled out globally. This grew the brand in the high double digits. The company was also getting into digital marketing, with many individual brands together with Kelloggnutrition.com. More products, including fruit snacks and Kashi crackers, were added to the DSD system. There was also a lot of brand renovation, following the twin tracks of reducing the ‘bad’ ingredients such as sugar, sodium and fat, together with increasing the ‘good’ ingredient. Fibre was added to Froot Loops and Apple Jacks. Clearly, the company was responding to perceived consumer concerns, but a lot of this activity was more good housekeeping than driving growth.

  2010

  Another sales decline, of 0.6%, was the result of a tonnage volume decline globally of 2.1%. The situation could no longer be remedied by price increases. In fact, there was price deflation in the cereal category in both North America and Europe, as retailers and consumers alike rebelled at prices continually being pushed ahead when real incomes were static at best. A new CEO – John A. Bryant – perhaps helped the soul-searching process as to what was going wrong. Four key factors were identified:

  · The old model of innovation and advertising had come unglued somewhat. There had not been enough innovation. All the renovation efforts to improve the nutritional profiles of the core brands had come at the expense of the level of innovation required in tough economic times. Putting more fibre into Froot Loops was a fine, noble and necessary thing, but, in tough times, not many more consumers were going to put their hands in their pockets as a result. The innovation pipeline needed to be refilled, and fast.

  · It was not a good year for the VP Manufacturing in North America. The company experienced major supply issues on waffles and then had to institute a product recall, the second largest in the company’s history, across some key cereal brands. This was thanks to an odour problem with the package inner liners. The cost of the recall itself was nearly $50 million. The consequential losses were greater, because the recall disrupted the important back-to-school promotions for products unaffected by the odour problem.

  · The company was losing share in cereals in too many markets. Although a shortage of innovation was fingered as the culprit, the fact was it had been quite a while since the R&D department had come up with a game-changer. The combination of insufficient innovation and the recall resulted in a 5% decline in the North American cereals business, the company’s single largest division. The European cereals did little better.

  · While price deflation was a reason for Kellogg’s lack of top-line growth, it was something of a disingenuous excuse. The company had been propping up the top-line with above-inflation price increases for a few years and, while it had had to deal with some major cost increases, it had perhaps turned to price increases too readily. Nor had it been early enough and aggressive enough with cost savings.

  Just to add to Kellogg’s woes, it admitted that it was going to have to re-implement SAP at an additional cost of $70 million. It also took a big write-down on a Chinese factory it had opened a few years previously - business had failed to take off as hoped. The new CEO did what new CEOs do, and reorganised the business segments into the following:

  · US Morning Foods Kellogg’s cereals, Kashi, Pop-Tarts, Health & Wellness products)

  · US Snacks (Cookies, crackers, fruit snacks, cereal bars)

  · US Speciality (Foodservice and speciality outlets)

  · North America Other (US Frozen and Canada).

  The overseas divisions remained unchanged. On the principle that it’s never a good thing to work in a business unit with the name ‘Other’, it would not be surprising to see Kellogg sell its frozen foods portfolio at some stage. The focus was clearly on cereals and snacks.

  2011

  Kellogg returned to top-line growth in 2011 with reported sales up by 6.5% and internal sales up by 4.5%. This did not herald a return to the heady growth days of the early/mid-2000s. Overall volume was flat, as was operating profit, which had gone nowhere in four years. The company was running fast to stand still and pushing prices ahead despite the price deflation of the previous year. Rather than bleating on about high commodity price inflation, Kellogg needed to accept it as a new fact of life and manage its business accordingly.

  Perhaps to make a point to the new CEO, employees in the Other division delivered the best sales increase of all the now seven divisions. They grew the business 7%, of which the majority was volume growth. An increase was always going to follow the previous year’s supply problems, but growing the Eggo brand 20% and returning to the historic share high of 70% were impressive achievements. US Morning Foods and Kashi returned to growth with a 5% increase. A strong innovation programme enabled a dialling back on past excessive levels of promotional spending. Sales from new products equalled those of all their competitors’ innovations combined, contributing to a global $800 million of sales from products launched in 2011. Share in the US cereal market increased by 0.6% to 33.6%. This was a good improvement but it would have led previous generations of Kellogg managers to fall on their swords. Breakfast snacks did less well overall, growing by 3%. Pop-Tarts as ever did the heavy lifting.

  The US Snack category grew sales by 6%, although off flat volumes. Special K Cracker Chips – an idea from the open innovation programme – had an exceptional first year, supported by the ever-reliable Special K and Fibre-Plus snack bars. Overseas volumes declined. Europe was the main culprit, losing 3% of sales volume. The Russian business, in the midst of a transition from an unbranded low-value product range to higher-value Kellogg brands, was starting to show positive signs. Volumes in Latin America returned to growth, albeit marginally, largely as a result of Kellogg’s Krave cereal’s launch in Mexico. In Asia-Pacific, the bright spots were South Africa and India, which more than made up for a return to sluggishness in the Australian business. President and CEO John A. Bryant and Chairman Jim Jenness declared they were ‘not satisfied with this recent performance’, although they did not elaborate going how far back. We agree.

  2012

  A top-line growth of over 7%, to $14.2 billion, suggests that things were improving. However, virtually all that growth was accounted for by Kellogg’s major play in the year: the acquisition from Proctor & Gamble of Pringles for $2.7 billion. If Kellogg had owned Pringles for all of 2011, it wouldn’t have grown the top line at all. The Pringles deal, while a bit pricey at eleven times earnings, has the potential to be transformative for Kellogg. It tripled the size of its overseas snack business, putting it global number two behind PepsiCo. It also gave the company a commercial and supply chain snack infrastructure in Latin America, Europe and Asia that it hadn’t had before.

  Meanwhile, back at the ranch, Kellogg had started the year paying the price for continually passing on commodity price increases without sufficient innovation to make the shopper stomach them. US cereal and snack sales were sluggish in the first half-year. The critical UK market did even wor
se, owing to too many initiatives not performing as expected. This was a major contribution to a decline in total European sales by nearly 4%. Kellogg’s inability to add sufficient value to make its price increases digestible drove its gross profit margin down by almost three percentage points over the previous two years. Its big success in the cereal aisle, Krave, gained a full share point in the category, but that came entirely at Kellogg’s expense as it only held share. While Pop-Tarts continued its record of sales increases for 30 straight years, Kellogg’s sluggish snacks and cookies business was propped up by Special K Cracker Chips and the new Special K Corn Chips.

  Elsewhere, the Other segment rode to the rescue once again. Frozen foods posted good increases - the new Thick and Fluffy Eggo waffles and Morningstar Farms plumped up sales. Over in Asia, question marks started to appear around Kellogg’s strategy for China. Its newly announced partnership with Singapore-based Wilmar International seemed to be along the lines of General Mills’ Cereal Partners Worldwide idea. Kellogg would provide the brands and manufacturing expertise, while Wilmar did the grunt work of scale and route-to-market infrastructure in China. This was the latest of several approaches by Kellogg to the Chinese market, and it was becoming difficult to shake the impression that it had no clear, long-term plan for the market. Overall, the Asia, Australia, South Africa and New Zealand region was only growing in the low single digits – not an impressive level, all things considered.