07 Aug 2017
For many years the Australian grocery market was a profit powerhouse for big-food brands. The national ranging strategies of supermarkets posed a barrier to entry for smaller, regional competitors and Australians were brand loyal consumers with relatively simple needs.
Three or four brands dominated each category, most with a stable of product variants. The healthy margins supported massive marketing budgets with extravagant TV ads, saturation media campaigns and ground-breaking new product development.
The supermarkets encouraged this innovation to drive category growth. The big brands were a fearsome beast, or so it seemed – particularly for niche producers who lacked the clout or scale to get onto supermarket shelves.
"As the market fractured it is the small-to-medium-sized food producers, once squeezed out by the old supermarket model, which have benefitted.”
In the last decade though, that has changed. The structure has been eroded at one end by the private labels of attacker brands like Aldi, hitting particularly staples like tomato sauce or soft drink.
At the other end of the market, where once consumers sought out the big brands, it is boutique, gourmet, premium brands attracting attention.
Counter-intuitively, as the market has fractured it is the small to medium-sized food producers, once squeezed out by the old supermarket model, which have benefitted.
They are innovative and low cost enough to produce private labels. And they are nimble and close enough to the produce and consumers to satisfy the fickle premium end.
With private labels, Aldi and Costco have arrived with refreshing alternatives including premium private label ranges with products at least as good, if not superior to the big brands.
The foreign retailers fuelled a still escalating price war in which private label products are a strategic weapon.
The supermarkets have followed suit and are learning to behave like brand owners, developing private labels with strong and consistent value propositions which emulate the market leader. They often have added features as well as a substantially discounted price.
In developing their private label strategies, supermarkets have rationalised ranges and reduced big brand stock keeping units (SKUs) in favour of private label.
This has pushed the big brands into on-going price promotions to preserve their shelf space. More of the marketing budget is now devoted to ‘below the line’ price promotion (i.e. discounts or volume specials) at the expense of brand building or so-called ‘above the line’ marketing.
At the same time the market is also becoming choosier. Changed eating habits are influenced by ethnic and demographic shifts, TV cooking shows, sensitivity around food allergies and rising health and social consciousness.
These shifts have transformed what were once specialty foods like ‘gluten free’ or ‘halal’, into mainstream growth categories.
That fragmentation has given an edge to nimble, regional and gourmet specialist producers who can be highly profitable in niches.
Big brands cannot because their business models require scale to amortise overheads. Furthermore, their culture is process driven so they do not understand the nuances of niche markets.
Supermarkets have relished ‘poking the big brand beast’ by welcoming smaller brands as a means of differentiating their offer.
Greater flexibility in store ranging to reflect local demographics and more localised buying within one state has opened supply chains for niche market food producers who in the past simply could not deliver the volume and consistency of supply the supermarkets wanted.
As a consequence of these shifts, the big food brands are losing share to private label on the one hand and boutique specialist brands on the other.
The obvious impact on margins is apparent with big brand owners cringing as supermarkets leverage their enhanced bargaining power to push down prices and increase trading terms, which are already over 25 per cent.
Some have made the strategic error of de-engineering products by downsizing or reducing ingredient quality. Social media savvy shoppers are onto this and it has added impetus to the shift to private-label.
The big brand beast is not responding. Part of the problem is they have lost the art of product innovation as well as the profit margins to invest or take risks.
Big food manufacturers lack the agility to react quickly in a dynamic market with short product cycles.
Some have responded by actively acquiring specialty, niche businesses, but this strategy rarely works. The start of the problem is they pay too much (multiples of 10 times earnings is common for food businesses), creating pressure to drive profit from day one.
They then burden smaller, agile companies with a layer of corporate bureaucracy, adding cost and removing what was their competitive advantage.
Once the entrepreneurial founders have been paid out, innovation generally expires. The creativity gene has been bred out of the big brand beast as they are accustomed to outsourcing all their idea generation to advertising agencies (who themselves are a species under threat).
Brand owners have also lost the advantage they once had of owning consumer insights. Traditional market research, once the domain of brand owners, has given way to smart card enabled big data, controlled by the supermarkets.
In attempting to defend their brands, the big manufacturers have resisted becoming private label packers. Initially, private-label contracts helped overhead recovery but as volume grows, they soon pass the tipping point into unprofitability.
Manufacturers of shelf stable and frozen products have a limited competitive stance against private label imports. When the Australian dollar reached parity the imports entrenched their position.
It is hard to see any means of resuscitating the big brand beast and the declining profitability is likely to drive further rationalisation and M&A. Some multinationals will no doubt sell out of the Australian market altogether as the parent companies apply pressure for improved performance.
Meanwhile, the opportunity for the smaller brands grows. Gourmet labels can now remain true to their founding promise without having to compromise for scale or price: the supermarkets know their customers want these brands.
Being close to market and the farm gate, they are quick to recognise new trends.
Even the arrival of Amazon, spreading fear in traditional retail, could work in their favour. Amazon Fresh is a distribution platform which happens to sell fresh food. It means a big investment in on-line trading and logistics IT promising delivery within two hours at no or low cost.
In the US, Amazon Fresh purchased bricks and mortar Wholefoods Markets with a strong offering in gourmet and healthy foods. It could provide a distribution footprint for smaller, specialty food players.
This is an edited version of a presentation by Dr McKinna at the Fordham Group’s Food Industry Seminar to an audience of food industry investors and producers
Dr David McKinna is the principal of agrifood consultancy McKINNA et al.
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
07 Aug 2017
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