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Middle-Market Companies Find Opportunity in Food & Beverage Disruption
By Colin Guheen and Paul Baisley
A short walk down any aisle in your local grocery store reveals the tremendous opportunities now available to middle-market companies in the food and beverage industry. Take a product that had been as innocuous and ubiquitous as yogurt. Just 15 years ago, Hamdi Ulukaya, seeing that this bland backwater in the dairy case was ripe for innovation, launched Chobani. Today, Chobani not only is the top-selling yogurt brand in America but, more importantly, has paved the way for scores of new entrants — Siggi’s, Stonyfield, Brown Cow, and Noosa to name a few — while inspiring a whole range of new yogurt categories, from Icelandic to Australian and high-sugar indulgence yogurt to non-dairy coconut milk yogurt. At the same time, retailers have reinvigorated their private label offerings in many of these subcategories.
Yogurt, of course, is not an exception. The same story has been replicated thousands of times across the grocery store, one sign of the sweeping transformation in food and beverage over the last decade. At a time when the relevancy of the bigger brands is slowly being eroded, these trends have created opportunities for middle-market companies for branded and private label offerings. That’s why for senior secured lenders, it is a great time to be providing financing for them.
The Consumers Engage
A number of factors came together to overturn the long-established order in grocery. The first, and likely the primary driver, was consumer behavior. Food has become a lifestyle choice, most closely approximating the taste of the younger generation of shoppers. Fresh tops frozen, local trumps mass-produced, and quality and authenticity trounce price.
But preferences have not simply changed: they have proliferated. Food is no longer simply a form of sustenance, it is an extension of identity. Shoppers have segmented, with distinct groups congregating around gluten-free, probiotic, sustainable, local, organic, and ethnic offerings, to name just a few. Shoppers also view food as fuel. They are seeking products that will promote heart and digestive health, raise energy levels and sharpen memory. These groups, augmented by the amplifying power of social media and the pronouncements of influencers and celebrity chefs, are substantial enough to have significant pricing power. According to the Bureau of Labor Statistics, Millennials are shaping today’s food industry as their spending power is expected to reach $4 trillion in 2020, and they have not even reached their prime earning years.
Big Food Creates an Opening
The larger food companies were slow to react to this change, continuing to focus on the traditional processed foods and condiments at the heart of their business model and concentrating on pruning costs rather than innovating. According to PwC‘s 2018 Global Innovation 1000 study, the major Big Food companies devote just 1.4 percent of revenues to R&D. They have been more comfortable with brand extensions than new products.
This sluggishness in the face of change has hurt their bottom line. A survey by consultancy A. T. Kearney revealed that the top 25 food manufacturers in the United States ceded 300 basis points to small- and medium-sized competitors between 2012 and 2015; their annual revenue growth was 1.8 percent compared with 11 to 15 percent growth racked up by the smaller companies.
Middle-market companies, by contrast, have the flexibility to respond to these trends and, unlike smaller companies, have access to sufficient capital to specialize and scale up production and to take new products more effectively to market. It doesn’t require a $10-million Super Bowl ad to introduce a specialty tortilla chip. On the manufacturing side, contract and private label manufacturing facilities are both specialized and technologically sophisticated, allowing middle-market companies to scale up strategically to accommodate sales and demand growth.
In addition, middle-market companies have ready access to consumer data. Some middle-market companies are utilizing this data along with sophisticated digital marketing tactics and distribution methods to punch well above their weight. Companies that understand how to combine data and social media channels together are poised to see excellent results and growth.
While Big Food is down, it is certainly not out. The larger food companies are responding while being mindful of their core brand customers. They are ramping up their own in-house development groups, purchasing attractive specialty brands, and starting their own venture capital operations to nurture young growth companies. To cite just a few examples, PepsiCo’s in-house incubator, the Hive, developed Maker Overnight Oats, which boasts flavors like mulberry and chia. Kellogg bought the protein-bar company, RXBar, for $600 million. And General Mills has its 301 Inc venture group, which has invested in Kite Hill, a maker of nut-based dairy products, and Beyond Meat, an alternative protein business, among others.
Retailers Add to the Opportunity
It is perhaps no surprise that retailers, with their vast amounts of data on consumer purchasing, have been much quicker to act on emerging consumer trends than the major food companies. Krogers, for instance, captures 97 percent of annual transactions from 60 million households nationwide in its 84.51° customer analytics platform.
This helps it target brands that are relevant to its customers, a trend that works to favor middle-market companies. Grocers are diversifying their store shelves by reducing the number of declining legacy brands they carry in favor of on-trend solutions. Middle-market companies that previously faced stiff competition from larger competitors are finding it easier to secure a place on grocers’ shelves. In addition, specialty brands typically come with a price premium over traditional products, which appeals to grocers.
At the same time, grocers have refocused their private-label brands, once synonymous with generic, on-brand-equivalent and specialty products. This enables them to ensure their relevancy with consumers while capturing more of the margin. For instance, Krogers reported that it added 219 Our Brands products in the first quarter of 2019, including such niche items as Private Selection Artisan Jerky and Kroger Deluxe Unicorn Swirl Ice Cream. It reported that its private label products accounted for 28.9 percent of the company’s unit sales at the end of the quarter.
To produce these products, the supermarket chains are turning to middle-market companies, both private label specialists and specialty brands with excess capacity. They depend on these suppliers not simply for their manufacturing prowess and fast turnaround times, but also for their sector-specific expertise. Working with middle-market companies, grocers can go beyond me-too private label products and provide consumers with differentiated offerings with the appropriate attributes for their target audiences.
Direct to Consumer Is on the Horizon
Over the last decade, the rise of the engaged consumer has disrupted the food and beverage, creating an environment favorable to middle-market companies. The next challenge on the horizon is direct-to-consumer sales, which promises to upset the food distribution channel.
This development presents both an opportunity and a quandary for middle-market companies as well as large food producers. Those companies that succeed in forging direct connections to the consumer will capture revenue that had been shared with distributors, but it is not going to be easy to create a viable platform, especially for fresh, perishable products. Options might include selling through a platform like Amazon or developing their own in-house direct-to-consumer capabilities. One of the reasons behind Kellogg’s purchase of RXBar was that the smaller company had developed an effective direct-to-consumer strategy.
Look for Value-Add Lenders
One thing is clear: after decades of predictability in food and beverage, which favored the large consolidated producers, the food and beverage market has entered a period of rapid disruptive change that creates openings for mid-sized companies. In these circumstances, middle-market companies should seek out lenders that specialize in the food and beverage industry. These lenders will have a better understanding of market dynamics. They will be able to more accurately assess the business trajectory and have a more nuanced appreciation of the risks they face.
At the same time, these lenders, because of their experience, can be a source of information and relationships for middle-market companies. They can, for instance, help speed middle-market products to market by connecting borrowers to suppliers and distributors. Having worked through issues as varied as plant automation and product recall with other customers, they can also be an important source of guidance and advice. And finally, financing from a respected lender that specializes in the industry is, in effect, an endorsement. It means that they have rigorously analyzed a customer’s business plan and chosen to risk their funds on its future. To succeed in this exciting, but rigorous, environment, middle-market companies should look for lenders whose contributions go beyond lending. TSL