Weathering Winds of Change

January 1, 2006
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Weathering Winds of Change
By Dan Malovany
Brace yourself for turbulence as the health and nutrition trend creates a warm front that’s converging against a nasty cold spell of burgeoning inflationary pressures that could result in rain on the whole grain parade.
After an unseasonably cool reception by consumers in previous years, the sun is shining once again on snack producers and wholesale bakers, especially for makers of premium variety and whole grain breads, or anything that’s perceived as good for you. Bread is back after the low-carb attack.
Yet, despite the improving outlook on the health and nutrition front, you’d better carry an umbrella for the coming months. Inflation is a storm that’s been brewing for some time, and several bakers wonder how long they can weather an onslaught of skyrocketing energy bills, aggravating fuel surcharges, looming pension burdens, increasing commodity costs and rising prices for health care benefits.
Today, the question is not if, but how to best pass on these costs to customers and eventually to consumers. Perhaps even more unpredictable is calculating just how much can be passed on.
As Mike Marcucci, chief executive of Chicago-based Alpha Baking Co., deadpans, “I’m sure the baking industry will continue to struggle with attempts to pass on the increases in health care and natural gas.”
Just imagine the impact of these rising costs. Picture the thousands of ovens, proofers and fryers that use natural gas, which is up anywhere from 35% to 75%, depending on the part of the country. Additionally, the baking industry operates one of the nation’s largest direct-store-delivery systems, with an estimated 140,000 routes. Most trucks rely on diesel or gasoline with prices that spiked upward of $3 a gallon following Hurricanes Katrina and Rita and that could set new record levels this spring. Hedging in on energy and commodities helps, but it can only go so far.
Frankly, it’s enough to have you grab Toto, click your heels and make you want to go home.
Fortunately, the current climate doesn’t mirror the perfect storm that the snack food and wholesale baking industry experienced in 2004. Back then, sales of baked goods slumped due to the Atkins and South Beach diets that slammed against higher overhead and rising operational pressures to create an economic super-cell that wreaked a whirlwind of havoc on business. Unlike before, this time, somewhere over the rainbow is that pot of gold, and it’s filled with whole grains.
For some industry executives, such as Gary Prince, president of Weston Foods U.S., the consumer movement toward understanding the benefits of nutritional foods and transforming consumers’ good intentions into sensible eating behavior feels like venturing outdoors on a warm day after a brutally long artic cold snap.
“Healthful, healthful, healthful. The issue is health,” Prince says. “This issue continues to gain traction. There’s much more interest in nutrition today. There’s much more interest in diets—not the fad diets, but the real way about how we should eat.”
In the retail and foodservice channels, higher quality products can command greater margins, and in some instances, even allow bread producers to pass on higher prices. But don’t get too giddy yet. It’s not as easy as predicting yesterday’s weather. Nobody knows exactly what tomorrow will bring, except that lightning rarely strikes in the same place all of the time.
“Consumers are changing, and our customers are changing,” Prince says.
Bakers, he notes, need to be nimble on their feet, reacting to shifting trends with creative solutions for their customers.
Mike Kafoure, president and chief operating officer of Interstate Bakeries Corp. adds, “Consumer eating and buying habits are affecting the baking industry in a big way. We must constantly monitor these trends and attempt to say ahead. We must also determine whether these are short or long term and establish a plan to react accordingly.”
Shifting Frontal Boundaries
During the past three months, the destruction and subsequent disruption of critical supply points caused by Hurricanes Katrina and Rita have put pricing pressure on everything from energy to packaging and commodities. Often, it’s an issue not only of costs, but also of supply, especially with respect to anything made of oil-based plastic and other raw materials. The aftermath of the hurricanes only highlighted many underlying problems and brought them to a head.
“If you trend back to the last decade and look at the back half of the 1990s, the industry was supported with lower costs, and the industry felt pretty good,” Prince recalls. “But what we don’t talk about is that in the first half of this decade, we have absorbed significant inflation, and that’s one reason, but not the only reason, that the industry has struggled over the past few years.”
Renato Turano, president of Turano Baking Co., wishes the industry’s overhead was near the levels it had been in the past. “If we had the same costs that we had three years ago, everyone would be making a ton of money today,” he says, “but unfortunately, the cost of utilities and fuel for any one of us with delivery trucks on the street, it’s a nightmare.”
Additionally, fuel surcharges are popping up like scattered thunderstorms and creating a downdraft on predictable profitability for bakers of all sizes.
“We’re at a point where a lot of my suppliers, and us included, have been eating a lot of price increases,” says Tobias Donath, director of marketing for Bäckerhaus Veit, a Woodbridge, Ontario-based specialty baker of European-style breads and rolls.
“We’ve been becoming more and more efficient and getting leaner with investments into further automation,” he says. “The same has been down the ladder of supply. However, we can’t continue to absorb price increases, whether they are oil, plastic or ingredients.”
Even in the toughest of times, Turano Baking has responded by investing in its Berwyn, Ill.-based bakery to further automate the operation and diversify its product line with higher-end artisan breads rolls that are on-trend. Actually, the company started that expansion before the low-carb craze struck, but it stayed with its plans, figuring the clouds would eventually clear. A long-time resident of the Windy City, Turano knows better than to rely on the latest forecasts.
“We kept on making the investments because we felt the market would change and become stable again,” he says. “Now, we’re ahead of the game because we’re able to offer products that others can’t.”
On another front, a tremendous wave of consolidation swept across the industry, creating opportunities for those who had prepared for a rainy day.
During the past 18 months, major players such as Kansas City, Mo.-based Interstate Bakeries and St. Louis-based Lee Bakery and Deli together have closed no fewer than a dozen plants, many of which should have been mothballed years ago because they housed equipment that exceeded the lifespan of the average American. Likewise, Northfield, Ill.-based Kraft Foods, Kellogg of Battle Creek, Mich. and others in the cookie category continued to eliminate excess capacity.
In some cases, these companies shifted production to smaller, more efficient co-packers. Others, such as Interstate Bakeries, which is in Chapter 11 reorganization, have acknowledged that they’re shedding business that they deem unprofitable or marginal at best, in an effort to transform themselves into stronger, albeit smaller, operations.
Throughout the last year, such churning of business stirred up an undercurrent of opportunity for several mid-sized snack and bakery producers still recovering from the aftermath of the post-Atkins era. For some larger companies, like Thomasville, Ga.-based Flowers Foods, new accounts created an urgent demand for additional capacity. Indeed, chairman, president and CEO George Deese calls the need for capacity “the biggest issue facing Flowers Foods today,” even though the company is one of the most automated bakery operations in the nation.
“We may be the only wholesale baking company in the country with this problem,” Deese explains. “Over the past three years, 12 bakeries have closed within our territory, removing more than one billion pounds a year of capacity. While much of this business came our way, we simply could not absorb all of it. During this time, we also began implementing our plan to expand our geographic footprint, which also was filling up our production lines.”
To resolve this issue, Flowers added a high-speed bread line to its Denton, Texas, bakery and bun lines to bakeries in Crossville, Tenn., and Miami, Fla. This year, it’s adding another bread line to its Villa Rica, Ga., plant, and building new bakeries in Newton, N.C., and McDonough, Ga., which should relieve capacity pressure on its existing bakeries.
Such a sea of change in the baking industry is a long time coming, especially in hindsight. Looking back over the past decade or so, the industry saw a spate of mega-deals that changed the competitive landscape for what was then the foreseeable future. Interstate acquired Continental Baking, Sara Lee purchased Earthgrains, Kraft bought Nabisco, and Kellogg responded by buying Keebler. Although many of these acquisitions were made at least five years ago, it can be argued that the fallout continued into 2005, partly because these companies never fully completed the integration process from an operational standpoint.
As Turano explains, “After making these acquisitions, [these companies] were using the same plants making the same products in the same way that they were doing before they were taken over. At the same time, they didn’t take advantage of the cost savings that they could have had by switching products and making certain products in one bakery and others in another one. When you’ve got to tighten your belt, you become a lot more selective and a lot smarter. That’s what’s happening now.”
In the Wake of the Storm
The current economic environment will likely spark further consolidation among bakers, snack producers and even in the retail food channel.
“We’ll see more plant closings, more merger and acquisition activity, and a further reduction in capacity,” Deese says. “On the retail side, weaker small or regional chains will close or merge with larger operations. Again, all of this will be driven by rising costs and the inability of companies to get a return on their investments.”
Such consolidation, Kafoure adds, puts more power in the hands of fewer customers.
“With the pressure on earnings performance, many retailers have continued to look to increased gross margins through higher retails,” he explains.
The shifts in the retail environment also changed the buying process.
“It brings in more sophisticated retailers who are doing more consolidated buying and sometimes merchandising, but it’s an opportunity for strong brands to get more customer- and consumer-intimate,” notes Pat Callaghan, the newly-named president of Pepperidge Farm.
Changes within the retail channel forced the Norwalk, Conn.-based cookie, cracker and baked goods producer to conduct extensive consumer research to identify who shops the categories in which it competes and why they buy Pepperidge Farm’s products. In addition to developing distinctive new items that differentiate the Pepperidge Farm brand from others, the company strengthened its sales organization to provide information and services that not only grow its brands, but the category as well, Callaghan explains.
“We’re really competing in broad-based categories, not just head-to-head with other baking companies,” he says. “We, in fact, are competing for the average consumer’s share of stomach.”
Although innovation has created category growth, inflationary pressures continue to prompt many retailers to turn to their bakery and snack suppliers for help. The S-O-S call also has been heard in the foodservice channel.
“Restaurants and foodservice operators feel the same cost increases as do the bakers,” Marcucci says.
The 12-month Forecast
Looking in the industry’s Farmer’s Almanac, Kafoure sees some cold fronts forming that could put a damper on the economy later this year. However, it’s tough to have a totally sunny disposition with the unstable atmosphere impacting the business climate.
“While I’m generally an optimistic person, today’s environment leads me to be only cautiously optimistic regarding the country’s economic condition,” he says. “There are too many incidents leading to increased cost pressure that are not being dealt with today and are being pushed into the future.”
For Turano, it’s all about focusing on what you can control.
“The economy is a [collective] state of mind,” he says. “If you put in your mind that it’s going well and if everybody else does the same, it will follow through. It will be a self-fulfilling prophecy.” SF&WB

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