Pity poor Kraft Foods Group (KRFT).
When it was spun off from Mondelez International (MDLZ) in 2012, the maker of Velveeta cheese and Oscar Mayer meats was left alone to try to squeeze sales out of a saturated North American market with its classic — and arguably tired — brands, while Mondelez was free to try and conquer emerging markets with brands such as Oreo and Trident gum.
Now, thanks to its planned merger with H.J. Heinz, led by a 3G Capital and Warren Buffett’s Berkshire Hathaway (BRK-B), Kraft stands a better chance of taking on overseas markets, getting the clout it needs to rein in rising commodity costs and attain more efficient operations that will lower its expenses.
Kraft needs all the help it can get. Despite owning three classic billion-dollar-plus brands (Kraft, Oscar Mayer, and Philadelphia), last year the company saw sales fall for the fourth straight year, while profit fell 62% to $2.7 billion. And, more worrisome, Kraft lost market share in the categories that generated 40% of its U.S. businesses in 2014, Kraft’s CEO John Cahill said last month.
Here are four key challenges facing Kraft as it moves forward.
1. International potential.
When Kraft and Mondelez went their separate ways just over two years ago, the split left Kraft devoid of the opportunity to grow overseas. As of now, Canada accounts for pretty much all of Kraft’s international sales, generating $1.9 billion in 2014, down 5% from a year earlier.
In contrast, Heinz is incontestably global: it sells its ketchup and other foods in some 200 countries, and for some products it holds the number-one or number-two market position in 50 countries.
As Kraft’s Cahill said, Wednesday’s Heinz deal means Kraft is now “well positioned” as the combined company starts to bring Kraft’s products to overseas markets.
2. More clout with suppliers, more efficiencies.
Kraft was really dinged last year by rising commodity prices, particularly for meat and milk. (Kraft gets about 25% of its sales from cheese products.) The company was able to pass much of the costs on to consumers, but doing so simply created yet another incentive for shoppers to look for alternatives, especially at a time many are turning away from the kinds of processed foods Kraft produces.
Combining with Heinz should give Kraft a bit more clout with suppliers and potentially rein in some of the impact from rising commodity prices. Excluding ketchup, Heinz still has sales of $5 billion a year from meals and snacks, including brands such as Ore-Ida french fries and baked beans.
When asked on a conference call on Wednesday morning why it made sense to split up Kraft and Mondelez, and then argue for the merits of the Kraft-Heinz tie-up, Cahill said: “I think scale works when you operate it well.”
3. Stable management.
Although it’s known for its cutthroat management style, Brazil’s 3G greatly improved the financial results at Heinz. According to the Pittsburgh Post-Gazette, Heinz had a $657 million profit on continuing operations in 2014, up from $18 million a year earlier.
Kraft could certainly use some management prowess and stability: Cahill became CEO in December, and then faced the departures of the company’s finance and marketing chiefs this winter. Kraft recently created, and filled, a new role of chief operating officer designed to improve its business.
4. Consumers’ changing food tastes.
One big question that hangs over the Heinz deal: How will it help either company deal with dramatically changing consumer tastes? Names such as Kraft’s Velveeta, Kool-Aid, and Shake N’Bake might stir nostalgia among the Gen X shoppers, but such processed foods are seen as passé by many U.S. consumers, and many Americans are growing weary of “Big Food” companies.
Kraft is aware of this issue. In its most recent annual report, the company said: “We must distinguish between short-term fads, mid-term trends, and long-term changes in consumer preferences. If we do not accurately predict which shifts in consumer preferences will be long-term, or if we fail to introduce new and improved products to satisfy those preferences, our sales could decline.”
But the proof of the pudding is in the eating. Both Heinz and Kraft talked innovation in the press release accompanying their deal news Wednesday, but gave precious few details on what that would look like.
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