Special Report: The war on big food

Try this simple test. Say the following out loud: Artificial colors and flavors. Pesticides. Preservatives. High-fructose corn syrup. Growth hormones. Antibiotics. Gluten. Genetically modified organisms.

If any one of these terms raised a hair on the back of your neck, left a sour taste in your mouth, or made your lips purse with disdain, you are part of Big Food’s multibillion-dollar problem. In fact, you may even belong to a growing consumer class that has some of the world’s biggest and best-known companies scrambling to change their businesses.

Lest you think this is hyperbole, consider the commentary in February at the Consumer Analyst Group of New York conference, the packaged-goods industry’s premier annual gathering.

“We look at our business and say, ‘How can we remake ourselves?’ ” said Richard Smucker, CEO of his family’s namesake jelly giant (SJM). A second exec—this one at ConAgra (CAG), which owns 29 food brands that bring in $100 million in annual retail sales apiece—bemoaned to Credit Suisse analyst Robert Moskow that “big” had become “bad.” A third conveyed what her industry feared would be the largest casualty of the public’s “mounting distrust of Big Food”—that shoppers would turn away from them for good. “We understand that increasing numbers of consumers are seeking authentic, genuine food experiences,” said Campbell Soup Co. (CPB) CEO Denise Morrison, “and we know that they are skeptical of the ability of large, long-established food companies to deliver them.”

And here’s one number to capture that skepticism: An analysis by Moskow found that the top 25 U.S. food and beverage companies have lost an equivalent of $18 billion in market share since 2009. “I would think of them like melting icebergs,” he says. “Every year they become a little less relevant.”

“Their existence is being challenged,” says Edward Jones analyst Jack Russo of the major packaged-food companies. In some ways it’s a strange turn of events. The idea of “processing”—from ancient techniques of salting and curing to the modern arsenal of artificial preservatives—arose to make sure the food we ate didn’t make us sick. Today many fear that it’s the processed food itself that’s making us unhealthy. Indeed, nearly half of the respondents in a recent Bernstein survey say they distrust the food system. Shoppers still value the convenience that food processing offers, says Moskow, “but the pendulum has definitely shifted in their minds. They have more and more questions about why this bread lasts 25 days without going stale.”

It’s pretty simple what people want now: simplicity. Which translates, most of the time, to less: less of the ingredients they can’t actually picture in their head.

While consumers have long associated the stuff on the labels they can’t pronounce with Big Food’s products—the endless strip of cans and boxes that primarily populate the center aisles of the grocery store—they now have somewhere else to turn (more on that in a bit). And that has brought the entire colossal, $1-trillion-a-year food retail business to a tipping point. Steve Hughes, a former ConAgra executive who co-founded and now runs natural food company Boulder Brands, believes so much change is afoot that we won’t recognize the typical grocery store in five years. “I’ve been doing this for 37 years,” he says, “and this is the most dynamic, disruptive, and transformational time that I’ve seen in my career.”

Shoppers are still shopping, but they’re often turning to brands they believe can give them less of the ingredients they don’t want—and for the first time, they can find them in their local Safeway, Wegmans, or Wal-Mart. Rather than carry traditional products with stagnant sales, chains like Target are actively giving increasing space on their shelves to a slew of New Age players like yogurt-maker Chobani, Hampton Creek (which sells a popular plant-based mayo), Nature’s Path, Amy’s Kitchen, and Lifeway Foods, which makes a yogurt-like drink called kefir. Retailers are creating their own brands too. Kroger’s (KR) Simple Truth line of natural food grew to an astonishing $1.2 billion in annual sales in just two years. And compounding the frenzy is that many brands are discovering they don’t need shelf space to begin with. Natural and organic food company Hain Celestial, with more than $2 billion in revenue, says Amazon (AMZN) is among its top 10 vendors in the U.S.

The search for authenticity has led organic food sales to more than triple over the past decade and increase 11% last year alone to $35.9 billion, according to the Organic Trade Association. Data provider Spins found that sales of natural products across nearly every category are growing in mainstream retailers, while more than half of their conventional counterparts are in decline.

Perhaps more frightening for Big Food, shoppers are doing something else as well: They’re skipping the middle aisles altogether. For each of the past two years, according to Bernstein research, the annual volume of packaged food sold in the U.S. has fallen more than 1%. While that dip may seem small, it’s a portent of a much larger, even seismic, shift in the stuffing-our-gullets business. Yes, as in every other legacy industry, Disruption (with a capital “D”) is here. Big Food is under attack from Startup Granola.

Traditional packaged-food companies, however, aren’t taking the assault lightly. Some are attempting to buy their way into the natural space, acquiring small health food companies by the fistful. Almost all are radically rethinking their own product recipes. Kraft Foods, for instance, is removing synthetic colors and artificial preservatives from its flagship mac and cheese. Tyson has announced it is eliminating the use of human antibiotics in its chickens raised for meat. General Mills (GIS), which has already removed genetically modified organisms (GMOs) from its original Cheerios, has cut sugar by 25% in its Yoplait yogurt. All of these developments have happened in the past half year.

Fortune spent months getting inside several of the industry’s key corporations to understand how they’re responding to the mounting threat. One thing is clear: Big Food is suddenly looking like an underdog.

American shoppers have become skeptical of “the barn on the package.” That’s the catchall phrase that Stonyfield Farm co-founder and chairman Gary Hirshberg uses for how big food companies dress up their products as “natural”—a mystical term in the food industry that has no real meaning. The U.S. Food and Drug Administration does not even define it. But as consumers, especially millennials, have taken a more active and informed approach to what they buy, the barn has lost its appeal. Says Hirshberg: “There’s enormous doubt and skepticism about whether large companies can deliver naturality and authenticity.”

Some are betting that authenticity can be purchased. Industry goliaths are busy filling up their shopping carts, hunting for natural food brands to buy. “The prices have gone through the roof because everyone wants in,” says Edward Jones analyst Russo. Arran Stephens, co-founder and president of organic food company Nature’s Path, says he receives some 50 overtures a year from interested buyers. “I’m talking about all the major names,” he says. “I don’t think there are any that haven’t contacted us.” (He refuses to sell.)

“What these companies are trying to do is expedite their evolution,” explains Hirshberg, whose yogurt operation is today owned by Danone.

Campbell CEO Morrison has clearly been in expedite mode. One of the more candid executives when it comes to addressing Big Food’s woes, Morrison tells Fortune that she knew she had to “shift the center of gravity at Campbell” when she took over the company in 2011. The trends for soup, Campbell’s core business, were not looking good. Over the past decade, industry tracker NPD Group has recorded an 18% decline in canned-soup consumption at dinner and a 7% decline at lunch. Not only were the category’s volumes declining, but so too was Campbell’s portion of the bowl—with its namesake brand’s U.S. share dropping from 49% in 2005 to 42% in 2014, according to Euromonitor International.

Campbell CEO Denise Morrison is remaking an American icon.Photograph by Patrick James Miller for Fortune

Something had to change. One of the fastest ways to do it was to acquire a change agent. Morrison had been tracking Bolthouse Farms for years, after coming across its juices and smoothies in the fresh produce aisle during a market tour. She understood the beverage market well through Campbell’s V8 brand, but seeing beverages in that section of the store was new to her. When the private equity firm that owned Bolthouse put it up for sale in 2012, Morrison decided to make her move—that is, if she could sell it to her board. And here there was a long orange sticking point.

In addition to selling fruit and veggie drinks, Bolthouse grows and packages fresh carrots—an old-fashioned, weather-sensitive farming business that Morrison suspected would be a turnoff for any packaged-goods company, including her own. True enough, Morrison’s board was skeptical at first. “Carrots, Denise? Really?” asked one director. But in the end, the numbers sold themselves. The so-called packaged-fresh sector, where Bolthouse was a standout, was already an $18.6 billion business—and one with promising growth.

Campbell paid $1.56 billion for the company in 2012. Today it has roughly half that amount (more than $800 million) in sales. The following year Morrison bought baby-food maker Plum Organics for $249 million. (It has over $90 million in sales.) Both of these new businesses are small in the context of the soup company’s total $8.3 billion in revenue, but they are transformational in their own way—giving Morrison some pastoral cred when she calls Campbell an “organic carrot farmer.”

The acquisitions have also, as intended, shifted Campbell’s center of gravity—moving it closer to what the food industry calls “the perimeter,” the outer ring of the supermarket where fresh foods are stocked. This is where the big growth is.

More important, Morrison didn’t just set out to buy Bolthouse, she went after Bolthouse’s DNA. Following a trend in the tech industry, legacy food companies are on an acqui-hiring spree, hoping to gobble up foodpreneurs, their more agile management operations—and their know-how in the natural food arena. Morrison made Jeff Dunn, who had been president of Bolthouse, the head of Campbell’s new “packaged fresh” division, where he is tasked with expanding the portfolio (though Dunn is cagey about what that might entail).

General Mills did much the same thing when it acquired Annie’s, a hotshot “real ingredients” mac-and-cheese maker: It began using Annie’s broker to sell other General Mills products to natural food retailers, says Jeff Harmening, General Mills executive vice president and chief operating officer for U.S. retail.

The inherent risk with such acquisitions is that the parent company swallows up the scrappy upstart into what food industry veteran Alan Murray calls “the machine”—a hidebound, groupthink corporate enterprise—rather than learning from its entrepreneurial culture.

Stonyfield’s Hirshberg says major food companies can bring their considerable acumen and deep pockets to help their new fast-growing divisions with their supply chains, but that “they should stay the heck out of their brand.” If not, they’ll pay the price, he says. Kellogg (K) made the mistake of relocating Kashi from the San Diego area to its parent’s headquarters in Battle Creek, Mich., but moved Kashi’s operation back after the brand’s sales slipped. “They tried to bring it under their corporate umbrella, and it lost its cachet,” says Erin Lash of Morningstar.

Morrison seems to have gotten the message—keeping Bolthouse managers (including Dunn) in Bakersfield, Calif., rather than integrating them into Campbell’s Camden, N.J., headquarters.

In what may be the clearest sign that Morrison is intent on doing more than “putting the barn on the package,” she backed Plum’s decision in 2013 to become a public benefit corporation, which codifies the business’s social and environmental purpose in its charter. It is among a slew of changes in corporate culture that Morrison has tried to make. Executives now even talk a bit differently, infusing a more wholesome-sounding vocabulary in day-to-day conversation. The company “cooks” and “preserves” rather than “processes” and “manufactures”; employees follow “recipes,” not “formulas.”

Sincere or not, these transformations may not be enough. General Mills got a ton of buzz when it purchased Annie’s, but the salubrious brand, with its cute bunny logo and cultlike following, makes up just 1% of its new parent’s $17.9 billion in revenue.

Likewise, at Campbell, soup is still the heart of the business, constituting the bulk of a division that contributes 55% of the revenue and an overweighted 70% of total operating earnings. While sales of soup are only simmering these days, its operating margins are greater than 20%, which is significantly fatter than margins for most other packaged-foods categories, according to Morningstar. Plum and the beverage biz at Bolthouse are the opposite: Sales for both lines have been leaping ahead at double-digit growth, but their margins are comparatively slim. (In fact, Campbell’s overall gross margins have suffered since absorbing both companies—an issue that has raised flags with some Wall Street analysts.)

That’s why, no matter how serious the rebellion among American shoppers is, Campbell can’t completely remake itself as Bolthouse Inc. It’s also why Mark Alexander, the Campbell exec who oversees the rows and rows of Warhol-celebrated cans on U.S. supermarket shelves, has such a tough job. He can’t risk doing anything to those classic soups that might hurt margins or sales, because Campbell needs that “big economic engine,” he says, to invest in fast-growth areas. Says Alexander, “It’s not an either/or.”

Americans are willing to give up a lot for their newfound interest in wellness. But apparently they are not willing to say goodbye to chocolate and candy, which have resisted the declines felt in other parts of the packaged-food industry. Confectioneries have held up in part because there was never any confusion over whether they’re an indulgence.

The world’s collective sweet tooth propelled Hershey (HSY), with $7.4 billion in 2014 sales, to the No. 2 spot on Credit Suisse’s list of the fastest-growing big U.S. food and beverage companies of the past five years. Sales are up from $5.3 billion in 2009, and Hershey has gained share in its category.

FOO.06.01.15.Hersheys Photograph by Adam Levy for Fortune

It might seem, then, that Hershey had no cause to be worried over the food revolution. But executives at this all-American chocolate maker could see the tumult happening all around them. Research had found that 68% of global consumers wanted to recognize every ingredient on the label, and 40% desired food made with as few ingredients as possible. “There is a connection in consumers’ minds between overall health, wellness, and knowing exactly what I’m eating,” says Hershey’s head of global R&D Will Papa. “Consumers want treats, and they want to know that the treat is really good and wholesome.”

This relatively new notion that a treat—which by definition is something that gives pleasure—should also be good for you, coincides with what Papa calls the “unreasonable consumer.” Explains Papa, who spent close to 30 years at P&G before coming to Hershey: “It used to be I could have great cellphone coverage and pay a premium for it, or I could have slightly lesser coverage and get a deal,” he says. “Now consumers want great cellphone coverage all the time and the deal. Because they’re getting it many places, they now expect it everywhere.” Translation: If we’re going to eat something bad for us, we want to know it’s the best kind of bad we can get.

In February, Hershey took a mammoth leap to get ahead of that trend when it announced it was starting to transition its products to “simple ingredients.” What’s more, the makeover would start with two of its most venerable products—Hershey’s Milk Chocolate bar and milk chocolate Kisses. Rather than, say, remove just artificial flavors—or only GMOs or milk from cows raised with the growth hormone rBST—Hershey was going to spike all of them. In their stead would be only ingredients that people understand: milk, sugar, vanilla, etc. Both the milk chocolate bar and Kisses will have “clean labels” by the end of the year. Says CEO John P. Bilbrey, “For us, this is really a very holistic concept in terms of how we want to run our company.”

Hershey’s first formidable task was to convince suppliers that this wasn’t some one-off experiment. “We made ourselves kind of a pain,” says Terry O’Day, Hershey senior vice president and chief supply-chain officer. “Suppliers would tell us how difficult it was, what the incremental cost would be. They’re testing you to see if you flinch when they tell you the price.” When it came to finding GMO-free corn sweetener, so little was available in the U.S. that one vendor had to restructure its operations to create the ingredient for Hershey. When the company broached the idea of using milk from cows that hadn’t been treated with rBST, some families that had been supplying milk to the company for 100 years questioned the logic. “We were asking them to really change the way they did business,” says O’Day. “There’s a lot of emotion that comes out.”

For now, Hershey is absorbing the added costs for the ingredient changes while it looks for savings elsewhere. “We want to prove we can change the supply chain,” Bilbrey says. He believes costs will come down as demand accelerates.

Apart from the hit to the P&L and the giant monkey wrench thrown into operations, there was one additional hurdle to contend with—and this one would be a heck of a challenge for the company’s food scientists: Under no circumstances, for any of Hershey’s classic products, could the taste change. “The experience has to be identical,” says Papa.

Some switches, like going GMO-free, don’t typically mess with flavor. But swapping out synthetic vanillin for natural vanilla is not so easy. Vanilla helps mellow out the taste of unsweetened chocolate, but as with any agricultural product, its taste can vary depending on the crop. So over the years, most chocolate manufacturers switched to synthetic vanillin, which is uniform from batch to batch. It falls to Jim St. John, Hershey’s master chocolatier, to make sure his milk chocolate’s taste isn’t altered in any way with the shift to the natural stuff. “Consumers do change,” he says, “but we would have a hard time changing the Hershey flavor profile.”

Another challenge has been what to do about emulsifiers. Hershey is ditching one ingredient that has long been a head-scratcher for consumers: polyglycerol polyricinoleate, or PGPR, which helps the chocolate flow into molds. To compensate, St. John and his team will add more cocoa butter to the mix—something that may ultimately increase the bar’s calorie count from 210 to 220. (All in the name of good health!)

The candymaker is taking a different tack with lecithin, a second emulsifier, which prevents ingredients from separating. Even though lecithin might be unrecognizable to your average shopper, Hershey says the emulsifier is not an artificial ingredient because it sources it from soybeans—something the company will explain on its website.

As for the ingredient transformations at the company’s other brands, from Almond Joy to York Peppermint Pattie, the details—and, in some cases, the big questions—are still being worked out. Should the Kit Kat be gluten-free? And what to do about the inimitable Jolly Rancher, which no amount of marketing spin could rebrand as healthy? “I can’t speak for all consumers,” says O’Day, “but I’d venture to say they’re not expecting an all-natural thing when you’re eating something that’s basically sugar and corn syrup.”

Still, Hershey is working feverishly on a solution to it all. “At the end of the day, it’s back to the unreasonable consumer,” Papa says. “We have to do what the consumer asks. It’s in no way a judgment.”

Back to Natural

In 2014, Nestlé called Jeff Hamilton back to the U.S. to help turn around the company’s frozen-food business. The biggest drag there was Lean Cuisine. Launched in 1981, Lean Cuisine grew for nearly 30 years with a low-calorie and low-fat message that meshed well with consumers’ views on diet and weight loss. But in 2010 the brand started to slip. Over the past five years, sales have dropped by about a quarter.

Working for Nestlé in Canada, Switzerland, and Australia, Hamilton had spent a decade out of the States. Returning home, he was struck by how much things had changed. Before 2005, when Hamilton first left the U.S. for a posting in Sydney, American consumers considered the amount of calories and fat in a product as the ultimate measure of its healthiness. Now a new language around health had emerged that included terms like “natural,” “organic,” and “gluten-free.” And more important, anything having to do with dieting was out. Astoundingly, unit sales of products with the words “diet,” “light,” “low,” or “reduced” in their names had declined by 11% in 2013, according to Nielsen, and had been flat to down for several years prior to that.

For the food industry as a whole it was an extraordinary paradigm shift. So in April 2014, Hamilton began to reframe Nestlé’s Lean Cuisine brand to align with the new wellness lexicon. The company is in the process of rolling out its Lean Cuisine Marketplace line, which taps into what Nestlé calls “modern health benefits.” Shoppers can now choose gluten-free, organic, high-protein, or extra-veggie options.

The creation of these Marketplace meals happened with lightning speed, at least compared with food industry norms. In the past, such product development took 18 to 24 months on average; in the revolutionary new world order, says Paul Grimwood, Nestlé’s head of the U.S. business, such a leisurely timeline is increasingly untenable. “In food, change is happening at a pace we’ve probably never seen before,” he says. The willingness of people to adopt new food trends “is at its highest level, probably, ever.”

But the cultural headwind driving into Lean Cuisine is stronger than even the anti-diet fervor would suggest. In truth, the brand faces a double-whammy backlash because American shoppers, it seems, are also rebelling against frozen food. Unit sales across the frozen-food category as a whole dipped 2.5% in the past 12 months alone, Nielsen reports. To many, after all, frozen is the antithesis of fresh.

Nestlé, for its part, is trying its best to fight that perception—banking on a notable exception to the sales chill in frozen food: the subcategory of “natural and organic” offerings, like those made by Amy’s Kitchen. Nestlé is nearing completion on a $50 million global R&D facility in Ohio dedicated in part to creating such healthy frozen fare. The stakes couldn’t be higher. Wrote Credit Suisse in a late-April report on Nestlé: “We and investors are about to find out whether the biggest food company can turn around one of the largest categories in ‘Big Food.’ 

The Packaging Test

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The existential crisis facing the legacy food giants becomes even more pronounced when you consider a company like Hain Celestial—which, with its $2.2 billion in sales last year, is clearly on the path to Big itself. CEO and founder Irwin Simon says he hopes to hit $5 billion by 2020. Hain owns more than 50 brands, from Greek Gods Yogurt to Terra Chips, all in the realm of natural and organic food and personal care. More than 90% of its products are GMO-free and about 40% are organic—two sweet spots for today’s consumer. That helped propel Hain onto Fortune’s ranking of the fastest-growing companies in 2013 and 2014.

Simon launched Hain more than 20 years ago after stints at Häagen-Dazs and then SlimFast (he recognizes the irony), where he saw how consumers were desperate to lose weight but had a hard time keeping it off. When he took Hain public in November 1993, it had a market cap of $7.5 million. Today it’s worth more than $6 billion. “They don’t have any of the old stodgy processed-food mentality,” says Russo of Edward Jones.

Hain’s strategy is simple: Take mainstream items and bring them into the natural realm. The company is getting its growth by taking market share from what Simon calls “dead or dying brands.” Says the 56-year-old native of Canada: “There are so many categories out there where consumption is not growing, and that’s what we’re picking away at.”

Simon has never started his own brand. Instead he buys up smaller ones and nurtures them, testing possible acquisition targets by seeing what products his kids eat when he brings them home. “If it’s untouched,” he says, “we’re not buying it.”

Despite Hain’s success, Simon still gets grilled by analysts about his margins, which lag those of traditional food manufacturers. “It’s something I’ve been beaten up about on a regular basis,” he says. “But thank God, my growth is not the same as theirs either.” If your products are non-GMO, organic, and have no artificial ingredients, says Simon, you’re always going to give up 10% to 15% on margin. He questions whether the hungry giants are really willing to leave that on the table. “The big companies today, they want to have Annie’s and Small Planet, but on the other hand they want to sell genetically modified ingredients,” he says. “You can’t go both ways. You’ve got to put your stake in the ground.”

Indeed, the polarizing and emotional GMO-labeling issue may best illustrate the dilemma facing big food companies today. Polls show that the vast majority of consumers say they support labeling products that contain GMOs, even though regulators—and established scientific organizations—have declared such modifications safe. Big food companies, however, have poured millions of dollars into overturning state initiatives that require labeling.

“The smartest thing you can do as a CEO right now is to side with the consumer,” says Stonyfield’s Hirshberg, who is also the chairman and co-founder of the pro-GMO labeling group Just Label It, and clearly has a dog in the fight.

FOO.06.01.15.sidebar Iger, Benioff, Williams, Dorsey: Getty images; Kaplan: AP Photo

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Campbell Soup has been caught in the middle of the controversy. It helped fund industry anti-labeling efforts in two states before backing off. Morrison says she has always supported letting consumers know which products have GMO ingredients, but she wants one piece of federal legislation rather than 50 state laws. “We have three soup plants that ship all over the country,” she says. “We can’t be shipping a different label to Vermont vs. other places.”

The message is resonating in Congress. A bill making its way through the House of Representatives and heavily backed by Big Food would create a voluntary national labeling standard, while preventing states from mandating labeling on their own. If it passes the House, that likely won’t play well with consumers. And that’s a marketing wedge that Big Food’s rivals are only happy to exploit.

For the old-school titans, says Boulder Brands CEO Steve Hughes, “It’s a classic case of winning the battle and losing the war.” 

This story is from the June 1, 2015 issue of Fortune magazine.

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