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Food and beer makers are on a dangerous diet

Food and beer makers are on a dangerous diet


Source: FT

by: John Gapper

January 13, 2016


When a US-Belgian conglomerate with Brazilian shareholders buys a Scottish-style ale made by a craft brewery in Arizona to give itself authenticity, the world has gone mad. Last month, AB InBev acquired Four Peaks Brewing, whose top seller is Kilt Lifter (“Take one sip and you’ll swear it had been brewed by men in kilts”).


You might wonder why AB InBev, which may this week launch the biggest corporate bond offering for its planned $108bn takeover of SABMiller, did not invent this imposter itself. It has many breweries, expensive research and development facilities, and pumps rivers of Bud Light – a clear, clean, almost flavour-free version of Budweiser that is the biggest selling US beer.


But this is not how the food and drink industry works. Instead, the creation of organic premium products – from craft beer to natural yoghurt and “bean-to-bar” chocolate – is often left to plucky outsiders. Meanwhile 3G Capital, the Brazilian private equity firm behind the merger wave, strips out costs with “zero-based budgeting”.


Conglomerates pounce every so often, buying products they did not create: AB InBev has acquired six craft breweries since 2011; Coca-Cola took full control in 2013 of Innocent, the British smoothie maker. This can work but it is not cheap – Constellation Brands paid $1bn to buy San Diego-based Ballast Point brewery in November.


The beer market has been upended. In the US consolidation had largely wiped out small breweries by the 1980s but they have since staged a remarkable recovery. There are 4,100 craft breweries, surpassing the previous peak in 1873. While big brands stagnate – Budweiser sales are falling – craft beer is growing in double digits to 19 per cent of the market in 2014.


This phenomenon is occurring elsewhere. As millennials with a taste for natural and quirky products reject the bland offerings of big food and drink conglomerates, the companies struggle to respond. Innovation at a conglomerate often means brand extensions or the repackaging of well-known sauces, such as the upside-down ketchup bottle created by Heinz in 2002.


So there is a certain ruthless logic to the strategy pioneered by Jorge Paulo Lemann, the Swiss-Brazilian investor, at 3G Capital, which is sweeping through even the parts of the food and drink industry that he does not yet control. Instead of worrying overmuch about the top line, he puts his companies on a diet. They reset budgets from scratch each year, trimming all fat.


This is not intended to halt R&D but it can easily have “a chilling effect on new product innovation”, as Moody’s, the credit rating agency, warned last year. If a laboratory has not come up with a breakthrough for a couple of years, its owner can save money by closing it or by putting it to work on smaller, more predictable variations of existing brands.


Zero-based budgeting is wielded at Valeant, the pharmaceuticals company that grew by acquisition while slashing R&D. It is having a similar effect at food and drink companies, leading them to outsource innovation. Instead of creating products, they wait for smaller companies to do so then buy them at high prices.


This is tempting: not only can they boost profits while taking acquisition costs on to their balance sheets, but they also indulge the self-image of younger consumers who like to consume “artisanal” food and drink. “They often cannot tell the difference in blind taste tests, but they like what the purchase says about them,” says Robyn Bolton, a partner of the Innosight consultancy.


Introducing zero-based budgeting would, however, be a disastrous admission of defeat. There is a place for niche companies making high-end food and drinks for small groups of luxury consumers and taste snobs. There is a much bigger opportunity for companies to offer premium products with good ingredients to consumers who like to avoid processed food without being obsessed by definitions.


Chobani, the company that popularised Greek-style yoghurt in the US by selling it only a bit more expensively than processed alternatives, seized this opportunity. It can also be exploited by big companies. MillerCoors, for example, has developed its own craft-style beers, such as Blue Moon, a Belgian-type wheat ale. They may not qualify as official craft beers, but they taste fine.


Nestlé is taking the approach to premium chocolate, launching its long-established Cailler Swiss chocolate globally rather than trying to buy a superorganic US bean-to-bar producer. European companies have advantages, since they did not strip themselves back to mass market products to the same extent as US counterparts, and European brands still carry some mystique.


It would be bizarre for the sector to abandon hope of creating premium products itself, like a PC industry without Apple or a car industry without Toyota. None has done so (although AB InBev has a $220m R&D budget to create concoctions such as Budweiser Brewmaster Reserve for China). Yet, as cost-cutting spreads, that will be the danger.


There are big gaps between Bud Light and Kilt Lifter, or between Hershey bars and Lindt & Sprüngli truffles. If big companies do not fill them, someone will.