The food and beverage industry is undergoing rapid change. Consumer tastes and shopping habits are evolving in dramatic fashion, and the battle for relevance is intense. In the wake of the recent acquisition of Whole Foods by Amazon, a large group of food-focused finance and law professionals gathered in Chicago to assess the state of the industry. Gian Ricco, a Director in Stout’s Investment Banking group, was a featured panelist at the event hosted by OPUS Connect. Moderated by Mark Hollis of Centerfield Capital Partners, the panel also included Jeffrey Walters of LaSalle Capital, Wayne Carpenter of Lake Pacific Partners, and Steven Silk of Silk Weil Group.
The panel unanimously agreed that massive shifts in consumer preferences and shopping habits are dramatically changing the landscape for traditional food and beverage producers, retailers, and distributors. Millennials are driving an explosion in fresh, clean-label foods with a greater emphasis on snacking and less attention paid to traditional dining occasions. Coupled with baby boomers’ desire to live healthier lives, there has been a significant transition to more perimeter-of-the-store purchases (e.g. fresh and prepared foods), more e-commerce, and fewer center-of-the-store selections. These shifts are forcing a reevaluation of how retailers should interact with consumers and a permanent strategy shift for some of the largest and most ubiquitous food brands as they deal with market share erosion and margin contraction.
If you watch the millennial consumer shop, the first thing they do is turn the product over to look at the ingredients. This new generation is not front-facing brand-driven, but rather bases purchasing decisions (in part) on the back of the package. Millennials seek authenticity and trust – they want to believe the food manufacturer, understand what is in the product, and feel confident that what is inside is good for them and their families. Value and trust is determined by cleaner, more natural and more familiar ingredients. Unfortunately for traditional consumer packaged goods (CPG) companies, current product portfolios tend to consist of shelf-stable, highly processed foods with unpronounceable ingredient decks. Managing these well-known brands will be of paramount importance going forward. “The opportunity for emerging food companies to undermine the traditional brand is unprecedented – you see it happening every day in the lower middle market,” Ricco noted.
Large retailers need to differentiate themselves in order to drive foot traffic, yet how can traditional grocers differentiate versus Amazon / Whole Foods? The panel suggested that increased emphasis on private label could be a path to survival – if executed correctly. Large retailers have to grow their share of private label products as a means for replacing lost margin from their traditional, center-of-store product mix. Penetration of private label within CPG in Europe is over 50% higher than in the U.S., though Ricco noted that this is expected to change with the continued domestic growth of discounters such as Aldi and Lidl where private label makes up over 90% of their SKU offerings. However, succeeding with private label requires the retailer to develop the trust of consumers, including helping them understand that a private-label product offers the best quality-to-value proposition. The panel cited Costco’s private-label Kirkland brand as a successful example. As mentioned on the panel, “There tends to be three tiers for private labels: 1) traditional private label that simply costs less, 2) great-quality private label at a fair price, and 3) premium private labels that command great margin. Each tier requires education and trust-building with the consumer.”
The panel agreed that retailers and food companies need to take an omni-channel view that includes traditional marketing, online/social, and in-store efforts to create a seamless brand experience. Instead of building the category to focus on “the mass market,” CPG companies have shifted focus to appeal to “the individual consumer.” Retailers and food brands need to be prepared to touch and interact with the customer in all of the myriad ways he or she might be thinking about making a purchase, whether that’s online or in person, or in front of a smartphone or endcap.
There is concern that the food industry is not thinking about e-commerce as much as it should be. One only needs to look at the Amazon / Whole Foods merger to understand that points of distribution are now dynamic and fluid. The question that needs to be asked, but for which the answer changes rapidly, is how is food going to get to the consumer? For example, Ricco noted, “Retailers need to come to the customer versus the other way around. Does this mean every retailer needs to offer a two-hour at-home delivery option? Maybe in affluent, dense urban areas where you are competing directly with Whole Foods … but perhaps rural retailers should invest in upgrading their buy-online, pickup-in-store capabilities instead.”
Overall volume is down across all mergers and acquisition activity, and food and beverage is no exception. However, valuations remain at record levels. Ricco estimates that EBITDA multiples within food and beverage are approximately 2.2x higher than just three years ago, “with companies that can demonstrate differentiation combined with sustainable growth more attractive than ever.”
Furthermore, size no longer holds the same relevance when it comes to driving value. “Market share is shifting back to businesses that are less than a quarter of a billion in revenue because, let’s face it, that is where growth has and will continue to come from. We have never seen a more exciting time for people to be investing in the lower middle market food and beverage companies,” Ricco said.
Another interesting development within the strategic buyer universe is that larger CPG companies are developing their own early-stage venture capital funds designed to take positions in smaller companies; similar to what Big Pharma has done for years, such players are now essentially using acquisitions as their outsourced R&D vehicle.
Private equity (PE) investors are also competing for companies with strong growth potential. But given the leveraged buyout model, it is equally important for PE to consider how a potential acquisition target could sustain an economic downturn. With multiples at such high levels, expected PE investment returns have trended down.
The expectation is that the food and beverage industry will continue to offer growth opportunities within even the most mature categories driven in large part by a surge of new players in branding, manufacturing, and distribution. Large, established CPG and retail participants will need to reinvent and reinvest in order to stay relevant to consumers. And all players will require a relentless focus on individual consumers and their changing preferences for how, what, and when they purchase.