Why the Changing US Grocery Retail Market Underpins the Kraft and Heinz Merger

On March 25th, 2015 it was announced that Kraft Foods and HJ Heinz would merge, ultimately forming a packaged food power house called the Kraft Heinz Co.  This combined company would have a 5.4% value share of the entire US packaged foods market, making it the number one company in the space with nearly US$20 billion in sales. This merger is primarily a response to a changing grocery landscape which prioritizes cost efficiencies, given the emphasis on low prices for the consumer.

Wal-Mart becomes king of grocery retailing

Within grocery retail, Wal-Mart maintains disproportionate power as the nation’s dominant grocery retailer with around 20% market share in 2014. Its second largest competitor, Kroger, only has 8%. Wal-Mart has managed to tighten its grip on the grocery market over the past ten years, growing sales from US$45.3 billion in 2004 to US$156.5 billion in 2014.  Wal-Mart was able to increase its grocery sales by 245% thanks to its core strategy:  lower prices.

The divergence of grocery retailing

Due to the outsized influence that Wal-Mart carries with both consumers and manufacturers, it is price that been the ultimate driver of grocery growth in the past decade. The recession of 2008/2009 made many consumers cut costs wherever they could and many have not stopped.  In the past ten years, two of the top five highest growth grocery companies have been discounters; Trader Joe’s and Aldi have grown combined sales by almost US$12 billion by relying on limited national brands and private label to keep costs low. However for some consumers, quality and taste take precedence over low prices. Upmarket grocers that focus on fresh food and more organically sourced products round out the top five highest growth chains. Companies like Whole Foods Market and Sprouts Farmers Market forgo the price-sensitive consumer completely and instead focus on quality-focused shoppers.

Highest Growth Grocery Retailers in the US by CAGR (2004-2014)

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Source: Euromonitor International

A more efficient and nimble supply chain could open new retail possibilities

With the middle of the market under siege, suppliers have been forced to position themselves as a bargain or as premium to hold any real sway with the most powerful retailers in today’s market. Because there is little chance that both Kraft and Heinz will ever be considered premium, they have decided to consolidate to help streamline costs, a move in which parent company 3G Capital maintains an expertise. This will not only help the combined company maintain its shelf space in top grocery retailers, but could earn them spots in burgeoning non-grocery retailers that have begun to encroach into the grocery  space. Drug stores and dollar stores have been seen greater growth than grocery in the past ten years and to get more people through the door they are continuing to expand their packaged food offerings. For example, Kraft managed to save single-serve Velveeta by bringing it into dollar stores, and if it wants to increase shelf space for its other brands it is going to need to figure out how to make them cheaper to cater to retailers that have succeeded by offering name brands at low prices.

Additionally, the merger will better position the combined company to take advantage of the need for more adroit distribution. The rise of the small format retail environment driven by increased urbanization and the influx of grocery into traditionally non-grocery retailers threatens to destabilize the traditional grocery supply chain if supplier and retailers aren’t on the same page. Retailers where a grocery isn’t a main focus need to make sure that they keep their high-turnover shelves stocked—a  problem that is exacerbated by less physical space in smaller stores. Out-of-stock grocery shelves alienate potential customers because it establishes burgeoning grocery outlets as unreliable grocery providers. To combat this and maintain their presence on shelves, Heinz and Kraft will be able to pool their resources to make sure that the supply of their product can be stocked quickly in these smaller formats at a low price.

Retailers remain at the top of the food chain

After a decade of minimal revenue growth in the US for both companies, the Kraft and Heinz merger will ideally result in a combined company that is better positioned to cope with the changing grocery retail landscape in the US with a focus on streamlining costs and quick, efficient distribution.  In a perfect world for the suppliers, this merger would endow the new company with greater bargaining power thanks to its increased catalogue of category leading brands. However, issues such as the fractured nature of packaged foods, the influence of low-price and new grocery retailers, and the bifurcation of the US consumer into the cost-conscious and quality-conscious, make bargaining power hard to obtain.  This has empowered retailers to demand greater flexibility on pricing and distribution, a prospect which has put the impetus on middle market brands to adapt.

 

Download Top Retailing Trends in The Americas: 2015 for more insights