David vs. Goliath in 2007

Two senior financial analysts offer their perspectives on what’s ahead for the food retailing industry, with an emphasis on commercial baking.

Without a doubt, the entry of Wal-Mart into the full-fledged supermarket arena this fall, complete with in-store bakery, gave a lot of people more jitters than a day-long session at a java house. Whether you eyed the big-box competitor, wondering if Wal-Mart’s bakery was going to crush the offerings of your in-store outlet, or, as a small, single retail outlet, you just wondered if you’d survive the low-price, high output competition, by now, the dust is still settling. And, whether you’re another Goliath on the field, or feeling more like David, there’s hope for both, according to these senior financial analysts who follow the food retail industry closely.

Stephen Smith, a Partner in KPMG’s Advisory Practice and Senior Vice-President and Director of KPMG Corporate Finance, didn’t need a crystal ball to predict that over the next decade the baking industry would experience a lot of mergers and acquisitions.  “Smaller companies are more nimble, with a proportionately greater commitment to innovation and higher end products,” says Smith. “This is where the fresh, artisan innovation is happening, the higher value-added product.”

In general, in many food industry segments, says Smith, innovation is begun by the small- to mid-size companies. They are the ones to develop the new and compelling consumer proposition that eventually, the big players want to have – so they knock on the smaller guy’s door and buy him out. Smith sees the baking industry at the beginning of a significant innovation cycle, where, over the next five to 10 years, there will be huge value creation from virtually nothing. “Look at the two-bite brownie, for example,” says Smith.  “That business went from nothing to being a big financial and commercial success.”

For retailers with in-store bakeries, this area is going to become more important, contributing more dollars as the supply chain shifts from longer shelf life to fresh, fresh, fresh. Local bakeries might face some competition around their margins, but Smith thinks only in products overlapping in offerings.  If they overlap too much, then they should find a unique, value-added proposition quickly to survive.

Smith commented that Canadians as a group are extremely well-served by retailers in quality and cost – with Wal-Mart’s entry probably improving on it.  He cites Panera as more direct competition for the family-owned bakery, since it will be in the more densely-populated areas.  “Panera will increase consumers’ awareness of higher-value, specialized bakery products,” says Smith, “and this will change the competitive landscape for individual bakers more than another big retailer opening in the community.”
At one point, boomers made the marketplace look like a huge bell curve – and we targeted that huge bulge of consumers, since it was where the majority of the dollars were.  Now, according to Stephen Brown, Partner, National Consumer Packaged Goods Segment Leader, Deloitte Canada, the growth segment of the market looks like a long tail.  “Changing consumer preferences are driving a long tail, especially in Canada,” says Brown.  “By ‘long tail,’ we mean retailers need to respond to all the niche markets – the multiplicity of them, smaller ones like ethnicity, format, eat-on-the-go, you name it – that comprise the tail.”

With more dollars being spent on food, Brown says it makes sense to come to the market with more formats, ingredients – since innovation is the key to growth.  Many of the larger bakeries or manufacturers may have suffered from the low-carb craze and had to look for ways to diversify. Facing the consumer preferences for fresh, authenticity and the need to exploit the “tail,” larger commercial operations are going to be dealing with cost pressures, growth pressures, as well as being locked into their information technology and automation. Brown says, “The larger operations need increased output for their assets to be profitable.  The production lines need to be pumping product out – and with market preference rapidly changing, they need to be able to switch ‘model’ lines quickly.” He used the example of auto manufacturers – a very expensive asset which would bankrupt the company if it took two years to switch over a production line to a new model.  For large commercial bakers, they need to achieve flexibility (responding rapidly to changing consumer preferences), balanced against automation (which can drive the cost of production down).

“There’s no one easy answer,” says Brown.  “Good market intelligence and a good relationship with retailers in order to understand how to accommodate change helps.”

In a white paper Deloitte has published, “Mid-Market Food: Small is Beautiful,” Brown observes that the globalization of consumer tastes has greatly expanded the types of foods Canadians are consuming, as well as driving an explosion in new product innovation, which is changing the competitive retail scene.  “Today, it seems as if practically everyone is a food retailer,” says Brown.  “Food is available in so many channels.  When I go home at night, I can shop at my local gas station – one of the leading grocery retailers is providing them with fresh items so customers can make their purchases quickly and conveniently.  It’s all about consumer preferences.”

Brown believes single retail bakers have a distinct advantage against the larger chains, and that is the personal connection they have with their customers – it will keep them loyal, returning for the handcrafted loaves and buns they’ve been buying for years, rather than heading to a new outlet for a few pennies less.  Even the demographics are in favour of the smaller operations – as we age, why would we want to navigate huge parking lots, then through a huge supercentre to purchase fresh items like baked goods, which we would with frequency?  Brown says it would probably take us at least 30 minutes a trip, which is not what an aging population wants, regardless of how fit or vital we might be.

Offering his own suggestion for innovation to drive the long tail, Brown says, “Why hasn’t anyone developed food for golf?  You have a market, and in my mind, it’s an untapped part of the tail.”  Chasing the long tail of consumer demand is the future.  Smaller is not only beautiful, it’s profitable.
   
Deloitte, one of Canada’s leading professional services firms, provides audit, tax, consulting and financial advisory services to a wide range of Canadian and international clients. Visit www.deloitte.com to download a free copy of “Mid-Market Food: Small is Beautiful.”

KPMG LLP is the Canadian member firm of KPMG, a global network of professional firms providing Audit, Tax, and Advisory services.  KPMG operates in 144 countries and has more than 104,00 professionals working in member firms around the world.  Visit www.kpmg.ca for more information.