Food: Always Room for Profits

Squeezed by increasing commodity costs, food companies are finding creative ways to cut corners without sacrificing quality

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by Judith Crown

Packaged food companies, under the gun to shore up profits squeezed by soaring commodity costs, are finding savings in unexpected places. So it was that General Mills (GIS) in recent months reduced the number of pretzel shapes in its Chex and other snack mixes to three, from 14. The company had pretzels in the shapes of the letters "H," "O" and "T." But research found (not surprisingly) consumers cared more about the variety of pretzel flavors than shapes. That move, combined with other manufacturing improvements, is saving the division more than $1 million a year.

In a similar vein, Minneapolis-based General Mills cut in half the number of pasta shapes it uses in Hamburger Helper, to 10. Food engineers and marketers even worked on the pasta bits so they nested together, enabling the company to shrink the box. That reduced the cost of raw materials by 10%. Chief Executive Ken Powell says General Mills had no choice. "With commodity prices increasing, we needed to think about how we generate productivity in a more powerful way."

Cost savings are a big issue for the food companies that gathered for the Consumer Analyst Group of New York annual conference on Feb. 19-22 in Boca Raton, Fla. Globalization—the rise of consumer incomes in India and China, in particular—is pushing up demand for all sorts of commodities, including foodstuffs such as wheat, corn, and dairy products. The price of wheat, for example, has doubled in the past year and is at an all-time high.

Passing Along the Costs

Meanwhile, the push for alternative energy sources is leading some farmers to divert corn to that use, and creating spot shortages of grains such as soybeans, as farmers divert acreage to the more lucrative crop. "That's not letting up for the foreseeable future," says Gary Rodkin, CEO of Omaha-based ConAgra Foods (CAG).

To be sure, food companies are passing along much of their higher costs to consumers, in the form of price hikes or smaller packages. Sara Lee (SLE) has raised bread prices four times in the past year and a half, and expects another increase before the end of June, says CEO Brenda Barnes. At General Mills, price increases accounted for two to three percentage points of the company's first-half sales gain of 7%.

So far, consumers have been willing to pay the higher costs, because the overall price of a full shopping cart is less than eating out. Still, food companies are feeling the pinch. As a group, their stocks are down about 11% since Dec. 1, according to UBS Securities (UBS). "There was a major spike in input costs in the fourth quarter," says UBS Securities analyst David Palmer. "We're seeing multiyear lows on [stock] valuations."

Saving Without Compromising

So the 25 chief executives who gave presentations in Boca Raton went to some lengths to assure analysts they can pare costs from their operations and meet profit expectations. On Feb. 20, for instance, Kellogg's (K) CEO David Mackay confirmed the company expects to deliver earnings for the current year of $2.92 to $2.97 per share—roughly in line with the $2.99 expected by 16 analysts surveyed by Bloomberg Financial Markets—through a mix of brand building, new products, price increases, and productivity gains.

That last part—finding cost savings without compromising quality—is where companies often get the most creative. ConAgra expects to save $20 million in annual costs by reducing the number of can sizes to 20, from 100, over two years, for everything from Hunt's tomato sauce to VanKamp beans. That initiative is part of a larger drive for $225 million in cost savings in the company's 2009 fiscal year. ConAgra has been viewed by analysts as a laggard in the consumer-products field, but CEO Rodkin told analysts that earnings for the second half of its fiscal year will be higher than the previously estimated 70¢ per share.

General Mills has outperformed many of its beleaguered peers in part by rolling out new, higher-margin products such as Progresso light soups and good-for-you snack bars. On Feb. 19 the company raised its earnings outlook for its fiscal year, ending in May, to a range of $3.64 to $3.66 per share, up from a range of $3.39 to $3.43. That's an increase from the $3.18 per share—and $1.14 billion total—General Mills earned in fiscal 2007. Analysts expect sales to rise 6.4% this year, to $13.2 billion.

Crown is a senior correspondent for BusinessWeek and BW Chicago.