Bread bakers see progress after 'year of living dangerously'
September 21, 2010
by L. Joshua Sosland
Severe pressure on bread prices, the worst in decades by some accounts, stood out over the past year as the most pressing issue affecting the financial health of the baking industry. The discounting was accompanied by only a limited expansion in sales volumes and was characterized by more than one baking executive as an exercise in futility.
While the debacle diminished profitability across an entire industry that enjoyed unimpressive margins before the discounting, some improvement in recent weeks prompted optimism over prospects for the year to come.
The price discounting was affirmed in data issued by SymphonyIRI Group, indicating unit price declines by all but one of the largest bread bakers in the United States.
At $2.14 per unit, the average price of bread in the 52 weeks ended Aug. 8 was down 3% from a year earlier. The data cover sales at supermarkets. Most prominent in price discounting, according to the SymphonyIRI data, was the nation’s largest baking company — Bimbo Bakeries USA, with unit price declines of 9.6% for Bimbo, 5.9% for Stroehmann and 5% for George Weston. The Stroehmann and Weston businesses have been owned by Bimbo since January 2009, but are still broken out separately by SymphonyIRI.
Other baking companies saw lower unit prices during the past year, including Flowers Foods, Inc., down 4.1%; Sara Lee Fresh Bakery, down 4.3%; Hostess Brands, Inc., down 3.3%; Pepperidge Farm, down 1.6%; and United States Bakeries, down 5.9%. La Brea Bakery saw a unit price increase during the period of 0.33%. The average unit price for private label was down 1.9%.
For baking companies, the weak economy and rising commodity prices have seriously squeezed bakers, said George E. Deese, chairman and chief executive officer of Flowers Foods, Inc., Thomasville, Ga. The current commodity environment is much more harmful for the baking industry than conditions in 2007 and 2008 when the industry raised bread prices in response to surging ingredient costs, he said.
“Because of the weak economy, grocer retailers have felt pressured to keep their consumer traffic, and bakers have participated in that effort by increasing promotions to the highest level in my 45-year career,” he said. “The promotional activity in the bakery category remains very high, and that is not healthy for grocers or the industry. Recently, however, there are indications that this may be improving.”
Christopher J. (C.J.) Fraleigh, chief executive officer of North American Retail and Foodservice and executive vice-president of Sara Lee Corp., Downers Grove, Ill., agreed that pricing conditions in fresh bakery have been extremely depressed, and that he has detected a meaningful improvement in recent weeks that he believes will be sustained. Mr. Fraleigh has oversight of Sara Lee Fresh Bakery in his role as c.e.o. of North Americana Retail and Foodservice. Noting that there has been widespread finger pointing in the baking industry over who launched what effectively has been a bread price war, Mr. Fraleigh said the most important point is that the pricing not only has been harmful to bakers but has done nothing to benefit baking customers — supermarkets.
“Unlike products like soft drinks or bananas, there is no evidence that discounting baked foods leads consumers to shift where they shop,” Mr. Fraleigh said. “Certain categories will drive traffic into a store based on price promotion.When we look at category drivers, the price of bread does not tend to increase traffic such as the top 10 drivers. Pricing on these, and I mentioned soft drinks because I used to be in that business, can become very aggressive.
“Bread tends not to play that role. It’s very important for retailers. It’s purchased by most customers. It tends to be one of the two most profitable categories. And with the large shares of private label and branded, presenting an even message is important, and product promotion is important. When we talk to retailers, this point rings true with most of them. The exception is a small subset trying to send an extreme value message.
“But the kind of promotion going on was essentially just giving consumers a product at a discounted price. They would have bought it anyway. It pressures profitability.
“With the rising cost of wheat, we have announced price increases that seem to have been accepted well by a number of our customer.”
Mr. Fraleigh said he’s seen evidence other large baking companies have taken similar steps, giving him optimism that conditions will improve.
The difficult pricing environment has not been limited to the nation’s largest chain bakers. Pressure on bakers has been incessant and intense, said Howard R. (Robin) Alton III, president and chief executive officer of Pan-O-Gold Baking Co., St. Cloud, Minn.
“I don’t think it’s a great time for baking,” he said. “We get constant pressure from grocers to give them a better price or a better deal so they can pass that along to consumers. They are getting pressure from the consumers to hold prices down. Consumers are more price sensitive today than they were three years ago.”
Brand loyalty, which Mr. Alton said always has been fleeting in the baking aisle, is lessening, he said.
“For the last 20 years our best selling loaf of bread changes every week in that it’s what’s being featured,” he said. “We see today an even bigger push toward what’s featured. Consumers are less disposed to buy their favorite loaf. Brand loyalty isn’t as strong.”
A trend related to discounting, making packaging sizes smaller, also is of suspect value, Mr. Alton said. Pan-O-Gold has not followed the trend toward smaller package sizes adopted in bread, ready-to-eat cereal and other categories, Mr. Alton said. He suggested the practice creates a false sense among bakers that the loaf may be priced at a significantly lower level.
“For us the savings in weight don’t justify the pricing disparity we see, that could be 30c,” he said. “There just isn’t the savings in there — in dough, shipping or packaging. I’m skeptical about whether the consumer fails to see the difference. More likely they feel snookered with smaller package sizes.”
Differing perspectives on private label emerged in bakers’ comments on store brands. Mr. Deese affirmed the conventional wisdom (and SymphonyIRI data) that private label was not gaining traction, while Mr. Alton took a different view.
“Private label has not grown significantly in the economic downturn,” Mr. Deese said. “Consumers continue to shift toward products offering more health and wellness attributes. In the bakery aisle, that is evident in the new product offerings over the last five years. Our Nature’s Own brand is well positioned to grow as consumers continue to seek better-for-you products. And, we continue to invest in new product development efforts to meet consumers’ demand for baked foods that offer health and wellness attributes. We are not seeing downward pressure toward private label. In fact, our volume increases are coming in the branded retail category.”
Reinforcing Mr. Deese’s view that branded bread has not lost share was the experience of Flowers, which achieved solid unit volume growth over the past year.
“Our increased volume is coming from branded retail, not from private label,” he said. “Nature’s Own, our No. 1 brand, is in the ‘sweet spot’ of where consumer trends are headed — better-for-you products.”
While SymphonyIRI data have shown private label bread gaining only limited traction in the marketplace, Mr. Alton said store brands have performed better in Pan-O-Gold markets.
“We’re seeing private label gain market share in the markets we serve,” he said.
Mr. Alton also decried what he termed the fragmentation of the bread market with ever-more categories and sub categories created, with store brands fitting increasingly into each.
“There is an economy-premium, premium, super premium and even almost a boutique that really gets
expensive, $6 or $7 a loaf, with olives and what not,” he said. “Whenever a 40c spread emerges between categories, another sub-category is created.
“Wal-Mart has two categories of private label and has added an even lower priced one-lb loaf. That’s how you can see some price mix trends change. It’s gone from 24-oz to 20-oz to 16-oz. It all seems aimed at getting that price point down. We see trade down in stores where consumers move from high-end stores such as Lunds and Byerly’s to Cub Foods, and from Cub to Wal-Mart, and Wal-Mart to Aldi. We’re seeing a lot of that.”
The discounted prices on bread have not translated into much overall volume growth, though figures varied widely from company to company. Bread sales in the 52 weeks ended Aug. 8 were 3,023,613,000 units, up 0.5% from the previous year. Private label unit sales were down 1.9% (dollar sales down 3.5%); Flowers, up 6.3% (dollar sales up 1.9%); Sara Lee, down 4.7% (dollar, down 8.8%); and
Bimbo up 5.5% at Weston, down 0.9% at Bimbo and up 0.3% at Stroehmann (dollar sales up 0.2%, down 10.3% and down 5.5%, respectively).
While bread sales volume, as measured by SymphonyIRI sales data, have been edging downward for a number of years, Mr. Fraleigh said this trend has been “pretty much in line” with total grocery sales, and over a multi-year period. The slippage in part reflected steady migration to the away-from-home dining sector, he added, noting that Sara Lee and other bakers participated in that growth.
Mr. Fraleigh brings to his remarks the perspective of an executive with responsibility at Sara Lee extending well beyond baking.
Since the departure of James Nolan earlier this year as c.e.o. of North American Fresh Bakery at Sara Lee, Mr. Fraleigh has been more visibly involved in the baking business. He discussed the baking unit as part of a broader investment presentation to Wall Street analysts last week.
Mr. Fraleigh said volume trends more recently have been “pretty unspectacular” for baking as a category, adding that the best remedy was innovation. The large number of companies competing in the baking industry adds to the pressure to offer innovation, he said.
“It helps drive volume, especially in a very fragmented category, like bread,” he said.
“That’s been our belief,” he said. “Where we’ve applied the most consistent formula, it has generated results. It’s about insight, innovation and discipline.
“We’ve invested millions of dollars on really understanding consumers better, not just at the macro level. We have $60 million to $70 million invested in an R.&D. facility. We have a lot of people spending a lot of time on innovation.
“In meat, there are a lot of analogies with baking, we’ve been much more consistent following the insight, innovation and discipline model, and it has given us much greater share and much better performance.”
Given the retrenchment from away-from-home eating, better volume growth may have been anticipated by bakers than has materialized. The anemic growth rates have raised speculation about changes in consumer behavior that may be adversely affecting demand.
“I don’t know if we will ever see consumers go back to free spending ways,” Mr. Alton said. “I think that will be across every product, from cars to bread. I think they will be more price sensitive than they were, at least over my lifetime.
“In the short run, we have high flour costs, higher sugar costs, health care, taxes … It’s going to be a challenging environment over the next year. That said, I’d rather be in baking than a whole lot of other industries. It’s a pretty stable industry.”
Mr. Deese also commented on consumer behavior and its impact on bread sales.
“The downturn has shaken consumer confidence, which translates into caution for all expenditures, including food,” he said. “Consumers are eating more at home (54% of the food dollar is now spent on at home eating) and that should be positive for bakers focused on retail outlets,” he said. “However, bakers focused on food service have been impacted as consumers spend less eating out as the result of economic pressure.”
Mr. Alton described a quandary facing bakers with regard to gluten-free dieting in which considerable consumer interest has been demonstrated in gluten-free baked foods, but the ability to bake a true quality product is not there yet. Philosophically, the concept of gluten-free is troubling, he added.
“The No. 1 request we get right now is for a gluten-free product,” he said. “That said, we don’t think the bread is very good to consume. We just haven’t formulated one that we think is good enough.
“Gluten free is just pulling something nutritional out. You aren’t adding a benefit. Here you’re asking us to unfortify, and that really bothers me. I also believe many more people believe they are gluten intolerant than truly are.
“In the end, I don’t think gluten-free baked foods will become a big deal, because gluten-free bread is terrible to eat. Foods need to be pleasurable. But the trend will take business away from us.”
The jury is still out on the effects the gluten-free eating trend will have on grain-based foods, Mr. Deese said.
“The gluten-free trend may be impacting sales of grain-based foods, but only time will tell if that impact will be significant,” he said. “It seems consumers are much more careful about everything they are purchasing these days — from high-ticket items to food. I believe people may be buying fewer bread items because they are shopping more consciously and using what they buy more prudently, which can affect volume trends.”
In the presentation to the analysts and in his comments to Milling & Baking News, Mr. Fraleigh was blunt in his assessment of Sara Lee Fresh Bakery’s financial performance, describing profitability as “unacceptable.”
In the Wall Street presentation, Mr. Fraleigh noted that Sara Lee profit margins of 2.9% fell well shy of the 8.5% at Bimbo Bakeries USA and 8.9% at Flowers Bakeries.
He said simplification of routes, formulas and structure will be keys to the company’s more disciplined approach as will standardized pricing and investment in marketing and promotion, innovation, marketplace competitiveness and innovation.
“As we think about what it means for our business going forward, we feel the best way to combat price pressure is very strong innovation, driven by great insights,” he said. “When we are introducing compelling new products, small innovations or big ones like Made with Whole Grain White, it is value added to consumers, and we can get a good price. That’s the way to keep the industry healthy.”
If insights and innovation have been strong points at Sara Lee Bakery in recent years, Mr. Fraleigh suggested that the third objective, “discipline,” has been more elusive. The need for improved cost controls was central to the hiring of Michael Feder as interim c.e.o., Mr. Fraleigh said.
“He came to us through a relationship we have through AlixPartners,” Mr. Fraleigh said. “We were using them for Project Accelerate (a company-wide cost savings and productivity initiative). We had been very good on iterative changes day to day, but for broader changes in cost or efficiency, we thought it would be good to get outside perspective. They’ve come in and helped us. They helped us in the meat industry save $10 million. When Jim Nolan left unexpectedly, we didn’t want to just fill the slot.”
In communications with Alix, Mr. Feder was identified as a possible interim c.e.o. “Michael was available, and I became more personally involved,” Mr. Fraleigh said. “Michael’s mandate was to keep the commercial side of the business moving and focus on operational improvement. Michael and his team have really started to do that. Meanwhile, we’ve engaged another firm to search for a permanent successor for Jim.”
In the markets Flowers serves, economic uncertainty looms large among risks to the company’s profitability during the period ahead.
“Housing in coastal and resort areas in the Sunbelt, as well as other parts of the country, thrived during the boom and now are impacted by the downturn,” Mr. Deese said. “Depending on tax policies, those areas could be further impacted. For instance, retirees depend on dividend income. If dividends are taxed as regular income, retirees’ income would be diminished and local economies impacted.
“I also believe consumers are more cautious and will remain cautious for some time. They are hesitant to make investments, to make big purchases, and they seem to be using whatever they purchase more prudently. In our business, that means they are more thoughtful when they buy bakery items and consume more of what they purchase.”
While economic conditions may keep Flowers executives awake at night, the changing structure of the U.S. baking industry does not, Mr. Deese said.
“For 50 years, Flowers has competed against much larger players in the baked foods arena,” he said. “Flowers Foods has not participated in transformational change. However, we are mindful of changes in the industry and the consolidation under way with the large players as well as independents. As we have throughout our history, Flowers considers whether potential acquisitions could add to our strength to our operations and help build value for our shareholders while not adding a level of risk that is more than we are willing to accept. Going forward, we will continue to grow sales organically and through acquisitions.”
Mr. Alton was particularly guarded in his outlook for baking. The addition of new baking capacity is not an auspicious sign for the industry, he said. Given weak overall unit volume trends, he said prospects for improved market conditions are questionable.
“I am cautious looking ahead because there continues to be more production capacity than needed,” he said. “As long as that’s the case, we are going to see bakeries competing to fill their plants, and they’ll be competing on price to do that, and that will affect profitability. As I said, we continue to have pressure from retailers to keep our pricing low. Consumers are demanding it.”
While pricing may have jumped to the forefront of issues of concern to bakers over the past year, health and wellness certainly has not left their radar screen. Many companies have deliberated over the role of high-fructose corn syrup in bread formulations in the current environment in which many consumers are seen as hostile toward HFCS. The price advantage offered by HFCS versus sugar remains a key in keeping bakers from switching to cane sugar, Mr. Alton said.
“I walked into a meeting this spring, and I said if I was just looking at a sales perspective, we’d take HFCS out of every single product immediately,” he said. “Some
consumers won’t buy your product just because it has it in. No one chooses a product because it has HFCS in. With HFCS, you run this risk of alienating customers.
“The reason we use it is because I’m in charge of manufacturing, and you save a lot of money. We’ve seen a real jump in sugar prices. Until sugar suppliers catch up to the demand, we will see a good disparity in price. If it were the exact same price, we wouldn’t make a single product with it. I don’t think anyone would.”
Mr. Alton acknowledged that beyond the pricing advantage, HFCS has additional manufacturing advantages over granulated sugar, which is more difficult to convey and measure.
“One thing I see bakers doing, including ourselves, is taking advantage of relabeling to corn syrup or corn sugar, which sounds better to the consumer.”
Flowers Foods is among a number of companies that has shifted to sugar and away from high-fructose corn syrup in at least some of its products, Mr. Deese said. The move, he added, was “in response to consumer demand.”
“Our sales trends show that the move was a good one,” he said. “Consumer perceptions matter, and at this point in time, many consumers are seeking products without HFCS. If consumer perception of HFCS changes in the future, we might consider a move back to HFCS.”
While consumers’ focus on health and wellness has been consistent, this interest has been manifested in baked foods in different ways over time, and further change is likely, Mr. Deese noted. He pointed out that health and wellness interest translated into enrichment of grains in the early 1940s and fortification with folic acid in the late 1990s.
“While bread is already fairly low in sodium, we may see bakers further reducing sodium content of some items, as we did with our Nature’s Own lower calories breads back in 2008 and with other items since then,” he said. “We are constantly studying how we can improve the nutritional profile of our existing products and develop new items to meet consumers’ needs for health and wellness. Those efforts include reformulating some of our products to reduce sodium and sugar content as well as adding healthy ingredients or nutrients such calcium, fiber and omega-3.”