Kraft Foods Group

Executive Summary

The report presents a detailed analysis of the Kraft Foods Group’s business environment and elaborates major opportunities and threats arising in this market. The company is a leader in the processed food segment in the North America, which is anticipated to continue growing in the next few years. Still, the group fails to address the change in consumer preferences, who require not only convenient, but also healthy, safe, high-quality products. Along with the increase in the commodity prices, this was the main barrier that resulted in the flat revenue performance in 2014.

The group announced its planned merger with the H.J. Heinz company to be completed in 2015, creating the fifth largest food manufacturer in the world. The process will provide the unprecedented economies of scale, greater production facilities, resulting in the higher production efficiency. Most importantly, the group will recover its international presence and will significantly benefit from strengthening the position of its brands in the global markets.

Introduction

Despite specific negative trends and other risks in the industry that hinder the performance of the company, the Kraft Foods Group is expected to gain large benefits and utilize growth opportunities resulting from a merger planned to take place by the end of 2015. The paper presents a brief overview of the industry trends and dwells on the specific threats imposed by the business environment of the company in question.

Key Industry Trends

The Kraft Foods Group operations are currently concentrated in the North America while the USA represents the world’s largest market of the packaged and processed food. The main drivers of the market that contribute to its further growth in the next years are “convenience, ease of use, longer shelf life” (“Convenience Foods Market,” 2014), saving consumers time and providing them with high assortment of good-quality products. In the developing countries, customers turn to pay increasingly more attention to the nutritional value, the high safety and quality of the consumed products as well as added “health benefits” (“Convenience Foods Market,” 2014).

Major Threats of the Kraft Foods Group Business

Change of Consumer Preferences

The main threat to the business arises from the changes in the demand. The growing trend towards healthier nutrition drives customers to prefer fresh goods and smaller local brands to the Kraft staple products. The pattern is particularly strong in the developed markets and thus directly affects the company’s performance. As the group’s CEO commented in the Q4 earnings call: “Our consumers have changed, but our company has not changed enough, and certainly has not kept pace” (“Kraft Foods Group’s (KRFT) CEO John Cahill on Q4 2014 Results,” 2015). Namely, despite the unique awareness and high recognition of the Kraft brands, in 2014 the company failed to increase its overall market share and lost the market share in 40% of the businesses. According to the 2014 annual report, the company performed below the industry average and the peer comparison group.

Commodity Costs

The company depends on the wide range of commodities and raw materials to manufacture and package its products. The most significant drivers are dairy products, coffee beans, grains, sugar, soybean and vegetable oils. Although the company monitors and manages risks related to commodity prices, the hedging strategies do not provide full protection “from increases in specific raw material costs” (“Kraft Foods Group Inc.”, 2015). The corporation partially offsets the commodity price growth by increasing final product prices. However, this strategy will not work in the highly competitive segments and may lead to losses in terms of volume of sales in other market segments. In 2014, the high commodity costs were the major negative driver of the declining profits.

Sustainability and Negative Publicity Issues

Since the spin-off of 2012, the company provided limited public communication regarding its sustainability-related projects. The sustainability and sourcing of the ingredients remain a key challenge for the industry segment. Whereas all major competitors address the corresponding issues, Kraft was ranked behind all other firms. The company took the last position in a sustainability “industry benchmark of 52 sources” surveying over 14,400 companies (Larsen, 2015). Although the corporation has a number of ecological projects, it fails to transparently communicate the results of these initiatives to the stakeholders. The sustainability rankings have dropped during the last years. The company faced accusations related to irresponsible sourcing of its materials that led to deforestation. The heavy reliance on processed foods in its product portfolio, the high content of the palm oil and other components in the ingredient list might represent a major issue for the company’s growth, aggravating the consumer perception problem.

Although the issues might be reinforced with an upcoming merger, there are reasons to expect that the company will address them more effectively in its planned international expansion. The opportunities presented by the planned merger are described in the following sections.

The Forthcoming Merger as a Major Opportunity

Background of the Business

In October 2012, the Kraft Foods Group was formed after a spin-off from the international Kraft Foods Inc., subsequently renamed to Mondelez International Inc. The newly formed North American business operates through six grocery segments, including cheese, refrigerated meals, beverages, desserts, enhancers and snack nuts, as well as exporting the products. Despite the fact that the company markets a number of high-performing brands in the USA and Canada, it failed to maintain sufficient revenue growth in 2014. The CEO summarized that the performance was negatively affected by both “the macro environment and the execution” (“Kraft Foods Group Reports Fourth Quarter and Full Year 2014 Results,” 2015).

New Merger Planned in 2015

On March 25, the company announced a milestone decision, which is the merger with the H.J. Heinz Co. The new Kraft Heinz Company will form a “fifth-largest food company in the world and the third-largest in the US” (“The Analysis of the Kraft-Heinz Merger,” 2015), after PepsiCo and Nestle. The current Kraft shareholders will keep 49% of the stock in the new corporation, whereas the 51% will be controlled by the new investors from the 3G Capital and Berkshire Hathaway companies. The estimated annual sales of the new firm are $28 billion; after the announcement of the deal the stock prices soared by 50% (“Historical Stock Prices of the Kraft Foods Group Inc.,” 2015).

The forthcoming merger will have a profound impact on the company’s operations, presenting a number of benefits for the new business. Essentially, this decision will mirror the split of 2012 and allow the Kraft Foods Group to re-enter the international market, although not keeping the full control of the company. The merger is expected to offset a number of issues related to the stagnating development of specific Kraft businesses by providing new international growth opportunities, synergy effects, and utilizing new economies of scale. Other business opportunities are presented in more detail in the next section.

Return of International Brands Licensed to Mondelez

During the next few years, the Kraft Foods Group will return many international brands which are currently licensed to Mondelez. According to license agreements of 2012, “the most important ones will run out in 2022, but some will come up sooner and some already have” (Fox, 2015). The new Kraft Heinz Company will be able to benefit from selling these brands in the global markets.

Expansion into the New Product Segments

Both Kraft and Heinz feature the same problem with the core brands in their portfolio, which rely heavily on the processed ingredients, GMOs, palm oil, sugar, high fructose corn syrup and artificial flavorings. Still, the synergy brought by the merger will not only provide greater production facilities, but also result in significant cost savings that could be directed to expand the assortment of healthier products. Introducing relevant product portfolio would allow the company to overcome the negative demand issues and reposition its brands according to the changes in consumer preferences. In 2014, the organic foods segment grew by 11% whereas Kraft exhibited flat revenues. The company should present larger assortment of “less processed and more natural foods or see the earnings suffer” (Lane, 2015). According to statistics on the Kraft corporate website, its products are consumed by 98% of the American households. The need to address the issue has a large immediate impact on the revenue growth.

Conclusion

The Kraft Foods Group is a market leader of the processed food and beverage segment in the North America. Operating in a competitive environment, the company faced some challenges in the last years, including increasing commodity costs, decline of market share caused by the changes in the customer preferences, and sustainability issues. Lack of growth in 2014 was followed by a decision to go for a merger with the H.J. Heinz company. Provided that the new corporation will revise the product assortment and reposition the brand to address the changed demand, the anticipated effects of the merger are expected to offset the threats imposed by the industry environment. Among the key positive factors are large cost savings, production efficiency increases and, a key benefit, the group’s renewed and strengthened position in the international market.

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