Under Betsy Holden, Kraft Foods is winning the war of the aisles. And causing plenty of casualties.
Kraft's size and ubiquity are great for business—for the Northfield, Ill.-based foodmaker and for the largest supermarket chains, that is. Not so great for the little granola maker or fruit popsicle company trying to edge its way onto the shelves of the big supermarket chains. Nor for smaller grocery stores that can't push as many foodstuffs and, hence, won't get the same favorable pricing that a Wal-Mart or Kroger will. This is a war where battles are fought over inches of shelf space and pennies per item—and where there are many casualties. Last year 720 U.S. grocery stores of all sizes shut their doors. Of 608 novel consumer packaged products introduced between 1996 and 1998, only 290 survived two years, according to Information Resources.
Leading the charge in this brutal industry is Betsy D. Holden, co-chief executive of Kraft since last year. She comes across more as a soccer mom or an elementary school teacher than as the head of a company that last year earned $2.1 billion on $33.9 billion in revenues. In an era when many businesswomen would recoil at such a description, Holden is proud of it. As a 46-year-old mother of two soccer-age suburban kids, Holden herself is Kraft's target customer. And 20 years ago, teaching in a fourth-grade classroom outside of Chicago, she learned how to get those kids to do what she wanted.
Today she gets the same results with giant retailers like Wal-Mart and Safeway. "The only difference is the age of the students," she jokes. In fact, it's been easier to convince supermarkets of the benefits of carrying lots and lots of Kraft foodstuffs, displayed the way Holden wants it, than it was to teach the virtues of multiplication tables. By dint of its powerhouse brands and marketing muscle—it spends $850 million a year on promotion and advertising—Kraft can present an irrefutable case for mutual best interest.
With those advantages, Holden and Kraft needn't bully retailers when they can win them over with consumer insights and marketing advice. Grocers are listening, and in many cases they're handing Kraft the keys to the storeroom, giving it power to make decisions about product placement, promotions and pricing—not only for its own category-dominating brands, but also for those of its competitors.
To a small foodmaker, this looks like a fox guarding a henhouse. To Kraft, it's the new era of database-rich retailing.
"Everybody's got the knife to their throats, and what retailers are saying is that Kraft is the go-to supplier," says Kenneth Harris, an Evanston, Ill. consultant with Cannondale Associates, which each year asks retailers to rank suppliers in several strategic categories. Last year, for the first time, Kraft overtook Procter & Gamble as the highest-ranked supplier, (see graphic).
The symbiotic arrangement between Kraft and giant retailers is redefining the way groceries are sold. It also represents the outcome of long-standing arm-wrestling between food manufacturers and retailers as each side consolidated to gain an advantage against the other. The five largest retailers' share of the grocery business climbed from 26.5% in 1980 to 38% in 2000. After years of cowering before the power of brand giants like P&G, consolidating retailers turned the tables, putting the squeeze on manufacturers, demanding price cuts and often extracting cash for shelf space—the notorious slotting fees.
Retaliating, the food manufacturers have combined as well, (see chart). Kraft represents the recent consolidation, under Philip Morris, of three foodmaking giants that even when separate were powerful enough to cause handwringing among antitrust lawyers. Already in their early-20th-century incarnations, as National Dairy Products (later Kraft), National Biscuit Co. (Nabisco) and Post Cereal (General Foods), these three were category leaders in a position to elbow smaller foodmakers off the shelves. Just two of the antitrust squabbles in this competitive business: a 1930s lawsuit in which Kellogg claimed that Nabisco was monopolizing the shredded-wheat industry; and a long battle, beginning in 1962, in which the federal government claimed Kraft was giving price breaks to national supermarket chains that it denied to little retailers.
Why did trustbusters sit on their hands while Philip Morris in 1988 added Kraft to its General Foods and then rounded out the line with its purchase of Nabisco in 2000? One reason is that the consolidation was a defensive move that simply evened the score with the newly powerful retail chains.
Not everybody is waving merrily as the Kraft juggernaut rumbles by. Smaller rivals are getting crushed. Although they are unlikely to force a breakup of the food manufacturing industry, antitrust officials are questioning the wisdom—and the legality—of an arrangement that gives selected suppliers disproportionate influence over shelf space. "As an antitrust matter, it seems rather strange that you'd have one company advising a store on how to handle the product of its competitors," says Federal Trade Commission member Thomas Leary.
Such collaboration terrifies the little guy, who already feels he's getting shafted. "[Retailers] might price you out, or they might put you down on the bottom shelf where nobody can see you," says Scott Hannah, chief executive of Pacific Valley Foods, a Bellevue, Wash. outfit that sells frozen vegetables.
These fears may be widespread, but few small companies are willing to talk about them—even to federal investigators. In October 1999 Senate Small Business Committee Chairman Christopher Bond (R-Mo.) asked the General Accounting Office to study slotting fees. Bond equipped the GAO with a letter promising confidentiality to anybody who came clean. A year later the GAO's Lawrence Dyckman came back empty-handed. "I have worked for the GAO for 31 years and this is the first time Ihave had to report to a committee that I have been unsuccessful in trying to carry out the work," a frustrated Dyckman testified.
So how does the system work? Specific pricing information is very tough to come by—secrecy shrouds the special deals that salesmen cut product by product, region by region, retailer by retailer, as they jockey for shelf space. This much is known: Real estate on the grocery shelves is largely allocated according to clout and to money passing to the retailer, either in fees or price discounts. Established manufacturers like Kraft still have to pay chains to take new products, but they receive preferential treatment in placement and display because of their ability to generate huge turnover.
For a new product the standard price of admission to the shelves is a slotting fee—up to $25,000 per item for a regional cluster of stores. (A California food producer says he met with a buyer at a chain grocer who demanded $250,000 for ten stores and wouldn't even take a meeting until he received a $100,000 check.) Small manufacturers hate paying upfront money; it can put them out of business before they've even started.
But retailers legitimately argue that they're taking a risk by giving over valuable space to an unproven product. If the product is the winner that the sales rep says it will be, the manufacturer can earn back that slotting fee. Just how much a foodmaker pays depends on several factors—more if the retailer provides distribution, less if the product appears to be innovative enough to create incremental sales for the store. The manufacturer can offer deep discounts or supply free goods or services. Some retailers, says Pacific Valley's Hannah, are beginning to demand in-kind payments like stockroom labor.
Increasingly common are what's called "free fills." A food supplier sells its product to a distributor for, say, $10 a case. The distributor marks up the price 25% to the retailer—who pays the $12.50 but then asks the manufacturer to rebate the $2.50 markup to him. On that case the food producer is netting only $7.50. "Free fill," sighs a New England manufacturer with $1.4 million in sales last year. "If it was actually free, it would be a little easier to swallow."
Even P&G pays slotting fees—sometimes at higher rates than tiny foodmakers. Why? "Large companies often pursue narrower product innovation strategies, just variations on products they already offer," says a former executive at two major food companies who now runs a small foodmaker. If Crest, he says, comes out with an all-in-one tartar control and whitening toothpaste, and Colgate already has a similar product out there, why should P&G get a free ride—particularly if it's further subdividing an existing market?
Kraft claims it doesn't pay for shelf space. It does cough up cash to promote new products, says Philip Pellegrino, head of sales and Betsy Holden's chief lieutenant in the shelf-space crusade. But it's not, Pellegrino insists, a slotting allowance.
The biggest emporium of all, Wal-Mart, doesn't charge slotting fees to anyone. It gets its ample gross profits by insisting on better pricing, such as an extra percentage point in the standard discount for early payment. Here the picture is clouded by an arcane 1936 pricing law, the Robinson-Patman Act. Enacted in a populist attack on the then-mighty A&P chain, the law forbids a manufacturer from giving volume discounts unless they are either justified by cost differences or are necessary to meet the prices of a competitor. That allows Wal-Mart to qualify for special treatment—if, for example, it does more of the warehousing or shipping than the next retailer or displays goods in a different way in the store.
Obviously, a giant retailer can pummel a tiny supplier with greater impunity than it can a big one. "Wal-Mart isn't able to put the squeeze on suppliers who are dominant in their market," says University of North Carolina professor Paul N. Bloom. The large manufacturer can insist that cheap house brands be kept further away on the shelf from its costlier brands; the small manufacturer takes its lumps. Robinson-Patman scarcely provides for such subtleties.
Retailers have another way to extract money from food manufacturers: Make them pay for the advertising circulars that jam your Sunday paper. The reason you rarely see a little-known brand in these flyers is that this sort of advertising can be prohibitively expensive—up to $3,000 for a one-inch square color photo, depending on the size of the chain and how many stores carry the item.
Nothing in this business beats access. One of Kraft's biggest advantages is face time with retail executives, which the tiny pasta or organic jam outfit can scarcely afford. Pellegrino spends three days a week with customers. Holden blocks out two days a month for what she calls "top-to-top" discussions with chains like Wal-Mart and Albertson's. At some of those meetings, each of Kraft's 12business units gets 30 minutes in front of the customer—a marathon day. "We're there to listen," Pellegrino says. Every division gets a score between one and ten and walks away with a list of improvements the retailer wants to see. "If we're not the best vendor, we want to know who is," says Holden.
More often than not, though, they are the bestseller. The Cannondale rankings prove it, but you can see it for yourself, in the heap of Oreo cookies or Ritz crackers at the end of the aisle. You'll find Oscar Mayer Lunchables in a case near—but separate from—the meat section. Down in the freezer aisle DiGiorno pizza is on prominent display.
Disputes over display space recently spilled into court twice, both times in the tobacco business. One case, brought by three cigarette companies, alleges that Philip Morris, Kraft's parent (it still owns 84%), paid retailers to shove competitors' smokes to the sides and to the bottom of displays, where nobody would see them. Trial is set for May 20.
Such fights have intensified as cigarette makers have lost their ability to advertise. In the food business it hasn't come to legal blows recently, but there have been plenty of skirmishes along the way to the uneasy truce that exists now, in which manufacturers give marketing advice to retailers.
The buddy relationship dates back to 1985, when P&G's vice president of sales cut a deal with his biggest customer, Sam Walton; the "channel partnership" would comanage the overlapping parts of their supply chain like a vertically integrated company. By 1990 P&G had a dozen full-time employees near Wal-Mart's headquarters in Bentonville, Ark. Meanwhile, the industry was embracing a new concept called "category management." Put simply, it called on retailers to plan marketing and strategy for an entire group of products rather than brand by brand, as they had traditionally done.
Eventually retailers began farming out category management to their suppliers. With profits slim, grocers didn't have much to spend on marketing (they'd never been particularly good at it anyway), and consumer tastes and habits were changing fast. Manufacturers like P&G and Kraft had huge marketing budgets, managed by legions of M.B.A.s. They spent lavishly trying to understand consumer preferences and buying patterns. As supermarkets tapped into those resources, the shift began. Mass-market advertising began giving way to in-store merchandising; in 2000, 13% of a foodmaker's sales went to in-store promotions and discounting,
Kraft began offering category management in 1993, but in those days it had bigger problems to deal with.
Kraft was going to supermarkets with its nine different sales divisions, organized under three different operating divisions—Kraft, Oscar Mayer and General Foods. That had to change. Retailers, consolidating and gaining strength, wouldn't put up with multiple visits from different representatives of the same company. In 1995 Kraft dramatically reorganized its sales force, centralizing it, then slicing it into teams of 300 people, broken up by customer—not by brand. Now Kraft has one customer manager for each major chain in a city or region.
While Kraft was shoring up its in-store connections, P&G was severing theirs. In 2000 (in an effort to cut costs) the folks in Cincinnati decided to eliminate the retail sales force, leaving only corporate dealmakers to work with their retail counterparts. That move, in conjunction with Kraft's buildup, set the stage for Betsy Holden to overtake Procter.
Through all this Holden was a rising star at Kraft. She had come to the company in 1982, already a long way from her fourth-grade class in Glencoe, Ill. While there she had taken a side job helping Playskool develop toys; a brief glimpse of the marketing side sent her into an M.B.A. program at Northwestern University's Kellogg School of Management. Two years later she came out of Kellogg with a husband, Arthur—a classmate and now chief executive of a Chicago gene-mapping outfit called First Genetic Trust—and a job at General Foods in White Plains, N.Y.
In her climb up the corporate staircase Holden served two years as brand manager for Miracle Whip, another two leading the new-product division. In 1994 she was running the Tombstone pizza unit. And she was riding a rocket: Kraft's new rising-crust pizza, DiGiorno, launched in 1995, blasted into the freezer section; today it brings in $400 million in annual sales.
But success was hardly a quick spin in the microwave. Any new product faces an arduous climb in the freezer section, the most competitive space in the supermarket. As DiGiorno rolled out, Holden rode with it—in trucks along with Kraft sales reps. She presided over the pitch to store managers: Put DiGiorno in the freezer, and it'll help you keep your customers out of Pizza Hut. The lesson she learned:"Customers are looking for innovation, but they're also looking for some excitement in their stores."
To spur excitement, Holden relied on a direct-delivery sales force for DiGiorno—the only one of its kind within Kraft. They worked closely with store managers to arrange displays, monitor placement, plan promotions and supervise extensive sampling. In three years Kraft's share of the frozen pizza market jumped from 28% to 34%.
Her blowout in pizza led Holden to the pinnacle of Kraft's mountaintop—the cheese division, where she worked for nearly three years, beginning in 1995. While there Holden perfected her pitch to retailers. As Kraft used its dairy-case dominance to take over marketing responsibility in grocery stores, even competitors had to admit it was working. Says one: "Betsy understood that cooperation builds categories. And she was wildly cooperative."
That trait would make her the perfect chief executive for Kraft two years later. But it took a couple of big breaks to clear the way. The first came in May 2000, when then-chief Robert Eckert unexpectedly bolted to take over Mattel. Holden became head of the food division at Philip Morris. Then, in January 2001, five months before Kraft's public offering, Nabisco chief James Kilts quit and took a job running Gillette. That cleared the path for Holden to be named Kraft's co-chief executive in June 2001 (she shares the job with Roger Deromedi, who runs the smaller international division).
Kraft brands sit atop 23 categories, from cookies (Oreo) to synthetic cheese (Velveeta). As the dominant brand, Kraft is often appointed "category captain" by retailers that believe the manufacturer has the greatest resources and the will to exert them to drive sales across the category. In that role it has one assignment: Make money for the retailer. That's only possible if you have the means to learn everything about the category—sales volume, shelf-space allotments, placement, pricing, retailer costs. Those costs can include the price paid for competitors' products, collected from third parties and fed to Kraft's sales division.
Kraft gets its sales data from industry number crunchers Information Resources and ACNielsen. Unless it's talking to Wal-Mart, which last year stopped providing its sales numbers to Information Resources, figuring it could get all the analysis it needed from its suppliers or its own sophisticated systems. That move rocked the industry: It was a shot across IRI's bow and a signal to manufacturers that the stakes are getting higher in the information game.
Kraft is ready to play. Once they get the numbers from their customers, Pellegrino's sales reps open their laptops. A Kraft-developed application called Three-Step Category Builder lets them tear a category apart, analyze all the data and create a management plan in two days—a process that used to take 200 hours. The software then distills the plan into a few simple charts. "It shouldn't take more than 15 minutes to explain," says Christopher Hogan, technology chief in Kraft's sales division. The plan will tell the retailer which products to move to eye level, where to position its house brands (the most profitable products in the store) and what to charge for each brand. As Pellegrino says:"You get to make the lineup"—or even recommend jettisoning slow-selling brands altogether.
The cozy relationship between giant foodmakers and retailers has put the FTCo n alert. A February 2001 report on slotting allowances (a practice the agency has been crusading against for years) detailed four potential antitrust problems with category captains: access to competitive information, exclusion of competitors' products, collusion among retailers that share a category captain and collusion among manufacturers.
"The practice raises questions about whether the big dog not only eats first, but also decides who gets the table scraps," says Senator Bond. Leary, the FTCcommissioner, remembers that while working as a private antitrust lawyer he had a client who claimed it had been disadvantaged by the recommendation of a competing category captain (he won't name names). Now the onetime adviser to General Motors finds the category-captain structure highly suspicious. "I would've been amazed if I thought anybody at GM would be advising auto dealers about how to price and promote Fords," he says.
The technological and economic forces that drive consolidation—and propelled Kraft to where it is today—seem destined to continue. But the populist reaction won't go away either. Holden's shelf wars are just beginning.
Additional reporting by Lea Goldman.