TreeHouse Foods and other private label companies face big COVID challenges
If you’ve been paying attention to any branded consumer goods company’s COVID-era financial returns, you’ll notice a familiar refrain: Things are crazy, but overall, business is going great. Private label companies? Not so much.
Nowhere is this more apparent than TreeHouse Food’s recent investor call.
Before discussing the company’s financial results, CEO Steven Oakland led with a bombshell. The $4.3 billion private label product juggernaut, which makes store brands for everyone from Walmart to Wholefoods, is looking to sell off its largest division—meal prep. “We have talked about those businesses as growth engines and cash engines,” Oakland told investors. The meal prep division, which includes products like condiments and mac-and-cheese, is a cash engine. It produces relatively low-margin staples that generate a lot of cash as products fly off the shelves. TreeHouse can use that cash to in higher-margin products within its snack and beverage portfolio. If that sales goes through, “We would simply have that cash available sooner and be able to execute that strategy a little faster.”
To understand why management is pursuing this new strategy, it’s best to take a step back and look at three things: The value proposition for a private label company, the operations that enable it, and how COVID upended it all.
A private label company’s value proposition
Private label brands have been around for about as long as large retail stores have existed. Private-label goods are nothing new, of course,” Matthew Boyle wrote in Fortune Magazine back in 2003, “having been around since the days when A&P owned vast coffee plantation in South America.” For most of the 20th century, private label was associated with cheapness and low quality. Then, in the last 30 years, something changed.
Retailers—once the lowly peddlers of brands that were made and marketed by big, important manufacturers—are now behaving like full-fledged marketers. And here’s the earthquake part: It is their brands—not those of traditional powerhouses like Kraft or Coke—that are winning over the (consumers) in the greatest numbers.
Private label manufacturers produce products that retailers can then brand under their own umbrella. However, most retailers don’t want to own their own factories, and with few exceptions, they rely on companies like TreeHouse foods for that. This setup worked pretty well before COVID-19. In the years leading up to the pandemic, sales of private label products typically grew at twice the rate of branded products.
The operations of a private label company
Since private label companies don’t handle the sales or marketing of their products, the companies have different core competencies than branded CPG companies.
If you think back to the six major business processes in consumer products, private label companies handle processes 1-4, while the retailer manages all aspects of Sales and Marketing.
1. Research and development: Creating a product that consumers want.
2. Production: Figuring out how to manufacture the improved product at scale.
3. Supply chain: Ensuring that you have enough raw commodities to manufacture the product.
4. Transportation: Getting the product to the customer (retailer).
5. Sales: Ensuring the product gets prime placement for a customer through negotiations and pricing.
6. Marketing: Generating consumer awareness and demand through advertising
The result is:
Consumers get relatively high-quality and low-cost products.
Retailers capture higher margins and generate brand loyalty through their own offerings (think Costco and Kirkland).
Private label companies operate as manufacturing partners and supply chains for retailers.
How COVID upended the private label business model
If you’ve followed this blog, you’ll know that branded CPG companies have excelled in COVID by maximizing each business process outlined above. Due to the nature of private label products, TreeHouse Foods can’t. “One thing I think to remember about us,” Oakland told analysts, “Is that we are only a supply chain business. We don’t have marketing levers. We don’t have many of the other levers that you have in your branded lives.”
Here are the levers he is referring to.
TreeHouse Foods couldn’t increase production to meet demand through third-parties.
When the initial lock-down started in March of 2020, panicked consumers flooded retail outlets. Stock-outs of common products became a regular occurrence as manufacturers couldn’t keep pace with demand. Most branded consumer goods companies opted to subcontract the production out to third parties to deal with the onslaught. In the case of General Mills, it added 50 additional partners to its production capacity. “If demand starts to taper off, that is the capacity that we will shed first,” Kofi Bruce, the CFO of General Mills, told the Wall Street Journal. Since TreeHouse Foods was the one making the already low-margin products, it didn’t have that luxury.
Private label companies couldn’t rationalize SKUs.
Faced with overwhelming demand and production constraints, managers at branded CPG companies embarked on SKU rationalization projects. “We’ve made some choices in our supply chain to — we’ve reduced some of the tail of our portfolio,” the CEO of Pepsi told investors back in July 2020. The company met with its retailers and prioritized production of the best selling SKUs. “We both agreed that it’s probably the best thing to do, to eliminate the smaller SKUs in the portfolio to maximize the best-selling SKUs and be in stock.”
Private label companies were out of luck. Since they’re focused on producing basic products, their SKU assortment is relatively limited.
The Wall Street Journal explained:
In frozen waffles, TreeHouse temporarily cut flavored ones, like chocolate chip, to focus on making the basics. The leading brand, Kellogg’s Eggo, suspended production of more obscure varieties and continued selling popular flavors like chocolate chip. TreeHouse’s frozen-waffle sales took a hit as a result, Mr. Oakland said.
Private label products have less pricing power.
Most branded consumer product companies have raised prices to offset rising covid-19 induced inflation. The smart ones have used revenue growth management techniques in a targeted way that boosts profitability.
Here’s what I wrote earlier about Kimberly-Clark’s RGM strategy:
Kimberly-Clark is looking to leverage these same insights. RGM will bring in reams of data that will allow them to understand opportunities. Currently, a 32 pack of Huggies is $8.29 at Target online. Given the current level of online competition, it seems unlikely that the company could increase this SKU price.
However, done right, RGM will allow K-C to understand the true cost of selling at each customer—by SKU. RGM uses a variety of COGS, Transportation, and Trade data to reveal profitability. Maybe they can increase the base cost of a less popular item by 25%, but make up the lost volume with a promotional coupon on the 32 pack.
TreeHouse Foods doesn’t have this flexibility because its products are unbranded. In fact, the cost of producing each item is rising, but the retail price is staying the same. TreeHouse Foods is taking this cost increase! Management claims it’s to maintain good relations with their customers, but in reality, the retailers hold power in the relationship and there isn’t another option.
Private Label products aren’t optimized for E-commerce.
In 2021, it’s anticipated that online grocery sales will reach $100 billion. Unfortunately for private label manufacturers, the private label industry isn’t optimized for e-commerce.
Private labels products mainly differentiate through price. Once consumers are in a retail store, they compare and contrast products side-by-side. E-commerce isn’t optimized for that. It’s optimized for keywords, and mobile ordering often shows one product (often promoted) at a time.
In 2014, I wrote an article on Li & Fung, the massive Asian supply chain magnate. In it, I argued that their business model was becoming obsolete. Its reliance on just-in-time production across multiple borders made it especially susceptible to the shocks associated with climate change.
The question is, what will Li & Fung do? Their product isn’t soda or shoes. It is a network that is dependent on the system that is becoming unstable. If they don’t change, they will go from the company that no one knows about to the company no one cares about.
You can lump the current iteration of TreeHouse Foods into that category. Its entire business model was built around acquiring a massive production infrastructure to produce unbranded products.
I think management would agree.
“We had built this supply chain designed for tremendous efficiency but very low volatility,” Steven Oakland said. “When the pandemic hit, we had complexity meet volatility.”