Lead article in WSJ on AIPC..... American Italian Pasta Corporation. We did not realize that GF had another division?
December 9, 1998
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American Italian Pasta Reflects
On Rise of Brand to National Clout
By REKHA BALU
Staff Reporter of THE WALL STREET JOURNAL
American Italian Pasta Co.'s plan to steal pasta sales from the likes of Hershey Foods Corp. was so audacious that its backers suggested it locate in a prime spot in Kansas City, Mo. If the operation failed, they reasoned, the real estate would be easy to unload.
But the company set up in the suburb of Excelsior Springs for cheaper labor and raw materials and easy access to railroads. Instead of unloading its property, it is now expanding.
In the past 10 years, AIPC has grabbed more than 25% of U.S. retail pasta sales, even though few shoppers know it by name. Its products sell under private labels such as President's Choice spaghetti and Albertson's linguini. One measure of AIPC's surge: Hershey and Borden Foods Inc. have decided to trim their pasta businesses. And Bestfoods, owner of the No. 1 branded pasta, Mueller's, recently hired AIPC to make the brand-name product.
"If I had said five years ago we'd have this kind of market share, people would have carted me off to the funny farm," says Timothy Webster, AIPC president and chief executive officer since 1991.
Power Shift
The success of AIPC is part of an enormous power shift taking place in the $430 billion U.S. food industry. Losing market share are the products -- such as Kellogg cereal and Nabisco cookies -- that showed how powerful a brand can be. Gaining shelf space are the private-label makers, whose products now account for 21% of sales at the top 15 grocers, up from 17% in 1992. While the food industry as a whole grew less than 1% last year, private-label brands grew 4% -- and growth looks set to continue in good times or bad.
Store brands, also known as private-label brands, are typically made by an outside manufacturer according to specifications set by the retailer. They're often sold under the store's name and marketed by the retailer. Branded products are typically marketed and made by the branded company. That is changing as more companies begin to assign production to some of the same companies that make private-label goods -- partly in response to the strides those companies are making. Kellogg, which has publicly criticized private-label makers for inferior quality, relies on Keebler Foods Co., the largest private-label cookie maker, to produce about half of all of Kellogg's Pop-Tarts pastries.
Private-label makers are defying the widespread perception of the food industry as sluggish and short on innovation. Branded-food companies like Kellogg Co., H.J. Heinz Co., Nabisco Inc., Quaker Oats Co. and others are firing employees, shutting down plants and selling off businesses. And the market capitalization of many branded-food companies has declined sharply.
By contrast, AIPC is adding capacity and distribution centers from coast to coast, while its stock has climbed to $22.75, Tuesday's close on the New York Stock Exchange, from $18 when it went public last year. Ralcorp Holdings Inc., which makes private-label cereal and snacks, saw its share price rise 80% over the past two years.
Fundamental Change
What is especially worrisome for branded companies is that private-label competitors such as AIPC have stolen market share during a decade of strong consumer spending. Historically, store brands grew only during hard times, when consumers watched every penny.
But the growth of private labels this decade indicates a fundamental change in consumer perception. Buying a store brand no longer necessarily means sacrificing on quality. When Jeff Moffatt was growing up, the "private label was frowned upon" as inferior, he says. But now, the San Francisco travel agent treats his pierced tongue to Safeway Inc.'s bran flakes and salsa because, he says, the quality is better than that of the Kellogg or Pace brands.
Appearance also has improved. Private-label products evolved from generics, and used to come in black-and-white cans that resembled government rations. But a great deal of design and packaging expertise is devoted to today's private-label products. Amberlyn Nelson, 30, says she buys Safeway Verdi pasta sauce over higher-end Classico largely because of the packaging. "It has a lot to do with the graphics," she says.
Big Advantages
In placing its products on retailers' shelves, the private-label maker boasts some big advantages over branded-food companies. At a time when retailers are losing market share to discounters such as Wal-Mart Stores Inc.'s Supercenters, private-label makers offer a way for supermarkets to compete on price. Store-brand products often are priced 10% to 24% below branded products.
An even bigger marketing advantage than customer savings is the cut that private-label makers offer retailers: Supermarkets earn an average of 25% more on store-brand products, according to Merrill Lynch. Little wonder that retailers are starting to place their own products at eye level and in prized aisle-end displays, instead of on the lower shelves. Packages, shelf signs and even taste-test tables loudly boast that the store's product tastes as good as the national brand. The store-brand box of Apple Cinnamon Tastees at Iowa-based HyVee supermarkets says "If you like Apple Cinnamon Cheerios, try this!"
Private-label makers also are going after regional markets. Heinz, the largest producer of private-label soup, recently introduced an "Italian wedding soup" for Pittsburgh-area stores and the Southwest Classics line of bean soups for the Southwestern U.S. For the 52 weeks ended Oct. 11, unit sales of private-label soup grew by 17.7%, compared with 1.5% growth from leader Campbell Soup Co.
Some supermarkets are pulling away from outside brands altogether. "We don't use our energies to advertise other people's labels," says Ira Cohen, director of merchandising at California-based Trader Joe's, which gets 85% of its sales from private-label goods.
The consolidation of the supermarket industry is only enhancing the private-label advantage. Back when most supermarkets were local, national brands carried a lot of clout. But now, the hot pace of acquisitions by a few supermarket chains such as Safeway and Kroger Co. has helped them gain a near-national presence. And bigger chains, in particular, are enlarging and enhancing their private-label offerings -- partly because their size gives them the sort of marketing clout that used to be wielded only by branded-food companies.
All of this raises the question of whether a store brand becomes a national brand when the store itself goes national. More than just semantics, the issue points to the logical goal of the private-label juggernaut. As grocers grow into national chains, they invariably create national brands, just as Sears Roebuck & Co. did. In England, where four supermarket chains control 75% of the market, store brands account for nearly 44% of sales.
A Trip to Italy
The changes in the pasta aisle reflect those throughout the supermarket. As recently as 10 years ago, branded pastas dominated the market. They came from giants like Hershey, Borden and CPC International Inc. Profit margins were sizable.
Then, in the mid-1980s, a Kansas college dropout named Richard Thompson vowed to create a pasta that was both lower in price and superior in quality. Mr. Thompson, an entrepreneur who had prospered in real estate and oil, spent months in Italy studying pasta making, from shapes and flavors to the art of cooking it to al dente perfection. Along with an Italian partner, he lined up investors including Morgan Stanley and Citicorp Venture Capital Ltd.
AIPC's first customer was Sysco Corp. the big food-service distributor. Mr. Thompson faced the task of delivering premium-quality pasta at a low price -- while taking over from Sysco's 30 other suppliers. AIPC soon discovered the upside of its fledgling status.
For one, prices are so high on branded products that a new player can afford to offer quality at a discount. In the store, AIPC pasta typically sells for 69 cents a pound, about 30 cents less than premium brands. Yet the store earns between 15% and 25% more on AIPC pasta. Moreover, new companies can invest in the latest technology, gaining an edge over competitors saddled with old plants and processes.
Expanding the Menu
So AIPC was able to pare its overall costs -- the company says its costs are 20% lower than its competitors' -- even as it spent more than its branded rivals on higher-quality ingredients and produced more pasta shapes and flavors. AIPC ended up with a large menu of proprietary products that enabled it to offer each of its buyers a unique product. The payoff for Sysco: After signing on with AIPC, its pasta volume rose 16% during a time when Sysco's total unit sales grew only 8%.
Supermarkets generally won't discuss their private-label business, for fear of offending branded suppliers. But Peter O'Gorman, executive vice president of the New Jersey-based A&P chain, which is operated by Great Atlantic & Pacific Tea Co., says AIPC met his pasta wish list: "I wanted European quality, something that didn't get mushy or fall apart," and at a competitive price. The result, he says, has been improved profits and image for A&P.
Calling on supermarkets around the country, AIPC won some enormous accounts. Nearly 40 grocers have hired it to make store-brand pasta. They include eight of the 10 largest chains as well as Wal-Mart. With many of these accounts, AIPC also has won the highly desirable contract to set up the pasta aisle, allowing it to give its products the best display.
AIPC expects its 25% market share to grow as sales rise. Earnings for fiscal 1998, boosted by the Mueller's contract, soared 53% to $15.3 million, on a 46% surge in sales to nearly $189 million. For 1999, earnings and sales are expected to settle down to still-hefty and industry-leading growth rates of 30% and 20%, respectively.
Other big changes are shaking the pasta establishment. Hershey, which sells $400 million a year of pasta under a variety of brand names, has put its business up for sale, saying it wants to focus on its more-profitable confectionery business.
Bestfoods' Concession
And then there's AIPC's Mueller's coup. Bestfoods recently hired it to make the brand-name pasta, the top-selling label in the country. In doing so, Bestfoods acknowledged that AIPC made a lower-cost product, despite using processes and ingredients that typically cost more. Until now, for instance, Bestfoods didn't use durum wheat for its Mueller's pasta. Already, AIPC's flavored pastas for Mueller's, such as lemon-pepper penne, are a hit.
For branded-food companies, the AIPC story doesn't necessarily represent a threat. It can offer a solution, since there's no rule against branded companies making store brands to compete against their own. Some category leaders already are doing it. Spice maker McCormick & Co. now makes Safeway's spices. Tyson Foods now makes private-label breaded chicken items just like its branded product.
Heinz owns the 9-Lives cat-food brand and also makes private-label canned cat food. "If we don't do it, somebody else will," says Steve Whitaker, Heinz Pet Products regional-sales director.
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