The Transitioning Landscape of the Natural Products Industry

How We’ve Created a Major Culture Shift Outside the Natural Category

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Mergers and acquisitions (M&A) have become a major factor in doing business within the natural products industry. According to Sawaya Partners LLC — a law firm specializing in M&A — between 2012 and 2016, the number of transactions in the dietary supplement category nearly doubled, with 29 transactions valued at $15.2 million compared to 17 transactions valued at $8.4 million during the previous five-year period. “I’ve been in the natural products industry about 23 years and this is probably one of the hottest acquisition periods I’ve seen in about 18 or 19 years,” says Jim Emme, CEO of NOW, based in Bloomingdale, IL. “The multiples are high, there is some big money being put on the table to buy some of these startup brands.”

Our little industry is no longer so little and realistically, hasn’t been for some time. The formerly radical ideas of organic agriculture, non-GMO ingredients and whole foods are now relatively mainstream — particularly gaining steam in younger circles, many of whom are new parents concerned about what they and their children consume. Concerns regarding food, agriculture and nutrition that have been raised for decades seem to have reached a peak in public interest as technology has increased media exposure ranging from socially shared articles to Netflix documentaries viewed through smart phone devices and televisions.

With this have come innovative startups disrupting the food and pharmaceutical industries, a distrust of large corporations and a scramble by these large corporations to regain the trust of consumers and profit from the category by purchasing these startups. Most recently, Amazon’s acquisition of Whole Foods Market has rocked our industry stoking our anxieties and there has been talk about major brands such as PepsiCo and Nestle pursuing the purchase of Hain Celestial. The year 2017 was indeed a tumultuous one for many reasons and as we embark into 2018, let’s evaluate where our industry is heading.

Culture Clash
The acquisition of smaller companies by big ones or the merging of two companies is nothing new in business and can present profound opportunity for growing or struggling brands to reach a broader audience and achieve their goals. Beyond the basic nature of business transactions, the significant string of mergers and acquisitions has profound implications for others in the industry. Among retailers, for example, the fear is that with small natural brands being scooped up by major players, the small independent retailer will then have to compete with major retailers for those same products.

Although a competitive disadvantage, this is not necessarily a new phenomenon for independents. “It has been the case since the 1980s when Hain Celestial went over to the mass markets,” explains Jay Jacobowitz, WholeFoods Magazine merchandising editor and owner of Retail Insights based in Brattleboro, VT. “It was really the first natural line that made a strategic shift that they were going to open up the conventional channel. Natural product retailers and independents have seen the progression of natural and organic consumer packaged goods companies as they launch in the independent sector and then migrate to other larger channels. It’s really just a continuation and you can say, an acceleration.”

Not to say this doesn’t impact business. “Does that change how independents handle their product mix? The answer is yes it does, but keep in mind there are far more startups, local and regional producers, that can help the independent retailer create a really interesting product mix,” explains Jacobowitz.

Looking at the big picture, this acceleration is a positive reflection on our industry. “I suppose one good view is that there is a lot of confidence in our industry,” states Emme. However, the overall concerns are valid. “I’m concerned [product] formulas can get changed to match the economic viability,” he continues.

Unfortunately, that is a potential outcome when cultures significantly differ and there are prominent examples. One of the most significant examples is the acquisition of Kashi by The Kellogg Co. based in Battle Creek, MI. The problems start when a large company tries to impose its procedures on the newly acquired innovative entity in an effort to maintain status quo, ultimately hindering any sort of innovation and sabotaging its integrity. One article examining this relationship compares it to a host releasing antibodies to attack innovation (1). For the first eight years, Kellogg allowed Kashi to operate with a great deal of autonomy, allowing it to remain at its original headquarters instead of moving to Michigan where Kellogg is headquartered and make decisions about its suppliers, product rollout and pricing.

This autonomy resulted in over 15 product launches in the first 12 months, annual 42% sales growth on a compound basis to about $600 million (1). Then it all stopped. “Kellogg’s forced its own complicated processes on the smaller company, making it difficult for Kashi to keep pace with rivals and reducing its ability to understand what customers wanted,” states the article. “Operating as a Kellogg’s brand, Kashi expanded into Kellogg’s traditional markets, channels and products. It also started including GMO and non-organic ingredients, losing the trust of Kashi’s traditional customer base and marketing channel.”

This resulted in a 21% decline in revenue for Kashi and many employees left the company. Now, Kellogg has very likely seen the errors of its ways, attempting to mend the damage to Kashi and eventually acquiring other influential natural brands, most recently buying the hot RXBar for $600 million. What Kellogg failed to understand at the time was the natural consumer and their expectations.

Scott Steinford, managing partner of Trust Transparency Consulting, based in Spring, TX, calls this transparency collision. “Transparency collision occurs when the expectation by a consumer or customer is different than that of reality and the realization that the truth isn’t what’s expected,” he explains. In the case of Kashi, their consumers expected natural, organic, non-GMO ingredients because that’s why they started buying their products in the first place. When Kellogg began changing this, the transparency collision occurred: consumers shopping for their favorite cereal were disappointed to see it change.

“Traditional category management tends to commoditize both the consumer and the shopper,” explains Daniel Lohman, founder of Category Management Solutions and WholeFoods Magazine contributor. In other words, Kellogg failed to see the difference between the average consumer and the natural shopper. “The core natural consumer is extremely loyal and committed to that way of life,” he continues. “The big companies see that the core natural consumer is the one driving sales across every category. They think if they buy that brand they will magically inherit all those consumers.”

The natural consumer’s commitments are based on strongly held beliefs about what is healthy and what is not. As mentioned in our introduction, people are perpetually exposed to resources that validate and reinforce these beliefs. “The old adage ‘knowledge is power’ translates succinctly into expectations and the more you know, the more you feel you have the right to know and the more your expectations are going to increase,” explains Steinford. “These expectations you and I have are based on our ability to find out the truth or opposing view — depending on how you want to look at it — because it is literally at our fingertips now. So you can’t expect to push things under the rug or hope that nobody finds out because the likelihood of truth coming out is high.”

The old adage ‘knowledge is power’ translates succinctly into expectations and the more you know, the more you feel you have the right to know and the more your expectations are going to increase.

Some clearly understood this. When Brattleboro, VT-based New Chapter was acquired by Cincinnati, OH-based Procter and Gamble (P&G) in 2012 for example, the parties involved likely foresaw that the sale of a popular organic and non-GMO supplement brand to a Fortune 50 multinational might create consumer backlash. “We have a very passionate, well-researched and vocal group of New Chapterites who love us, and it would only make sense that in something like the sale of the company they would ask us a lot of questions,” said Sarah Newmark, New Chapter’s then senior director of sustainability (now VP of social impact for Food State, based in Manchester, NH) in an interview with Forbes (2).

Becoming a B Corp was a way to ease these concerns for consumers. “Certifying really was one of the ways that we made that commitment and communicated our intention — and our new parent company’s intention — not to change who we were,” said Newmark. Because of this effort by New Chapter and P&G to continue to represent the interests of the natural products consumer, New Chapter continues to thrive and P&G was able to come out with some valuable insight. “In terms of understanding B Corps, they certainly know and understand B Corp because of the work we’ve done internally with certifying and maintaining being a B Corp,” explains Newmark. “In terms of raising awareness, certainly many people within P&G are well aware of this movement and its importance, and of the role it played within New Chapter and that it plays within our industry and our consumers.”

The China Connection
The reputation for commitment to quality in the dietary supplement industry has definitely made us a desirable commodity, not simply when it comes to large consumer packaged goods (CPG) companies, but also foreign investors, which is important to keep in mind when discussing this M&A landscape. “The standpoint from which I’ve been involved with is the interest in a burgeoning nutritional health environment in China and the preference in the Chinese market for American-made dietary supplements,” says Steinford. “So that was driving a number of deals over the last few years. That continues to be an area of opportunity from the Chinese market.”

Indeed, “China” is a term that carries a heavy stigma within our industry. This might change with more investment from that region and forthrightness from manufacturers about their ingredients coming from China. Despite being overshadowed by their acquisition of Whole Foods Market, one particularly significant thing Amazon did before that was release their Elements line of products, seven in total, completely traceable and transparent to the consumer by scanning a QR code. “The newest Amazon Element offering, Biotin 5,000 mcg, is markedly different from the previous six products in that it is the first to have the primary active ingredient sourced from China,” writes Steinford in the Trust Transparency Consulting blog in October (3). “All manufacturers to date have been reluctant to call out Chinese sourced ingredients and often go out of their way to avoid admitting the reality that most ingredients are Chinese sourced. I have had the good fortune to have visited many outstanding Chinese manufacturing facilities so I know geography is not a determinant of quality.”

NOW did something similar, describing an audit of a potential Chinese contract manufacturer in overwhelmingly positive terms (4). What is significant about Amazon’s disclosure however, is their far reach which can overwhelmingly influence consumer opinion on Chinese ingredients if their supplements take off. However, what’s surprising is that this stigma exists even among the Chinese. So they prefer American supplement companies which is encouraging Chinese companies to invest in them and not want to ruin their reputation. “To date, the Chinese have been very hands off in their management after acquisition,” says Steinford.

An Industry Disrupted
As it stands now, many major food and consumer products giants are understanding that the status quo doesn’t cut it. Just two years ago Congress was drafting legislation regarding the labeling of genetically modified ingredients in food in response to a bill in Vermont that made labeling GMOs mandatory. Trade groups like the Grocery Manufacturers Association (GMA) were lobbying for a bill that made labeling voluntary and would pre-empt the Vermont law in order to prevent a patchwork of labeling standards. The prospect of having different labeling standards in different places was an expensive one for large mainstream manufacturers and the disclosure of GMOs in their products was a risk many were unwilling to take, except for an influential few. Before the federal labeling law was passed, firms like Campbell Soup Co. and General Mills came forward with plans to disclose GMOs in their products whatever the resulting bill mandated.

One can interpret this as a calculated business decision. They had a July 2016 deadline to meet Vermont’s standards and depending on Congress to come to a decision by that deadline was a dubious prospect. But they also saw the writing on the wall and decided to win over the respect of natural shoppers, who would be more receptive to future products by those companies if they were to meet their standards. General Mills for its part was well prepared to make this move, having already acquired a variety of natural brands, most significantly Annie’s, and having made a commitment to grow its organic farmland to 250,000 acres by 2019. Fast forward to more recent memory, Campbell Soup Co. has joined the Plant Based Food Association, the only industry trade group representing the plant-based foods sector as well as announcing its decision to leave GMA. Nestle, too, decided to leave GMA amid substantial shift in consumer tastes toward not just better-for-you foods but greater transparency from the companies that sell them products.

Politico quotes a GMA spokesman regarding the departures of these major brands, as saying, “It is not so much an industry divided as an industry that has been tremendously disrupted and is evolving at an unprecedented pace. There’s no question that companies — and GMA — are all different today than they were five years ago or three years ago — and that we all will continue to evolve and change at a faster pace” (5). Five years is a very short amount of time for establishment companies to change in such ways but adaptation is crucial when it comes to shifting consumer trends and expectations. Particularly when you consider the rate at which people consume information, it has become rather impossible for these companies to control the narrative when it comes to the benefits both for health and the environment as related to organic or non-GMO foods, for example. GMA’s position on the labeling of GMOs is not particularly surprising but the fact that companies are distancing themselves to better represent consumers’ new tastes is significant because it appears that change is the only option.

Campbell Soup Co. in particular is a company that understands what natural products mean for manufacturers as a whole. As the keynote speaker at the 2017 Natural Products Expo West, Campbell CEO Denise Morrison made some illuminating statements about her company’s approach. She explained that change is not linear and this ensuing complexity is an opportunity for companies, but requires both responsive and responsible leadership. Clearly, Campbell Soup sees itself as an important leader in this transitioning marketplace with its future oriented approach, preparing for further disruption and perhaps even partaking in it.

What it comes down to is that brands are now aspiring to a level of authenticity instead of trying to inherit it by acquiring natural brands. The best way to be authentic to the ideals of the natural products industry is to practice transparency. This can be a difficult pill to swallow, just think about the efforts taken by GMA to prevent transparency. But the actions of Campbell Soup and General Mills demonstrate a move in that direction for mainstream brands. Of course, true natural brands have been doing this for years.

“Transparency to us means that we’re telling the truth and consumers have a way of verifying it,” explains Emme. He describes an infographic on NOW’s website that explains what GMOs are and what amount of the company’s products can be classified as non-GMO (6). “What it says is ‘Look, we’re not perfect.’ For example, a hundred percent of our food products have non-GM ingredients and we’ve applied for certification through the Non-GMO Project for every one of those products. Our supplement — we don’t say it with a lot of pride, but the reality — only 88% of our supplement products are made with non-GM ingredients. What we’re admitting is that we have some items that might have genetically modified ingredients. For example, the majority of vitamin C in the world is made from corn, synthesized through corn, and we just don’t have any solid way of knowing the exact source of corn for every vitamin C product that we have.”

It’s a pretty simple concept but requires a huge culture shift. Some opt for organic certification by the U.S. Department of Agriculture or Non-GMO Project Verification, but it’s not easy for a company to be candid and say, “Listen, we can’t prove these products are non-GMO or organic.” Infographics become a useful resource because it lays everything out in simply-to-understand terms. “Consumers are looking outside the four corners of the box for information, doing their own research,” says Lohman. “That presents the opportunity for manufacturers to change the messaging so that there is less label fatigue.”

The Role for Independent Retailers
Product labels themselves can be confusing and lead to misunderstanding down the line. One of the prime examples of this is the differentiation of non-GMO and organic. Arguably, at this point, non-GMO is highly popular among manufacturers to place on their labels because of consumer recognition. However, less savvy consumers seeing products labeled both organic and non-GMO, or one or the other, may not understand that organic is actually intrinsically non-GMO, while non-GMO is not intrinsically organic. This is where the retailer comes in. As you all well know, educating the consumer is what sets the independent natural products retailer apart from the mainstream supermarket chains. Consumers look outside the four corners of the packaging because they don’t trust what’s on the label. Independent retailers can have the opposite effect by providing their shoppers with a highly curated product set that they can rely on.

Some excellent examples are our most recent Retailer of the Year, Dean’s Natural Food Market, based in Ocean Township, NJ, which has a non-GMO policy for all its products and Full Circle Market, based in Winchester, KY, which has a set definition for “natural” in its store which is no artificial colors, sweeteners or preservatives, high fructose corn syrup, hydrogenated oils, or MSG. In a video on the WholeFoods Magazine website Laura Sheehan, founder and owner of Full Circle says, “I opened Full Circle Market in 2001 with the mission to have a store where folks didn’t have to come in and read labels” (7).

That’s a pretty simple but radical idea to provide people assurances about their products they can trust. It’s also an opportunity for natural brands and retailers to cooperate. “Natural brands who are experts in their categories need to educate the retailer on why consumers come into their store,” explains Lohman. “And why those consumers shop that little store vs. the big store. The small natural brands need to help that retailer remain relevant and if the retailers and the natural brands can do that, have a strategic plan around that, they will survive and thrive.”

This remains the greatest advantage of an independent, the ability to be a resource for quality information as well as a source for quality products. You are indeed the tastemakers and the trendsetters.

Retail Giants
This brings us to the talk of the town, Amazon’s acquisition of Whole Foods Market. Whole Foods Market has long been a successful peer in the natural products industry, a place where brands long to have shelf space and retailers strive to match in success. Amazon has been a platform many brands can’t afford not to sell on and a thorn in the side of brick-and-mortar retailers. All too often at WholeFoods Magazine, we’ve heard stories of customers wandering into a local natural product retailer seeking information on a product only to pull out their phone with the intention of purchasing it online for a cheaper price.

The small natural brands need to help that retailer remain relevant and if the retailers and the natural brands can do that, have a strategic plan around that, they will survive and thrive.

Now that the ecommerce giant has purchased the natural products retail giant, what does it mean for the rest of you? Some of the first tangible changes that have occurred are price cuts in Whole Foods Market on everyday market basket items such as milk, eggs and bananas as well as the appearance of a limited assortment of “365 Everyday Value” the market’s private label line on Amazon Fresh and Amazon Pantry customers, generating an estimated $1.6 million in sales in the first month (8). Given the novelty of the merger and the price cuts, foot traffic has increased for Whole Foods Market locations, shifting traffic from large competitors such as Walmart, Kroger and Trader Joe’s.

Whether this will continue to be the case remains to be seen. It was also announced at Expo East that vendors selling mostly shelf-stable, non-perishable vitamins, supplements, and personal care items must go through the market’s primary wholesale distributor UNFI instead of selling directly to Whole Foods Market like they’ve been doing (8). These direct vendors for the Whole Body section will also no longer have direct access to store and regional buyers, instead having to negotiate terms with the market’s Austin, TX, headquarters.

As Jacobowitz explains, UNFI’s chronically tight warehouse space will make it tough to accommodate upwards of 10,000 additional supplement and body care SKUs, putting pressure on manufacturers to list directly on Amazon.com or it might alienate some brands entirely, causing them to turn to independent natural product retailers. “In cases where the percentage for a former direct line to Whole Foods [Market] is a minority of sales, or where their lines have so many SKUs that going through UNFI is impractical, a significant chunk of these vendors may decide to take the hit and move on,” he writes. “Historically in our industry, before Whole Foods [Market] became dominant in the mid-90s, the first and easiest path to market was through the independent natural retail channel. Back then, natural and organic manufacturers loved how easy it was to work and grow with independents. But once Whole Foods [Market] came along, the temptation of vastly greater sales took over distribution decisions.”

Jacobowitz brings up another interesting point about distribution, that despite the healthy number of startup and regional brands independents can cater to, there exists a distribution gap. “If you go back to 1980, the pathway for a small startup, natural organic food company, would be through the dedicated wholesale distribution company,” he explains. “Today we [only] have UNFI and KEHE, that are so large and so focused on the super natural channel and the supermarket channel that their slots, the ability to pick up these smaller startup companies, is limited.”

With the distribution changes at Whole Foods Market, this creates a good deal of supply, “but on the other hand there is a question about how that supply gets distributed into scale-appropriate channels,” says Jacobowitz. “I think it’s an opportunity on the wholesale side actually.”

Considering the focus by these major distributors on the supernatural and supermarket channels and the established brands they cater to, Lohman says Whole Foods Market is shifting toward traditional category management. “Because there are no natural brands that are at the level of the big CPG companies, there were no natural brands to fill the void and become a category captain at Whole Foods,” he explains. That means mainstream CPGs that have inherent bias in their own products — instead of the natural brands they now own — will become category leaders, “so now instead of having a retailer that is very committed to their core shopper, now we’ve got a retailer that is basically a healthy version of the other guy,” Lohman adds. The merger, though intimidating, may leave the door open for natural products retailers to be more competitive as Whole Foods Markets drifts further away from the core natural consumer.

All this circles back to the initial discussion about the cultural change occurring in foods and supplements toward transparency. Amazon Whole Foods Market is a major example of this, though there may be some growing pains.

“I think it’s going to be challenging and will continue to be difficult for the cultures to align,” says Emme. Steinford concurs. The merger may be an example of transparency collision if they’re not on the same page. For example, despite the transparency of Amazon’s Element line, Steinford says there are over 10,000 supplement brands listed on Amazon, none of which are vetted like they are by natural products retailers and Whole Foods Market themselves.

“My concern is that they’re coming from two separate focal points and if you look at the focus wheel on the Amazon (Fly Wheel, as they call it) there is no mention of quality in that presentation. However if you look at Whole Foods Market’s core values, quality is at the center,” he explains. “I think that may be a transparency collision that may be coming, a requirement that something be done to create a vetting process similar to what had been previously occurring at retail.”

Ultimately, the natural products industry is gaining momentum, inspiring innovation and forcing institutional change. Mergers and acquisitions are intimidating but necessary for progress, but we must resist pressure to compromise our principles and remain loyal to the wants and needs of the natural consumer. WF

References

  1. M. Krigsman, “Large company innovation gone wrong: Kashi vs. Kellogg’s” http://www.zdnet.com/article/large-company-innovation-gone-wrong-kashi-vs-kelloggs/
  2. J.C. Gilbert, “How To Sell Without Selling Out And Buy Without Burying The Brand,” https://www.forbes.com/sites/jaycoengilbert/2017/09/04/how-to-sell-without-selling-out-and-buy-without-burying-the-brand/#396ca9823dcd
  3. S. Steinford, “Amazon Transparency Goes to China,” http://trusttransparency.com/amazon-transparency-goes-to-china/
  4. A. Secrist. “An Audit Trip to China,” https://www.nowfoods.com/now/nowledge/audit-trip-china
  5. H. Bottemiller Evich, “The big Washington food fight,” https://www.politico.com/story/2017/11/26/food-lobby-consumer-tastes-washington-190528
  6. “Our Non-GMO Commitment Infographic,” https://www.nowfoods.com/now/nowledge/our-non-gmo-commitment-infographic
  7. “Retailer Spotlight: Full Circle Farms,” https://wholefoodsmagazine.com/multimedia/video/retailer-spotlight-full-circle-farms/
  8. J. Jacobowitz, “Whole Foods Abandons the Field,” https://wholefoodsmagazine.com/columns/merchandising-insights/merchandising-insights-whole-foods-abandons-the-field/

Published in WholeFoods Magazine January 2018

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