Research Paper: Kraft Food, Inc

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Kraft Food Inc.

Kraft Foods is the world's second-largest food company with revenues in 2009 of $40.4 billion. The company has nine brands that are worth over $1 billion each -- Kraft, Oscar Mayer, Philadelphia, Maxwell House, Jacobs, Nabisco, Oreo, Milka and LU. There are around fifty brands in the company's portfolio that generate revenues in excess of $100 million. Kraft operates with a geographic structure based around three units -- North America, Europe and Developing Markets. The former two units are managed by product and the latter by country (Kraft Foods 2009 Form 10-K).

Market Conditions

Kraft Foods operates in the mass market grocery business. This industry can be characterized as being a state of monopolistic competition. There is broad-based competition. Products are differentiated, typically using branding but sometimes along product attribute lines as well. Consumers easily perceive these non-price differences. No producer has sole control over price and there are few barriers to entry or exit.

In general, there is ample supply and demand in Kraft's businesses. Supplies of factor inputs are often governed by both world commodity markets and by large supply companies. Kraft has some power of over price on account of its size, but the suppliers are often also very large entities so pricing power is only moderate. Because Kraft markets to broad, global audience, there is generally high demand for Kraft products. Demand may fluctuate with prevailing economic conditions, particularly in the Developing Markets segment. However, fluctuations are not strong because many of Kraft's products are staple foods.

The degree of differentiation in Kraft's markets introduces some price elasticity of demand. Kraft products are staples, but they are often priced at the higher end of the middle range. For many of Kraft's products, there are generic or low-cost options. Thus, if Kraft prices too high, the utility of Kraft products will decrease, driving demand to lower-cost products. In addition, there are cross-price elasticities of demand. If generics -- often perceived to be of inferior quality -- become too expensive consumers may simply purchase Kraft. As a food company, Kraft also competes indirectly against restaurants. There are notable cross-price elasticities of demand. These are particularly notable for products where the differentiation between the restaurant product and the supermarket product is relatively low, such as pizza or coffee.

Government regulations in Kraft's business are typically related to food safety. In the United States, the Food and Drug Administration (FDA) governs food safety. This governance is typically applied at the manufacturing level and in labeling. Similar agencies or programs exist in many other countries, particularly in the West. While the federal government runs the FDA, the cost of the measures to be put into place to satisfy the FDA fall on the food company. The higher the degree of regulatory burden, the higher the costs imposed will be. Government also involves itself in the regulation of business activities. The degree to which this occurs varies by country, with the level of interference lower in the West and higher in the Developing Markets segment. Even in low-interference regions, merger and acquisition activity typically comes under regulatory scrutiny, as evidenced by recent UK government interference in the company's takeover of Cadbury (Parliament.uk, 2010).

Competition in Kraft's businesses is typically intense. Kraft markets staple products in mainstream segments. For any given product, Kraft will face numerous direct competitors at different price points, and a large number of substitutes as well. Competition is based on both price and differentiation. Some of Kraft's competitors are equally large multinational enterprises, but the type of competition ranges to very small businesses depending on the product and geographic market.

It is expected that the market for Kraft products will continue to grow. In general, North American and European markets are mature, so growth will be relatively slow. There is considerable room for growth in Developing Markets, however. This growth is correlated with economic growth in these regions due to Kraft's premium positioning in those markets. This is evident in the volatility of earnings in emerging markets (Form 10-K).

Financial Ratios

Kraft has a fairly good balance sheet. The company's current ratio is 1.1, which is lower than the industry average. The quick ratio is 0.8, mirroring the industry average. The debt-to-equity ratio is 0.73, which means that the company has a lower degree of leverage than the industry average. Kraft adopts a slightly premium position in the market. This is reflected in their margins. Kraft's gross margin is 36.2%, higher than the industry average. The net margin is 7.5%, in line with the industry average. Over the past five years, Kraft's margins had trended towards the industry average.

The maturity of Kraft's major markets, combined with the high intensity of competition, has meant that its returns have historically been inferior to the food industry average. Their return on equity is 12.5%, versus an industry average of 22%. Return on assets is 4.7% and return on capital is 5.6%, both well below the industry average. Kraft is less efficient operationally than its peers. The company's receivables turn (8.2), inventory turn (6.7) and asset turn (0.6) are all below the industry average.

Overall, while Kraft is a relatively strong company, it underperforms its peers. The company has been more or less unable to improve its performance in key metrics over the past ten years, save for interest coverage. In other measures, Kraft has shown little to no improvement in recent years.

Improvements

Kraft's relative inefficiency relative to the industry seems incongruous with its large size. The company should enjoy economies of scale in production, bringing increased efficiency. Addressing this issue will require an analysis of potential underlying causes. For each brand, for example, Kraft offers a wide range of packaging formats and sizes. This channel stuffing may meet certain needs but it is not likely to improve efficiency. In addition to solutions such as lineup simplification, Kraft can increase output in order to improve efficiency and increase its margins.

In order to increase output, Kraft may need to reduce its price points slightly. While the products do enjoy some differentiation, the fact that the company is relatively inefficient indicates that they are pricing too high and not selling enough. The price may not accurately reflect the perceived differentiation among consumers. As such, some are choosing lower-cost products, higher-quality products or substitutes. Given the elasticity characteristics of the grocery business, it is likely that consumers are choosing lower-cost products, believing that there is insufficient differentiation to warrant paying a higher price for the Kraft product. While this is not a major problem, it does represent an opportunity for improvement for the company. Lowering the prices will improve their utility and convince more consumers to buy more.

In the short run, this will squeeze margins but in the long run, it will improve them. The company will sell more, which will allow it to gain greater production efficiencies. By improving efficiency, costs will be reduced, bringing the company to its new equilibrium point, which will have improved margins and improved sales. It does not appear that the price decrease will need to be substantial, given the ongoing strength of Kraft's $100 million and billion dollar brands.

In addition, Kraft can improve its efficiency by restructuring its operations. The company's current organizational structure is a convoluted mix of product and geography, but not in a pure matrix form. It is recommended that this organizational structure issue be resolved. Perhaps the best way to reorganize based on product in all countries. Consumers in Developing Markets that can afford Kraft typically display the same buying behaviors as those in developed markets. Therefore, the company can treat them the same way. This will allow for greater production efficiencies to be realized, particularly in Asia and Latin America, where production can be done on… [END OF PREVIEW]

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