Kraft: Caught in a Price Vise

On Wednesday, I noted that Kraft and Sara Lee’s disappointing most-recent quarters were due in part to their pricing strategies. The companies have raised prices to cover commodity costs that soared in the first half of last year, and have since come down.

Retail prices, though, haven’t. At least not by much. As the recession wears on, consumers are increasingly turning to increasingly available, and increasingly high-quality, private-label brands. Grocers are stepping up their pressure on food producers to lower their prices, which will have to come down if food producers want to hold on to their market share.

That spells trouble for makers of branded packaged-foods like Kraft and Sara Lee.

Patrick Garot, a blogger at SeekingAlpha who once worked on strategy at Kraft, took a look at the numbers through the filter of “organic” revenue, which eliminates currency fluctuations and mergers from the mix (a concept that he says he introduced to the company). This is important because both of those figured into Kraft’s fourth-quarter results.

What he found was trouble. Organic growth was good for both international and domestic revenue. Until, that is, you see where the growth came from – price increases. Revenue growth from volume was down. And it was down from “mix” (high revenue vs. low revenue products).

In North America, price increases boosted revenue by 9.4 percent. Internationally, it drove revenue up by 10.5 percent.

“Shocking,” Garot calls it, and he goes on to show how price increases on particular products and product lines cause declines in volume sales. Market shares, he says, are being “slaughtered.”

And market share is “the font of all goodness,” he says. “Everything at which Kraft excels – marketing, operations, sales – is scaled for massive volumes.”

And:

The biggest risk to Kraft is Share decline. Share is horrible to lose. It is costly and tough to regain. The big trick to running Kraft always has been to pass higher costs onto the consumer, without inciting wholesale revolt. This must be done gently.

Not easy, of course, when incomes are declining and input costs are fluctuating wildly over just a few months. But in the fourth quarter, Kraft was less than gentle, and stuck to its pricing even as shoppers looked elsewhere for bargains.

Kraft has to decide now whether it wants to hold on to (or regain) market shares or to boost margins for, perhaps, the next quarter or two. Costs are still falling and incomes are still dropping. The answer, if not easy to swallow, seems clear enough. It has to lower its prices.