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General Mills' Aisle-Opening Strategies

Erin Lash, CFA

Erin Lash: Hi, my name is Erin Lash, and I am a consumer products Analyst here at Morningstar.

Today we're welcoming Don Mulligan, executive vice president and chief financial officer at General Mills to talk about the competitive landscape in the consumer products industry, both domestically and abroad.

Thank you for joining us, Don.

Don Mulligan: It's my pleasure, Erin. Happy to be back.

Lash: The news is ripe with headlines about the divergence in spending among high-end consumers, which seem to be spending abundantly, and low- to middle-income consumers, whose budgets appear to be stretched.

What are you seeing with regards to your business, and in addition how have your strategies maybe changed over the past two years given that we haven’t really seen a real rebound in spending?

Mulligan: Well, it's a great question. It's very top of mind for us. Obviously, it focuses mostly here in the U.S. or the developed markets. We can talk about the emerging markets later. We see the environment remains very challenging. Consumers are cautious. They are being very planful in terms of how they spend their money.

But that does two things; I think it actually helps our business. First of all, [consumers are] looking for value, and the best food value you are going to find is in the store.

And the second is, you have to eat, and so food is a very resilient category, and as we see those two factors, if you will, coming together, we actually think it's great time to be in the food industry.

We've actually seen our categories grow over the last quarter. We're up actually 4% in aggregate, and 11 of our 12 largest U.S. categories grew year-on-year in our first quarter. And that's because I think we're bringing to bear what the consumers are looking for; obviously, great taste, convenience, health, and then value.

If you look at our core products, a bowl of cereal is going to be a $0.25, a cup of yogurt is $0.70, a granola bar is $0.55. So, we constantly are making sure that the food tastes great, that it is bringing the right benefits--and health is one of those--but also that it's at the right value. The combination of those things has allowed our business and our categories to grow.

Lash: Building on that, one of the things that we've been impressed by is General Mills' commitment to investing in product innovation and marketing that resonates with consumers.

However, your competitors seem to be re-energized in their efforts as well to generate new sales from new products.

How do you ensure that your products continue to end up in consumer shopping carts?

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Mulligan: Well, there is a couple of things, and I guess as a backdrop, one of the first things I'd say is we like healthy competition. We think if there is new news, new benefits being brought to the category, that’s going to drive more consumers to our space, and we're going to win our fair share or more of those consumer occasions. So, we think is healthy competition is what drives category, as we've seen it across all of our major categories. So we like that environment.

What the consumers are looking for is, as I mentioned before, they're looking for taste, they're looking convenience, they're looking for health, they're looking for value, and we focus on bringing those. We've launched over 100 new products in the first part of our fiscal year, which started in June. Products like Fiber One 90 Calorie Brownies, which is a nice indulgent dessert, but has fiber benefit and only 90 calories.

We have a product in our Pillsbury line called Egg Scrambles and Grands! Biscuits, which are all about microwave convenient meal occasions--breakfast meal occasions.

And then outside the U.S. with our Häagen-Dazs brand, we're offering a product called Secret Sensations, which is a great tasting ice cream that you expect from Häagen-Dazs, which actually has kind of a fudge or a sauce center. So it's almost like a sundae or fondant offering. And if you are hitting on taste, you're hitting on convenience, you're hitting on right value, and particularly with the Fiber One example, if you're hitting on a real health benefit, consumers will gravitate to that. That’s what they're looking for.

And so, we think first is that new product and then the second is, is the support of advertising. Over the last five years, we've actually increased our advertising over 80%, so at a 14% annual clip, and we think that’s important because in today's world when value is so important, it's not only the national brands you're competing with, it's the private label, or the retailer brands as we call them. And we need to make sure that we are front and center in the consumers' mind. They understand our benefits that we're bringing before they come into the store.

And so we think the combination of great new benefits we're bringing through new products as well as the strong advertising behind those brands are the combination that will allow us to win and have allowed us to gain share over the last few years.

Lash: That's interesting. Beyond aggressive competition, input cost inflation persists, and obviously raising prices to offset those higher costs could negatively impact sales volume growth.

Have you seen trade down to private label accelerate over the past several months in light of these pressures, and in addition, how does the management group think about the price/volume trade-off in an environment where there is little to no growth overall in spending?

Mulligan: You hit on one of the key factors that we absolutely have to manage, and everybody in our space has to manage, and that’s input cost inflation. We'll see 10% to 11% inflation in our fiscal year that’s under way now. That’s at the very high-end of what we hope to see, but we expect to see inflation at the 4% or 5% range on a regular basis going forward. We think it will be volatile. 10% or 11% this year, but we think it will average that kind of level.

So, for us this has been something that we've been managing quite assertively over the last six or seven years as we've seen that, really a step change in inflation. So, we have really a cultural approach called "holistic margin management," and it consists of productivity--and not just supply chain or COGS productivity--but with our administrative expenses, our advertising expenses, and the whole focus is, how do you ensure you're protecting or enhancing your margins even in today's inflationary environment. So productivity is one. There is a lot of tools we have behind that that we can talk about a little bit later.

Second is mix management. So we talk about new products. One of the benchmarks we look at with new products is not just the consumer interest, but also, what's the financial structure of the new product, and we want them to be margin accretive, and the vast majority, literally 80% to 90% of the new products we launch, are margin accretive, so that helps protect our margins.

And then the very last lever is pricing. Again, fundamental to our proposition is affordable products. So, pricing is the last lever that we pull. And if you look back over the last four or five years, we've averaged that kind of 5% inflation, our pricing has only been a fraction of that. So we've offset the vast majority of that inflation through productivity and mix management.

Now in a year with 10% or 11% inflation, you're going to see some pricing, we have in the marketplace. We expected that to impact our volumes. Our guidance for the year is our volumes will be down modestly, and that’s what they're tracking to through the first quarter of the year, and now another month or two under our belt. Volumes are tracking very much as we expected: down a touch, but we're in the range that we thought. But that combined with the pricing is still allowing us to see mid-single-digit sales growth, and that will allow us then to deliver the profit that we expect for the year. So, quite honestly, the year is unfolding both from an inflation and a pricing and volume standpoint very much in line with what we expected coming in.

Lash: Do you think that customers that have traded down or are trading down will trade back up, as the economy improves?

Mulligan: You would expect that they would. Again, as a little bit of context, in our categories, private-label, or retailer brands as we call them, are about 14% to 15% market share. I think across food and beverage overall in the U.S., it's close to 20%. So [retailer brands are] underpenetrated [in our categories], which really reflects the fact that our categories, you can really differentiate. That’s why brands have held their share better than in some more commoditized categories.

And we expect that to continue, and as that continues, as we bring benefits ... and we monitor our business against the retailer brands, as we call them, or the private label, the same way we do against our national branded competitors. So, we want to make sure we have a clear product quality win. We want to make sure we're bringing benefits that are hard for private label to replicate, and obviously, we want to make sure the pricing is right. It's going to be a premium, but we want to make sure that premium is in a certain range.

So, we monitor all those very closely, and what we've seen is, if you go back three or four years, when the economic slump really first hit, we saw private label pick up 100 to 150 basis points of share. It gave some of that back over last two years and has kind of held steady over the last six to eight months, and we think that's a combination of the consumers, while not feeling better, at least maybe are plateauing, and the fact that branded competitors, ourselves included, have gotten a lot sharper on all those points I just mentioned before in terms of quality, in terms of the brand equity, in terms of the pricing, and that's how we're going to continue to fight the battle going forward.

Lash: In light of the sluggish economic environment domestically, a lot of consumer product companies have made further penetrating emerging and developing markets a top priority.

I was curious if you could talk to the competitive dynamics and how they differ between emerging and developing markets to developed markets?

Mulligan: It's really interesting. There is a dichotomy of the consumer. U.S. developed markets still very cautious, as I mentioned. Emerging markets remain aspirational. There is higher growth, there is higher employment, people are thinking of the future in much brighter terms. As that evolves, as the middle class evolves, many of the same kind of opportunities and stresses, if you will, of life in developed markets are emerging. Things like dual-income couples, less time to cook, maybe less skills in cooking.

So the strengths that have allowed us to succeed in the developed markets are playing very well in emerging markets as well. You have [to have] a convenient meal. It has to taste great. It has to be in their regular repertoire. It has to be affordably priced. So that's been our focus.

Combine that with how trade is developing. As modern trade develops in the emerging markets whether that's because you have a Carrefour or a Walmart entering the market, or you have the local trade modernizing, that gives us an advantage as well, because again the sales skills that we have that allows us to succeed in the U.S. are transferrable to those markets.

Best example for us is China; we have a $0.5 billion business, growing 20% a year, very profitable. We're expanding geographically, and one of the foundational businesses is a brand called Wanchai Ferry. It's a frozen dim sum line, so a core local cuisine product that we, an American company, sell locally, managed by a local management team, a team that has been with us for over 10 years, and it's frozen dim sum, so it meets all the criteria I was talking about earlier for that emerging middle class family: It's convenient, so, they don't have to spend all day actually making the dumplings, which their mother or grandmother would have done. It tastes great, because it's got to be competitive with what they remember that product to be from growing up. It's got to be affordably priced. It's got to be readily available.

And what has happened in China over the last five to 10 years, as the modern trade has developed, this being a frozen product, we needed that frozen supply chain, the retailer supply chain, developed. As it has, it has allowed us to expand that product. So if you look back five years, we were in half a dozen cities; now we're approaching 100, and we've been just as successful in those secondary and tertiary cities, which still have 5 million and 10 million population, as we are in the Shanghais and the Beijings. And it's bringing our core capabilities to bear: Great brand, great product, great marketing, a supply chain that gets it there efficiently and in an affordable fashion, and we see a ton of upside in the emerging markets by continuing to bring those kind of capabilities and those brands to the consumers.

Lash: Now last year, consolidation was a hot topic, both of products and of companies. And now focus has ... taken center stage more or less as consumer product companies have decided to spin off businesses.

Is it safe to assume that General Mills still believes operating a multiproduct platform is ideal? And if so, how is that more optimal than operating a singularly focused business?

Mulligan: Well, I think we are singularly focused. I mean, it's consumer foods, so it's not as wide as the conglomerates of years past, if you will. But that said, if you kind of lower the microscope to our space, you are right. The flavor of the day is going from consolidation to spin-offs. And I think for individual companies that may be the right strategy as your product line diverges or your geographic base diverges.

We don't view it that way for the simple reason that we think we have a portfolio that is actually quite synergistic. In the U.S., we are a larger player across multiple categories, which gives us the scale with the retailer. Our brands are well loved and our categories are well loved by the consumers, but in today's world with consolidating retailers, you also have to have scale with them.

And ... this isn't scale about leverage on pricing and negotiations. This is scale that we can see the whole store, whether it's a frozen aisle, refrigerator, or shelf stable. And we can bring, whether it's a supply-chain solution or a merchandising solution, like our Box Tops for Education, we can run a program that spans the whole store. So we can bring in one of their shoppers and not just drive him to the cereal aisle, we can take him to the yogurt aisle, and the refrigerated baking goods, so they are over in their refrigerated section. We can take them to the frozen [aisle] with our Green Giant or our Wanchai Ferry, or our Totino's brands. And not many of our competitors can do that. As a matter of fact, nobody else can really do that to the breadth that we do. So, the combination of the brands, the properties (like Box Tops), and the view of the store really gives us some scale in the U.S. that make all the categories play for us.

Now, when you look outside the U.S., it is much more about focus, because you can't have 20-some categories worldwide. We concentrate on five, and they are relevant in the U.S. and they are relevant outside the U.S., so we get scale across markets.

Cereal clearly is our largest single play, a $24 billion category worldwide growing midsingle-digits.

Yogurt, which we've been in the U.S. for 30-plus years, have now gone global with, with our controlling-interest acquisition of Yoplait International. A $65 billion category growing high-single-digits.

With healthy snacks, which is around our Nature Valley bar, a $10 million category growing midsingle-digits.

Ice cream, where we own Häagen-Dazs, the world's largest ice cream brand, plays in the super-premium segment, but a category that's growing mid-single-digits, and that super-premium is actually growing faster.

Then, lastly, convenient meals, where we have a number of plays, such as Wanchai Ferry I talked about in China. Quite honestly the largest category, it's really an amalgamation of several different brands--$80 billion-plus growing low- to midsingle-digits, and again our play in that is growing actually slightly faster.

So, across those five categories, 60%-plus of our sales today, more than that of our growth as we look forward, and an ability to get scale between our large and successful U.S. business and our still rapidly growing international business. So, our portfolio really has a lot of pluses to it. It's the strength of the U.S. and it's the growth opportunity geographically and in those five core categories outside the U.S.

Lash: This has been very helpful, Don. Thank you for taking the time to talk to us today. We really appreciate it.

Mulligan: It's my pleasure. Always happy to be back at Morningstar.