Dominic Miles, partner and global co-head of L.E.K.’s consumer practice, sheds light on the likely scenarios paving the way to recovery
By Murielle Gonzalez
Food and drink companies that have managed to navigate the storm presented by the Covid-19 pandemic are yet to face the challenges on the road to recovery along with a looming recession casting a shadow over plans, particularly on the investment front. Most businesses have been forced to embrace new sales strategies and distribution channels with technology at its core to an extent never experienced before. Finding ways of supporting future growth has never been more important.
While the economic climate set to welcome businesses in the fourth quarter this year is uncertain, advisors at L.E.K. Consulting believe the outlook is driven by three fundamental themes rooted in consumers’ behaviour. These include existing trends prior to the Covid-19 pandemic, the habits learnt in lockdown, and the practices arising in periods of recession that have been observed in the past, during the global financial crisis, for example. “These consumer behaviours are likely to shape the food and drink market for the next three-to-five years,” says Dominic Miles, partner and global co-head of L.E.K.’s consumer practice.
Having foodservice halt from March to June due to the Covid-19 lockdown put businesses in the sector into financial stress with plummeting sales overnight, but sparked an increase in grocery purchases. The uplift, however, has not offset the collapse of the foodservice and restaurant sectors.
Miles notes that the future landscape in the food and drink space largely depends on the success of public policy in managing future outbreaks as much as on finding a vaccine.
“Our working view is that, depending on the scenario, it will take two-to-three years from January 2020 until the economy starts getting back to the same level of consumer expenditure,” he says.
Getting ready for what is to come requires a bird’s-eye view to understand the dynamics driving the changes on the consumer and food manufacturing sides.
Three trends have dominated consumers’ behaviour in the past 10 years. These include the food-on-the-go lifestyle, a trend associated with the lack of time, ability or confidence in cooking; the shift to ‘better-for-you’ propositions, which is aligned with the notion of personalised nutrition to meet dietary requirements; and the polarisation of items with premium brands at one end of the spectrum and value or discounted products at the other.
“The shift to food and drink products with health and sustainable credentials is the key trend that has been strengthened by lockdown, and it’s likely to continue beyond Covid-19,” says Miles.
Miles says that there was a brief moment during the initial stockpiling period where private label accounted for more than its normal level of grocery sales. However, the private label gain relative to branded product has to date been limited.
The rise of e-commerce
L.E.K. Consulting‘s view is that the overall consumer response to the Covid-19 shock combined a surge of preparedness with spending deferrals typical of economic crises.
Miles argues that the shift to e-commerce is perhaps the most dramatic change we now see in the food and drink space.
“E-commerce hasn’t really been as strong in food and drink as in other consumer categories,” says Miles. “In the UK, for example, home delivery and online grocery services have penetration in the mid-high single-digit share of the total market, even twenty years after the first propositions were launched,” he explains. “In continental Europe, e-commerce penetration has been significantly lower.”
Miles notes that on the foodservice front, home delivery for restaurant meals has been growing fast, driven by platforms such as Just Eat and Deliveroo, but was still at a relatively low level of penetration prior to Covid-19.
“We are likely to see a huge step increase in ordering online being fulfilled by home-delivery where the capacity existed,” says Miles, noting the trend will see most adoption in the UK and to a lesser extent in France and Spain. “The shift towards direct-to-consumer channels has moved towards click-and-collect where home-delivery infrastructure didn’t exist,” he adds.
New shopping trends
Six trends emerged from the Covid-19 lockdown, and were consistently across large global economies. These are:
- Initial preparedness for a disaster, which led to increasing sales of cleaning and sanitising products
- Stockpiling of pantry staples and non-perishable items, such as toilet paper and pain relief
- Increase of online and on-demand purchase across categories, such as food, grocery, and exercise equipment
- Increase in streaming services and at-home entertainment;
- Cessation of out-of-home leisure, travel and tourism
- Elimination of non-essential and luxury products
“The first four trends are a reaction behaviour to containment and lockdown while the last two are typical of economic contraction,” says Miles.
The impact of Covid-19 lockdown on consumer purchasing has been pronounced. The US published data last week showing a drop in consumer spending of 35% in the second quarter.
While equivalent data for European markets have not yet been published, L.E.K. Consulting has estimated the impact in consumer expenditure across European markets to be in the range of a 25% to 30% reduction.
“Overall food and drink sector, spending has been less affected than other consumer categories, but this masks divergent trends,” says Miles. He notes that grocery spending has been resilient because as foodservice shut down, people have been obligated to eat at home, and has been buying kitchen staples from local shops.
“Grocery sales have been up between 15%-25% across European markets during the lockdown period, and those gains were widely distributed across all categories, led by frozen and packaged food, alcohol, and dairy,” says Miles.
However, the spend lost in foodservice has not fully transferred to the grocery. The latest data from market research company IRI for France showed that the loss in consumer spending on out-of-home meals during the first months of lockdown was €6 billion. The uplift in grocery sales gained only €1.7 billion.
New lockdown behaviour
There hasn’t been a pronounced shift in consumers’ brand and private label choices to date, but Miles recognises some minor shifts occurred early on most likely due to most popular branded products being out of stock as their supply chains couldn’t cope with the exceptional level of demand.
“What is more clear is the fundamental shift from where and how people are buying,” says Miles. “People move away from the weekly structured shopping at a ‘hypermarket to greater use of near-to-home supermarkets, local shops and convenience stores.”
Miles believes that a similar local focus is going to be adopted by food manufacturers for their supply chain going forward.
“Food and drink businesses are typically sourcing regionally, but we think there will be a further drive towards more local sourcing, and it may push the development of vertical farming,” says Miles. “These are indoor, closed controlled farming systems very close to point of sale. We see a growing interest in these platforms across the northeast of the US.”
If the lessons from the global financial crisis are anything to go by, there will be further changes in the food and drink space.
“During GFC, consumers prioritised spending in core categories, such as dairy, bread, fruit, alcohol, and affordable luxury, but withdrew from more expensive ranges such as organic,” says Miles. He recognises that before 2008 many food companies launched organic ranges across most groceries, but consumers stopped being prepared to pay for the premium.
“This time around, it is less likely that consumers will move away from organic as health and nutrition, product provenance and convenience are still top-of-mind,” he says.
“There was also a shift from trusted brands to private label, smaller and value packs, fewer impulse purchases, and more deal and promotion hunting,” says Miles. “Retailer competition for consumer spending put pressure on manufacturers’ cost basis and caused food manufacture consolidation.”
Manufacturing consolidation will spark M&A deals, and Miles says that in the years following past recessions in 2003-04, and 2010-12, the activity surged. An analysis by Harris Williams of MergerMarket data showed that transactions in the sector typically account for between 3.5% and 6% of all deals, and were above 5% during these post-recessionary periods.
Harris Williams’ analysis also highlights that while food and drink deal volumes have dropped in past recessions, the recovery is generally rapid with overall volumes rebounding within three years, and that the split between strategic and private equity buyers in the food and drink space has remained stable at approximately 75% and 25% over time, respectively.
The waiting game
Miles observes that, as we move from health-scare to recession, it is likely that we will see some of these recessionary behaviours reappearing.
“Up until now, we haven’t seen these recessionary behaviours, such as the shift to private label because the negative impact on household income has been moderate given job support schemes from governments. The true economic impact of the recession hasn’t been felt yet,” says Miles.
The road to recovery will see lockdown consumer behaviour disappear in the next six months or so. These include eat-at-home and pantry stocking.
On the business side, the ‘margin pressure holiday’ that food manufacturers have enjoyed due to the absence of promotional activity is likely to end, too. Consequently, the price competition and promotional pressure on manufacturers from grocery retailers are expected to step back up.
The long-term effect will hit the market amid a recession. Miles argues that as people recognise the hardship that is likely to come as a result of the overall economic situation they will likely push the switch from brands to private label.
In this period, the behaviour learnt under lockdown, such as food safety, home-cooking, and local shopping will remain untouched.
“Likely winners of this period are food manufacturers with benefit of scale that can provide reassurance to grocery chains that they can maintain security of supply,” says Miles.
For Miles, the recovery phase outside the economic recession is likely to be driven by four Covid-19 surviving trends. These are an acceleration of the level of digital consumer engagement, the consolidation of health and wellness driving purchasing decisions, supply chain resilience with the uptake of local sourcing; and sustainability credentials.
On the digital front, big food companies have launched direct-to-consumer platforms designed to benefit from their economies of scale.
Heinz, for example, launched a box delivery service for its canned products in April, which has since expanded to include baby food and sauces. Similarly, PepsiCo launched two direct-to-consumer platforms in the US in May, snacks.com and pantryshop.com.
“There is a substantial potential economic benefit for brands going directly to consumers,” says Miles. “The tricky bit has been the home delivery, but that is a model likely to continue to evolve.”
From the consumer perspective, sustainability is a key concern and consumers’ interest in these values translates into a requirement for the brands they choose. Companies willing to gain consumers’ loyalty must demonstrate they are treating the planet in a more sustainable fashion.
“Looking ahead, brands will have to demonstrate a focus on innovation to support food safety, sustainable packaging and new formats,” says Miles. “And manufacturers will have a focus on securing supply chain resilience to grocery customers while adapting propositions to address the better-for-you and sustainability concerns,” he concludes.
Date published: 6 August 2020