HOW KING KELLOGG BEAT THE BLAHS The cereal champ lost its edge, then came roaring back. Now it has creamed its competitors and brought new life to a business everyone said was mature.
(FORTUNE Magazine) – MONDAY MORNINGS AT 7:30 William E. LaMothe, the chairman of Kellogg, and 30 or so of his top executives sit down to a breakfast of cold cereal. They sample several bowls, each containing cereal from one of Kellogg's five U.S. cereal plants or from one of the company's 16 factories abroad. Using terms like ''mouth feel'' and ''bowl life,'' they discuss flavor, appearance, texture, and if it's Rice Krispies, the sound of the snap, crackle, and pop. Each sample gets graded ''satisfactory'' -- the top rating -- ''acceptable,'' or ''BKSL,'' which means below Kellogg's standard level, and the comments are passed on to plant managers and quality control people. Tough judges, these consumers. On average only 12% to 15% of the cereals tested at the Monday breakfasts in Battle Creek, Michigan, earn satisfactory ratings. * ''We're setting the highest standard to drive to,'' says LaMothe, whose name rhymes with ''oath.'' An eight-year stint overseeing Kellogg's research and development turned him into an apostle of quality and prompted him to start the taste tests in 1979, when he became chairman. Truth to tell, the cereal maker had gotten out of touch with consumers too old to send in a Froot Loops box top and 50 cents for a Toucan Sam doll. It was underspending its competition in marketing and product development, and by 1983 its U.S. market share hit its low of 36.7%. A prominent Wall Street analyst summed up Kellogg as ''a fine company that's past its prime.'' Those were fighting words to LaMothe. ''Past our prime?'' he snorts. ''We loved that.'' He and his managers became so obsessed with the remark that for the next year strategy sessions ended with someone asking, ''How's that for a company that's past its prime?'' Kellogg has gained five share points since it hit bottom, in a market where every point is worth about $42 million in revenues to the manufacturer. Another problem that confronted Kellogg and its chairman is one that many companies in fickle consumer industries face: what to do when your basic business stops growing. Some companies diversify their way out of the dilemma. Kellogg had bought two small businesses, Mrs. Smith's pies and Eggo waffles, in the 1970s, and industry analysts thought the company foolish for not diversifying further as General Mills and Quaker Oats were doing. Kellogg's critics, who saw baby-boomers reaching adulthood, noted that grownups do not eat much cereal, but LaMothe refused to heed their warnings that the market would mature in the 1980s. He decided to stick with the cereal business -- and make that no-growth industry grow for Kellogg. ''I thought, what are these companies really getting out of diversification?'' says LaMothe. ''We looked at demographics and saw this big group -- 80 million baby-boomers. We knew they were health oriented, they were joggers. People said, 'Forget about them. They don't eat breakfast.' We knew they were too big to forget about.'' Instead of concentrating on kids, cereal's customary customers, LaMothe zeroed in on this expanding adult population. By pitching cereal's convenience and nutritional value, Kellogg has helped persuade U.S. consumers age 25 to 49 to eat, on average, 26% more cereal than people that age downed five years ago. The ''no-growth'' U.S. ready-to-eat cereal market, worth $3.7 billion at retail in 1983, now totals $5.4 billion, and has expanded three times as fast as the average grocery category. ''We're driving the cereal industry's growth,'' says LaMothe proudly. Adds David G. Owens, a consumer products consultant: ''Kellogg has taken an unexciting growth prospect and made it exciting.'' THE COMPANY'S revenues have swelled from $2.4 billion in 1983 to $3.8 billion last year. Foreigners are spooning up Kellogg's cereals too. Says executive vice president Arnold G. Langbo, who heads Kellogg's fast-growing international division (1987 revenues: $1.1 billion): ''We've struck the word 'mature' out of our language.'' Today LaMothe talks about raising Kellogg's U.S. market share to 50%, and his competitors don't know how to stop him. General Mills, the largest rival, sells mostly kids' cereals and hasn't snared more than 21% of the market for the past several years. But Kellogg has gained most of its market share at the expense of the No. 3 manufacturer, General Foods' Post division, part of Philip Morris. Post makes cereals for grownups, but it has not had a successful new product since 1982, and its market share has slid to 13.2% from 16.5% five years ago. Ralston Purina, RJR Nabisco, and Quaker Oats each control less than 8% of the industry. Says an executive at one of those companies: ''We don't see any major areas of weakness in Kellogg that we can attack.'' Adds another: ''These guys act like they want it all.'' Indeed they do. Wall Street analysts who criticized Kellogg a few years ago now praise LaMothe for his commitment to the cereal business. Short and wiry, he started selling cereal on his hometown streets of Brooklyn after earning an economics degree from Fordham University in 1950. Like most Kellogg managers, the 61-year-old chairman is low key and serious, ''a soft-spoken, no-nonsense high achiever,'' says former Ford Motor chairman Philip Caldwell, who sits on Kellogg's board. ''He doesn't go around beating his chest.'' But LaMothe is a tireless worker -- usually seven days a week and often at a stand-up desk in his office ''to keep the adrenaline flowing,'' he says. His concentration is formidable and beamed relentlessly on the cereal business. LaMothe says that running a diversified company such as a Procter & Gamble ''would blow my mind.'' HOW DO YOU hitch up your market share and disprove the doomsayers? LaMothe has no formula, but his advice is instructive: ''You have to have enough muscle to bring to the marketplace value-added products that really do offer the consumer something better, and then you've got to be able to tell the consumer about them. You have to have a strong franchise and continue to build on it.'' Spending to develop new products is key. Kellogg's R&D budget last year was $40 million, about 1.1% of sales, vs. General Mills' $38.3 million, or 0.7% of its $5.2 billion in fiscal 1987 revenues. With 47 cereals introduced worldwide in 1987, Kellogg launches twice as many new products today as it did five years ago. The story of one of those new brands, Mueslix (pronounced muse-licks), illustrates how Kellogg is successfully pitching to the big kids products that are a lot more exotic than plain old Corn Flakes. Mueslix is dense, crispy flakes mixed with dried fruits and such unusual morning fare as hazelnuts. Horst W. Schroeder, 47, the German-born president of Kellogg North America, came up with the idea for Mueslix in 1986 only to be faced with terrific opposition from Kellogg's researchers, marketing department, ad agency -- everyone, he says, except Bill LaMothe. A decade earlier the company had been singularly unsuccessful in getting Americans to eat muesli, a mushy, oat-based porridge that Schroeder had successfully launched for Kellogg in Europe. The skepticism, says Schroeder, '' made it fun to prove Mueslix would make it.'' Though he had never even tasted American-style cold cereal until he reached his 20s, Schroeder's task was to change Kellogg's European cereal to fit American tastes. Working closely with Kellogg's researchers, he created a toasted-flake mixture that bore little resemblance to the oat porridge that Americans found so unpalatable. Mueslix was launched last November with a $33 million marketing budget, an industry record. TV commercials feature Swedish actor Max Von Sydow touting the stuff as a ''centuries-old balance'' of healthy ingredients, ''what breakfast was meant to be.'' Mueslix's sales have been running close to $100 million on an annualized basis, twice what Kellogg had projected. John M. McMillin, a food industry analyst at Prudential-Bache Securities, says repeat purchases are 25% higher than average for a successful new cereal, even though Mueslix costs about $2.89 for a 14-ounce box, vs. $1.55 for 12 ounces of Corn Flakes. Kellogg anticipated a loss the first year, but the brand is already making money and making Schroeder the odds-on favorite to succeed LaMothe as chief executive when the chairman retires, probably in 1991. Under LaMothe, Kellogg has been especially good at attacking market niches with technologically innovative products. The company introduced Crispix in 1983 to get its spoon into Ralston Purina's Chex family of cereals, which had about $125 million in annual sales and no significant competition. Crispix, which bonds two grains in one bite-size cereal -- corn on one side, rice on the other -- had sales last year of about $65 million. Kellogg has cracked Nabisco's Shredded Wheat niche with a pantryful of products. Among them: Raisin Squares and other fruit-filled shredded wheat cereals, and Nutri-Grain Biscuits, a shredded wheat without preservatives. The commitment to creating new products has paid off abroad too, where the company competes with Quaker Oats, Swiss-based Nestle, and many smaller concerns. Kellogg maintains its 50% share of cereal sales outside North America partly by developing new cereals for specific foreign markets. Just Right, a mineral-laden, multigrain flake now sold in the U.S., was created for health-conscious, athletic Australians, who are the world's third-biggest cereal eaters. (The Irish are first; the British, second; Americans, fourth.) For Japan, where many people still eat fish and rice for breakfast, Kellogg cooked up Genmai Flakes, made of whole-grain rice.
Like the milk on Rice Krispies, the money Kellogg pours into marketing gives all these products their snap, crackle, and pop. Annual spending has tripled since 1983 to an estimated $865 million, or 20% of sales. Most of that goes into brand-building advertising because Kellogg, the 800-pound gorilla in the cereal business, does not have to pay retailers so-called slotting allowances to get them to stock new products. These fees devour up to one-third of a new product's first-year marketing budget. MUCH OF the ballyhoo goes into drawing adults to what only the kids used to munch. Kellogg began selling Frosted Flakes to grownups in 1984 with a campaign that claims, ''Frosted Flakes have the taste adults have grown to love.'' Ad spending on the 36-year-old brand has doubled, and sales have roared ahead more than 40%. Kellogg gets cash to outspend competitors by investing heavily in plant and equipment and financing its marketing and product development partly out of the resulting cost savings. Since 1983, Kellogg has quadrupled capital spending. This year's budget is close to $600 million. Manufacturing efficiencies have helped the company improve gross margins -- total sales minus the cost of goods -- to 49% from 41% five years ago. The food industry average is 35%. Nothing better illustrates LaMothe's confidence in the future of the cereal industry than Kellogg's latest expansion plan: a new plant in Memphis that will increase domestic capacity as much as 35% and cost up to $1.2 billion. It will be the most expensive food-processing facility ever built. To put the cost in perspective, Honda spent $632 million to build its auto factory in Marysville, Ohio, and the most GE has ever spent on a plant is $1 billion. THE PROTOTYPE for Memphis is a factory called Building 100, erected as part of a modernization of the Battle Creek operations where W. K. Kellogg began churning out Corn Flakes in 1906. Building 100 started up in February, and it is the most efficient cereal factory in the world. Kellogg, which stopped taking the public through its plants in 1986 after it found two European competitors on a Battle Creek tour, gave FORTUNE a look at Building 100 in June. It was the first time anyone not directly associated with Kellogg had been inside. Each of its four floors is larger than a football field, and when you stand on the 50-yard line peering in every direction, the degree of Kellogg's cost cutting becomes comprehensible. Not a human is seen. Seven days a week, 24 hours a day, computer-monitored machines perform every step of the cereal-making process, from mixing the grains to packing the boxes in cartons. The technologically advanced equipment helps Kellogg improve product quality. For example, the new production line for shredded cereals minimizes handling of those fragile Nutri-Grain Biscuits. The computerized ovens cook huge sheets of the biscuit mixture evenly -- no burnt edges -- and other machines slice them neatly into bite-size pieces. Building 100's products are 20% to 25% more consistent in quality than cereal that comes out of Kellogg's older plants. Loyal customers, plus new cereal eaters, boosted profits 24% last year, to $395.9 million, and helped the company rack up a stunning 33% return on shareholders' equity, vs. a median of 16% for the food companies in the FORTUNE 500. Industry analysts expect earnings to rise more than 20% this year. Though LaMothe is tenacious about expanding Kellogg's home market, international operations should provide most of the company's growth. In all but five nations in the world, breakfasters consume less than two pounds of ready-to-eat cereal a year, vs. an average of 9.6 pounds in the U.S. Kellogg, which sells in 130 countries, thinks it can raise international volume 7% to 10% a year, compared with 3% to 6% in the U.S. Not bad for a company past its prime.
CHART: NOT AVAILABLE CREDIT:NO CREDIT MARTHA STANITZ CAPTION: SCARFING DOWN THE BIGGEST SHARE OF CEREAL Kellogg peddled about a billion pounds of cereal in the U.S. in 1987, almost twice as much as General Mills. Having risen from 36.7% of the ready-to-eat cereal market in 1983, it is now shooting for 50%. DESCRIPTION: Percentage of 1987 market share for Kellogg, General Mills, General Foods, Quaker Oats, Nabisco, Ralston Purina and other companies for cereal.
CHART: INVESTOR'S SNAPSHOT KELLOGG
SALES (four quarters to 3/31) $3.9 BILLION CHANGE FROM YEAR EARLIER UP 14%
NET PROFIT $412.5 MILLION CHANGE UP 19%
RETURN ON COMMON STOCKHOLDERS' EQUITY 33% FIVE-YEAR AVERAGE 36%
STOCK PRICE RANGE (last 12 months) $38.00-$67.75
RECENT SHARE PRICE $55.25
PRICE/EARNINGS MULTIPLE 16
TOTAL RETURN TO INVESTORS (12 months to 7/29) -11%