Starbucks had $3.2 billion in annual sales in 2002; the company's success is the result of convincing the public to pay more than $3 for a cup of coffee.
For decades, the American palate has been associated with white bread, vanilla and mainstream tastes. Kitchen tables have been more likely to feature corn dogs than Cornish hens. That changed in the late 1980s when, faster than you can say “Ben and Jerry,” Americans embarked on a love affair with decadent food. Fortunately for processors, their passion shows no sign of fading.

It happened not a moment too soon, as far as some food producers are concerned. Margins were—and still are—being squeezed like a lemon by the convergence of two separate trends. The retail sector was consolidating, and these newly powerful buyers were pushing hard for lower prices. Second, multinational competitors had become so big that, through economies of scale, they were producing more food more cheaply than ever, forcing prices down even more.

However, because food had become so abundant and cheap, consumers' mindsets also began to change. “How could our food be better than ordinary?” they asked their grocers. “How can we get restaurant quality at home?” Consumers had more disposable income than ever, and they already had demonstrated a willingness to pay more for quality in other industries.

Developing the Premium Market

In the mid-1980s, auto manufacturers created numerous luxury brands, such as Acura and Lexus, to meet accelerating demand for high-end automobiles. Once unique, opulent brands such as Mercedes and BMW soon became part of a mainstream auto landscape cluttered with premium product offerings.

Haagen-Dazs (a unit of Nestle Ice Cream, Glendale, Calif.) and Ben & Jerry's (South Burlington, Vt.) demonstrated the automakers' success could be duplicated in the food industry, when a multitude of consumers began to enjoy high-quality ice cream, packaged in cartons half the size and twice the price of competing brands. Starbucks, Seattle, confirmed the possibilities by convincing coffee drinkers to switch from $0.50 black coffee to $3 cups with exotic names.

Super-premium products captured an ever-expanding share of the total category through the late 1980s and 1990s, but skeptics pointed to obvious risks. Could they maintain that success when the economy took a downturn? Was consumer demand large enough to sustain a full-scale business?

Economists might agree. They like to believe that consumers are rational beings that, in uncertain economic times, shift to economy brands, causing premium product consumption to fall. However, the world is not that simple.

The super-premium concept revolutionized the frozen pizza category, as new products costing twice as much as standard frozen pizzas were introduced under the California Pizza Kitchen, DiGiorno and Wolfgang Puck brands.
What economists fail to understand is that food-purchasing decisions are as emotional as they are logical. Even in lower-income areas, eating a super-premium product is a special event that temporarily enables the consumer to enjoy the same experience as others who are more fortunate.

During the modest downturns experienced in recent decades, the American consumer consistently showed premium food is an affordable luxury. During the recession of 1990-1991, overall ice cream sales slowed, but Haagen-Dazs sales increased. Consumers were happy to make sacrifices so they could enjoy the occasional indulgence.

Today, the super-premium ice cream market exceeds $400 million, almost 10% of the total ice cream category. Ben & Jerry's was the only ice cream brand to increase pint volume in supermarkets in 2001, even though it cost about $2 more than non-super-premium brands. The Starbuck's chain relies almost entirely on super-premium products, and its 2002 annual sales were in excess of $3.2 billion.

Producers of other categories quickly duplicated these pioneers' early successes. However, initial attempts to market Euro-style (artisan) breads, which cost at least two to three times as much as common white pan bread, were met with limited success. In 1991, market research estimated that only about 11% of the market consisted of potential consumers of this super-premium bread. By the end of the 1990s, that demographic comprised more than 40% of the market—artisan bread makers had proliferated. Machinery had been developed that was capable of bringing automation to super-premium production, and specialty foodservice retailers such as Au Bon Pain, Boston, made the breads readily available.

The amount of disposable income keeps going up. This has been an important part of the growing acceptance of premium brands in the food industry and elsewhere.
Even the mature frozen pizza category experienced a metamorphosis. After the development of pizzeria-like rising crust pizzas in 1995, an enormous premium category was born almost overnight; new products hit the shelves priced almost twice as much as the standard frozen pizza. Kraft's, Glenview, Ill., premium DiGiorno brand quickly displaced its more-mainstream Tombstone brand as the number-one line in sales. Soon, super-premium gourmet pizza lines followed—such as Wolfgang Puck and California Pizza Kitchen—enjoying great success as well.

So it goes. Expensive, aged cheeses now appear on the shelves of mass merchants and club stores. Super-premium cuts of meat, such as filet mignon, are more available than ever. The market for costly organic foods is growing beyond most expectations.

For cost-comparison purposes, Ben & Jerry's Karamel Sutra has a retail price of $3.79 for a pint, while other ice creams go for $3.33 for a half-gallon. Nonetheless, the public appears perfectly willing to pay extra for perceived quality.

The Virtuous Circle

Observers note that many food processors are inclined to think of their products as premium or even super-premium when, in fact, they are not. This misperception can distort the company's ability to effectively sell to this consumer segment.

Food falls into four basic categories—economy, value, premium and super-premium—based on their net price. The thresholds of each vary by food category, but a good rule of thumb is to compare a product's net price to that of the mainstream product (which usually represents over 50% of the product category). Value brands usually cost within 20%, either higher or lower, of that product. Economy brands generally cost less than 80% of the mainstream offering. Premium products tend to be from 20% to 100% more expensive than the mainstream. Super-premium products cost more than double the mainstream product.

This is an important distinction, because the business model for super-premium food is fundamentally different from that of all other categories.

Mainstream food processors make profit by producing large volumes of low-margin products. Successful super-premium product lines, on the other hand, currently find themselves in the midst of a virtuous circle. Because volumes of super-premium foods are generally smaller, producers need a higher margin contribution per unit in order to make the same profit as a volume producer. Specialty processors use higher-quality raw materials to justify the higher consumer price. The cost of these materials is a relatively smaller percentage of the of the total cost of the product because the incremental cost increase is offset by a even larger price premium. At the same time, the production and the sales and marketing process, once developed, are comparable in cost to the mainstream product. In other words, once the super-premium product or brand is established, processors have the opportunity to send strong profits to the bottom line.

Indulgent products—whether in terms of price or taste—have grown into an industry unto themselves, while proving their ability to weather concerns both economic and healthful.

Successful super-premium offerings generally share a number of characteristics:
  • The product can be developed such that it can be produced relatively efficiently;
  • The consumer can identify the quality of the product as, indeed, super-premium;
  • The particular super-premium category is large enough to support a certain threshold of scale and level of competition;
  • The processor can maintain reasonable raw material costs in order to capture the product’s value-add in profit; and
  • There are barriers to entry for competitors (super-premium products tend to have more unique characteristics) and lack of awareness to the opportunity.
More than ever before, people are more willing to pay to have a little of something that is really good, rather than a lot of something that is just okay. Although there are no guarantees for companies that develop new super-premium products, consumers seem primed to respond. Whether coffee, bread, dairy, organic products or convenience foods, the opportunity in super-premium food products is compelling.
 
Jeff Taylor is vice president, investment banking, of Harris Nesbitt's Food Group (www.harrisnesbitt.com), a firm providing capital, investment banking and financial servies. His number is 312-461-2716, and his email is jeff.taylor@bmonb.com.

Website Resources

www.haagen-dazs.com — Haagen-Dazs
www.benjerry.com — Ben & Jerry's
www.starbucks.com — Starbucks
www.aubonpain.com — Au Bon Pain
www.kraft.com - Kraft

Sidebar: Entering the Fourth Dimension

A fundamental rule in the food industry is that the intrinsic growth rate is equal to the growth of the number of mouths to feed. The U.S. food market has been enhanced in recent decades by a combination of the obesity gap—the amount by which the food consumption growth exceeds population growth due to the excessive dietary consumption per capita—and the waste gap, the allowance for increased waste and losses in processing.

That aside, however, this fundamental rule sets the base line for food companies' strategic goals. So, how do food companies enhance their growth rates beyond that of the population?

The traditional approach to growth is to focus on the three dimensions of the food industry—product category, product type, and customer channel—and capture more shares in one of those dimensions. A company may push a current product into a new channel, pull a new product into a current channel, or design a new product type for a current product (i.e., turn a mix into a frozen ready-to-heat product). Increasingly, differentiation is being seen in a fourth dimension—quality.