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Sri Lanka Cargills’ food manufacturing business emerges to challenge multinationals
The island's largets supermarket chain's vision to create brands that can stand out beyond Sri Lanka
Shamindra Kulamannage
LBR,Monday 06 June 2011

Seven months ago Ice cream sales at Cargills Food City, a super market chain, started declining at an alarming rate. ’Magic’ brand Ice Cream is important to Cargills for two reasons; because it’s made at Cargills own factory and risks idling capacity and market leadership is crucial to maintain. Cargills is also out to prove that size and operational efficiency are not mutually exclusive.

Its 159 Food City supermarkets, the largest such network by far, received a fillip with the giant retailer’s foray into food making, causing the rest of the industry to huddle together for comfort or allege abuse of market dominance. Ice cream is Cargills’s biggest success in food manufacturing so far. Its main retail rival is the Keells Super chain controlled by conglomerate John Keells Holdings, while consolidation among other supermarket chains hasn’t created another formidable challenger.

However Cargills management was confused by the unexplained ice cream sales dip, as high as 15% in some months starting last year. Food City staff however figured the downturn was caused by a management decision to store ice cream in upright freezers which are like a refrigerator with a glass front rather than storing them in flatbed freezers which better display the brands on the lids of the packs which was the case earlier. “When you display it like that, customers can’t see the product and its branding. Our staff said that on the flat bed it was more visible and sales much better” explains Cargills Managing Director Imtiaz Wahid. “We are re-changing back to flatbed freezers,” he says underscoring the sort of challenge in retail that requires sharp observation and quick action.

Cargills’ focus on its people, products and brands over the last decade has brought the company phenomenal growth and success. Food retail is a high volume low margin business and double digit sales dip can put in doubt the continued availability of shelf space.

Cargills controls over half of supermarket retail sales in Sri Lanka and over seven percent of grocery shopping altogether. This year it will add another 40 supermarkets and 35 smaller ‘Cargills express’ outlets to the network if electricity services can be connected at the same pace at which it finds buildings large enough to locate outlets. Smaller ‘express’ stores have ditched the meat counters that require large deep freezers and don’t sell a few other categories. The concept will be used to establish a presence in smaller towns which cannot sustain a Food City. Express outlet costs are lower because of lower rents, fewer staff and reduced electricity consumption. At the Cargills group electricity accounts for around three percent of the top line. Based on 2010 turnover, that’s an annual energy bill of nearly a billion rupees. On top of that, all outlets have to have a generator to deal with unreliable electricity supply, which adds another layer of costs.

Despite the challenges, headlong expansion continues, either through the opening of yet more new stores or through a rash of takeovers. “The expansion drive, which is well on track, would ensure a greater market share for Cargills as well as industry growth in modern retail trade,” says L R Page, Chairman of Cargills Ceylon and older brother of Ranjith Page, in the group’s 2010 annual report. Because quality, cleanliness and food safety are still rare supermarkets that strive to offer that can prevail over a corner store.

Sri Lankan retail sales are worth at least Rs250 billion annually, but only 15% of this total is transacted at supermarkets because only a little is accounted for by processed food, the speciality of supermarkets.

But in the last decade supermarket retailing has grown and grown and revolutionised a previously dull industry. Cargills group’s revenue, which includes supermarkets and food manufacturing topped Rs30 billion in 2010 from Rs10 billion five years ago. By revenue Cargills is an emerging behemoth that strikes fear in the hearts of consumer goods manufacturers everywhere. Unless they are able to secure shelf space at the chain, grand plans to dominate any fast moving consumer brands category mean nothing.

Just as remarkable, given its size and success already, Cargills looks set for yet another spurt of top line growth with the 75 outlets it’s planning to add this year. Just as Wal-Mart is the biggest company in the world by revenue Cargills is quickly rising up the Sri Lankan corporate league. It may soon eclipse by revenue Sri Lanka’s largest firms like Dialog (Rs41 Bn), JKH (Rs41 Bn in 2009) and SLT (Rs50 Bn) with the type of expansion on the cards. Incorporated as a public company in 1946, Cargills Ceylon’s profits are also up 353% to Rs712 million in five years ending 2010.

Ranjith Page, now Deputy Chairman of Cargills, who during the decade to 2010 led the firm through a competition shattering growth phase is notably ambitious;”My vision for Cargills is to be bigger than any of the other big food multinational companies and to create brands that can stand out beyond Sri Lanka,” he says during an interview at the firm’s historic York Street office where Cargills is still headquartered.

Food City is the public face of the firm’s transformation to a high growth company in the last decade. However unseen, it’s fully owned food manufacturing unit called Cargills Quality Foods (CQF) has become a large venture. Unlike the retail business which does not have any multinational competitors, processed food is extremely competitive. The two global food behemoths Nestle and Unilever have both operated in Sri Lanka for decades.

For food multinationals, Sri Lanka ticks all the boxes except one. The country has an open market economy, it allows multinationals to hold majority ownership of the business, a trainable workforce and a welcoming government. The only disqualification would if at all be the relatively small population which won’t deter Nestle or Unilever because they have already been here for decades.

Cargills Quality Foods (CQF) took off in 1992 with the purchase of a small meat company that marketed under the ‘Goldie’ brand. “We invested to upgrade the facility. It took a while to build market share because meatballs and sausages became a commodity. So we invested further in 2007 and built a plant today that not only supplies Sri Lanka but also exports,” says Page about its new meat processing facility at Ja-Ela.

It was around a decade earlier, in 1983, that Cargills opened its first ‘Food City’ branded supermarket at Staples Street in Colombo at a time when grocery sales all happened at corner stores where a few drab items, often kept well out of the reach of shoppers, were fetched by a shop assistant.

Supermarkets still have a long way to go. Even today most people buy food from daily markets or directly from producers. Organized food production and consumption of processed and branded food remain relatively new.

Page also didn’t fully realize the potential of food and the retail trade till much later. His meeting a group of rural farmers, who were struggling to achieve a reasonable return from their agriculture investment in 1999, was a watershed for the group. It convinced Page, who wears a Sri Lankan flag tiepin on the pocket of his crisp white shirt, that Cargills needed a greater social ethos to grow and succeed as a food company.

This is because food is both an emotional, as well as an economic, issue. People have strong feelings about food and it’s affordability unlike they would about shampoo or washing-powder. In Sri Lanka food is also about national identity and yearning for an era when the country produced a grain surplus. “When we got in to food in 1992 I thought of CQF as a unit to feed Food City and that’s it. It’s much later that I realized there is a huge market out there because food is consumed daily,” points out Page.

Cargills, he told the board of directors, could create something new and impact the lives of many farmers by directly sourcing produce from them instead of purchasing it at the wholesale market. “Until that day I didn’t see the point in going out to serve one supermarket and one manufacturing unit by going to the farm gate,” he says about 1999 when Food City was a single outlet in Colombo and ‘Goldie’ meats factory had limited output.

Circumstances also conspired. The Page family controlled Ceylon Theatres and had acquired control of Cargills & Millers in 1982 but the business was drifting. “We had to do something to get the company on the right track,” says Page about the sense of desperation that was beginning to set in. “It was an emotional case. It was also the best thing I did and that’s what made the company. That’s why the consumer trusts us,” he says of the transformation since 1999 when they started purchasing produce from the farm-gate by setting up a collection center.

When Ranjith Page first pitched the idea of a role for Cargills in a ‘big society’ he said “let’s give it our best shot,” to be met by skeptical reactions of doing something that’s ‘not up our street’. Page prevailed for the want of another option.

In a decade Page built Cargills in a hurry, both retail and food operations. In the year 2000 the firm launched its iconic ‘On your way home’ TV advertising campaign, inviting middle class Sri Lankans’ to try its supermarkets. It was an overwhelming hit that broke the notion of supermarkets serving only the affluent.

Success with food and retail has uniquely positioned Cargills to occupy every single stage in the value chain. It isn’t unusual for supermarkets to offer ‘private label’ products, but to have its own food manufacturing is. In fact CQF is now a formidable unit accounting for 43% of group turnover and 56% of profits in 2010. While dominating the value chain the recognition of the emotional ties people have with food has been engrained in to the organization’s value system.

Page says the group stands for three values. To bring down the cost of food, build skills of rural youth and bridge the divide between urban and rural. Cargills’ business model lends itself to these values because they have the resources, the infrastructure, the distribution, capabilities and scale to make food more affordable. Its over 5,000 staff are encouraged to climb the corporate ladder from shelf stackers to store managers. By purchasing directly from farmers, it takes cash directly to the rural economy in ways that few other listed companies can ever hope to do.

Page hit the acquisition trail to dominate the entire supply chain, in 2002, buying Unilever’s ice cream plant and rebranding the product ‘Magic’. The same year he also purchased the Kist brand from Unilever under which jams and cordials were marketed. Last year Cargills acquired Kotmale Holdings, a dairy firm, for Rs922 million and Diana Biscuits for Rs350 million. These, together with the KFC franchise obtained in 1996 and the Millers distribution arm make up CQF.

“Now onwards it will be organic growth. This year we are investing in increased capacity and to bring new product lines in dairy, in Kist and in meats,” Page points out. Acquisitions were driven by the desire to reap economies of scale and dislodge multinational food brands which still account for 70% of supermarket branded food sales according to Ranjith Page. “So here is a great opportunity to create Sri Lankan brands that can take market share from them, and we are doing that by not producing something overseas and putting our brand on it and bringing it here. We are manufacturing it right here.”

Over the past few years, Cargills has used its size and efficiency to turn the tables on category leaders in Ice Cream where Cargills Magic is now the dominant brand and processed meat where it launched a new product line to challenge Keells, the market leader. And now Cargills is training its big guns on dairy, which is dominated by multinationals, with its Kotmale brand and biscuits where 85% of market control is by Maliban and Munchee. Cargills expects to gain 10% market share in biscuits within two years while the factory it acquired last year has 20% of the island’s installed biscuit manufacturing capacity.

Having cleaned up the portfolio of acquisitions with new capacity and fresh brands the general management challenge at CQF is now consolidation. Its overall food manufacturing capacity utilization is 65% according to Managing Director Imtiaz Wahid. “We will try to increase it another 20% this year and 20% the year after. And we will continue to invest in new capacity,” he says.

“We cannot make a facility viable unless we utilize its full capacity and each of our facilities has tremendous spare capacity,” says Ranjith Page. In 2011 new investment to expand and upgrade factories is forecast to top a billion rupees continuing the high spending on fixed asset additions in the group. Since acquisition the group has spent Rs350 million upgrading the ice cream plant and Rs250 million upgrading the Kist jam and cordial factory. It also invested Rs300 million to relocate and expand the meat manufacturing factory outside Colombo.

To achieve its goal of becoming the country’s largest food company Cargills is aiming to quickly fill up its idling capacity. “If you want to be the market leader and grow a brand you should not be focused too much on margins. If you overprice a brand to keep margins you may lose market share,” explains Wahid the category leadership seeking Cargills growth model.

Cargills Ceylon has invested over seven billion rupees over the last decade on acquisitions, expansion and upgrades for both its supermarket chain and processed food businesses. It has a long term approach, to business and its main shareholder Ceylon Theatres, which controls 70% of Cargills

Ceylon, has allowed the firm to invest way ahead of time in processed food manufacturing capacity.

“We want to grow each category and be the leader in that category,” says Wahid, who is also Deputy Chief Executive in addition to being Managing Director, a role he took over last year after returning from Egypt where he had spent the previous five years setting up and running a retail chain for a private equity firm.

They have already wrestled away the leadership in most categories of the dairy sector with the addition of Kotmale, which has its own range of ice cream and liquid milk, to the existing Cargills’ Magic business. Kotmale collects 35,000 liters of milk daily from a farmer network which is supplementing a smaller collection network that Cargills already had for its Magic ice cream. “We have integrated this whole system to grow that category and be the leader,” said Wahid during an LBR interview at his second floor office in the colonial era Cargills York Street headquarters building.

The Urban Development Authority says the bright red York Street fronting building, owned by Cargills Ceylon, will make way for a high-rise hotel soon but Ranjith Page himself does not comment about it. He is emphatic however about the bright future for Cargills in food despite the challenges in the market and the price volatility in recent years.

Less than 25% of CQF’s food production is sold at Cargills own supermarkets. Millers, the CQF distribution arm, supplies the products to retail outlets countrywide. Yet getting people to spend more is only half the task. Retailers must procure goods at the right price and that’s where the Cargills supply chain advantage shines. Trucks pick up perishable produce from farms and stock the supermarkets that are directly on their route to the main collection centre. Once there the perishable food stock is distributed daily to its entire network. Packaged goods distribution, from the same central collection centre is less frequent but is designed to optimise stock holding. Fruits and vegetables also offer the highest margins for the high street retailer. “Our strength is in perishables because we offer a range of quality products,” says Wahid of the category that’s growing 35% a year. “On vegetables we have fatter margins than we do on packaged goods,” he confides.

While Cargills sells fruits and vegetables at the same price as do other retailers, its procurement cost and supply chain costs are much lower because economies of scale are hard to achieve for smaller players. Most retailers use a myriad of small suppliers operating through wholesalers, raising costs and lowering efficiency. In retail, margins are so thin that even a percentage cannot be squandered on stock holding or inefficiency.

Cargills Chairman L R Page acknowledges in the annual report that, “Growth in profitability is mainly attributable to higher average gross margin achieved coupled with containment of cost increases through improved operational efficiencies across the portfolio of companies, and substantially lower finance cost.”

Managing Director Wahid, an accountant by training, who started his Cargills career at the audit division, is trying to wring out another two to three percent savings in a cost cutting drive. In its manufacturing facilities, peak production is being scheduled to take advantage of off peak electricity charges introduced in the 2010 budget. Wahid aims to offset much of the recent spike in food prices and the knock on increase in the input costs for processed foods. He conceded that processed food prices can’t be increased in step with rising input costs.

As a company, Cargills is doing a remarkable job keeping things simple which allows it to expand quickly. Every supermarket is a replica of every other one. Few firms of Cargills type complexity and size have managed to keep their management structure so flat.

Cargills introduced a notoriously hard-nosed negotiating culture with suppliers who want it to stock their products on its shelf. The strategy has precluded many dominant competitors of products it also produces from gaining shelf or freezer space.

Animosity with its main supermarket and food competitor JKH has settled in to a stalemate. Cargills doesn’t carry Keells branded meats and ice creams, preferring to promote its own products. Keells also carry Cargills branded products except ice cream and meats. “It’s sort of like an unwritten understanding but in the long term we may look at it differently,” muses Wahid. Cargills ‘exclusion’ strategy which Wahid describes as making ‘perfect business sense’ is effective because Sri Lankans are generally brand conscious but not loyal. They are more interested in value. In smaller towns the appetite for brands is also much less than in more cosmopolitan Colombo.

But the retail battles could escalate with the entry of Cargills own biscuit brand in to a market dominated by Munchee and Maliban. Three Coins, a beer company, was also recently acquired by the Page family, though Ranjith Page did not wish to discuss the strategy behind that deal.

Other challenges may also emerge as the chain expands in to rural Sri Lanka which is not just sensitive about food but also touchy about preserving its unhurried way of life. Supermarkets, it is alleged, spread suburban blight in rural communities by running out of business honest, hardworking small retailers who are willing to offer credit to customers and offer alms to the village temple, something market share driven supermarket chains can’t do.

However it’s difficult to take away from Cargills its significant role in social transformation of young people and rural Sri Lanka. The firm does this while setting the stage for long term growth and unsurpassed supply chain domination. Its architect Ranjith Page sums up the outlook: “In the food business you can make money, because food is consumed everyday”.

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