By Lisa Baertlein
LOS ANGELES (Reuters) - Kraft Macaroni & Cheese has been a favorite meal for generations of American children, but smaller brands made with more natural ingredients are starting to nibble at its market share, part of a trend that is biting into growth at large U.S. food companies.
Zenobia Godschalk, an Atlanta mother of two young boys, stopped buying Kraft's "mac and cheese" after reading its complicated ingredient list. Now she buys Annie's organic version in bulk at Costco Wholesale Corp (COST).
"I'm fully aware that it is not a health food," said Godschalk, of Annie's macaroni and cheese product. "But the ability to make it just a little bit better, and the color that I can believe comes somewhat naturally is good."
Sales of macaroni and cheese are growing as busy Americans look for convenient and inexpensive meal options and older consumers indulge in the comfort foods of their youth. Kraft Foods Group Inc (KRFT.O) still dominates the category, but the battle for the hearts and minds of American mac-and-cheese lovers may become a new front in a running war in the $360 billion U.S. packaged food industry.
On one side stand established food companies like Kraft, which seem more focused on slashing costs than taking big risks on emerging trends. The challengers are more nimble upstarts catering to rapidly evolving consumer tastes by offering products in the fast-growing "health and wellness" category.
"Even though individual companies by size are quite small, in aggregate they're more on trend with consumer demand and pose a threat to Big Food over time," said Consumer Edge Research analyst Robert Dickerson.
Nestle SA's (NESN.VX) Gerber baby food division and General Mills Inc's (GIS) Yoplait yogurt business may each offer a cautionary tale for Kraft. Both led their respective categories, but their market shares tumbled in recent years. In Gerber's case, it was the growing popularity of small organic baby-food brands. In Yoplait's, it was the arrival of Chobani Greek yogurt, which has more protein and a thick, creamy texture that struck a chord with consumers.
Kraft dominates the U.S. market for packaged macaroni and cheese, but its share fell to 78 percent this month from 82 percent in March 2010, according to Consumer Edge data.
A key rival is Annie's Inc (BNNY.N), whose natural and organic foods were once sold only at specialty retailers like Whole Foods Market Inc (WFM) but are now available at Wal-Mart Stores Inc (WMT), Kroger Co (KR) and other mass-market grocers.
Catering to middle- and low-income consumers can transform brands from niche players to powerhouses.
Annie's macaroni and cheese share grew to 7 percent this month from 5 percent in March 2010, according to Consumer Edge.
WhiteWave Foods Co's (WWAV.N) Horizon brand, the No. 1 U.S. organic dairy purveyor by sales, also is coming on strong. Its new macaroni and cheese already is sold by natural and mainstream grocers. Analysts bet the big-box retailers, which stock Horizon's organic milk and cheeses, will soon follow.
Kraft, with net revenue of more than $18 billion last year, has said its macaroni and cheese business generates more than $500 million in annual sales. It also has an organic version, but distribution is limited.
Dollar sales for Kraft's macaroni and cheese last year rose more than 1 percent. But because the category grew at a faster rate than Kraft's sales growth, the company's share declined slightly, a spokesman said.
Kraft, which also sells Velveeta, Cheez Whiz and Jell-O, is tweaking some items with its more mainstream customers in mind, including adding whole grain and removing artificial colors from some macaroni and cheese products. It also took artificial preservatives out of its Kraft Singles processed cheese.
"Consumers (are) seeking more fresh, real foods that are made with simple ingredient lines, and we have to think that this is more than just a premium trend," Kraft Chief Executive Tony Vernon said at a recent industry conference in Boca Raton, Florida. "We are democratizing health and wellness, we are not marketing to the 1 percent."
IS 'BETTER FOR YOU' GOOD ENOUGH?
Some experts estimate that health and wellness brands account for roughly 10 percent of overall packaged food sales.
Organics and Greek yogurt fall into the category, as well as gluten-free products for special dietary needs.
A recent survey from consultancy AlixPartners showed that so-called "superusers," defined as individuals who spend 40 percent or more of their budget in the health and wellness category, are most willing to pay a premium of 10 percent or more for locally-sourced or organic products.
Large packaged food companies, under pressure to change from parents and anti-obesity activists including first lady Michelle Obama, have made incremental moves into health and wellness.
Like Kraft, they tend to rework existing products to be "better for you" by removing fat or sodium, or by adding fiber or vitamins. They have also bought small but successful health and wellness brands that end up accounting for just a tiny slice of overall revenue.
Some food industry observers warn that there could be a limit to how long large companies can resist consumers' stepped-up demands for changes.
"The food industry is at a tipping point," said Stephen Hughes, chief executive of Boulder Brands Inc (BDBD.O), which makes Smart Balance spread. Boulder was a pioneer in removing artery-clogging trans fats from its products and is taking out ingredients with genetically modified organisms (GMOs).
The industry's big players won't start taking more risks until "the cost of not changing exceeds the cost of changing," Hughes said.
(Reporting by Lisa Baertlein in Los Angeles; Editing by Jilian Mincer and Paul Simao)