An Unquenchable Thirst for Success

Strong brands, product innovation and operational efficiencies propel Quaker Oats to the top tier of food companies.

BOB SWIENTEK, Editor-in-Chief

With a 60% market share, oatmeal is Quaker's oldest and most profitable brand

The Quaker Oats man (both the guy on the oatmeal box and Robert S. Morrison, chairman, president & CEO) is all smiles. And for good reason.

In fiscal '99, Quaker Oats' operating income jumped 13% to $710 million and net income leaped nearly 60% to $455 million. Sales from ongoing businesses grew nearly 4% to $4.7 billion.

Worldwide sales of Gatorade drinks increased about 7% last year to $1.8 billion. Today, about 40% of Quakers' sales and 37% of its operating profits are derived from its sports drink business. Over the past 10 years, Gatorade sales, on average, have grown more than 10% per year.

Quaker Oats has also turned in solid results on the food side. In '99, the company's U.S. and Canadian food business achieved close to a 4% sales growth and an 8% increase in operating income.

Even Quaker's most mature product, oatmeal, posted a sales gain of 13%. In the hotly competitive ready-to-eat cereal market, the Chicago-based company hit a record market share of 10% and grew revenue 2% in '99.

Product innovation coupled with brand-building activities have been key to Quaker's top line and bottom line growth. About 93% of Quaker's U.S. sales are from brands that hold either the No. 1 or No. 2 position in their respective categories. Furthermore, more than 90% of North American sales are from brands in growing categories, such as snacks, beverages and convenience foods.

For the past 10 consecutive financial quarters, Quaker Oats has delivered double-digit earnings growth.

It's no coincidence that Quaker's financial turnaround began when the company hired Robert S. Morrison as its chairman, president in CEO in the fall of 1997.

Morrison's Makeover
"Not long after I joined Quaker two and a half years ago, I made several presentations to the investment community--both formal and informal," stated Morrison. "I outlined my view of the situation I found when I arrived at Quaker, and my strategy to move it forward."

The first thing that Morrison set out to accomplish was simplifying the company's operations. "This meant flattening the organization structure and focusing more squarely on the 20% of activities that led to 80% of the results. It meant cleaning our 'attic' of a number of businesses that were not earning their keep--or cost of capital--and had no reasonable prospect of doing so," explained Morrison.

Since Morrison took over in late '97, Quaker has divested itself of businesses totaling about $450 million in annualized sales. As a whole, these businesses had virtually no operating profit.

This year, Quaker has streamlined its regional customer business centers from six to four. "We have formed a multifunctional, national accounts team to work with our largest grocery customers on a national basis," declared Morrison, "have consolidated our Golden Grain operation into our Chicago headquarters from San Francisco, and have deployed our Customer Financial Service function from Chicago to the field to improve our customer response time."

Morrison's second task was to develop a more focused rational approach to its international operations. "Most importantly, this meant getting our profits up in Europe and cutting our losses in Asia," he noted.

His third goal was to vigorously attack costs. "This meant cutting our procurement costs, manufacturing costs, distribution costs and inefficient deal spending," reported Morrison. "It meant cutting down our asset base and taking a knife to our G&A overhead."

To reduce costs, Quaker announced in the first quarter of this year that it would be closing two food plants, consolidate production, outsource certain milling operations and create a new warehousing and distribution network.

"These actions will drive higher capacity utilization, significantly lower operating costs and deliver greater returns on invested capital in our North American foods business," explained Morrison. "In addition, these actions should lead to an estimated savings of $40-$50 million in 2001, increasing to $60-70 million in 2002."

Morrison fourth strategy was "to reinvest the bulk of these savings in new products and brand-building programs behind our most attractive brands in order to begin the virtuous circle that would lead to volume-driven profit growth.

"To aid us in effectively implementing these four 'operating' strategies, we also committed to developing an overall company culture characterized by simplicity, innovation, passion and a commitment to excellence in execution."

Morrison's four-point strategy has served Quaker well. In addition to an exceedingly strong '99, the first half of 2000 has been excellent.

In the first quarter of this year, Quaker's sales grew 9% and operating income jumped 24%. Second quarter sales increased 6%, while operating income rose 10%. Most of the expansion in the second quarter was due to Gatorade, which posted a 15% sales gain and a 6% operating income bump.

Points of Sweat
Gatorade thirst quencher has been a phenomenal growth engine for Quaker. Last year, sales in the U.S. and Canada leaped 15% to $1.5 billion. Gatorade holds a commanding market share of the sports drink category--an amazing 86% share in grocery channels and an equally impressive 83% share in convenience stores.

"These are impressive and growing shares," noted Morrison. "But we view our real opportunity as growing our share in the context of the much larger 'active thirst' market. In this market--where our main competitor is tap water--we have well under a 10% share. By bringing news to Gatorade through new flavors, new packaging, new points of distribution and new marketing campaigns, we hope to capture more of this larger market."

In February, Quaker rolled out three new products--Propel fitness water, Torq energy juice drink and Gatorade energy bar--under the Gatorade umbrella.

Available in natural orange, lemon and berry flavors, Propel is a lightly flavored water with six essential vitamins and only 10 calories per eight-ounce serving. "Propel is an active thirst beverage for those committed to exercise, but not necessarily competition," declared Sue Wellington, president of Gatorade U.S.

"Research shows that people will drink more of a lightly flavored beverage than water and will therefore stay better hydrated," noted Wellington. "Propel is perfect for people who want a great-tasting thirst quencher when plain water gets just too boring."

Currently distributed in about 20% of the country (mostly across the South and Southwest), the fitness water is available in 16-ounce plastic bottles and 24-ounce sports bottles. It is sold in the water section of supermarkets and convenience and club stores.

Torq energy drink features simple and complex carbohydrates, plus four B vitamins and three antioxidants--vitamins A, C and E. "As a pre-workout fuel, Torq is loaded with carbohydrate energy that revs you up and keeps you going," explained Wellington. "It's a great complement to Gatorade, which is scientifically formulated to quench thirst, replace fluids and replenish carbohydrate energy during and immediately after activity. Torq is about energy 24-7."

Available in natural orange, grape and wild berry flavors, the energy drink is currently distributed in 11 states in the Northwest.

Made from crisp rice and whole grain rolled oats, the Gatorade energy bar incorporates a blend of both simple and complex carbohydrates, six B vitamins, three antioxidant vitamins and seven grams of protein. "This is an exceptional product that combines our sports nutrition knowledge from Gatorade and our food expertise from the Quaker Snacks Division to create a truly great tasting and satisfying energy bar," stated Wellington.

Last year, Quaker launched Gatorade Fierce for active consumers who want a bolder and sweeter taste with the same energy and hydration benefits of Gatorade thirst quencher. Only a year in the market, Fierce has racked up more than $130 million in sales. Two new flavors--Berry and Grape--have been added this year.

Along with product innovation, Gatorade has enlarged its marketplace availability. "Over the last two years, we have been expanding Gatorade's distribution to more 'points of sweat'--health clubs, beaches, golf courses and schools--through what we call our 'availability' initiative," declared Morrison. "This initiative has developed about $100 million in annual sales, currently reaching about 40,000 sites outside of traditional retail outlets."

Snack Attack
At the start of the year, Quaker combined its Snacks and Golden Grain rice and pasta businesses to form a new Convenience Foods division. "This change is the next step in the company's goal to share resources and best practices across our key businesses," stated Morrison.

In '99, grain-based snacks, which include Quaker Chewy Granola bars, Quaker Fruit & Oatmeal cereal bars and Quaker Crispy Mini's rice snacks, hit a record $305 million in sales--a 5% increase over the prior year. Quaker Chewy granola bars led the growth, upping its share of the $360 million granola bar category to 39%. During the past five years, Chewy granola bars have grown, on average, more than 8% per year.

To keep the momentum going in 2000, Quaker has added to new varieties--Nestle Crunch and Nestle Butterfinger--to the Chewy granola bar line.

With the addition of three new flavors, Quaker Fruit & oatmeal cereal bars grew 22% last year. This year, the company rolled out a new Blueberry-Cheesecake variety.

"In the rice cake category, our innovative Quaker Crispy Mini's rice snack line is revitalizing what had been a declining category," noted Morrison. "We now have eight flavors of Quaker Crispy Mini's, having just added two new savory flavors--Nacho and Ranch. For the first time in several years, Quaker rice snack sales are growing."

Last year, Quaker's Golden Grain business achieved record sales of $344 million. With its Rice-A-Roni, Pasta Roni, Near East and Mission brands, Quaker holds the No. 1 category position in value-added rice and is No. 2 in value-added pasta.

In addition to supermarket chains, the Near East product line is sold in specialty and natural food stores.

Bullish on Breakfast
Last year, sales of Quaker's hot cereals grew 13% to a record $485 million. With a 60% market share, Quaker oatmeal is the company's oldest and most profitable brand.

"Building off the success of the 'adult' flavors we introduced in 1999--Baked Apple and French Vanilla, we are introducing two additional flavors this season--Cinnamon Roll and Honey Nut," stated Morrison.

To make its oatmeal more convenient, Quaker is rolling out Instant Oatmeal Express this fall. The single-serve and portable product is packaged in an insulated cup, which can be microwaved or filled with hot water to prepare the oatmeal.

Another product innovation is Quaker Oatmeal Nutrition for Women. Fortified with nutrients (i.e., calcium, soy protein, iron and folic acid), the product is currently available on the East Coast.

"Innovation is equally important to ready-to-eat cereals," remarked Morrison. "But here, we have a different strategy. With only a 10% share of this $7.5 billion category, our focus is keeping our brands--Cap'n Crunch, Life and Quaker Toasted Oatmeal--strong, while running our businesses more profitably."

In July, Quaker kicked off a new promotion for its Life Cereal by turning the clock back and replaying its highly successful "He likes it! Hey Mikey!" television commercial for a limited time. The advertisement, which ran from 1972 to 1984, is still recognized by nearly 80% of Americans.

Quisp cereal, which disappeared from most grocery store shelves in the past 25 years, has made a comeback. Since the cereal went online for sale on Internet grocer NetGrocer.com in late '99, the saucer-shaped product has become the No. 1 selling cereal on the website.

Consumers also can purchase the alien-endorsed cereal on the Internet by visiting Quaker's Quisp website at www.quisp.com.

Another cereal brand, Mother's, is sold primarily through health food stores. The brand also distributes rice cakes.

The Aunt Jemima brand, No. 1 in the syrup category, enjoyed a 17% share of the $560 million syrup market and a 21% share of the pancake mix category in 1999. Quaker is also No. 1 in grits, holding a commanding 77% share of the $100 million corn grits market.

Stickin' with the Plan
"We will continue to build a pipeline of ideas to help us drive top-line growth and to implement actionable plans to drive out costs and improve our operating returns," declared Morrison. "The key is to work both sides of the value equation simultaneously--innovation and cost savings. We are clearly majoring in both...to continue our virtuous circle of profitable growth.

"That's our plan, and we're sticking to it."

And why not. It's working to the envy of his peers. PF

A Virtuous Circle of Profitable Growth

Take costs and inefficiencies out of the operation and use those savings to fuel product innovation and marketing investments. Quaker's chief Robert Morrison has coined a term to describe this operating philosophy. He calls it "a virtuous circle of profitable growth."

"Basically, it involves a relentless pursuit of cost savings as a means to fuel innovation and investment in our leading brands," explained Morrison.

"Each year, our supply chain team has identified hundreds of projects to drive more efficient and cost-effective operations," noted Morrison. "This year alone, we have more than 500 of them. They generate savings by modifying our purchasing, manufacturing, warehousing and distribution processes. Projects of this type have been, and will continue to be, a very important source of cost savings, ranging in the tens of millions of dollars each."

Last year, more than 40% of Quaker's U.S food volume and 30% of its U.S. beverage volume was delivered through an electronic order replenishment system, which helped lower costs and improve inventory turnover and cash flow.

Savings from cost reductions have been reinvested in new products and packaging as well as promotional activities. For example, Quaker increased its global advertising spending more than 6% last year to $1.3 billion. In the first half of this year, the company's beverage marketing spending is up more than 20% to support the rollout of Propel fitness water, Torq energy drink and new flavors of Gatorade Fierce.

When it comes to cost-saving opportunities, Morrison believes that they're endless--"they're always more."

"Three years ago, we did not foresee the opportunity to operate our food plants seven days a week, 24 hours a day with no overtime," revealed Morrison. "This change alone will enable us to operate our Foods businesses with a 10% reduction in fixed assets.

"Two years ago, we did not foresee the benefits that would accrue from on-line bidding for raw materials." In February, Quaker announced that it had identified more than $8.5 million in savings on direct materials (e.g., food ingredients and packaging materials) and transportation services through the FreeMarkets.com online auction marketplace. Quaker has been conducting reverse auctions on the website since 1997, buying more than $59 million worth of goods and services over that time period.

In August, Quaker was one of five companies that participated in a consortium bid for computer equipment and services through the FreeMarkets.com website. Each company realized a savings of nearly 10%.

"And, two years ago, we had not even considered blow-molding beverage bottles in our plants," remarked Morrison. "Today, our largest Gatorade facility is saving significant dollars by this change alone. Our other beverage facilities will soon follow."

Morrison concluded, "In many areas, we are just beginning to scratch the surface--consolidated buying, expanded outsourcing and e-commerce consortiums. Each represents a potential source of cost savings."

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