There has been no big-bang merger in the food industry--no Exxon-Mobil or DaimlerChrysler. But consolidation has come nonetheless. There have been hundreds of small restaurant mergers and a handful of large grocery takeovers. And it is likely to set the tone for the industry in the years to come.

Increasingly, size is what counts. In a bid to win market share, the big restaurant chains have been expanding so fast over the past few years that they have outpaced the surge in diners. McDonald's, for example, has increased its number of U.S. outlets by 50% over the past decade. That kind of saturation makes it tough for the mediocre--or midsized--chains to stay in the game. And as consumers buy more and more prepared foods, and look to the Internet for delivery, medium-size supermarkets will also find themselves outclassed. "When the going gets tough," says Piper Jaffray Inc. restaurant analyst Alan F. Hickok, "the weak get weaker."

The problems affecting the industry aren't getting any easier. Although most analysts expect food costs to remain low, they will rise slightly from 1998's historic lows. Low unemployment rates will keep labor costs relatively high. And the number of new restaurant outlets added, though slowing after the decade's huge building spree, will continue to exceed demand. The National Restaurant Association estimates that the nation's restaurants will produce real growth in 1999 of only 1.8%, compared with 2.6% last year.

Looming over the industry is a possible downturn in the economy. Much of the restaurant sector's recent growth has come at pricey joints like steakhouses, which saw sales increase 6.5% in 1998. Even without a slowdown, profit margins have been squeezed industrywide to below 3%, not much more than half what they were in the early 1990s, a result of too many seats and not enough bodies. Given the high cost of labor and pricing pressures at fast-food and midscale restaurants, "I can't see a scenario in which margins will improve," predicts Ron Paul, president of Technomic Inc., a Chicago market researcher.

For packaged-foods companies, the goal will be a calmer year with solid growth. Last year, old standbys Kellogg Co. and Nabisco Inc. paid the price for losing touch with consumers, allowing private labels to grab market share. As a result, their 1998 earnings got hammered. "Historically, the industry has been known for its consistency," says Prudential Securities Inc. analyst John M. McMillin. "It was anything but consistent in '98."

With cost-cutting programs and new management in place at many major firms, double-digit earnings declines should be less likely this year. In this uncertain economy, that's about the best news to be found for an industry that's supposed to be relatively recession-proof.

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