The Food Giants Go on a Diet

Worries about obesity are rising, and that's forcing big changes at outfits from McDonald's to Pepsico

By Pallavi Gogoi

Only in America? On Oct. 19, NBC (GE ) premiered The Biggest Loser, its latest entry into the reality-TV genre. In this show, however, the losers can be big winners. It features 12 overweight contestants competing to see who can shed the most pounds, chronicling their efforts over weeks. The winner gets a fabulous cash prize of $250,000. This and other reality shows in the past year (remember the one in which participants underwent surgery to remove fat?) show just how widespread public interest and concern over obesity have become.

Caught in the middle are U.S. food and beverage outfits. The obvious question for investors: Is there a prize for businesses that join in the fight against obesity? And, metaphorically speaking, will customers vote fast-food chains and other purveyors of fat-laden food off the show?

HUNGER FOR CHANGE.

  Many companies clearly are vulnerable. Nutritionists and other experts say in addition to reduced physical activity, the factors that have led to the obesity epidemic include readily available sodas and snacks, growth in the number of fast-food outlets, supersizing of food portions, and an increase in the number of high-calorie, high-fat grocery products. "There is a real change in people's underlying values when it comes to health, and food companies have no choice but to respond," says Americus Reed II, professor at Wharton School of Business. Indeed, obesity ultimately threatens the companies' own customer base.

Shifts in consumer buying are coming at the expense of flagship products. After decades of unabated growth, for instance, per-capita consumption of carbonated soft drinks declined for the fifth year in a row, to 53.8 gallons, in 2003, according to Beverage Marketing Corp. The percentage of restaurant orders for hamburgers at lunchtime peaked at 26.4% in 1997, since dropping to 23.3% in 2004, despite getting a slight boost this year from the Atkins and low-carb diet trends, says NPD Food World. Orders for french fries also peaked in 1997, at 27.2%. NPD says they're now ordered only 23% of the time. And cookie sales have declined since 1999, according to Mintel, a global market-research firm.

Smart companies are trying to view these shifts as an opportunity: "Healthier consumers are going to be good for us," said Coca-Cola (KO ) CEO E. Neville Isdell in June at a food-business summit in Rome. "They will grow older, healthier, wealthier and, hopefully, therefore able to buy more from us."

WEIGHTY ISSUES.

  Coca-Cola, Pepsico (PEP ), and Kraft Foods (KFT ), the largest U.S. food company, all have promised in recent weeks to provide better nutrition labels on their products. On Sept. 30, General Mills (GIS ) said Cheerios and the other breakfast cereals it sells will henceforth be made with healthy, high-fiber whole grains. On Oct. 8, McDonald's (MCD ) introduced a new McVeggie Burger in Manhattan. The meatless, soy-based patty claims to be cholesterol-free and contains just eight grams of fat and 370 calories, vs. the Big Mac's 600 calories. Then there's Wendy's (WEN ), which has begun broadcasting a commercial showing a boy chowing down on miniature orange slices, rather than French fries.

Concern over obesity has been rising rapidly at least since 2001, when the problem was labeled an epidemic by the World Health Organization. The same year, the U.S. Surgeon General issued an alarming report noting that 61% of American adults and 13% of children and adolescents were overweight or obese. Hundreds more studies have been commissioned, and the reports get more worrisome as they come out. The latest is Preventing Childhood Obesity, issued on Sept. 30 by the Institute of Medicine, which was assigned by Congress to come up with a plan to decrease juvenile obesity.

Among the report's alarming conclusions: Since the 1970s, the percentage of obese kids has more than doubled among preschoolers and those in the 12- to 19-year-old segment. In children between the ages of 6 and 11 it has tripled. Approximately 9 million children over 6 are now obese, which has led to serious health problems such as diabetes and heart disease. Obesity-related annual hospital costs for children and youth more than tripled over two decades, rising from $35 million in 1979 to $127 million in 1999. And the national health-care spending related to obese and overweight adults could hit $129 billion this year. By Pallavi Gogoi

LARD-AND-CLEAR MESSAGE.

  Some companies are already making broad changes in their product offerings. In March, 2003, McDonald's started targeting young moms with its premium salads, also offering milk and fresh Apple slices as options in its Happy Meals for kids. So far, says Cathy Kapica, McDonald's global director of nutrition, the chain has sold 200 million salads and anticipates selling 35 million pounds of apples this year. Sales of 1%-fat milk sold in attractive Milk Jugs bottles have more than doubled since their introduction last year. McDonald's has also said it would eliminate its supersize menu options.

These changes helped nourish a turnaround at McDonald's, where sales are rising again after a four-year decline. Same-store sales increased 5.8%, and revenue rose 9.3%, to $4.9 billion, in the third quarter, which ended Sept. 30. The new products also gave profits a boost -- earnings were up 42%, to $778 million, in the quarter. Said CFO Matthew Paull in a conference call after announcing the results: "There is no doubt that McDonald's is far more relevant today."

Pepsico has also been quick to recognize the shifts in consumer tastes, removing artery-clogging transfats from Cheetos, Tostitos, and Doritos snack. Sales jumped 26% almost immediately. Spokesman Mark Dollins says Pepsi has vowed to improve the nutrition profile of its products. Over the last three years, he notes, "better for you" products have accounted for 50% of new-product revenue. Pepsi also is getting ready to roll out a new line of snacks based on vegetables and fruit.

FLAT FIZZ.

  Pepsi's financial returns reflect the strategy's success. Third-quarter profits jumped 35%, to $1.36 billion, while revenue climbed 6.3%, to $7.26 billion. It attributes much of the gain to its new products, as well as strong sales that are getting a boost from the health trend, such as Aquafina, the top-selling bottled water in the U.S., and Gatorade, the nation's best-selling sports drink.

Adapting to shifting consumer tastes can be risky. On May 24, Coca-Cola introduced C2, a cola with half the carbohydrates, calories, and sugar of regular coke at a grand gala in Los Angeles featuring appearances by Paula Abdul and Ryan Seacrest of American Idol fame. But the response from consumers was a collective yawn. Sales of C2 peaked in July, and have since fallen 60% in U.S. supermarkets, according to researcher Information Resources.

Developing healthier products can take time. In 2002, McDonald's promised to cut trans fatty acids from its french fries by half within six months. It has been two years, and the pledge still hasn't been fulfilled. Chief U.S. Operations Officer Ralph Alvarez said in a release: "While speedy implementation is an admirable goal, we are most focused on the satisfaction of our customers." If tweaking a product can be that difficult, overhauling an entire business is a mammoth undertaking.

FADED WONDER.

  Nonetheless, pressure for change will continue to grow as consumers become more aware of the dangers of obesity. Many school districts are banning junk food from vending machines and cafeteria menus. And concerned Congress members have introduced several bills aimed at improving food labels and promoting nutrition and exercise plans for children. Congress is also starting to fund community-based nutrition-education programs.

Food companies are increasingly being targeted by lawsuits. So, far they haven't gotten anywhere, but the companies know that could easily change. "Saying diet is your personal responsibility doesn't work anymore, and the lawsuits have sent food companies scrambling," says Marion Nestle, professor in the Nutrition, Food Studies & Public Health Dept. at New York University.

Companies that don't change can quickly get in trouble. Consider Interstate Bakeries (IBCIQ.PK ), which filed for bankruptcy Sept. 22. It had been pinning its future on the successes of the past, turning out Wonder Bread and Twinkies even as consumer demand shifted to healthier fare. When losing weight becomes the basis for reality TV, it's a trend a lot of people are going to be responding to.

Editor's Note: This is the first in a series of stories on how attitudes toward obesity are changing the corporate and cultural landscape.

Tomorrow: Fighting fat with federal grants in Florida. And a boarding school in California that helps overweight children slim down.

Gogoi is a reporter for BusinessWeek Online in New York

Edited by Thane Peterson

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