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Focus on Function

By Sean Moloughney | September 1, 2009

A new report indicates that the functional food market continues to profit from growing consumer awareness and an increased focus on preventative care.

The dynamic and evolving functional foods market offers a wealth of growth potential for prospective investors who take time to understand this emerging $20-30 billion segment, according to a new report released by PricewaterhouseCoopers LLP (PwC) last week.

The report, titled "Leveraging Growth in the Emerging Functional Foods Industry: Trends and Market Opportunities," estimates growth for the functional foods category between 8.5% and 20% per year. Glenn Pappalardo, strategy retail & consumer team leader and director, Transaction Services, at PwC, says the popularity of functional foods will make a lasting impression on the consumer packaged goods industry.

"Fundamentally, this space has a lot of positive opportunities," he noted. "This is something that is by no means a fad. It will be an ongoing part of our diet and food offerings for many years to come. It will be interesting to see how it evolves and to what level it becomes part of the average American's dietary lexicon."

Several trends are converging to create a market ripe for accelerated growth, the report says. First, consumers are increasingly focused on their own personal health and wellness. At the same time, government, medical and healthcare communities are looking to control spiraling costs associated with disease treatment by focusing on prevention. Additionally, over the past few years, food science and technology has opened doors that were previously locked.

"The convergence of these larger trends has helped propel the category into more prominence and we think will continue to do so into the future," said Mr. Pappalardo. "It's a sector that's very interesting, very dynamic and still evolving-and as a result, is not particularly well-defined yet."

Consequently, there is a tremendous need for education among consumers, the industry, healthcare professionals and interested investors about what functional foods are and where the opportunities lie across segments, Mr. Pappalardo added.

A Broad Base

According to PwC, the functional foods market represents about 5% of the overall U.S. food market. The U.S. functional foods market is estimated to be the largest in the world, representing between 35% and 50% of global sales, with Asia-Pacific being the next biggest market. Combined, the two markets account for approximately three-quarters of the current global market for functional foods.

"The top 20 functional food companies are estimated to account for about 70% of the U.S. market, with a small number of multinational companies comprising a significant share," the report indicates. Mr. Pappalardo explained that in the category's infancy, larger companies with strong distribution footholds in other segments were actively watching emerging opportunities and brands, and were able to pursue investments very easily. Also, "it didn't take much for them to alter existing products and create something that could be marketed as a functional food. So it was easy for them to grab market share in the early days," he added. "What I think you're going to see now-with people understanding the opportunity-is all kinds of niche areas pop up that could move into the mainstream, allowing smaller competitors to see appreciable growth."

PwC segments the functional foods market in two ways: by food type or by health benefit. Currently, soft drinks and dairy products constitute 60% of the market by food type. The soft drink category includes enhanced water, which has grown in popularity as consumers seek alternatives to carbonated beverages, and sports drinks. Between 2002 and 2007, U.S. functional soft drink revenues grew at about 12% annually, to more than $9.5 billion.

Dairy, the second largest growth segment, continues to gain popularity, largely due to innovation in functional yogurts. During the same time period, dairy grew to nearly $7 billion at about 8% annually.

Energy is the largest segment by health benefit with 29% of the market, largely due to the fact that these products tend to have attributes consumers can quickly feel. In the U.S., the energy segment grew more than 6% annually between 2002 and 2007 to almost $8 billion.

"Products for enhanced cognitive health, such as omega 3 fatty acids, are expected to be a $7 billion market by 2011, according to Packaged Facts," the report states. "Other areas to watch are products for weight management, mood enhancement and those that promote healthy, beautiful skin."

Mr. Pappalardo said he expects to see continued penetration in the well-established dairy and juice segments, especially given the popularity of berries and other fruits. As for future food categories, he said, "I think you have to line up the consumer packaged goods spectrum and think about where the logical leaps are, based on what the consumer is comfortable with right now and what the technology will allow you to do."

The PwC report attributes its expectations for future growth to a combination of increasing consumer awareness and changing demographics-including the aging Baby Boomer population and current healthcare trends.

"Food and beverage conglomerates are reshaping to reflect these fundamental demand trends," the report states. "Five years ago, Nestlé declared it was 'moving from an agrifood business to an R&D driven nutrition, health and wellness company.' Other top food and beverage companies have signaled similar intentions, including Danone, Unilever, General Mills, Kellogg, PepsiCo, Coca-Cola, Yakult and Kraft."

These major players will clearly play a significant role in the future of functional foods, said Mr. Pappalardo. "The trend we've seen is moving more toward a pharma model of letting other people take on the risk of developing something, and once it gets to a certain level of success then buying that from them at a certain premium and then plugging that into a larger distribution and marketing network and really blowing it out to a mainstream level. You'll probably see that within functional foods as well, but that doesn't mean there aren't spaces for new or smaller players to really find appreciable growth as the category continues to proliferate."

Tough Times & Issues

Despite the picture painted in the PwC report, functional foods have had to weather the economic storm, especially in light of the premium price attached to their health benefits.

As a result, private labels have capitalized on the opportunity presented in this recession, across various industries. "We've seen private label on the non-functional side do very well over the last few years," said Mr. Pappalardo. "[Manufacturers] have caught on to the importance of this segment and the consumer desire to still get the benefits of functional foods, but at a more reasonable price level. I don't think consumer appetite for functional foods is going to go away because of what we're going through economically."

Faced with inflated, ongoing healthcare costs, consumers who recognize the value of functional foods in terms of their role in preventative care will be willing to "trade up," especially as the economy stabilizes and consumers see signs of recovery, he added.

Moving forward, Mr. Pappalardo said the relationship between food and medicine will likely become more intimate. "We're really starting to see food as science these days. Where that goes 10 years out I think is a very interesting and healthy debate to have as we consider the synergies that exist in terms of promoting health and wellness between the medical and pharmaceutical communities and food, beverage diet and behavior."

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