K&N’s vs everyone else: the battle for the frozen food aisle

Overheard at a supermarket in Karachi: a young mother, clearly agitated by the constant nagging of her child, tells her 8-year-old son to “go and get the K&N’s for yourself if you really want it.” The child, however, goes over to the frozen food section of the supermarket and begins picking a variety of frozen items, not necessarily just those branded “K&N’s”.

If this scene is a metaphor for the state of competition in Pakistan’s frozen food market, the battle appears to be over. K&N’s appears to have achieved the status of a noun synonymous with the category itself, a stature most brand managers covet above all else. In reality, however, the battle appears to have only now begun in earnest.

Estimates of the size of Pakistan’s total frozen food market are difficult to come by, and sizing the frozen meat and poultry market is even more difficult. However, according to Profit’s estimates based on data from the Pakistan Bureau of Statistics’ 2016 Household Integrated Economic Survey, Pakistanis spent approximately $1.3 billion last year on a category called “readymade food”, which includes all types of processed food. This is on top of the $4 billion Pakistanis spent on meat and poultry in 2016, of which $1.7 billion was on chicken.

The size of the prize of being the dominant brand in this market, in other words, is sizeable. And given the fact that the processed food market appears to have nearly tripled in dollar value over the past decade, it is a rapidly growing prize.

K&N’s is by far the largest player in the processed poultry market, commanding an estimated 80% in market share. Founded in 1964, and named after the first-name initials of Khalil and Naushaba Sattar, the couple that started the company, K&N’s has the first mover advantage as well as the benefit of being the only fully vertically integrated company operating in this space. But competitors like Dawn Foods, Al Shaheer Corporation, and Menu Foods appear determined to make headway in what has hitherto been almost exclusively K&N’s home turf.

The story of the frozen food market, however, is not simply the story of a few companies battling it out for a larger slice of an esoteric pie. It is the story of the rise of Pakistan’s middle class, particularly the increasing economic empowerment of its women, as well as the challenges facing any business seeking to grow in the country, most notably the lack of a reliable supply of electricity.

K&N’s: the ‘side business’ that grew into an empire

The tale starts with Khalil and Naushaba in 1964. Khalil was the son of a well-to-do family that owned an edible oil mill and his father had encouraged him to experiment with his own business ideas from a very early age. Among the ideas that Khalil and Naushaba were trying in the early 1960s was a small chicken farm which they set up in an unutilised oilseed warehouse in the family’s factory.

The idea may have stayed nothing more than an experiment had it not been for a conversation Khalil had with his cousin, who had visited Australia in 1964 and mentioned to Khalil that he had seen chicken farming as a highly profitable business in Australia. Khalil, then just 23, was intrigued by the idea and increased his investment in his chicken farm and grew it to have 1,000 birds within a few months.

“The articles that I then read on poultry [said] that it [poultry] can grow faster than other food items and also has good nutrition in it,’’ says Sattar about his initial research. “So I thought that in a country like ours where people were deficient in protein, I could try this on my own,” says the 75-year-old about the country where 80 percent of children were affected by diseases due to protein, vitamin and mineral deficiency at the time.

“I never had the idea that it could become a big business. It was considered only a part-time sort of project,” he says about the ‘side business’ that had started earning over $250 million in annual revenues in 2011.

It was not all smooth sailing for Sattar at his home. His father did not think of chicken farming as a “respectable profession” and it took some persuasion on Sattar’s part to convince his father to abandon his opposition to his new business venture.

Starting as they did when the phrase “processed food” in Pakistan was virtually unheard of, K&N’s began by supplying chicken to as many institutional buyers as it could find, of which there were not many in Pakistan at the time. His first customers were hotels and embassies.

The 1965 India-Pakistan war disrupted the feed supply for K&N’s, impressing upon Sattar the need to control his own supply chain. By 1971, K&N’s had been able to build its own feed mill, and by 1974, he was able to start producing a layer parent stock in collaboration with an American company. By 1981, he was selling day-old broiler chicks across the country in addition to being rapidly recognized as the premier chicken supplier in Pakistan.

By early 1990s, Sattar’s ‘’side business’’ had turned into K&N’s Group of Companies: producer of grandparent stock, parent stock and broiler as well as producer of feed supply for the poultry.

The company had a near-fatal blow in the early 1990s, when its farms suffered from an outbreak of Newcastle disease. The farm survived, but Sattar took the disease outbreak as a sign to diversify his business. By January 1997, he was joined by his son Adil, who had graduated from Cornell University just a few months earlier. The father and son duo decided to move into the processed chicken.

It was a fortuitous time to make that decision. KFC opened its first franchise in Pakistan in 1997, and McDonald’s in 1998. Restaurant dining was beginning to take off in the country, and as the upper middle class shifted in its taste from beef to chicken, K&N’s was well positioned to supply that need.

In 2001, K&N’s had another bit of good fortune: Artal, a Belgian company, had set up a chicken processing plant in Pakistan but was never able to navigate the dynamics of the largely undocumented informal chicken and feed supply market, and was forced to sell its assets at a somewhat distressed price, and K&N swooped in to buy the equipment for $100 million. That is started K&N’s direct-to-consumer ready-to-cook line.

‘’I was always eager to go into processing because ultimately that’s the end,’’ says Sattar. This was easier said than done. “Who is going to eat frozen?” his friends asked him. “They thought it won’t work as people want to see the animal being slaughtered in the Halal way,” he remembers. Sattar laughs as he recalls the questions his peers raised.

Today, as the largest vertically integrated poultry farm, with a force of 6,000 employees, over 70 company outlets and distributing to over 1,000 retail outlets across the country, K&N’s Foods stands as the market leader in the market once thought impossible to even exist.           

Looking to the next stage of growth, Sattar’s ambitions have turned global, seeking to export Pakistani processed food across the world. Sattar thinks Pakistan’s market has yet to emerge onto the world map, which he believes will only happen after more than one company is exporting. This is where he does not hesitate to share K&N’s best practices with the local poultry industry.

Yet international growth is not easy, mainly due to the fact that even though K&N’s itself follows stringent international quality standards, the government of Pakistan does not regulate the market or its standards, meaning that K&N’s cannot offer traceability of its products should there be a disease outbreak.

“They [importers] want to know what is the government’s stance on controlling viral [and] contagious diseases? What are the notifiable diseases? Unfortunately, there are none, other than bird flu,” Sattar says with disappointment in his voice.

As a result, the company decided to invest $5 million in a manufacturing plant in Syracuse, in New York State, in 2012. That plant, which started operating in 2014, serves as the launch pad for K&N’s global growth ambitions and, according to sources familiar with the matter, already produces close to $8 million in revenue.

“You don’t need many permissions to export from the United States. They check if you’re USDA [United States Department of Agriculture] approved and they say welcome,” says Sattar. From the plant in Syracuse, the company supplies to Canada, Singapore and Malaysia. K&N’s has also been able to spread its wings in Saudi Arabia and UAE after accreditation from their respective governments recently.

Since K&N’s is still private, it does not disclose its revenue numbers, though data from the Federal Board of Revenue states that the group paid Rs584 million in corporate income taxes in 2015 on its profits. Khalil himself paid Rs93 million in personal income taxes, making him the seventh highest individual income tax payer in the country. His son Adil paid Rs28 million during the same year.

In come the competitors

While K&N’s has a dominant market share, a number of businesses see the processed food market as one that is likely to see rapid growth over the next few years. In large part, this is due to considerably higher labour force participation rates by women, which have risen from 16% to 24% during the past decade and a half, according to data from the Pakistan Labour Force Survey.

 

 

That increase represents an extra 9 million in the workforce, who simultaneously have less time to spend on domestic chores and increased income to spend on high-cost, high-convenience foods. The proportion of households that can afford such food is still relatively small, but is projected to grow exponentially over the next decade.

Pakistan’s small ready-to-cook food market has welcomed more than 10 new entrants in the segment in last five years such as Al-Shaheer, Big Bird, Frozen Fresh, Sufi, Menu, Dawn and PK Foods to name a few.

Perhaps the strongest competitor for K&N’s is Dawn Foods, which is better known to most Pakistani households for its brand of bread. In 2001, Dawn launched its brand of frozen parathas, which are currently the leading brand in that category. The company also makes frozen samosas and has more recently made its foray into the frozen meat products business, and already has a 6% share in the market. That is far behind K&N’s, but still in second place in Pakistan.

Dawn Foods’ CEO Anwaar Hussain, says that his company has been able to make K&N’s “feel the heat” largely through its innovations in its product line and claims that many of K&N’s ideas come from copying Dawn. “Our success primarily came when the market leader [K&N’s] started copying our products, as in started launching the same products. They launched shami kabab, then malai boti and then they launched samosas. K&N copied four or five of our products, and crispy fillet was also one of those,” he said.

“K&Ns should not be worried of what is happening specifically here [Dawn Foods], but rather because of so much competition,” said Hussain. “So if you see that huge billboard of K&N’s near Sherpao Bridge in which they are advertising all these discounts, you can tell that they have started to feel the heat. The good old glory days are no longer there,’’ Hussain said. The Dawn Foods CEO believes it is now going to be a ‘buyer’s market’ rather a seller’s on the back of availability of various brands and choices in the ready-to-cook segment.

Like K&N’s, Dawn appears focused on building up its capabilities to export its products one day, even though it knows it cannot do so right now. “We established a new plant in Raiwand Manga,” said Hussain. “It is a state-of-the-art plant, and we got German and Dutch consultants to build that factory because one day we wanted to export from our Pakistan factory so we wanted it to be of international standards.”

Dawn also has a production facility in the United States, in Dallas, Texas, which is designed to serve the lucrative North American ethnic food market.

Unlike K&N’s, Dawn does not have its own chicken farm and buys from the market, which can be highly volatile in terms of the raw material costs. It had the added disadvantage of K&N’s refusal to sell to them, since Sattar saw Dawn Foods as a competitor. To overcome that disadvantage, Dawn is planning a joint venture with Charoen Pokphand Foods, the second largest poultry company in the world, and a subsidiary of the Thai CP Group, one of the largest conglomerates in Southeast Asia.

That development, maintains Hussain, should scare K&N’s. And while Sattar feels confident of his company’s ability to retain market share, he has been becoming increasingly vocal about his criticisms of what he sees as unfair trade incentives the government has set up to encourage foreign investment in the Pakistani meat and poultry sector, a set of policies designed to attract investors like CP.

“Regrettably, the government’s policies are very strange,” said Sattar. “Somehow it seems that the government has the policy of encouraging imports rather than the local production,’’ he said referring to the free trade agreement (FTA) with Malaysia, signed in 2014.

Under the FTA, Islamabad has allowed tariff-free imports of chicken from Malaysia. “We were meeting the requirements of some multinational fast food chains over here. They audited us and found our quality to be acceptable with flying colors but when they got cheaper supplies from Malaysia they stopped buying from us,’’ Sattar said of another loss business has suffered on the back of policies which increased his product’s costs despite being the local company.

Along with this, the poultry industry was previously zero rated (the input sales tax was refunded to the producer) in Pakistan. Now, the zero rate policy is only applied on importers, advantaging them over local producers.

The government has also levied an import duty and sales tax on the import of grandparent stock (the multiplying seed). Sattar, says this move is a discouragement for the branded sector which accounts for approximately 5% of total poultry consumption in Pakistan, estimates K&N’s.

Meanwhile, Dawn is not even close to being the only company that has entered or is planning to invest in building up the capacity to sell Pakistanis frozen foods.

“If you look at the slaughterhouse business, one new player has already entered which is Big Bird, and you have got to more entrants coming in, Sabir and Al-Shaheer (the one in meat; they have two outlets, one Meat one and another one lower end for mid segment market. Theirs is under construction, Sabir’s is already constructed). Third player who is going to start processing very very quickly is called Neat Foods, that is Shafay Hassan, Chaudhry Shafay, who have already established the plant but yet to have to get into COD, but he is only doing primary, contract slaughtering,” said Hussain.

The real challenge: the last mile problem

However, while the competitive dynamics might be heating up, all companies in the industry face the one challenge that will require nothing short of several years of concerted effort from the government to solve: the last mile problem. Simply put, the country does not have a reliable supply of electricity, which means that, no matter how much any company invests in its own cold supply chain, it ultimately runs into the problem of what to do with when its product gets to the retail outlet.

While some larger retailers like Carrefour’s Hyperstar and Metro Cash N’ Carry have their own cold chain, the vast majority of retailers need to be supplied with freezers, generators and an allowance for fuel so that they can keep frozen foods at the right temperature and prevent thawing and damage to the food, which dramatically lowers the profit margins in the frozen food industry.

Some industry consultants estimate that as much as 60% of the final retail price of frozen food products in Pakistan goes into paying for the freezers and generator fuel that goes into maintaining a cold chain through to the retail outlet. And that is even before one gets to the fact that even for the minority of Pakistani households that have a freezer in their home, they may not always have a reliable electricity supply to keep their food from spoiling.

“Another big challenge is electricity outages,” said Hussain. “We get lots of soiled products returned to us because of power outages. Another issue is of the retailers. They try to save electricity and switch off the fridge at night and switch it on in the morning, which spoils the frozen food. Maintenance of the cold chain is an equally big issue. Distributing the products itself is a challenge. We have our cold chain and we own about 30% of our storage while 70% is outsourced. With respect to vehicles, about 90% are our own and 10% are outsourced.”

As a result of these challenges, most analysts believe that frozen food is primarily a volume business, and has relatively thin margins.

Zeeshan Afzal, an equity research analyst at Insight Securities, says that the profitability in the frozen food market comes from volumes instead of margins, the higher the volume the better the profit. Arguably this is the reason why Big Bird, despite investing Rs6 billion into starting its frozen foods business, is struggling to break even: its volumes are very low.

The market now looks up to Al-Shaheer Corporation who is starting as the only publicly listed company in the sector. Due to its presence in the listed sector, market experts say it can invest heavily and pace up against the pioneer K&N’s.

Ultimately, though, analysts believe that K&N’s lead is vulnerable. “An 80% share in any consumer good category is not sustainable. If any new player comes in, they won’t try to grab share from any small player that is itself playing under a 10% share,” says Afzal. “They’ll definitely go after K&N’s 80% share either by acquiring its already existing market or by making a new market for themselves,” he added.