Tag: asia

The current tremendous inflationary pressure on the cost base of virtually every food producer has yet to be absorbed further downstream in the supply chain. Will it be the consumer, the food retailer, or the foodservice operator that ultimately picks up the bill? Or will the problem be pushed back into the chain?

Inflation in itself is not necessarily a bad thing, according to Rabobank’s chief macroeconomist – as long as everyone expects and calculates with the same inflation rate, that is. Well, the current cost inflation in food was definitely not modeled for and is unprecedented. Apart from maybe depreciation, virtually every cost line in the P&L is experiencing upward pressure. Whether it is agri commodities, packaging, transport, energy, or personnel costs, all have shown a massive price increase. And relief is nowhere in sight in the short term. Part of the cost increases even have a structural nature, as supply chains are shifting from ‘just in time’ to ‘just in case.’

The exact magnitude of the cost inflation is difficult to gauge. Supplies are often covered by contracts, so the actual contracted prices and timing of contract renewals will differ from company to company. Moreover, the cost inflation a company experience depends on the type of products it produces, which raw materials are used, and where products are sourced. A bakery company will have more issues with the gas price, whereas a beer company will monitor glass and aluminum prices more closely, and a nut trader has to deal with the 822% price hike in container prices from Asia.

So, rather than focusing on the cost itself, we have asked a broad range of suppliers throughout Europe how much they would have to raise their prices to food retailers and foodservice operators in order to cover their exploded cost base. The answers ranged from 0% up to 30% or more. On average, suppliers are looking for about 9% to 10% higher prices (PPI) toward retailers and foodservice companies to cope with the inflated costs. One thing is for sure, given the average operating margins in food production, not many producers will be able to absorb the cost inflation in their own operation. Many producers made it abundantly clear that subsidizing their products was not an option, so negotiations will be tough this autumn.

Whatever You Do, Don’t Blink First

The obvious next question is: What will food retailers do? Given the operational leverage in their business model, passing through any price inflation is in the best interest of supermarket organizations – in theory, that is. Food retailers across Europe are active in highly competitive markets. Being first to raise consumer prices would likely be detrimental to a retailer’s reputation and, if competition holds out long enough, also to sales volumes and market share. Also, the food retailer’s profit margin would not suffice to absorb a 10% higher cost of goods sold bill.

It will be a matter of closely monitoring competition, timing any consumer price hikes carefully (preferably later than competitors), and weighing how much of the cost inflation can be absorbed without aggravating the stock market, shareholders, or co-op members. History provides ambivalent clues as to how supermarkets have dealt with previous inflation peaks.

Looking back some 20 years, we have seen the cost base and producer prices in the EU-27 peak before, in 2007/08 and 2010/11. In the first cost rally, food retailers benefited from a favorable economic climate – just ahead of the financial crisis – and clearly decided to pass most of the inflation on to the consumer (CPI) with a limited delay. In 2010/11, the financial crisis and associated tax increases took a toll on consumers’ wallets, and, consequently, food retailers were much more cautious in how much and when they raised the prices on their shelves. Whether the economic climate in today’s market reflects 2007/08 more or the broader inflation experienced outside food more closely resembles the 2010/11 consumer is the million dollar question.

In order to calculate an index representing the cost inflation of food producers, we have constructed a cost base of a nonexistent, average food company that uses the FAO food stuff index as agricultural raw materials (40% of costs), the Eurostat energy index representing transport, production, and packaging (30% of costs), and the Eurostat labor cost index for all staff-related costs in production, sales, marketing and, administration (30% of costs).

The Worst Is Yet to Come for the Consumer

Given that neither the food producer nor the food retailer are able or willing to absorb the cost price inflation in full, the consumer will likely be confronted with higher grocery prices sometime in the early months of 2022, though not necessarily in one go. Food retailers may choose to raise consumer prices in phases in order not to upset the consumer too much.

The good news for most consumers is that they have means to circumvent that inflation in their budgets by trading down to cheaper products or cheaper channels: buying ground beef instead of steaks, opting for private label products instead of brands, shopping at hard discount instead of full-service supermarkets, or having dinner in a QSR outlet rather than a fast-casual restaurant.

To make it more complicated, this trading down by the consumer may trigger substantial volume shifts in demand, which both food producers and food retailers will need to factor into their decisions on how to deal with the unprecedented inflationary pressure.