Food Price Inflation: Why Businesses Are Losing
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The acceleration in food price inflation in recent months has been a nasty shock to UK consumers, who have become accustomed to seeing their weekly groceries becoming cheaper relative to household income.
According to the British Retail Consortium and NielsenIQ, UK grocery prices were 13.3 percent higher in November than in the same month a year ago. The official ONS reading is even higher at 16 percent for the same month. Prices haven’t risen that much since the late 1970s.
All supermarkets say their own prices are rising more slowly than headline figures, which don’t take into account shoppers switching to cheaper products or simply buying less.
But they also recognize that customers feel the pressure and are trying to save in any way they can. Several have publicly stated that they will forego part of the profits this year to keep prices competitive.
If they don’t benefit from rising prices, who, if anyone, will?
Forage, fuel and fertilizer
The biggest costs in the food chain are the “three Fs” – feed, fuel and fertiliser. Their price increases are noticed first by the farmers, then by the processors and finally by the retailers and their customers.
Processors are often shielded from price increases by purchasing ingredients ahead of time. Charles Hall, head of research at Peel Hunt, said this means it’s normal for price increases to take six months or more to reach consumers.
“If you take dairy, by late 2021 farmers started to see feed prices increase. This then accelerated until 2022 with the Ukraine war, but milk prices really started to rise in May,” he said.
The livestock industry has been particularly hard hit by rising feed prices, accounting for up to 70 percent of the cost of raising chickens and pigs, he added.
Prices of many staples have since fallen, but some processors will still close deals agreed months ago when conditions were different.
“You probably have six months left [raw material costs] Start slacking off,” Hall said.
In its September half-year results, ready-meal maker Bakkavor said it expects “substantial” inflation to persist throughout 2023, after forecasting a 12-14 percent rise for its current fiscal year.
Even if global commodity prices fall, there is an aggravating factor for food manufacturers in the UK and Europe.
The US dollar has appreciated this year — partly because that usually happens during times of geopolitical uncertainty, and partly because the US Federal Reserve has been raising interest rates faster than other central banks.
Forward purchase and treasury management will have mitigated some of this impact. But the effects of a stronger dollar – the currency in which almost all commodities traded around the world are priced – will likely be felt for the remainder of 2023.
Most food processing and retail sectors are not particularly energy intensive, and historically the industry has not paid much attention to the cost of gas and electricity, as these represent a relatively small proportion of total production costs.
That changed with a vengeance in 2022. Companies like Premier Foods, meat processor Hilton, poultry giant 2 Sisters and Associated British Foods are often paying three times more for energy than they did a year ago, pushing up food prices.
Hall said prices for many winter vegetables would rise as growers using greenhouses passed on higher heating bills. Cucumbers and peppers have already been hit, with prices rising and domestic harvests falling as some farmers decided they were no longer viable.
Although wholesale gas prices have moderated from their 2022 highs, support from the UK government to help businesses weather soaring energy prices is expected to be less generous from April.
wage price spiral
A major problem for food manufacturers and retailers existed even before the Ukraine crisis: labor costs.
In the UK, the minimum wage paid to most workers in the food industry has risen to £9.50 from £7.20 in 2016 and is set to rise a further 9.7 per cent to £10.42 in April.
Most supermarkets are already paying more to recruit staff as older workers leave the labor market and fewer people arrive from Eastern Europe due to Brexit.
Recruitment is also a problem for labour-intensive parts of food production, such as meat and poultry processing and fruit growing, which also relied on low-wage workers from Eastern Europe.
Ministers have introduced a visa scheme for seasonal farm workers, allocating 45,000 this year. But additional administrative expenses and the need to seek labor as far afield as Indonesia and Nepal have pushed up costs. Farm labor costs increased 13 percent in the year through fall 2022, according to data compiled for the National Farmers’ Union.
Soaring costs have particularly hit egg farmers, who have reduced their flocks as costs outstripped egg prices, causing shortages on UK supermarket shelves. In contrast, dairy farmers have benefited from soaring milk costs and helped their profits recover, said Clive Black, research director at Shore Capital. “It’s really a complex puzzle of winners and losers.”
Increasing prices for so many things at once have prompted companies at all stages of the supply chain to cut other costs and calculate how much of the increase they can pass on without losing market share.
Big branded food companies like Nestlé, Unilever and Mars have much larger profit margins than bulk processors and retailers. Their brand strength makes it easier for them to push through price increases, while their superior profitability gives them a little more leeway to absorb rising costs.
“Global tier one manufacturers have been much more ruthless — because they can be, because they control their brands — in enforcing price increases,” Black said.
Most companies took a hit to profit margins in 2022: For example, Unilever’s first-half operating margin fell 2 percentage points year-on-year to 15.2 percent. One group bucking the trend was Premier Foods, makers of Mr. Kipling cakes and Sharwood sauces, which boosted trading profit margin from two years earlier.
Shoppers are starting to turn to supermarket private labels to save money, but the profitability of the companies that make these goods is low. “Private label manufacturers, which tend to inflate early and recover late, are being challenged in the current inflationary environment,” Black said.
Grocery retailing is a highly consolidated industry in the UK, with the four largest traditional supermarkets – Tesco, J Sainsbury’s, Asda and Morrisons – and the two discounters Aldi and Lidl controlling more than four-fifths of the market. But competition is intense, and recent history shows that those who don’t maintain competitive prices lose customers very quickly.
And profits are meager: Even market leader Tesco had an operating margin of 3.9 percent in the UK and Ireland for the first six months of the year, and costs have continued to escalate since.