OUTLOOK | February 10, 2022
Authored by RSM US LLP
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Price increases are necessary but could prove costly for food and beverage companies
If 2021 was the year for middle market food and beverage companies to absorb cost increases and solve challenges to getting products on shelves, then 2022 will be their year to maintain and grow market share while passing along those costs to consumers.
Food and beverage businesses were caught between rising costs of ingredients, packaging, labor and shipping, as well as grocery and mass retail customers using flexing to keep end consumer prices low. As a result, these businesses saw margins squeezed as the producer price index for food at home outpaced consumer prices in that category 12.7% to 6.5% year over year.
The narrowing of the spread between these two indexes indicates that players across the food and beverage supply chain recognize deferring price increases to the end consumer is no longer sustainable. The result will be consumers facing even higher food prices in the center-store and refrigerated categories, which were muted compared to surging meat and seafood prices earlier in the pandemic.
Despite the impact on margin, supply chain disruptions allowed middle market companies to fill the empty space left by food and beverage industry giants by focusing on profitability and velocity. The result was middle-tier companies capturing 40.3% of the packaged food market, up from 38.5% in 2019, according to estimates by Credit Suisse and Nielsen. While overall food-at-home demand is expected to remain elevated from pre-pandemic levels due to new household creation and consumer habits developed during lockdowns, structural difficulties may affect middle market companies’ ability to maintain market share while raising prices.
Over the past two years consumers have been able to absorb higher grocery bills with excess funds from government assistance and savings from reduced spending on services. With extended employment benefits expiring in September, moratoriums on rent, evictions and student loan payments set to expire in 2022, and uncertainty surrounding the child tax credit, consumers could be looking to stretch savings accumulated during the pandemic. A price increase could push a brand out of a consumer price point altogether. Businesses with exposure to lower-income consumers could see the biggest market erosion, as those consumers transition to purchasing value brands and private labels.
Increased competition on the shelves only exacerbates the risk of price increases. Volatile inventory shortages have forced major retailers to keep more brands on shelves. While this created opportunities for middle market food and beverage businesses overall, increased competition will make raising prices more challenging. With a broader supplier base, food retailers are expected to renew trade spend demand, which is still tracking below prior year levels but beginning to tick back up, according to IRI total store view data. Margin pickups from any price increases could be eroded by promotional dollars spent trying to stand out from the competition.
Finally, large-cap food and beverage businesses and food retailers deployed data tools that combine third-party data with their own organizational data to refine strategy during the pandemic. This allowed producers and brands to focus on the products that were most likely to sell at the highest margins and permitted retailers to better understand the end consumers and adapt to changes in behavior.
Middle market businesses have been slow to invest in data tools that their larger counterparts have leveraged to navigate a changing marketplace. Business intelligence solutions have enabled larger businesses to stay competitive during the pandemic by allowing them to understand how changes in price elasticity, consumer behavior, channel shifts and other market forces develop in real time.
No relief on the supply side
Structural factors will keep pressure on food and beverage margins throughout 2022 even as businesses raise prices for their customers.
While input cost increases across several agricultural indexes tempered in the fourth quarter of 2021, increases are still elevated compared to historical growth rates. Continued threats from La Nina weather factors and geopolitical turmoil could create supply-side issues while demand for food products and competition for biofuels are continuing to increase. This could mean the slight reprieve in input costs may only be temporary.
Food and beverage manufacturer and distributor response to labor shortages that plagued the supply chain will be another source of rising costs in 2022. Over the past 18 months, businesses in the sector have struggled to keep warehouses, production facilities and distribution routes staffed due to competition for a small labor pool and safety fears. Food manufacturers as a whole were able to close the gap, climbing to within 4,000 employees of pre-pandemic peaks, but the response was costly. Wage growth for nonsupervisory employees in the food manufacturing sector hovered between 7% and 8% during the most recent quarter, far surpassing wage growth for similar employees in other sectors. Unlike commodities, it’s unlikely these costs will reverse; in fact, there may be room for wages to increase further given the elevated food demand, regulatory requirements and stubborn labor participation rates.
Likewise, other areas of the supply chain that have been slower to raise rates, such as warehousing and trucking, may need to follow suit to meet their own employee shortfalls, further driving up the cost to produce and distribute food and beverage products.
With packaging, storage and transportation costs expected to continue to climb, middle market businesses should be looking toward labor-enabling technology that will allow them to get more productivity out of their employees. This could come in the form of warehouse and production automation on the floor and demand-planning tools in the back office to help navigate volatility in production and find efficiencies in distribution. Other creative solutions to retain labor could be nonmonetary, such as cross-training, upskilling, flexible schedules and title changes. With fewer workers seeking out urban homes, many food manufacturers and distributors are rethinking where they will locate their plants and warehouses so they can be closer to available labor.
Supply shortages create alternative opportunities
The proliferation of plant-based products throughout a growing number of food and beverage categories was accelerated by and helped offset out-of-stock issues during the pandemic. The increasing popularity of these offerings should have a lasting impact on consumer grocery baskets in 2022 and beyond. Plant-based products benefited from the premiumization and innovation-seeking behaviors that have driven grocery consumers throughout the pandemic. One pre-pandemic barrier—price—became less of a concern as meat prices soared. Meat-alternative prices grew a modest 3.7% on a year-over-year basis, according to data compiled by IRI, compared to the 12.5% increase in the consumer price index for meat products. Dairy alternatives performed similarly compared to their traditional counterparts.
Disrupted supply chains also allowed for these innovative ingredients to find more space on shelves. According to an IRI study from August 2021, grocery outlets were offering an average of 17 plant-based items in the refrigerated section and 34 items in the frozen section, up 14% from a year ago. Plant-based ingredients have also expanded into other areas, such as frozen entrees, pizzas, condiments and dressing. More competition in the plant spaces will help keep price growth in check and will be an important catalyst to achieving price parity with traditional meat.
Food service is also benefiting. This was a vital channel for introducing meat alternatives into our minds, hearts and stomachs. Fast-food and quick-service restaurants are turning to plant-based meats to offset shortages, demonstrated most recently with the launch of Kentucky Fried Chicken’s partnership with Beyond Meat to help deal with the chicken wing and breast shortage.
While plant-based alternatives won’t be a cure-all for every category and business, the category’s growth demonstrates how an innovation once thought to be niche can be quickly adopted to address supply chain volatility and consumer preferences.
This article was written by Peter Cadigan, Karen Galivan and originally appeared on 2022-02-10.
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