Food price inflation: why companies are losing out

The accelerating pace of food price inflation in recent months has come as a nasty shock to British consumers, who had grown accustomed to their weekly shop becoming cheaper relative to household incomes.

According to data from the British Retail Consortium and NielsenIQ, UK food prices were 13.3 per cent higher in November than in the same month a year ago. The official ONS measure is even higher, at 16 per cent for the same month. Not since the late 1970s have prices risen at such a rate.

Supermarkets all say their own prices are rising at a slower rate than the headline figures, which make no allowance for shoppers trading down to cheaper products or simply buying less.

But they also acknowledge that customers are feeling the squeeze and looking to economise in any way they can. Several have publicly stated that they will forgo some profit this year to keep pricing competitive.

If they are not profiting from rising prices who — if anyone — is?

Feed, fuel and fertiliser

The most significant costs across the food chain are the “three F’s” — feed, fuel and fertiliser. Increases in the prices of these are felt first by farmers, followed by processors and finally by retailers and their customers.

Processors are often shielded from price increases for a while by forward purchasing of ingredients. Charles Hall, head of research at Peel Hunt, said this meant it was quite normal for price rises to take six months or more to filter through to the consumer.

“If you take dairy, farmers started to see feed prices rise at the end of 2021. That then accelerated into 2022 with the Ukraine war but the prices of milk didn’t really start to rise until May,” he said.

Livestock farming had been particularly affected by rising feed prices, because it accounted for up to 70 per cent of the cost of rearing chickens and pigs, he added.

The prices of many staple commodities have since fallen back, but some processors will still be on contracts agreed months ago when conditions were different.

“You’ve still got probably another six months before [raw material costs] start to ease off,” said Hall.

At its half-year results in September, prepared meals maker Bakkavor said it expected “significant” inflation to persist throughout 2023, having forecast a 12-14 per cent rise in its current financial year.

Greenback whack

Even if global commodity prices fall, there is a complicating factor for food producers in the UK and Europe.

The US dollar has strengthened this year — partly because it usually does at times of geopolitical uncertainty and partly because the Federal Reserve has raised interest rates more rapidly than other central banks.

Forward purchasing and treasury management will have ameliorated some of this impact. But the effects of a stronger dollar — the currency in which almost all globally traded commodities are priced — are still likely to be felt for the rest of 2023.

Greenhouse effect

Most areas of food processing and retailing are not especially energy-intensive and historically the industry has not worried much about the cost of gas and electricity because it was a relatively small component of overall production costs.

That changed with a vengeance in 2022. Companies such as Premier Foods, meat processor Hilton, poultry giant 2 Sisters and Associated British Foods are often paying three times more for energy compared with a year ago, driving food prices higher.

Hall said the prices of many winter vegetables would rise as growers that used greenhouses passed on higher heating costs. Cucumbers and peppers have already been affected, with prices rising and homegrown crops declining as some farmers decided they were no longer cost-effective.

Although wholesale gas prices have moderated from their 2022 peaks, UK government support to help businesses cope with sharply higher energy prices is set to become less generous from April.

Wage price spiral

One big issue for food producers and retailers predates the Ukraine crisis: labour costs.

In the UK, the minimum wage — paid to most workers in the food industry — has risen from £7.20 in 2016, to £9.50 now and will increase by a further 9.7 per cent to £10.42 in April.

Most supermarkets are already paying more to attract staff following the departure of older workers from the jobs market and fewer arrivals from eastern Europe because of Brexit.

Recruitment is also a problem for labour-intensive parts of food production, such as meat and poultry processing and fruit farming, which had also been reliant on low-paid workers from eastern Europe.

Ministers have launched a visa scheme for seasonal farm workers, allotting 45,000 this year. But extra administrative expenses and the need to look as far afield as Indonesia and Nepal for workers have ramped up costs. Agricultural labour costs rose 13 per cent in the year to autumn 2022, according to data prepared for the National Farmers’ Union.

Rising costs have especially affected egg farmers, who have reduced their flocks as costs outweighed the prices they receive for eggs, leading to shortages on UK supermarket shelves. Dairy farmers, by contrast, had benefited from steeply rising milk costs, helping their profits to recover, said Clive Black, head of research at Shore Capital. “It really is a complex jigsaw of winners and losers.”

Brand power

Rising prices for so many things at once have left companies at all stages of the supply chain scrambling to cut other costs and calculate how much of the increases they can pass on without losing market share.

Large branded food groups such as Nestlé, Unilever and Mars have much bigger margins than commoditised processors and retailers. Their brand strength makes it easier for them to push through price increases while their superior profitability allows them a little more leeway to absorb rising costs.

“The global tier-one manufacturers have been much more ruthless — because they can be, because they control their brands — in putting through price rises,” said Black.

Most took a hit to profit margins in 2022: for example, Unilever’s operating margin declined 2 percentage points to 15.2 per cent in the first half from a year earlier. One group bucking that trend was Premier Foods, maker of Mr Kipling cakes and Sharwood’s sauces, which pushed up trading profit margin from two years earlier.

Shoppers are beginning to turn to supermarket own-brands to save money, but profitability at the companies producing these goods is low. “Private label manufacturers, which tend to incur inflation early and get cost recovery late, are challenged by the present inflationary environment,” Black said.

Food retailing is a highly consolidated industry in the UK, with the top four traditional supermarkets — Tesco, J Sainsbury, Asda and Morrisons — plus the two discounters Aldi and Lidl controlling more than four-fifths of the market. But competition is intense and recent history suggests those that do not maintain competitive pricing lose customers very quickly.

And profits are meagre: even at market leader, Tesco, operating margin was 3.9 per cent in the UK and Ireland in the first six months of the year and costs have escalated further since then.