Grocery prices are going up but at what cost to the future relationship between branded food manufacturers, retailers and consumers?
While anecdotal evidence seems to suggest consumers facing a cost-of-living crisis are trading down, with discount grocers and private-label the beneficiaries, manufacturers of branded food, which have raised prices to counter their own inflationary pressures, say they are still experiencing low levels of elasticity.
So what is happening?
Well, it could be that we are not seeing the impact of their pricing actions yet and the pain is yet to come, or it could be that consumers are trading up and down and we are experiencing a ‘squeezed middle’.
What we certainly have is an environment shrouded in uncertainty and one in which consumer behaviour observed in previous inflationary periods will not necessarily be replicated, some market-watchers suggest.
Reading the research runes
As food manufacturers consider their options, all eyes are on market data.
A report from management consultancy McKinsey in May revealed UK consumers, facing a cost-of-living crisis exacerbated by the Russian invasion of Ukraine, are trading down in stores and on products, switching from supermarkets to discounters and from branded to lower-priced and private-label products.
McKinsey’s survey found 64% of UK consumers say they have responded to price increases by adapting their shopping behaviour, with noticeable shifts in channel and brand as they search for value for money.
The consultants said a net 40% of consumers had traded down on snacks and confectionery and frozen foods, while 24% had traded down on bread and bakery products.
And more recent findings from market research company Kantar have confirmed a shift to cheaper own-brand products in the UK.
Its research – published on 14 June – showed UK supermarkets’ sales of branded items fell 1% over the four weeks to 12 June, year-on-year, while sales of own-label products rose 2.9%, boosted by strong performances from German-owned discounters Aldi and Lidl.
The UK is not alone of course. McKinsey found similar results in terms of changing consumer habits in France, Germany, Italy and Spain. Meanwhile, in the US, consumer trend analyst firm The Hartman Group published research this month that showed rising food prices are “influencing noticeable changes to grocery shopping habits”.
“Specifically, we find that when asked how much rising prices have affected their ability to buy foods, beverages and other grocery items that they normally shop for, 24% of consumers who say food prices have risen say such shifts have impacted them ‘a lot’ and that they’ve really had to ‘rethink how they shop for groceries’,” The Hartman Group said.
And the trend is likely to continue. The UK’s Institute of Grocery Distribution (IGD) predicted on 16 June the country’s food prices will rise at a rate of 15% this summer as households pay more for staples such as bread, meat, dairy and fruit and vegetables.
The IGD, which provides analysis to major grocers, said the UK was facing the highest cost of living pressures since the 1970s, mainly down to the Ukraine war.
It is against this backdrop that manufacturers of branded food are having to operate.
They, of course, are also having to cope with inflationary pressures with the cost of ingredients, packaging, transportation and energy all going up.
And, despite the evidence suggesting consumers are cutting their cloth accordingly, most have reacted to these inflationary pressures thus far by putting their prices up.
The cost of passing on costs
John Stapleton, co-founder of UK food businesses New Covent Garden Soup Co. and Little Dish, says: “It’s a perfect storm at the moment with prices of everything going up across the board. It is going to be passed on to consumers.
“The problem is that we haven’t had price increases for the last few years so it’s all coming at once. Consumers will have to re-adjust but private-label across the board has really upped its game and that’s paying dividends. They satisfy consumers’ needs better than they have in the past.”
Cyrille Filott, global strategist for consumer foods, packaging and logistics at Netherlands-based financial services group Rabobank, has seen private-label benefiting from premium brand manufacturers’ pricing actions.
“Premium brands, in general, tend to have increased their prices more than private-label so the gap on the shelf is widening,” he said.
“The disposable income of consumers has shrunk and may continue to shrink. Wages are not necessarily following [inflation] and that’s got to hit.
“The move towards private-label in retail in the UK is happening very fast.”
US-based analysts are seeing a similar picture emerging.
Shelley Balanko, a senior vice-president at The Hartman Group, says: “Consumers are finding premium quality in private-label so that’s not much of a trade-off.
“The US has lagged a bit behind Europe [in private-label] but in recent years retailers have invested more in this area. There’s a European influence there from the likes of Aldi but also Trader Joe’s which is 80% private-label. And from club stores such as Costco with its Kirkland brand.
“Consumers can maintain that level of quality but at a price they are willing to pay. Consumer willingness to unquestioningly accept price increases is a thing of the past. It is a game that can be lost very quickly.”
Manufacturers have to be much more alive to elasticity and the substitute effect on productsShore Capital’s Clive Black
The question about whether consumers will walk away from brands they know and trust – particularly those priced more at a premium – if prices rise too much is key but so is the question about whether major grocers will be willing to pass those increases on as they compete against discount rivals.
Clive Black, a director at UK investment group Shore Capital, says: “What’s different this time is the magnitude of inflation, which is much greater than in previous cycles.
“They [manufacturers] have to be much more alive to elasticity and the substitute effect on products.
“Supermarkets are more much concerned about the ultimate consumer now and are also alive to the German discounters.
“They are much more judicious about promotions and are more interested in single pricing and the relative price compared to the discounters and private-label.
“Supermarkets see private-label as a mechanism to deliver basket price value to shoppers and are giving that much more shelf-space prominence.
“German discounters will gain incremental footfall as householders search for value.”
So far, at least manufacturers, often following intense discussions with retailers, says consumers have largely accepted the increases they have implemented.
Speaking last month, Ryals McMullian, CEO of US-based bakery business Flowers Foods, said elasticities related to the consumer have so far “been lower than even we anticipated”.
McMullian said the Dave’s Killer Bread and Nature’s Own brands maker had not yet seen a trade down into private label despite a price rise in January and that demand has actually increased for its branded bread lines.
He told analysts in a post-results call: “We all know that the consumer is under quite a bit of pressure, though I will say a lot of the information out there is somewhat conflicting.”
But McMullian said Flowers Foods will be watching a second round of price increases – due this month – for any demand reversion and “shift in behaviour”.
Mondelez International, meanwhile, has a similar story to tell.
Speaking at the Sanford Bernstein Strategic Decisions conference at the start of this month, the Cadbury and Oreo brands owner’s CEO, Dirk Van de Put, said raising prices has had no effect so far on the number of households buying the company’s brands and the average quantity households purchase.
But he said: “There's certainly going to be heightened scrutiny on price increases.”
Some are expecting the picture to change.
US snacks brand Utz Brands’ CFO Ajay Kataria said in mid-May: “We are expecting price elasticities and SKU rationalisation, [and] market dynamics to suppress volumes in the second half.”
In Europe, the story is largely the same. When Nestlé announced its first-quarter sales numbers in April, CEO Mark Schneider said: “I think, so far, the punchline is that consumer demand has proven to be resilient and then obviously, we do expect now some elasticity later in the year because of the fact that, simply when you stack all these price increases on top of each other, it does have some impact on what the consumer has to pay for the basket.”
And it is not just large companies being affected.
Stefan Lagerqvist, CEO of Swedish no-added-sugar snacks firm Nick’s, tells Just Food: “It’s very challenging at the moment. We are in touch with retailers on pricing.”
He says Nick’s hasn’t noticed a move away from its products thus far but is taking nothing for granted.
“I can’t tell if it’s too early or not. Sweden, where we have a meaningful market share, is different for us than other markets where people will seek out new products from smaller players and we need to be more adaptable and flexible on price,” he says.
The question of whether manufacturers rely on retailers continuing to back price hikes is yet to be fully answered.
Van de Put at Mondelez said. “I think they [retailers] have their own cost pressures that they need to deal with. I do believe that they understand that price increases need to happen. So I don’t think there will be a refusal to increase prices.”
But, speaking on 17 June, Ken Murphy, CEO of Tesco, the UK’s largest grocer, may have been signalling a reluctance to go much further with price hikes when he revealed sales at the supermarket group have fallen as “unprecedented increases in the cost of living” are felt across the country.
“We are seeing some early indications of changing customer behaviour as a result of the inflationary environment,” Murphy told reporters.
“Customers are facing unprecedented increases in the cost of living and it is therefore even more important that we work with our supplier partners to mitigate as much inflation as possible.”
In May, when Walmart announced its fiscal first-quarter financial results, the US retail behemoth acknowledged the cost pressure faced by the whole industry but underlined how the grocer and its suppliers needed to try to keep costs down for shoppers.
“Our team and our suppliers need to do everything we can do to keep costs low so that we could have values for customers that are meaningful. That’s the purpose of the company,” John Furner, the president and CEO of Walmart’s US division, said. “We’re positioned to do well in great economies and economies that aren’t as good. So we’re going to be positioning ourselves well to take care of our customers going forward and, our teams and our suppliers, we both need to do more to help customers out.”
More pricing to come?
However, Black at Shore Capital does not believe we have necessarily seen the end of moves by manufacturers to up prices.
“I think there is a lot of push-back [from retailers] but the likes of Nestlé and Unilever are price setters,” he says.
“There have occasionally been high-profile spats and there are tough negotiations going on.
“We are into the fourth round [of pricing] in some cases, which is a reflection of cost inflation pressures.”
But he warns: “Leading brands need to be alive to the affordability of their product to shoppers, otherwise they could face unpleasant volume shifts.”
Filott at Rabobank also sees more pricing action ahead. “I don’t think the retailers have pushed on all the price increases to consumers. The second wave of pricing is still to come. Price negotiations are still happening,” he says.
But he warns consumers who may still have some spending money knocking around from the peak of Covid-19 when they were forced to stay at home, may not be quite as happy to accept hikes in the future.
“The crystal-ball stuff is that, after their summer holidays, European consumers will look at their wallets and their euphoria will have gone,” he says.
Of course, the largest manufacturers can always threaten not to supply products if retailers block price increases.
Black says: “When it reaches the stage where manufacturers say they can’t supply [products] then it has reached an unhealthy impasse. It’s the ultimate sanction. But those discussions have undoubtedly taken place.”
While food manufacturers have thus far have remained bullish about the reaction to their moves to up prices, there are now clear indications they are starting to look at other options for coping with inflation.
Speaking at the Deutsche Bank Global Consumer Conference this month, Rafael Oliveira, US food major Kraft Heinz’s EVP and president for international markets, said “you have a whole arsenal of other weapons to fight inflation that we’ve been working on.
“It doesn’t mean that you won’t price if you need to price more. It’s still a very valid and important weapon in that sense. But then all the other revenue management arsenal of things that we’ve been working on and the investments in technology that we made in the last couple of years make us very confident on the systems. A few examples are how you play with packs, how you change the pack design or pack architecture.”
He added: “So [it’s] really going deeper into analysing what’s creating value for the consumer for that specific product. So one example on cheese, on Singles cheese. We start looking, what are the attributes that consumers really value? For example, we detected that we have Vitamin D in the cheese. Frankly, the consumer studies show that consumers don’t really buy cheese for vitamin D. So we don’t need to have that. That’s an ingredient that you can take it out.”
Changing pack sizes – shrinkflation – or the ingredients mix, as Kraft Heinz indicates, can help reduce costs, as can scaling down promotional activity.
Another weapon in a branded food manufacturer’s arsenal is ‘shelflation’, cutting down on the number of its SKUs that grocers sell. The thinking is simplifying a range could make it cheaper for retailers to stock and manage.
Analysts suggest there are other cards the food companies can play to try and retain customers.
Balanko at Hartman Group in the US points out “they [consumers] are willing to pay for more high-quality food and beverage that’s more indulgent.
“They are pivoting away from foodservice so they can [have these products] in their grocery cart.
“Products with strong health and wellness credentials are seen as a superior consumption experience as well.”
But she warns a lengthy relationship with consumers or a creditable mission statement may not be enough.
“They can start making nostalgia claims but really trust has to be earned while being mission-led is not sufficient,” she says.
Stapleton says: “The focus for brands is to be clear on what your USP is and state it very clearly through your branding. For brands that are smart about it, there are a bunch of opportunities.
“I’m absolutely sure that there will be room for brands. Own-label brands growing doesn’t mean there is no future for brands, far from it.
“Brands with a clear message and a loyal base that have good taste and texture will appeal to more people.
“Smart brands can talk about price but can also talk about benefits to the retailer, such as certainty of delivery when they have had disruption.”
However, Black cautions food companies to be “strategic and tactical” in their approach.
He says: “There will be a reasonable expectation that in the next one to two years we will be in more reasonable times [inflation-wise}.
“There is a real need to understand what is necessary in the next quarter [but] no two-footed challenge on price recovery.
“They need to recover pricing but not overdo it. Pricing products to the point where brand equity is eroded could be damaging.”