Inflation has become a hot topic globally in the packaged food industry as manufacturers grapple with rising commodity, freight and packaging costs, and in some cases currency depreciation, posing a dilemma for both suppliers and retailers.

Increasing costs of food inputs couldn’t have come at a worse time when developed countries are just starting to get a handle on the pandemic with the roll-out of vaccines, while the less-developed world is still struggling to contain the virus – India being a case in point. The lack of mobility associated with lockdowns has hit many an economy, with slowing growth and people out of jobs directly linked to Covid-19, and higher prices now giving rise to the classic stagflation scenario.

The dilemma for food manufacturers revolves around how they can pass costs on to retailers and still maintain volumes and protect margins, with resistance likely to be forthcoming from the major supermarkets in order to retain customers and remain competitive. Manufacturers could, of course, absorb the increased costs, but that seems implausible given the levels of inflation expectations flagged by the Big Food fraternity during the first-quarter earnings season, and, most importantly, how long some think the pressure on costs could continue.

Unilever has said it was facing the worst inflation “in about a decade”, while Tyson Foods noted it was “substantial”. Nestlé has warned the predicament could spill over into next year, and Conagra Brands expects a “future acceleration” over the next few quarters.

How might manufacturers seek to manage pressure?

Many of the manufacturers have already raised prices and have plans to continue to do so. However, in such a precarious operating environment, there are other tools they can fall back on to save damaging relationships with retailers and preserve consumer loyalties.

Revenue growth management practices have become widely used among consumer-goods companies over the past decade and are the most immediate and viable solutions centred around the parameters of pricing, promotions, product assortment and trade investment. Some supermarkets, at least in the UK, have employed a tactic of offering discounts on certain items for clubcard holders but that arguably hides price increases elsewhere across the store.

Hedging exposure to currencies and commodities is a standard practice, while other available options include improving productivity to lower production costs and improve margins, using alternative ingredients and packaging inputs, and, another hidden tactic, shrinkflation.

The chairman and CEO of Kellogg, Steve Cahillane, said on a recent first-quarter results call the US cereal and snacks maker’s positive price and mix was down to “revenue growth management actions made all the more important by the recent rise in input-cost inflation”.

Cahillane explained: “On the pricing front and just the cost-pressure front, what I’d say is we have a host of tools at our disposal. We want to always start with productivity and drive productivity as hard as we possibly can. And then we’re going to look to revenue growth management … whether they be price-package architecture, whether they be pricing, which would include list pricing. All of those are at our disposal.

“But, at the end of the day, we have to earn that price in the marketplace through investing in our brands, through innovating, through putting in the types of performances that we’ve been able to put against our brands.”

Private label may emerge as a stiffer competitive threat for branded manufacturers, especially when consumers tend to turn to discounted products during times of crisis.

Andy Searle, a UK-based managing director and partner of US-headquartered CPG and retail advisory AlixPartners, says: “If we’re looking at cost increases on branded, one of the concerns always is what’s happening on private label, and that opening gap will just force more value down into private-label business. Retailers at the moment are interested in cash and their profits and so it needs to be a story that you take to the retailer about joint value creation and how does having your brand at a higher price point drive that.”

Searle touches on product assortment, too, an area where food manufacturers might struggle in terms of price increases when many, along with the supermarkets, have cut their mix during the pandemic to concentrate on the in-demand and most popular items.

“It could be that you are able to push up the price on that brand but give them [retailers] something else, it could be around promotions or NPD in different categories, it could be helping them take out cost inefficiencies in their network but really kind of pushing on the whole kind of product complexity range solution, which retailers have been doing – and to an extent CPGs have been doing,” Searle explains.

“But lots of that is more price-pack architecture. I do think there are probably, in some categories, too many SKUs and so, could I put through a price increase but take out complexity, which reduces my costs, improves my procurement leverage and reduces the retailer’s costs?”

Who may face trouble in passing on costs?

Bruno Monteyne, an analyst at New York-headquartered asset manager AllianceBernstein, paints three scenarios around higher costs and gives an inkling of what type of companies and food categories might be better placed to push through price increases.

“Costs can be passed on but volumes will be impacted; expect margin compression but volume stability; or the worst of both worlds, lower margins and lower volumes,” he says.

“Inflation can be beneficial when it drives higher top-line for some but can cause major margin compression if competitive dynamics make it hard to pass through prices quickly and lower consumption volumes for products where consumer demand is elastic.

“With food, there is a clear mix between the winners (snacking, soft drinks) and losers (food staples, dairy). The ability to drive through price increases is materially impacted by market structure and level of commoditisation of the category.”

Among major listed players in Europe, Monteyne identifies pressure on the ability of Danone and Unilever to drive higher prices through the retailers, while he says Nestlé is better positioned. “This reflects our view that Danone and Unilever have categories with low consumer relevance where commoditisation, and therefore pricing pressure, is much more advanced,” he explains.

Danone said in its first-quarter results commentary in April it was targeting price initiatives, “which bodes well for our ability to innovate and to selectively pass on price when and where needed, which is very important as we will be in an increasingly inflationary environment”.

However, the Activia maker told investors it was looking inwards, too. “On the moving part for margin, it’s important to mention that we observed since the beginning of the year a broad-based acceleration of inflation in several areas, including milk, including ingredients, but also packaging and on logistics. We have, therefore, intensified our efforts to deliver another record year of productivity. We will also use pricing actions strategically when and where relevant without harming our competitive positions.”

For Unilever, its finance chief Graeme Pitkethly said in April after raising prices by 1% in the first quarter with more in the pipeline, that “the business is very focused, market by market, on recovering commodity costs.”

He added: “We will continue to take price action in countries and categories where we see that inflation, while always taking the needs of the local consumer into account. We will also try to drive our savings programmes hard in order to offset inflation. Overall, we are confident we have the toolkit and the ability to navigate higher inflation through dynamic pricing actions and cost savings.”

Monteyne suggests Nestlé is likely to be a beneficiary of input-cost inflation because of its “high consumer relevance and therefore lower levels of commoditisation”, which will enable the company to increase prices and improve the top-line without a hit to volumes and profitability.

Nestlé CEO Mark Schneider gave his interpretation of the inflationary environment last month, telling investors: “I think you are seeing, as you look at various quarterly updates, a very consistent picture here from our peers as well. And obviously that is not lost on the public, consumers and retail partners. So I think that’s giving us hope here that pricing action, where appropriate and where warranted by the cost increases, is possible.”

US-headquartered snacking major Mondelez International is another member of Big Food having to push through prices, now and into next year, but as a last resort as the company’s CFO Luca Zaramella explained.

“We are pricing more and we are pricing away inflation. We are not necessarily going all the time with list price increases. We use a lot of revenue growth management techniques within the company. Those provide a better impact for consumers and elasticity.

“We will protect free price point, particularly in emerging markets, and price-pack architecture is a key element of price increases throughout both emerging markets and developed markets. We are clearly optimising promo spending and we are optimising mix.”

Clive Black, a director at UK brokerage and advisory firm Shore Capital, says branded food manufacturers have a better chance of raising prices with retailers than their own-label counterparts given the implications around slowing economies and affordability. But he notes the drop off in promotional activity during the pandemic will limit such activity to compensate for higher prices.

“The tier 1 players are, of course, proprietary brand (PB) operators, where pricing power tends to be stronger than is the case for private-label (PL) operators, albeit one key development in recent years has been the introduction of cost-price matrices to help supply chains manage change in input costs,” he says. “In this respect, particularly in ambient and household categories, there is a constant tension between PB and PL, the latter being a weapon that the major retailers can draw upon if and when they feel the affordability of PBs is becoming stretched.

“We anticipate lesser use of the promotional tool this time. In days gone by, particularly in the UK, PB players would often raise case prices to retailers in order to recoup rising input prices and, then more often than not, seek to offer promotions to drive some volume. Indeed, such a tactic became a strategy through the last decade to the extent that the promotional tail started to wag the dog. Accordingly, and expensively, supermarkets have had to work hard to wean themselves and their customers off hi-lo strategies in favour of a more blended assortment comprising more stable and single pricing.”

In the UK, Black suggests the pressure the country’s major supermarkets felt by discounters like Aldi and Lidl in the financial crisis of 2008-09 would have had an impact on retail strategy. “We sense that in the UK mass-grocery market, there will be no return to prior-year promotional participation highs as the major supermarkets are demonstrably more determined not to let the price gap on lines that matter with the German discounters re-open to the damaging levels witnessed around the time of the Great Financial Crisis, which set the tone for earnings through the last decade.”

Black suggests an inflation print of as much as 3% in the UK is “manageable”.

“In a year where sales comparatives for the UK supermarkets will be challenging in light of the distortions as a result of the pandemic – that is the probability of negative like-for-like sales volumes through to spring 2022 – any increase in compensating food inflation can be considered welcome to the respective profit models, so long as consumer confidence and household finances improve, and such price appreciation remains manageable,” Black notes.

Monteyne at AllianceBernstein says many US food companies have revealed expectations for at least a mid-single-digit increase in the cost of goods sold (COGS) this year linked to higher input costs. Separately, Kellogg has singled out a rate at the high end of that range.

“In general, companies report that the sweet spot for COGS is at a steady low-single-digit rate, which enables them to have conversations with retailers about modest price increases, as well as using price-pack architecture and other revenue management tools, to manage price and margins,” he explains. “However, when input cost inflation starts to increase COGS at a mid- or even high-single-digit rate, it becomes much harder for the companies to take enough pricing to cover this and, even if they are able to take pricing, the hit to volumes is such that overall dollar profits and margins tend to take a meaningful hit – as happened with the commodity price spikes of 2007/8 and 2011/12.”

For some food manufacturers, they might have to concede concessions to retailers in return for price increases, Searle at AlixPartners says, but suggests the ultimate decision-makers will be the consumers themselves.

“There’s often a reticence to put through prices. The nervousness of the industry is that every time they go and ask the retailer for something, they end up giving more away than they wanted to – that’s the perception. The expectation normally is that if there are commodity increases, I can offset it through my improvement programmes, or I can work with my supply base to change the way they’re configured or the specification, so it’s much more internal than pushing it back into customers. And, certainly, over the last however many years, we haven’t really been in an inflationary cycle in food and so consumers have got used to the price of things coming down.”