2011 was a year of commodity cost inflation and the food industry had hoped raw materials prices would fall back this year. However, in some cases, prices remain stubbornly high. The just-food Confidence Survey showed manufacturers remain determined to push through costs but competition between retailers remains intense, which could lead to a wave of consolidation in the sector.

The early months of 2012 have witnessed continued volatility in commodity costs.

Manufacturers were hoping the pressure of last year’s commodity inflation would ease significantly in 2012 – and help bolster margins at a time when consumers remain uncertain about their spending power and economic prospects. 

At General Mills, for example, Ken Powell has said the company “strongly believes” commodity cost inflation will moderate.

However, food manufacturers have seen pressure continue in 2012. Some commodity costs remain stubbornly strong (sugar), others have reached annual highs in recent weeks (palm oil) and the cost of other ingredients have escalated in the wake of regulation (eggs in the EU).

In our survey, over 41% of you said you expected your commodity prices to be higher this year than last. A further 30% expected raw material prices to be “volatile” this year.

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In the round, commodity inflation is unlikely to hit the levels seen in 2011 but the signs do point to ongoing significant pressure in parts of a manufacturer’s commodity bill.

In our survey, over three-quarters of manufacturers said they would be trying to push through price increases to retailers in 2012.

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Data from the British Retail Consortium on “shop price inflation” in March showed there was the largest month-on-month increase in the rate of food inflation in UK stores since August 2010.

Inflation accelerated in categories including meat, fish, convenience food and there was also a “sharp rise” in bread and cereal prices.

The data suggests that some manufacturers operating in the UK have been able to pass on some of the commodity inflation to their retail customers.

However, for all the pressure on their commodity bill, manufacturers need to be wary about how far they try to push through price increases.

Retailers, facing cautious consumers, may not always be ready to pass on the full extent of price increases.

Now, the major multinational FMCG manufacturers do hold some pricing power over their retail customers and can pass on commodity cost inflation.

That said, continued inflation – not just from the shopping basket but also at the petrol pumps – will put more pressure on consumers.

Elasticity of demand can only go so far. Price hikes last year hit volume sales in a number of markets and the major manufacturers – even if they could succeed in getting price increases through – may have to decide to hold back to maintain consumer demand.

Where retailers do hold more power is with their private-label suppliers, which can face a longer lag in seeing commodity inflation passed through.

In short – the picture on commodities in 2012 may not be as straight-forward as some might have felt it could be as 2011 drew to a close.

Pressure remains in certain areas – and we cannot discount the price of oil on all parts of food distribution. Add to that concerns over crop yields in northern Europe amid the recent dry weather and some industry watchers believe that pressure could continue into the second half of the year and maybe beyond. 

Manufacturers will therefore face all sort of challenging decisions in terms of consumer demand and retail negotiations for months at least.

Which leads us on to M&A. This year, retail giants Carrefour and Metro have new CEOs in place, who will be desperate to revitalise their businesses after a challenging 2011 when both saw profits fall. 

Philip Clarke has just marked his first year as Tesco chief executive and will be uncompromising in his quest to turn around the retailer’s fortunes in the UK.

What could this mean for suppliers? Well, when combined with continued pressure on costs, it will likely mean the industry witnesses more consolidation in 2012. 

Facing retailers battling for market share and looking to their suppliers to fund promotional activity, manufacturers may find it necessary to join forces or acquire rivals to gain scale and a degree of bargaining power.

In our confidence survey, we asked you whether you thought there would be more M&A opportunities for your business in 2012. Over 44% of you believed there would be more this year.

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Of course, an opportunity does not always lead to a deal. 2011 was a year in which an expected flurry of deals did not materialise. Prolonged economic stagnation in the US and Europe – with the latter’s problems exacerbated by the sovereign debt crisis on the Continent – led to a mood of conservatism among manufacturers that could have been looking to expand via acquisition.

And, while the argument that intensifying competition between major food retailers could mean more deals among food manufacturers this year is strong – and some argue there are signs that deal volumes are picking up – concerns over the economy or tight financing conditions could limit any wave of consolidation.

There is, however, an air of cautious optimism among M&A advisors. Spayne Lindsay believes deal volumes are on the rise. And Grant Thornton has told us that both private-equity and trade buyers view M&A in the food sector as a “strong opportunity” this year.

Private equity will remain a competitor for manufacturers looking to acquire, although there is some debate over which kind of business will be at the forefront of any deal-making. The level of debt finance available to private equity has declined from the heady days of the mid-Noughties, although it is argued that buy-out houses have the experience of doing deals that some smaller food manufacturers may lack.

The M&A advisors at Spayne Lindsay have argued that quite “a lot of roads” lead to private equity. It says there is “a lot of capital in the private-equity world” and it says food companies, with their stable cash flows, remain top targets for private-equity firms.

There is also some debate over whether more companies from the powerful emerging markets of China and India will become buyers of FMCG businesses in the West. 

There have been some deals made – China’s Bright Food acquired Australia’s Manassen Foods last year and this month India Hospitality Corp. bought UK convenience food group Adelie Food Holdings. However, Bright Food’s talks to buy United Biscuits in 2010 failed to lead to a transaction and there has not, as yet, been a wave of deals. 

Nonetheless, Grant Thornton has told us that businesses in developing economies may become more interested in Western firms. Companies in markets like the UK have built up a lot of expertise in distribution, technology and branding – and groups in China and India may want to attain that knowledge for their own businesses back home – and could do that through acquisition.