Russia’s war on Ukraine is hitting the food supply chain and looks set to impact consumer behaviour far from the conflict zone – and shape manufacturers’ supply chain strategies over the longer term.
With swathes of Ukraine now a war zone, the distribution of food has been severely impacted, with factories closed or operating at reduced capacity, logistics upended and retail stores either shut or selling fewer items.
Food manufacturers in Ukraine face the unenviable task of looking after staff while trying to maintain some level of production. MHP, which accounts for around half of Ukraine’s commercial poultry production, employs more than 26,000 people in the country in normal times. “The safety and security of our workers and their families are of utmost concern to us,” MHP’s executive chairman Dr John Rich, says. “Where necessary and possible, we are ensuring their relocation to safe areas and will provide financial support as necessary.”
The London-listed company has felt the impact on its production and distribution, with the group facing “significant difficulties with its supply chain”, Dr Rich said yesterday (28 February). However, he added: “In order to ensure the national food security of Ukraine, MHP’s production will not cease.”
Danone has closed one of its two factories in Ukraine, while Nestlé, which has three factories and 5,000 staff locally, has stopped the manufacturing and distribution of its products.
Against a volatile military and security backdrop, companies are having to react quickly. Germany-based wholesaler Metro has 26 stores in Ukraine, employing 3,400 staff. Yesterday, four of Metro’s outlets were closed but the number varies “according to the security situation”, a spokesperson says. “We want to do our part to keep the food supply for the Ukrainian population up as good as possible. The opening of stores is done under constant risk assessment.”
The impact on agri commodities
Ukraine’s position as a major exporter of ingredients including wheat and sunflower oil means the war is having an impact on commodity prices. The price of wheat jumped in the wake of President Putin’s order to invade and again yesterday after Western nations fresh sanctions on Russia. Corn and soy futures also rose.
The conflict has also pushed up the prices of oil and gas, promising another squeeze on energy costs for businesses, particularly in Europe. And it comes on top of the inflation that’s already in the system due to the impact Covid-19 has had on supply chains. “It’s the same double whammy you’ve had before,” Cyrille Filott, global consumer foods, packaging and logistics strategist at Netherlands-based financial-services group Rabobank, says. “Talking to food companies, some of them are now in the third round of negotiations with retailers which is unprecedented. If this continues, there may be a fourth wave of price increases and so this will flow through to the consumer.”
Hedging strategies may provide some short-term protection but those only last so long, Andy Searle, a managing director and partner at management consultants AlixPartners, says. “The immediate impact on consumer products [companies in Europe] will to an extent depend on their cover strategy,” he explains. “I think most will be, or probably should be, covered through until the harvest in September.
“I would have thought the issue if I’m sitting in their shoes is less about price at the moment and more about supply. In old-school inflation times, there is a benefit of actually having physical possession of something. I’d be looking at how can I maximise what’s in my silos. Can I park trucks on my sites just to make sure I’ve got supply? Where I’ve got committed supply through hedges and cover, I've got physical inventory behind it.”
The pressure on consumer spending
The conflict looks set to add to the pressure consumers in Europe are already facing on their household bills, presenting more challenges for manufacturers even in an industry like packaged food, which is relatively more price inelastic than some other consumer categories. “Net-net, I think in the short term, you’ve got big shifts in consumer behaviour across Europe and in Russia, with inflation going up,” Searle adds. “We’re going to see continued price increases. I suspect that the buffer in margin and historic cover that’s limited some of the price rises to date is all either used up, or it’s going to be burnt through pretty quickly. We’re going to have to see increased price rises on the shelves.”
It’s unlikely the impact on consumers will be limited to Europe. Ukraine, the fifth-largest exporter of wheat globally, according to FAO data from 2020, is a major supplier of the commodity to emerging economies. Disruption to supplies and the upward pressure on wheat costs globally will be keenly felt in countries where food security is always a pressing problem.
“Over the past 30 years, the Black Sea region has emerged as an important global supplier of grains and oilseeds,” Joseph Glauber and David Laborde, both senior research fellows at the Washington D.C.-based International Food Policy Research Institute, wrote in a blog post. “Russia and Ukraine exports account for about 12% of total calories traded in the world. North Africa and the Middle East import over 50% of their cereal needs and a large share of wheat and barley from Ukraine and Russia. Ukraine is an important supplier of maize for the European Union and China, as well as several north African markets including Egypt and Libya.”
Fertiliser giant’s call for action
Fertiliser also looks to be an area of concern, given the impact Russia’s invasion of Ukraine will have on gas prices. Supply- and demand-side factors have already contributed to near-record fertiliser prices and the conflict appears set to worsen the situation. As well as being a major supplier of gas – a key component in the production of fertiliser – Russia is a significant exporter of other important agricultural inputs.
Yara International, the Norway-based fertiliser maker, says the world needs to “reduce the dependency” on Russia when it comes to food supplies.
“In addition to being one of the largest producers of wheat, Russia has enormous resources in terms of nutrients,” Svein Tore Holsether, the president and CEO of Yara International, says. “Plants need nitrogen, phosphate, and potash to grow. In total, 25% of European supply of these three nutrients comes from Russia. With the geopolitical conditions out of balance, the biggest sources of raw material to Europe’s food production are being subject to limitations, and there are no short-term alternatives. One potential consequence is that only the most privileged part of the world population gets access to enough food.”
Holsether adds: “It is therefore crucial that the international community come together and work to secure world food production and reduce dependency on Russia, even though the number of alternatives today is limited. This constitutes a difficult dilemma between continuing sourcing from Russia on a short-term basis or cutting off Russia from the international food chains. The last option may have considerable social consequences. These considerations are not to be taken by individual companies but need to be made by national and international authorities.
“The urgency now lies in helping Ukraine and the Ukrainian people. At the same time, we are pleading Norwegian and international governments to get together and protect the global food production and work together to decrease dependency on Russia.”
Operating in Russia
The Russian economy itself has become a source of concern in recent days amid the sanctions imposed on the country.
A tranche of measures the EU and the US announced over the weekend – including a move to cut off selected Russian banks from the SWIFT international messaging system – saw the value of the rouble collapse on Monday and Russia’s central bank double its key interest rate to 20%. As well as being home to some of the largest food manufacturers and retailers in the region, a number of multinational suppliers have significant operations in the country.
There is, at the moment, a hesitancy among manufacturers to comment on the situation. “We can’t provide a comment at this point in time as the situation can change fast,” a Nestlé spokesperson says. Their counterpart at Danone adds: “Anything forward-looking or regarding potential impacts, it’s too early to say.”
The collapse of the rouble looks likely to herald a period of inflation, even if Russia’s central bank sought to draw the sting with its bank rate rise. The rate increase may itself put pressure on consumer spending.
“I suspect that, in the short to medium term, there’s going to be some reduction in demand,” Searle suggests. “Most [international] consumer products companies serve the more middle-class consumer base, which has been expanding. [Those consumers] won’t personally be hit by the sanctions but the inflation is going to impact their standard of living significantly.”
Oleksandr Volik, a Ukraine-based project manager at Civitta, an Estonia-headquartered consultancy focused on markets in eastern Europe, says the pressure from the sanctions on Russia “has reached unprecedented levels” and will impact food manufacturers operating in the country in three ways.
“First, general consumer spending of ordinary Russians is likely to decrease enormously, forcing consumers to limit their consumption or downgrade to value price segment,” he tells Just Food. “Second, SWIFT sanctions will complicate payments disrupting export-import contracts, including in existing value chains. Yes, currently only some selected banks are expected to be cut from SWIFT. However, given the growing escalation from Russia, there are high chances the EU can move with a full-scale ban in the nearest future. Thirdly, there will be logistics issues. Maersk is already limiting its operations in Russia. Many countries are discussing the closure of ports for Russia.”
Volik argues some foreign companies will start to withdraw from Russia. At the time of writing, BP and Shell have said they will divest assets in Russia, while dairy giant Fonterra and UK car maker Jaguar Land Rover have reportedly paused sales to the country.
“Foreign companies should limit their exposure and start withdrawing from the country, divest from their local assets,” Volik argues. “Big brands might get very large reputation costs if they continue to do business as usual. Obviously, for some producers this will be a hard move to do but, long-term, we can already see Russia transforming into a pariah nation.”
Earlier today, Russia’s Prime Minister, Mikhail Mishustin, announced Moscow would temporarily stop foreign investors selling their assets in the country. “In order to give business a chance to make a considered decision, a presidential order was prepared to impose temporary curbs on exit from Russian assets,” Mishustin was widely reported to have said.
International food manufacturers will be considering their positions carefully, especially given the uncertainty and volatility of the situation in the region.
“Will we see a Russian consumer backlash versus foreign consumer brands? There could be,” Rabobank’s Filott suggests. “If this crisis really extends further, will the Russians, with all the sanctions, decide to nationalise all foreign assets? I can’t fathom how bad this potentially could be.”
For now, against the backdrop of sanctions and uncertainty over whether more are on the horizon, non-Russian food manufacturers will be focusing on ensuring their local businesses can fund themselves, Searle at AlixPartners argues.
“In terms of kind of cash funding, if I was one of those firms, I would not want to be in a position of putting more cash into the country. I’m not quite sure how you do it but, if you put it in now, you’re not likely to be able to get it out again,” he explains.
“You could see it throttling back on the investments they’re going to make. To be honest, they’re probably putting all that capex on hold but it’s going to mean they’re not going to get as much growth out of those markets as they would have thought.”
Russia’s investment in food production
Russia’s annexation of Crimea in 2014 led to tit-for-tat sanctions between Moscow and Western capitals, which included the Kremlin banning a range of foods from markets including the EU and the US. A shock to Russia’s food supply, the country has spent eight years becoming more self-sufficient in production, Alexander Sinyanskiy, a food industry consultant in the country, explains.
“After the situation with the Crimea in 2014 and the sanctions against Russia, the ‘import substitution’ programme was launched in Russia. All Russian companies, and especially food companies, had to reorient their food production to Russian raw materials and ingredients,” Sinyanskiy says.
“As a result, in eight years, Russia was able to replace all foreign food banned by sanctions. Of course, these Russian foods are not yet as high quality as foreign ones but these products are available in Russia and every Russian who wants can buy without problems. No matter how strange it may sound now, it is food manufacturers that will now be in the most ‘protected’ situation in Russia.”
Sinyanskiy concedes the fall in the value of the rouble will affect manufacturers using raw materials from outside Russia but he plays down the possible impact the sanctions could have on food companies.
“Food manufacturers in Russia have been operating in crisis mode for eight years now. Therefore, the new sanctions for the food industry in Russia practically do not change anything in everyday life,” Sinyanskiy insists.
“As for the banking system, there are more than 300 banks in Russia, and the fact that about nine banks now fall under new sanctions does not change anything in Russia and in the Russian food industry.”
He adds: “As for transnational food companies, I can say companies such as Nestlé, Danone, Mondelez International and Mars have long since localised their food businesses in Russia. They have their Russian legal entities, their factories. These companies use Russian food raw materials, Russian labour and cheap Russian energy resources. Therefore, these multinational companies are maximally protected in Russia by the laws of Russia. The sanctions will not affect the work of these companies in Russia, since for many years, these companies have not exported anything to Russia but have been producing their food in Russia.
“So far, the main problem is seen only in the exchange rate of the rouble, which has so far fallen by 25%. Food companies who use exclusive foreign food raw materials will simply be forced to raise prices.” Consumers, he notes, have “had two years to get used to strong inflation and rising food prices” during the Covid-19 pandemic, even if he concedes that did hit sales of “premium foods”.
Sinyanskiy also points to the role of inputs coming in from China. “The basis of the food industry is the price of raw materials, ingredients, packaging, wages, energy resources. The price of gas and electricity in Russia hardly changes and is not very expensive, the average salary of workers in Russia is RUB35,000 per month. The main ingredients for the food industry are supplied by China,” he says. “For eight years, all Russian companies that produce packaging for the food industry have refocused on paint and packaging from China.”
Overall, while Sinyanskiy acknowledges some overseas players may want to leave the Russian market, he argues for calm. “I would like to advise foreign food companies currently operating in Russia to just wait until the emotions and the storm subside and then it will be clear what to do,” he says. “To make strategic business decisions, you need to be calm.”
The issue of supply-chain resilience
There will, however, be concern in business circles about the size and scope of the impact the war in Ukraine could have on the industry. “Even if the invasion ended next week, prices would come off but there’s still going to be a lot of speculation, a lot of wanting to pay higher prices to secure supply and an awful lot of uncertainty,” Searle says.
“I think longer-term it’s going to be another driver towards how you have a supply chain that’s more robust, agile, multi-sourced, potentially more kind of compartmentalised, to accommodate some of these disruptions.”
How to make supply chains more resilient is a topic food industry boardrooms have been grappling with in recent years amid regional issues like Brexit but also the longer-term challenge of making their operations more environmentally sustainable. Covid-19 also brought these questions into sharp focus but made it difficult to spend much time grasping the nettle and starting the complex work to reshape supply chains. It was hoped a window was emerging but, even if the Ukraine crisis has again brought short-term issues to the fore, it has underlined the importance of trying to make supply chains more robust.
That’s not to say food manufacturers necessarily know how to do so. “We’ve been in a relatively calm, steady-state environment for 20 years, 30 years, 40 years – low inflation, increased globalisation. Organisations have gotten used to running like that and you could argue they have scaled back procurement, supply chain organisations to be for the running of the business in that steady-state,” Searle offers.
“And so, when it comes to disruptions like this, they just don’t have the muscles or the muscle memory to know how to act in inflationary environments or how to deal with these changes.”
The combination of short- and long-term challenges, from wars to sustainability, has made supply chains more a priority for manufacturers, Filott says, suggesting three principal factors.
“There was, already happening, let’s call it Covid-related inflation and a rethinking of supply chains because of some products not being available,” he says.
“Then, some companies were already thinking about what geopolitical changes might mean and whether regionalisation is on the agenda. I had a few chats with companies on that last year, without even knowing that Russia would invade Ukraine. You do see geopolitical components shifting and regionalisation. There are blocs appearing around the world. We’ve seen de-globalisation, so companies needed to prepare for that. And then the third element is the reduction of Scope 3 emissions.”
Lifting his hand, Filott adds: “Supply chains have moved from here to there on the corporate strategy agenda. This is the key theme for the next couple of years.”