Input-cost inflation already is outstripping the elevated projections that executives penciled in earlier this year. The worst is yet to come, they predict. Conagra CFO David Marberger said on the company’s fourth-quarter earnings call July 13 that the frozen-food specialist now expects costs to rise 9% in the fiscal year that started July 1, up from a forecast of 6% in April.
“This is an atypical level of inflation,” Conagra CEO Sean Connolly told Bloomberg. “It’s the highest inflation level our company has seen in as many years as we can remember.”
Higher costs have started to squeeze profit margins. Conagra said inflation contributed to a decline in quarterly gross profit, and Mondelēz flagged cost increases as a factor in declining operating income in its North American business.
The simplest response, of course, is price hikes. Theoretically, companies could just raise prices to offset higher costs.
Easier said than done. Consumers may balk at paying higher prices, turning instead to cheaper alternatives. In addition to potential consumer resistance, packaged food companies also have to consider possible pushback from the retail chains they sell to.
Another possible obstacle is slowing demand. Already, there are signs that consumers who stocked up on packaged foods during last year’s lockdowns are spending less on groceries as they venture out again. Conagra said its 10% decline in fourth-quarter organic sales was “driven by lapping the prior year’s significant surge in at-home food consumption at the onset of the COVID-19 pandemic.” Mondelēz’s quarterly organic revenue edged down less than 1% in North America, where the pandemic stock-up phenomenon was particularly pronounced.
To be sure, price hikes aren’t the only option for food companies when input costs rise. They can cut spending elsewhere to boost efficiency, fiddle with package sizes and hedge commodity costs in futures markets.
“(Pricing) is one tool in their arsenal to offset higher costs,” says analyst Erin Lash of Morningstar.
Packaged food companies are pulling most of those levers to one degree or another. Yet many are leaning hard on price hikes. Mondelēz CFO Luca Zaramella called pricing “a key contributor” to strong worldwide organic revenue growth of 6.2% in the second quarter. Conagra, meanwhile, predicts overall price increases of 3% to 4% this year.
Kraft Heinz, which reports second-quarter results next week, has yet to raise prices, CEO Miguel Patricio told Time magazine in June. But the maker of such grocery staples as Kraft cheese and Heinz ketchup is “studying” possible price hikes as costs rise, Patricio said. For now, he said, “We are very concerned, concerned but acting to mitigate the possibility of increasing prices through efficiencies.”
Raising prices is one thing. Making price hikes stick is another. It’s too early to say if the increases put through so far will hold, much less predict how much higher prices might rise.
The answer will vary from company to company and product to product, depending on pricing power. Lash says pricing power tends to be greater in packaged foods categories with fewer low-priced store brands, such as chocolate. Brand-name companies have less pricing power in commoditized categories where private label brands abound, such as dairy, meat and cheese. That suggests snack makers like Mondelēz have more pricing power than grocery staples suppliers like Kraft Heinz.
The real key to pricing power, Lash says, is pairing an increase with some kind of innovation that meets changing consumer preferences. For example, smaller packages might now appeal to consumers who are becoming more mobile, giving a food company leeway to charge more on a volume basis.
In the end, pricing power corresponds to perceptions of value. Consumers are more likely to accept higher prices for products they consider uniquely valuable.