Food retailers experienced better profit margins in June as they passed along price increases to customers while their costs from suppliers dropped.
This relief marked a welcome change from recent years, when their ability to pass along rising food costs met stiff resistance from consumers.
The shift has come at a good time for food retailers, allowing them to offset some of the increased costs associated with the pandemic like increased sanitation and reorganizing layouts. Yet the favorable current price environment for retailers may only be temporary.
Producer prices soften
Food producer prices were on the rise even before the pandemic because of rising wages and increased cost of getting the food from those who make it to those who buy it.
The significant decrease in food producer prices can largely be attributed to falling meat prices.
When the pandemic set in, these costs of logistics initially increased as the virus shut down production plants, disrupted supply chains and forced companies to invest in new equipment for personal protection and sanitation. This was especially the case in meat-packing plants.
But then as companies adapted, producer prices fell 1.5% and 4.4% in May and June after jumping to 2.6% in April. The decrease can largely be attributed to falling meat prices, which fell 43% in June.
Consumer behavior also helped many national packaged food companies reduce costs through efficiencies. As grocery customers have embraced online shopping, delivery and in-store pickup, they have retreated to the flavors, brands and categories they are most familiar with. Food companies have in turn reduced their offerings and focused on the products they could sell and replenish most efficiently.
Consumers keep prices high
Just as producers adapted to the pandemic, consumers changed as well. Shoppers accustomed to a wide variety of choice in the supermarket aisle suddenly faced shortages in wide ranges of grocery staples.
As selection become limited during the early days of the pandemic, consumers paid higher prices.
With limited selections, consumers were forced to purchase products regardless of price in many cases. Additionally, as consumers made more online purchases, some grocers made only high-margin items available through their websites.
At the same time, food companies also pulled back on promotions like coupons and in-store discounts, which further drove up basket prices. Grocers followed suit by scaling back their own trade promotions.
All of these factors allowed grocers to pass along price increases from producers as they rose in March and April — as evidenced by 0.7% and 1.0% increases in the Consumer Price Index for food-at-home prices in May and June.
Unlikely to last
While these factors should lead to overall margin improvements for grocers in the short-term, the following headwinds suggest that these favorable conditions may only be temporary:
- Coronavirus cases continue to rise. The biggest increases are taking place in areas most important to the produce and agriculture sector, including California, Texas and Mexico. Farms in these areas are dependent on migrant workers who often live in close quarters. These conditions make workers particularly vulnerable to the virus. An outbreak among farm workers could result in wasted produce and empty shelves, mirroring the meat shortages experienced in May.
- Sanitation costs will remain high. Stores have improved their cleaning practices to protect employees and make customers feel safe. But it does carry costs, and is likely to remain long after the pandemic eases. Moreover, regional and national grocers will have to deal with policies that vary from city to city and state to state.
- Warehousing costs have been moderated. Although the costs of logistics have fallen, it’s unlikely that will hold true over the course of the summer, especially as fuel prices rise. According to DAT Freight and Analytics, the seven-day moving average spot rate for dry van and refrigerated truckload surged during the week ended July 5.
- Consumer behavior will be unpredictable. While food-at-home demand has been strong, understanding consumer preferences will remain a challenge. For example, as consumers embraced bread baking while sheltering in place, retailers and producers of baking products were slow to adapt.
- Will consumer confidence return? This is perhaps the biggest uncertainty of all. Grocers’ ability to pass along price increases has been contingent on consumers’ willingness to pay those prices. Rising consumer confidence at the tail end of the second quarter has showed signs of erosion in July, and government programs designed to encourage consumption such as extra federal unemployment benefits and the Paycheck Protection Program are set to expire mid-summer, which could leave consumers trying to stretch their grocery budgets further.
How to respond?
Investments in innovation and technology can help grocers navigate a changing landscape and maximize consumer experiences. Consider these approaches:
Invest in private label brands. The growth of private label products has outpaced that of national brands for the past three years, according to IRI Data compiled by Bloomberg. Whether online or in store, grocers will have more leverage to position these brands for consumer adoption especially as national brands shrink marketing and promotion budgets.
Embrace business intelligence technology. Greater innovation in the supply chain will minimize instances where high demand products are out of stock. Grocers should leverage real-time data for decision-making at the store level and that will allow them to communicate and collaborate with suppliers to ensure reduced instances of customer frustration and improved flexibility.
Keep developing online channels. Despite consumers doing less online grocery shopping than at the height of the pandemic, retailers shouldn’t ignore the channel. Rolling COVID-19 localized outbreaks could persist. Investing in strong omni-channel capabilities will allow grocers to meet the needs of their customers as situations change.
Adopt automated solutions. Automating tasks in warehouses protects against the risk of outbreaks and counters rising wages. It also provides scalable capabilities as channel mix changes to consumer behaviors.
For more information on how the coronavirus is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.