After years of cheap food, prices are on the up. Staples such as bread, milk and cheese are all climbing and the rising cost of living has been making headlines.
The fear is that the golden age of low-cost food is coming to an end. Last week, the Office for National Statistics reported the Consumer Price Index showed food price inflation jumped to 5.9 per cent year on year in December. Along with April 2007 it was the highest recorded rise since 2001.
So just what is the true state of food price inflation in the UK grocery sector? What is causing it and what effect will sustained food price inflation have on the wider retail industry?
International food and grocery organisation IGD believes that higher food price inflation is here to stay. IGD chief economist James Walton says: “We expect an extended period of elevated food price inflation for the foreseeable future, but from a low base.”
The seeds of the present high level of inflation were sowed in the autumn. At that time, a global concoction of rocketing commodity prices, soaring oil prices that hit the supply chain, rampant demand for corn-based biofuel and continuing strong demand for food from developing countries, including India and China, started to hit home.
Compounding these factors were a series of awful harvests stretching from Australia to the UK, which had its wettest summer on record, as well as diseases affecting livestock, such as bluetongue in the UK.
Waitrose managing director Mark Price says: “There is no doubt that those categories that have been affected by global conditions have gone up.”
While Waitrose’s food price inflation is running at about 2.5 per cent, Price emphasises that there have been “massive fluctuations” in prices. “Dairy is running at about 20 per cent and 30 per cent higher than last year, particularly on milk and cheese,” he says. “This is the cost of food prices working through the chain.”
Iceland managing director Andy Pritchard agrees. “It is anything to do with grain, such as protein, cheese, milk and meat,” he says. “There has been inflation in food for the past 12 months, but it has increased over the past six months and everyone is fighting to minimise its impact. In our supplier business, the price pressure is about 3 to 4 per cent.”
Price says that Waitrose, whose own farms serve both its stores and other retailers, received£135 a tonne for its harvest in the autumn, compared with£70 a tonne the previous year.
According to online grocery price comparison web site Mysupermarket.co.uk, the price of 24 staple products sold by Asda, Tesco and Sainsbury’s was up 12 per cent in January compared with the same month in 2007. But, while the price of a white loaf, free range eggs, English mild cheddar, oil and fusilli pasta have increased substantially over the past 12 months, certain products such as baked beans and the price of some own-label tea have flatlined or fallen.
Under control?
While the big UK grocers accept price inflation on certain categories, they vigorously deny it is spiralling upwards. Tesco corporate and legal affairs director Lucy Neville-Rolfe says the grocery giant’s inflation, including food and non-food, is just more than 1 per cent.
Although it is likely that substantial price deflation in non-food, particularly electricals, will help the big grocers keep a lid on overall price inflation, Neville-Rolfe insists this is far too simplistic an argument.
Sainsbury’s chief executive Justin King says that the grocer’s non-food deflation is running at between 8 and 10 per cent.
To combat food price inflation, retailers have various tricks up their sleeves so that they can avoid passing price rises to consumers. “That is the choice: do you pass it on or do you try and absorb it?” says Price. To avoid passing on rises to customers, grocers can drive further costs out of their supply chain and store operations, reduce prices on other products or de-spec – in other words, reduce the expensive elements of products, such as the amount of meat or fish in a pie.
Price says: “There is no way we are going to de-spec our products. If the product costs more that is what we will follow.” Other grocers, he claims, are more willing to de-spec.
Asda retail director Andy Clarke says that his company will balance out costs. “Although some commodity items are rising in cost, we are able to lower the prices of other items to ensure that [the cost of] our customers’ shopping baskets does not increase,” he explains.
The big grocers have more scope to drive cost efficiencies from their operations to keep a lid on rising food prices. “Every year, we have a programme of what we call step change, where we work to increase efficiencies, such as less time [for customers] at checkouts. We use those savings for price campaigns,” says Neville-Rolfe.
Walton believes that higher food price inflation will force grocers to step up their sustainability and environmental programmes. “We are seeing really strong pressures for grocers to reduce things like road miles from their transport fleets or the performance of their refrigeration units. Those things will move from being nice-to-have initiatives to must-haves,” he explains.
Clarke says: “We will absorb some inflationary pressures by being an even greener business. For example, by reducing our packaging on food and non-food items over the next 12 months, we’ll save in the region of£10 million – all of which will be ploughed back into lowering prices.”
In addition to cost-saving initiatives, a market characterised by higher food price inflation will favour big grocers that have deep enough pockets to take a short-term hit on their margins and enough muscle to persuade suppliers to shoulder more of the burden.
Planet Retail global research director Bryan Roberts says grocers with a well-established own-label business are also likely to emerge victorious. This is because many customers during straitened times shift their spending from branded products, which are typically more expensive, to own-label value lines. “Any retailer that has a value line may consider making a substantial migration from branded to those lines,” says Roberts.
At Spar, customers have led that trend. Managing director Jerry Marwood says that sales of the convenience retailer’s Saver value range are growing at twice the rate of some of its other own-label brands.
Turning the screws on suppliers
If higher food price inflation continues as forecast, suppliers should expect tougher negotiations with their suppliers. Asked what he can do to combat food inflation, Pritchard says: “First of all, we fight with suppliers to take costs out of the business.”
Certainly, most retailers believe food price inflation is more likely to go up than down this year. “The risk is that it will increase, not go down,” says Pritchard.
Neville-Rolfe is keen to emphasise that the inflation affecting the UK grocery sector is a global phenomenon and that this year is unlikely to deliver the same convergence of events and global price pressures that occurred in the autumn. “We had a lot of special factors last year that I am not sure will be repeated,” she says.
But, according to Walton, the grocery industry and consumers globally will probably have to get used to living with higher food price inflation. “We are seeing a fundamental shift within the food market – not just in the UK, but worldwide. This is a global phenomenon,” he says. “We are not talking about a blip or a spike. It is a much greater change than we have seen for many years.”
While grocers and their suppliers face a tough year ahead, their fortunes are likely to compare favourably to non-food retailers – particularly those selling big-ticket items. “I think I would be more worried if I was an electricals retailer,” says Roberts.
Capital Economics UK economist Vicky Redwood agrees that if the price of food, which is a non-discretionary purchase, continues to rise, there will be less for consumers to spend in other high street stores at a time when they are also being squeezed by rising petrol, energy and council tax bills. House prices also seem poised to stagnate this year.
“We think continued price inflation will mean there is less left over to spend on other areas of the high street. We would expect it to affect discretionary spend on clothes and other non-food items,” says Redwood.
So far, grocers have been able to absorb many of the rises in food price inflation, partly because of fierce competition in the sector and the strength of the pound, which helps UK buyers purchasing dollar-denominated commodities.
However, Walton believes that absorption cannot be sustained and that higher food price inflation for customers is here to stay. “The supermarkets are absolutely loath to initiate price increases, but in times when you have pricing coming down the supply [chain], that will inevitably be passed on to consumers,” he says.
Higher food prices will have big ramifications for the grocers, but it looks likely that its impact will be felt more acutely by non-food retailers this year.
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