Decades-high inflation rates in the western world are likely to get worse before they peak, presenting operational challenges right across the supply chain.

Inputs have gone up so much that some industry executives and managers have never faced such a taxing environment during their working lives, and the era of cheap money is coming to an end as central banks raise borrowing costs to temper price increases. Unilever has put the cost of inflation at EUR3.5bn (US$4bn), while US-based manufacturer Hain Celestial estimates the pricing effect at $100m.

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Retailers, manufacturers, ingredients suppliers, packaging makers and logistics providers are all feeling the pinch from higher commodity, energy, fuel and labour costs.

At ground level, farmers are arguably reaping the benefits from elevated commodity prices, though, of course, they will be facing similar hikes in areas like labour and energy and growers face uncertainties from climate change and unpredictable weather. Rising fertiliser prices don’t help either.

Input-cost inflation has dominated food manufacturers’ earnings headlines for months and is a topic likely to feature highly through 2022 and perhaps into next year, particularly as industries grapple with pent-up consumer demand as the world gradually comes out of the pandemic and freedoms return. That same demand, and the machinations around Covid-19, have led to across-the-board supply chain constraints, while labour shortages pressure wage inflation.

Andy Searle, a managing director and partner at consultants AlixPartners, says there are unlikely to be “any winners”. Nevertheless, it’s arguably the larger, branded, food manufacturers that have an advantage, with the firepower and scale to pressure retailers to accept pass-through costs – and the ability to trim costs in areas such as marketing, an option those in private label don’t have. Branded companies, based on recent earnings reports, have so far managed to pass on costs to retailers, and with more in the pipeline.

Searle says discussions between food retailers and manufacturers are intense. “Historically, the conversation was, I’m going to take price but I’m going to give you innovation. Or I’m going to give you a lower price and you’re going to give me more shelf space and I’m going to grow and I can reduce the margins. Now, it’s a very difficult conversation to have.

“Big food has a much better position to take price. I think it is on a category-by-category basis how successful they will be.”

Consumer behaviour

Ultimately, it’s the consumer taking the brunt, and with interest rates, at least in the UK, the US and Canada, going up or about to go up, the cost to service mortgages and debt increases. Food-wise, the smaller, niche and artisanal manufacturers tend to price at a premium and have less leverage – and have less scale benefits when it comes to cost.

Nevertheless, thinking about the UK, Shore Capital director and sector analyst Clive Black suggests household finances shouldn’t be underestimated, arguing many remain robust due to restrictions on eating-out during lockdowns and fewer people taking holidays or going to entertainment venues.

Analysts agree the effect of inflation on household spending will vary depending on budgets and disposable incomes and won’t necessarily lead to a flight to retailer discounted own-label, at least not immediately.

Speaking in the context of the 2007-08 financial crisis, which led the world into a recession, Black says: “First of all, folks reduce their volumes. They go basket shopping rather than trolley shopping.

“Secondly, they down trade from chilled and fresh into ambient and frozen. Thirdly, they go from proprietary brands into private label, and fourthly, they go from premium private label into entry-price private label.

“For some households, it will still be ‘we buy what we want, we’re not price-sensitive.’ For other households, it will be ‘no I’m sorry, we can’t afford that.’”

Cyrille Filott, a strategist at Dutch lender Rabobank, says the trickle-down starts with cutting out restaurants, at least in countries were Covid-19 permits, suggesting private label won’t become prominent at least for the next few months.

And even if it does, retailers may push for better terms. “What I’m not sure about is what the margin structure will look like, whether these private-label suppliers will get the same margins as before,” he says.

Own label hasn’t seen the same boost to growth in shopping baskets during the pandemic as brands – as evidenced in recent reporting from TreeHouse Foods and Hain Celestial – a reflection of the cash-on-hand from mobility restrictions, and the consumer preference for familiar branded goods.

But, as purse strings tighten, “something has to give and something will give”, Filott suggests.

Inflation currently stands at 5.4% in the UK, a level not seen since 1992, with bread, cereals, meat and vegetables leading a 4.2% increase in the food components, the higher since 2013. In the US, the latest headline rate is 7.5%, the most since 1982, with food inflation at 7%.

Filott adds: “What usually happens in times of recession, and this is not technically a recession but it is something you can benchmark for, is firstly trading down from expensive foodservice to cheaper foodservice, then into quick-service restaurants.

“Then it spills over into food retail, so you might see premium products still doing well because people are not going out. Then that goes slowly into other categories, moving into more value items, and that is private label.”

The impact on conventional – and plant – protein

In other categories, Sylvain Charlebois, a professor in food distribution and policy at the Faculties of Management and Agriculture at Dalhousie University in the Canadian city of Halifax, and John Baumgartner, a managing director and US grocery industry analyst at Mizuho Securities, say beef may suffer.

“Beef may well be under pressure as a premium product, so we are expecting consumers to go for the other two components of the meat trifecta, chicken and pork,” Charlebois says.

Baumgartner says consumers will switch from buying steaks to minced beef or other cheaper cuts and, in other areas of the store, might accept they have to pay higher prices on favourite items with less money to spend on middle-store products like peanut butter and jams, for instance.

“I think the one real uncertainty is what you see consumers doing,” Baumgartner contends. “They have two options, either continue to buy the perimeter of the store – your fresh produce, your meat, your dairy – and have less money left over for the centre-store products, the cereal, the pasta.

“Or you see consumers start to reduce their spending in the perimeter in order to save those dollars for the centre of the store.”

Charlebois suggests the exorbitant prices for dairy in Canada might accelerate the trend into dairy-free, noting supply constraints have pushed up liquid milk prices by 8.4% and butter by 12.4%, “almost double the previous record over 50 years”, he says.

“The non-dairy offering has actually improved immensely in the last few years and prices are actually becoming more competitive. So, at some point, you just need to give another excuse to consumers to walk away from the dairy section and go to towards alternatives,” Charlebois adds.

On the other side of the fence, Filott suggests meat-substitute manufacturers are willing to sacrifice margin to stay on-shelf in a highly competitive and growing category.

“When you look at the prices of the main ingredients like soy or peas – pea prices have been skyrocketing – or the plastics and the transportation, they may take a margin hit just to secure shelf space.”

Capex plans

And it’s becoming a cut-throat environment for food suppliers in the battle with retailers to take price. If you are operating in a country with only five major retailers and you are delisted from one, you potentially lose 20% of your revenues or volumes. As Filott says: “You’re not going to go out of business but it is truly painful.”

Food manufacturers, however, face a quandary. During Covid-19, more people shopped at retailers amid stay-at-home restrictions and many industry watchers and manufacturers expect people to eat at home more often beyond the pandemic. And the demand has been amplified by hybrid working.

Manufacturers have struggled to keep up and, in many cases, have turned to capital expenditures to boost capacity. But rising prices, largely based on supply constraints, have pushed up equipment costs, while higher interest rates drive up the cost of borrowing to fund new plants.

In the meantime, wage inflation on the back of persistent and widespread labour shortages threatens to increase costs for the manufacturer and prices for the end consumer.

Baumgartner argues: “You see a number of companies looking at this as an opportunity to introduce automation. If you’re going to have absenteeism on the lines and labour tightness, does this now justify increasing the capex budget and automating?”

Or, he says, manufacturers could choose to absorb “volatility on a short-term basis”, muddle through, and then “look to automate functions and have longer-term cost savings”.

Black adds: “Automation, digitisation and robotics will undoubtedly become more important, particularly in the UK, although such investment is “a five-year programme”. He continues: “Another area of inflation is process engineering but, if you want to buy kit for a food factory, join the back of the queue, it’s going to take two or three years until you can get the stuff.”

Just-in-time

Baumgartner presents other alternatives to manufacturers raising prices – promotions and advertising – although each comes with challenges.

“You’re not going to make wholesale changes to your organisation because of input-cost inflation as you’re passing the pricing through. I don’t think they’re going to go the distance to do massive layoffs because the view is that inflation should be temporary, even if it’s 12 or 18 months.”

He continues: “They’re not spending money on promotions because if you spend money on promotion, it drives an increase in demand. But you can’t meet that demand because you don’t have the supply. In some cases, advertising spending is down as well [and] advertising drives more demand.”

Charlebois adds artificial intelligence to the equation in terms of processors in Canada. “What I’m hearing right now our salaries are going up by anywhere between 25% to 30% over the next four years. That will come at a cost – to reward human capital they have but also invest further into automation and robotics.”

Searle at AlixPartners says supply issues have exposed the fragility of the “just-in-time” systems food manufacturers and suppliers are accustomed to. And he’s not the first analyst to suggest the bout of inflation we are experiencing is a new phenomenon for many managers in the sector.

“When I talk to big firms, dealing with inflation is kind of a muscle they’ve lost. It requires more flexibility and agility,” he says.

Black takes the issue up a step with respect to the UK, a viewpoint that could be extrapolated to other western markets.

“We probably don’t pay enough for our food. If we want sustainable supply chains, if we want friendly animals, if we want better waistlines and all the rest of it, Britain doesn’t pay enough for its food. And that’s going to be a feature of the next decade. We will be paying more for our food to meet all these challenges,” Black says.

Searle puts forward a proposition similar to hedging – “really think about your cash and inventory”. He explains: “You could argue that the future value of cash goes down as interest rates go up, as inflation goes up.

“All of the work that’s been done to move to vendor-managed infantries, just-in-time, thinning out the supply chains, means that if you’ve got a lot of cash, you could really deploy it by buying early, getting cover, holding onto stock that’s going to accrete in value.”

At the farm gate, cultivators and animal rearers are trying to push input costs back up the supply chain only to be met with resistance and pressure from the retailer to manufacturer.

But farmers face the same inflationary challenges and other difficult decisions, too. While Black says there are benefits to be had from high wheat prices in the UK, growers could then shun soya and maize, for instance, in search of better returns.

He says the stock-to-use ratios of soya and maize, are “relatively low” but not yet “worrying”. But he warns: “If we had a shock to the system, this summer in the Northern Hemisphere, we would absolutely have another bout of commodity-driven inflation in the food system.”

There’s also a global shortage of fertilisers, which could impact crop yields during the summer, particularly if there’s a “bad weather event”, according to Baumgartner.

He says farmers are selling off herds to benefit from higher beef prices, which could put further pressure on dairy. It could take four to five years to rebuild cattle stocks, all factors that could lead to “lag inflationary issues even into 2023 and beyond”.

Searle concludes: “It means that 2022 could be where all of the Black Swans come home. We’ve got the underlying inflation, scarcity, we’ve got really high shipping costs, we’ve got issues with climate and harvests, and we’ve got fertiliser costs going up. It’s not a very positive picture.”

For more coverage across our publishing network of the issues created by the supply chain crisis, read the following: