Those manufacturing businesses which have operated in the UK food industry for a decent length of time will have been through a number of economic cycles. And while that should stand them in good stead when assessing how to handle the down periods before the next inevitable upturn, even the most optimistic of them will be anticipating 2023 with hope rather than expectation.
After a year of ingredient shortages, labour issues, rampant inflation and arm-wrestles with retailers over pricing actions, it would be nice to think things would ease off a bit as we enter a new year, but analysts suggest there is some way to go yet before anything resembling a broad sunlit upland is spied.
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The war in Ukraine is still the great unknown. While the human factor on the ground there is the most important thing of course, in our own area of specific interest Russia’s invasion last February had a marked impact on the food industry in the UK – as elsewhere – with shortages of ingredients such as wheat and sunflower oil resulting from a blockade of Ukraine’s Black Sea ports. Meanwhile, the world’s opposition to Moscow’s action contributed to soaring energy prices, which hit manufacturers and consumers.
Inflation on household essentials
As we don’t know how things will play out in this conflict, all manufacturers can do is seek alternative sources of supply where they can and try to manage high bills as best they are able.
Whether they will be able to continue to pass the additional costs on to retailers and ultimately consumers in 2023 is a key issue.
Consumers are facing a financial crisis of their own with inflation on household essentials, sky-high energy bills and wage increases few and far between.
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By GlobalDataUK food inflation hit a 45-year high in November. Prices for food and non-alcoholic beverages rose 16.5% in the 12 months through November, a sixteenth straight month of increases.
When it comes to household budgets, something has to give, choices have to be made.
This is the environment in which manufacturers in the UK food industry will be operating in the next 12 months.
Sector analysts and market watchers expect things to remain difficult at the macro level for much of 2023.
Siobhan Gehin, senior partner for the retail and consumer sectors at consultancy firm Roland Berger, says: “Inflation might have peaked but it will remain high in 2023. Householders are under pressure.”
Veteran industry analyst Clive Black, director and head of research at Shore Capital, takes a similar view.
“The first half of next year could be particularly challenging,” he says.
Wage concerns
And Robert Lawson, managing partner at sector consultancy Food Strategy Associates and a former executive at food firms including United Biscuits, Premier Foods and Quorn, also points to macro concerns.
He says: “We will still have inflation for much of next year and that will be top of mind, as will wage levels and keeping things on track with trade unions.”
Black also has an eye on salaries. “Labour costs are going to go up again in April when the national living wage goes up by 10%. That will impact on the major processors,” he says.
But there is a feeling among analysts some of the macro issues could ease as we go through 2023.
Black says: “With other operating costs, energy and fuel-related, we may see that easing comparatively from the spring.
“And cost of goods and raw material should be easier in 2023 than in 2022.
“Inflation is the key metric. Expect it to ease in 2023. It should start to stabilise and could lighten the mood of shoppers as the year progresses.”
The mood of shoppers is crucial of course.
Lawson points out that “a lot of customers are going to be hit by affordability issues” and analysts are weighing up what this means for manufacturers of brands as cash-strapped consumers eye cheaper private-label alternatives and turn again to discount retailers such as Aldi and Lidl.
Gehin says: “Discounters are winning and there is a new surge in private-label partly because of the discounters but also the other retailers are changing their value credentials so it’s about good value and not just cheap.”
Consumer resistance
Black says: “We’ve seen a switch into private-label and that’s why proprietary brand manufacturers need to think about brand equity so as not to do brand damage, never mind losing volume [through price increases].
“We are starting to see consumer resistance to this [pricing actions] and supermarkets and enlightened manufacturers are concerned about consumers trading down.
“Proprietary brand manufacturers need to be careful of over-inflation. They could lose some shelf space if retailers prioritise private-label brands. We could see retailers flexing their muscles a bit.
“Brand owners need to think about the affordability of their products.
“Demand will marginally improve throughout the year but it’s not a reason to put up the bunting. You have rising interest rates to build in.”
When it comes to pricing actions in the UK food industry, Gehin sees a “real split”. She says: “Players who can afford to go into battle with grocers but they are having to make the trade-off between how hard they can push it before people go to private-label instead. That’s the key – how consumers respond.
“For the smaller brands, it is a double-whammy. They haven’t got the negotiating power [with retailers] and could also lose some SKUs [as grocers make more room for private-label].”
But Lawson at Food Strategy Associates can see more pricing initiatives taken by manufacturers.
“Consumers may have had enough but manufacturers will not supply at a loss. There will be more pricing but retailers will seek to resist it,” he says.
“It is tough times out there. Few players have margins enough to survive double-digit inflation.”
There is the question also of what manufacturers produce. Will they de-prioritise initiatives linked to health and sustainability if consumers are focused on price and will plant-based products, often more expensive than meat equivalents, similarly suffer?
Black says: “Things like animal welfare, sustainability, I sense it will be harder for them to gain traction in the way they could before as people focus on filling their trolleys for the least possible price.
“I do think that in the future animal welfare and sustainability will remain important but in the short term it may be a ‘nice to have’ because of slower market conditions.”
Pressure on plant-based
Gehin at Roland Berger agrees. “Consumers will be prioritising sustainability a bit less than pre-crisis and we are seeing a lot of companies and retailers asking how they can deliver on their sustainability agendas but not crater their P&L,” she says.
“Affordability is going to be the hard lens on top of our best intentions.”
And she sees a similar outlook for plant-based products.
“We will see a softening of vegan meat in the UK. Price will need to be addressed. Value for money is a big issue as is quality. Research suggests consumers are not convinced by a lot of it. Also, there is a long ingredients list in many cases and that’s quite off-putting for people,” she says. “Producers have to really think about it. People will be less willing to experiment.”
Lawson see plant-based products suffering for at least part of 2023.
“For many consumers, plant-based is a choice. Flexitarians can choose how much they flex and they may flex less because there is a lot of pressure on their wallets,” he says.
“But I think plant-based dairy and meat alternatives will come back strongly at the end of the year. It is a long-term trend and high growth and it will have good and bad years.”
UK food industry M&A
Analysts are divided on whether the tough market conditions will mean pressure on M&A activity in the UK food industry next year.
Black at Shore Capital says: “Rising interest rates will have some bearing here. Private-equity has been able to outbid trade because of the financial dynamics but interest rates going up changes things.
“I expect less M&A from financial [groups] but more from trade buyers as they have less financial competition. I do think that within silos we will see more trade M&A.”
Gehin says: “For sure, the cost of capital is higher but businesses that are struggling may still be picked up.”
Lawson points to “gaps in valuation” being important here.
“Buyers want to pay less but sellers are reluctant to move down to what the business is worth today compared to a few years ago,” he says.
“The private-equity side of the market has ground to a halt.
“But businesses are sold because they have to be sold – maybe they have run out of money or the founders are retiring.”
More generally, Gehin advises food manufacturers to go through their costs with “a fine tooth-comb”.
She says: “It is a time for retrenchment and back to basics with a focus on current products and underlying price dynamics and price analytics and having to drive value for at least the next six months.”
Black’s observation is similar. “A tighter focus on costs and cashflow is a feature of all industries in the UK at the moment, not just food,” he says.
Lawson said food businesses need to question whether they have the right distribution with the right retailer and the right pack formats for these times.
And he points to a fight for survival in some instances.
“Some businesses have been burning more than earning and won’t be able to survive. We will see a weeding out of businesses that don’t have the funds to sustain themselves and can’t get funding,” he says.
“There will be a lot of distress out there. I would expect to see a number of small businesses going bankrupt and maybe one or two big ones as well.”
SMEs can prove resilient
But Gehin’s fears for the future of smaller manufacturers in the UK food industry next year are not entirely shared by Theadora Alexander, co-founder of London-based small- and medium-sized enterprises (SMEs) network and consultancy Young Foodies and small brands ‘supermarket’ Mighty Small.
“I’m generally optimistic about next year, although I’m not under any illusions. It will be a challenging time in terms of costs and accessing capital,” she says.
“But not more challenging than this year and people have now planned for it and made adjustments.
“There will be casualties. A lot of businesses have been living on borrowed time since Covid but the high-quality propositions will succeed.”
But Alexander admits negotiations with retailers over price increases and shelf-space will continue to be difficult for many SMEs.
“It has been a real challenge this year with retailers withholding or delaying price negotiations while manufacturing plants have not,” she says.
“The slightly more progressive retailers realise there is no point doing that. It is lose-lose.
“Pricing comes down to category dynamics. The [SME manufacturer] prices tend to be higher as the companies’ products tend to be premium. It is up to retailers to test the category dynamics but if a medium-priced product goes up in price so does premium. The retailers won’t let the premium range be cheaper than the value range.”
Retaining shelf space has also been an issue for SMEs.
“Rationalisation is very visible but some {SME] businesses play a very valuable, accretive role in categories. What they are removing is where there is duplication but that tends to be the middle that is squeezed, not the premium,” Alexander says.
And she says that consumer sentiment towards the products of SME manufacturers remains robust.
“We’ve not seen any major shift yet. Client demand is remaining really buoyant. Obviously, everyone is watching it really closely but, for premium grocery, people will trade up,” she says.
“If consumers show a robustness to pay for premium now I feel quite optimistic, but that’s not to say that brands don’t need to be agile and to be focused on their P&L.”
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