A year ago, when the cost of commodities such as wheat, oil, and corn was soaring, grocers grudgingly accepted price increases from Kellogg (K), General Mills (GIS), H.J. Heinz, (HNZ) and other food manufacturers. The strange thing is, those price tags never came back down, even when commodity prices collapsed in the fourth quarter of 2008. As a result, grocers have little cheer to offer their shoppers at a time of deepening economic gloom. "The prices don't seem to go down as fast as they go up," says Jeffrey Noddle, CEO of Minneapolis-based Supervalu, one of the nation's leading grocers.
Now, the grocers are demanding action. On Jan. 7, Noddle told analysts to expect a "battleground" over the next six months as he pressures manufacturers to adjust their prices. And if they refuse? "In almost every category," notes Noddle, "you have other vendors to look to."
The food companies recognize that increases in the price of food outpaced commodity inflation during the fourth quarter last year, which should have resulted in higher profits. However, they argue, previous price hikes didn't completely cover escalating production and commodity costs. That's why, in January, Kellogg raised its prices on Frosted Flakes, Cocoa Krispies, and most of its other cereal brands. Commodity prices "are still well above historical averages," says a spokesperson for the company.
What's more, many foodmakers are stuck in purchasing contracts that locked in record-high commodity prices from several months ago. Kraft Foods (KFT) estimates production costs soared 13% in 2008 compared with the previous year. And many food companies simply don't want to lower prices with so much uncertainty ahead. A Heinz spokesperson says he doesn't anticipate many more price hikes, "but it will depend on what commodities do in 2009."
Struggling retailers don't want to wait. With commodity prices still falling, Safeway (SWY), a 1,700-store chain based in Pleasanton, Calif., says it will "encourage" its vendor partners to help pass savings along to shoppers. One way to do that is to increase the use of private-label or "store-brand" goods, which are cheaper than national brands and offer grocers higher profit margins. Nationwide, such goods grew 10% last year, according to market watcher Nielsen. To stoke customer interest, Weis Markets (WMK) of Sunbury, Pa., and upscale Wegmans of Rochester, N.Y., recently trimmed prices on a number of store-brand products. If big food manufacturers feel pinched as a result, "maybe they'll be more willing to reduce list prices," says Wegmans CEO Danny Wegman.
Private labels, used as levers, probably aren't powerful enough to pry sweeping adjustments from the manufacturers. But analysts say they're already seeing an increase in so-called promotional dollars, or money that vendors give to retailers to subsidize temporary discounts like two-for-one offers. Those discounts can blunt price hikes, but grocers much prefer more lasting price cuts.
The one thing that's guaranteed to do the trick is a continuing crash in commodities. Eventually "someone will break with the pack" and lower food prices, says BB&T analyst Andrew Wolf. With pressure building from consumers and retailers, the price disparity can't continue, says Supervalu's Noddle. If prices go up, "We want to understand why."