Companies Reluctant to Hike Prices Despite Rising Costs

U.S. companies are reluctant to raise prices on their frugal customers, a trend that economists and investors warn could squeeze profits as many corporate costs rise.

According to the U.S. Producer Price Index data released Sept. 16, the cost of "crude materials"—inputs for the products made by U.S. companies—rose 2.7 percent from June to July and another 2.3 percent from July to August. The Dow Jones-UBS Commodity Index is up 12 percent since July 1.

Yet, despite higher costs, many executives say they can't raise prices. "We don't think it's prudent of us to plan on that in this environment," ConAgra Foods (CAG) Chief Executive Officer Gary Rodkin told analysts Sept. 21, as his company reported that inflation exceeded cost savings last quarter.

Airlines are cutting prices despite the higher fuel costs. Domestic airfares fell 2.1 percent from June to July and 1.8 percent from July to August, according to Air Transport Assn. data released Sept. 20. The cost of jet fuel is up 10.8 percent since July 1 in New York trading.

Regulation Impact

Commodity prices aren't the only worry for cost-conscious corporations. New government rules are pushing costs higher in certain industries, says David Chalupnik, head of equities at First American Funds. Federal legislation reforming the health-care and financial systems could push up prices in those sectors, he says.

Higher labor costs in China are raising the cost of apparel, technological devices, and other imported goods. JCPenney (JCP) Chairman and Chief Executive Officer Myron Ullman acknowledged those cost pressures at an investment conference Sept. 14. "As an industry, we're going to have difficulty passing on price increases to the consumer," he said.

With the U.S. unemployment rate at 9.6 percent in August and the important holiday retail season approaching, "it's those companies offering deals that will pull in consumers," Chalupnik says.

With costs jumping, some companies and industries are going through with price increases anyway.

Commodity Squeeze

Commodity costs at food producer Sara Lee Corp. (SLE) will rise 15 percent in the fiscal year that began in July, the company estimated while reporting earnings Aug. 12. As a result, C.J. Fraleigh, the head of North American retail and food service operations, told Bloomberg News that Sara Lee would raise prices in "a majority of our businesses."

Moody's Corp. (MCO), the credit ratings agency, may raise the fees it charges issuers in the "mid-single-digit range" to cover higher regulatory and compliance costs, according to Piper Jaffray (PJC) analyst Peter Appert, writing Sept. 20 after a meeting with top Moody's executives.

For companies that have seen raw material costs surge, price increases may be inevitable. Companies have been cutting costs and boosting productivity since 2007, says Michele Gambera, head of quantitative analysis at UBS Global Asset Management.

"How much more can they tighten the belt?" Gambera says. "I don't think there is a lot of fat to trim." Companies "have to sooner or later pass it on to the consumer or final user," he says.

Cooper Tire & Rubber Co. (CTB) plans to hike prices up to 6.5 percent starting in November, Bloomberg News reported Sept. 17. The company is reacting to a jump in the price of rubber, which is up 43 percent in the past year for rubber traded in Tokyo. According to Bloomberg News on Sept.22, Tyson Foods (TSN) spokesman Gary Mickelson said in an e-mail that the U.S.'s largest chicken processor may be "forced to raise our prices to offset the increase in input costs," especially the higher cost of corn. On Sept. 24, corn futures hit their highest level since Oct. 1, 2008.

Cautious Consumers

It remains to be seen how customers react to these price moves. Recent examples suggest it may be difficult to get consumers to open up their wallets any wider.

Wal-Mart Stores (WMT), the world's largest retailer, has cut prices on detergent, cereal, and other items, but the price-cutting hasn't produced the sales or traffic the company had expected, executives said last month. "Gas prices and unemployment continue to influence how our core customers shop," U.S. stores chief William Simon told analysts Aug. 17. "Customers are spending cautiously."

The movie industry has in effect raised prices by charging an extra $3 or more for tickets to 3D movies. The result, according to Box Office estimates released Aug. 30, has been 2.4 percent higher summer box-office revenue. However, attendance—the number of tickets actually purchased—fell 2.6 percent, to the lowest level since the summer of 1997.

Companies can only charge more if they offer a unique, higher-quality product, says Thomas Stemberg, the founder and former chief executive of Staples (SPLS) who is now managing general partner of Highland Consumer Fund in Lexington, Mass. "The consumer is very smart and in most products has figured out where they can get the best deal," Stemberg says.

Pricing Power

Brand names can provide companies pricing power. Kraft Foods (KFT) Chief Executive Officer Irene Rosenfeld told Bloomberg Television Sept. 16 her company's emphasis on its brand names is paying off. "We are finding we are able to price to reflect those [higher] input costs," Rosenfeld said. "Given the strength of our brands, we are able to get that pricing realized."

It's the sort of strategy that works only if you "have a brand that is really different," Stemberg says. So, it might work for Kraft Philadelphia Cream Cheese—"a truly differentiated product"—but not Kraft mayonnaise. Kraft can call its cream cheese the "category leader," while rival Unilever (UN) claims that its Hellmann's brand—known as Best Foods in the western U.S.—is the most popular mayonnaise.

New, innovative products are the best way to get consumers to pay more, ConAgra's Rodkin told analysts.

"The more intense value mindset of consumers is here to stay," he said. "The food industry, both manufacturers and retailers, will not win by continuously dropping prices. Value does not just mean a cheaper price. It's much more holistic."

Technology companies may be in the best spot when it comes to pricing, First American Funds' Chalupnik says. They can charge more because of growth in the global economy, companies' need for technology that boosts productivity, and consumers' desire for hot new products. "People will spend money on an iPhone but they don't want to pay extra for apparel," he said. His fund owns shares of Apple (AAPL), the maker of the iPhone.

Profit Worries

If prices continue to rise and consumers remain frugal, the result could be lower-than-expected profits in several sectors, says Gary Wolfer, chief economist at Univest Wealth Management. Most of the effect could be felt in 2011, when it becomes tougher for companies to top 2010 results, he says.

According to analysts surveyed by Bloomberg, earnings per share for the Standard & Poor's 500-stock index are expected to rise 24 percent and 31 percent year-over-year in the final two quarters of 2010, but 10 percent and 8 percent in the first two quarters of 2011.

In the meantime, the shrinking profit margins could discourage job creation by corporations. Against the backdrop of rising costs and weak sales, Wolfer says, "What is going to be the trigger for companies to hire?"

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