Ingredient role in product pricing and profitability

by Morton Sosland
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While food manufacturers, along with all of American industry, have strived to keep a lid on costs in responding to global recession, the food business has benefited particularly from the past year’s declines in many ingredient prices. Operating margin improvements in many cases are tied to lower market prices for wheat, corn and soybeans from the peaks of the year before. These margin gains, a thankful respite from the searing cost pressures faced during the unprecedented escalation in grain markets, are realizable only when wholesale and retail prices hold fairly steady. Benefits from ingredient weakness vanish speedily and to terrible effect when product pricing itself faces competitive forces that seem aimed at neglecting, if not undermining, these opportunities to improve results.

Political pressures sometimes come into play when prices of finished products are linked directly to major ingredient markets. Sure, the doubling and trebling of a few important ingredients during skyrocketing 2008 triggered sharp advances in product prices. That these have not fallen exactly parallel to the ingredient declines has prompted broadsides from the political elements of more than a few national and group entities intent on finding scapegoats for this harsh economic environment. Often overlooked in these allegations of product prices rising when ingredients advance and product prices not declining commensurately on market setbacks are the many complex elements that make up food product pricing. Even if dramatic advances in ingredient costs account for product price increases, there is no direct relationship that says the relief of such pressures should mean an equal setback in product prices. It is unnecessary to look beyond food manufacturing profitability to underscore this absence of equivalent relevance.

The basic truth, though, relates to the powerful impact of ingredient costs on the economic results of food manufacturers. Sure, wages, marketing, manufacturing and capital costs remain important to the well-being of food manufacturing, but in recent times, it is the volatility of commodity prices that has been the driving force. While hedging and similar techniques are meant to lessen the negative effects of commodity volatility, these swings have become so extraordinary and so unexpected that it is no exaggeration to place commodity price movements as central to food manufacturing profits. Similarly, the ability to maintain prices as ingredient markets decline has become important, especially during economic conditions like the present-day when positive results, much less adequate ones, are difficult to achieve.

Even as primary attention in food manufacturing focuses on moves of the major commodities like the grains and meat and poultry, it is often lesser ingredients that merit attention. Two recent examples stand out. International rice prices soared to near record levels due mainly to domestic crop shortfalls in large consuming countries that ordinarily produce enough for domestic use. Suddenly, the grade of rice primarily moving in international trade soared 50%. And then there is garlic, an important food ingredient, that has seen its price in China, the main producer, soar 15-fold. The supposed cause of this record-setting explosion in prices is the sudden demand for this pungent bulb as a protection again swine flu among children in China. As a result of this health-related claim, which has no scientific backing, garlic has been put on a pedestal as China’s best performing asset.

Considering the way in which a few of the most successful food manufacturers have seen their results undermined by a sudden surge in ingredient prices, it is no wonder that a firm grasp on factors driving these markets is absolutely essential for food industry success. Looking at the way products like rice and garlic soared, even while most other commodities were holding in a narrow range, provides a stark reminder not only of the way that ingredient prices not just affect product pricing, but actually are playing the central role in determining profitability. That this has happened is one of the great measures of the transformation of the food marketplace.

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