The Pricing Game

ELLIOT ZWIEBACH and MARK HAMSTRA

The sharp inflation in food costs in 2008 only seemed to exacerbate the economic recession and to cause pricing problems for retailers and manufacturers alike.

But now that the inflationary wave has crested and passed, in its wake a new pricing battlefield has emerged — between retailers anxious to present their customers with savings opportunities, and manufacturers who want to preserve shelf space against the rising tide of private label.

The conflict was exemplified by the recent dispute between Delhaize in Belgium and supplier Unilever, when Delhaize stopped carrying a selection of about 300 Unilever items after the two sides could not agree on pricing and promotional terms. The companies said they resolved their dispute earlier this month after a few weeks of additional negotiations.

Some observers said similar forces are at work in the U.S., where food retailers have repeatedly bemoaned a lack of pricing relief from suppliers, many of which have seen their input costs go down but have not lowered their wholesale prices.

Just this month, Richard Galanti, chief financial officer at Costco Wholesale, Issaquah, Wash., said in a conference call discussing second-quarter results that the company is putting pressure on suppliers to lower their prices now that input commodity costs have fallen.

“We respect the fact that, for years, there was probably some pent-up demand for some price increases, as the retailers could push back hard during those periods of small inflation,” he said. “But there's some big inflation here that had come last year — and every time it was explained to us, it was because resin prices went up this, and electricity costs went up that, and feed prices and grain prices went up X, Y and Z. We know what those prices are now, and we're going back for [relief from suppliers].”

His comments followed statements reflecting a similar frustration with CPG pricing made recently by Jeff Noddle, chairman and chief executive officer of Minneapolis-based Supervalu, and Steve Burd, chairman, president and CEO of Pleasanton, Calif.-based Safeway.

Last week, David Dillon, chairman and CEO of Kroger Co., Cincinnati, struck a more conciliatory tone in a conference call discussing year-end results, but he pointed out that CPG pricing policies are partly responsible for the strong growth in Kroger's private-label sales.

He noted that the company's growth in tonnage during the fourth quarter was driven by Kroger's own brands, while national brands were flat or slightly down in terms of tonnage.

“We have a lot of active dialogue with vendors, but I would characterize our relationships with them as outstanding,” he said. “We do push back a bit on price increases, and we push back on the failure of prices to decline when the underlying costs have declined, but ultimately we're pushing back on behalf of our customers, not on our behalf, because our intent is that when prices rise, we pass them through, and as costs decline, we expect those generally would be passed back to customers too.”

Retailers and CPG companies have both said that they expect the lower input costs will eventually be reflected in more promotional spending by the manufacturers, rather than lower list prices.

In the meantime, food retailers are seeing big spikes in their private-label sales growth as they roll out more items and expand their promotion of those products. Private-label grocery sales are increasing at double-digit rates at some retailers, according to reports.

Making Up Margin

Jon Hauptman, a partner in consulting firm Willard Bishop, Barrington, Ill., said national- and regional-brand suppliers seem to be seeking to make up for lost margins encountered as inflation on raw ingredients escalated last year.

“Retailers are seeing that a lot of commodity prices are coming down, and they are wondering, ‘At what point do costs start coming down?’” he said. “I think for many consumer packaged goods companies, they waited as long as they could to pass along price increases, so they are still in a place where they are trying to get ‘whole’ before they pass along cost reductions.”

He said most traditional high-low retailers — along with those who have adopted a “hybrid EDLP” strategy — stand to benefit from an increase in promotions from CPG companies, even if the manufacturers hold the line on list prices.

“I think most retailers can work with that and see great benefits from that,” he said. “Standing out in today's increasingly competitive marketplace requires retailers to be bold, and while some retailers prefer to be bold with everyday low prices, many prefer to be bold with strong promotional programs. So manufacturers coming back with increased promotional monies fits very nicely into helping promotionally oriented retailers differentiate.”

The preference by CPG companies to reflect price reductions in the form of more promotions helps them retain a measure of control over their brands, Hauptman explained.

“It stabilizes their list costs, which has several benefits, and by increasing promotional monies, it allows manufacturers to be much more in control over the price position of their products,” he said.

That has become increasingly important at a time when retailers are leveraging their private-label lines more than ever to present a better price image to consumers, he said.

“We are seeing shoppers seeking out opportunities to trade down in the category, so private label is benefiting,” he said. “We are also seeing more and more retailers expanding their offerings of second-tier or entry-level private label, and that raises the stakes for manufacturers in a couple of ways: First, they have to compete aggressively against both a national-brand equivalent and a second-tier brand, and also it forces manufacturers to fight for shelf space.

“Since retailers are expanding their private-label lines, and adding many more second-tier items, it is squeezing shelf space for national-brand companies — many retailers will be pulling back on the number of national and regional brands that they carry — and so offering promotional money is one way for manufacturers to stand out.”

Shorter, Deeper Promotions

Dick King, vice president of Associated Food Stores, Salt Lake City, said he anticipates improved pricing from suppliers, based on conversations with various CPG company representatives at Food Marketing Institute's Annual Business Conference meeting in Dallas earlier this month.

“Generally, what we've learned is good news about the direction manufacturers are going,” King said. “As wholesalers and retailers we want lower costs, but several CPG companies are saying they want to make sure they get pricing right on their core items,” rather than repeatedly lowering and raising prices.

“Some companies are saying they want to help us lower prices, but they're not sure when current prices will stabilize,” he explained. “But once they stabilize, some are telling us they plan to offer deeper promotional deals and more frequent deals on their basic, core items in 2009 and 2010 while keeping list prices at higher levels.

“So rather than deals every eight to 12 weeks, it could be deals every six to eight weeks, with more brand advertising. That means we'll need to react as quickly as possible to reductions as they come, because we owe that to our customers,” he said. “If the suppliers will deal deeper, then we would certainly need to pass those reductions on as temporary price reductions or consistent everyday low prices.”

He said CPG companies have been discussing rationalizing their product mix, and some observers noted that manufacturers are holding off on some new-product launches in favor of promoting value on core items.

King said CPG executives understand where retailers are coming from, “and they're receptive to our desire to lower pricing when that's possible.” He said Associated also has empathy for the position suppliers are in, “because as a wholesaler, we have items at our warehouse that we bought in a period when prices were high, so we may have to take a loss when we sell them.”

Hauptman of Willard Bishop agreed that promotions this year could be of shorter duration but deeper than many retailers are accustomed to.

“The main thing I would expect to see are deeper promotional offers, even if they are for shorter amounts of time, which would help traditional food retailers differentiate between discount stores,” he said. “Discounting just a little is not enough, especially against private label. We could see one- or two-week deep price reductions instead of longer, shallower temporary price reductions.”

Richard Gunn, executive vice president, merchandising and marketing, for K-VA-T Food Stores, Abingdon, Va., who also attended FMI's ABC meeting this month, also said he believes CPG companies will offer more promotions in lieu of reducing list prices.

“The CPG companies told us they don't expect to roll prices back but they will be more aggressive on promotions,” he told SN. “More than 80% of the companies we spoke to said there would be no overall price reductions, but as costs go down, they said they would offer more promotions and promote on a more frequent basis. But we couldn't get a single commitment from any company as to when that change would occur.

“Meanwhile, the outcry from our customers about prices not going down is getting louder,” he said. “Last year the media did a good job making it clear that food prices were rising because of higher gas prices, but now customers see gas prices under $2 a gallon and they expect food prices to come back down.

“We tell them we are negotiating hard to get manufacturers to lower their prices, and when we get them, we will pass them along.”

Gunn said K-VA-T is running its normal pattern of promotions; so far, the frequency of supplier promotions has not increased, “and the discounts are not as deep as in the past.”

He said he's pessimistic that CPG companies will actually pass any lower costs back to retailers — “only as much as they have to,” he said. “I believe they will use this as an opportunity to become more profitable, even as they pick up the frequency of deals or go a little deeper on discounts.”

Gunn said K-VA-T has been “pretty aggressive” in promoting private label in its ads for the last 24 months, but it has been primarily in addition to the brands it regularly advertises rather than supplanting those brands.

More Support Needed

Mike Proulx, president and chief operating officer of Bashas' Supermarkets, Chandler, Ariz., said the current economic deflationary environment has not impacted the way the chain promotes.

“The economists in Washington, D.C., say we're in a period of deflation, but customers don't know or care about that. All they know is their grocery shopping wallet has shrunk, and they have not benefited from all that the economists say is going on,” he said.

“Bashas' is just a small player in a large grocery arena, and we know what the big retailers are saying to challenge the CPG companies,” he added. “We join with them in hoping costs go down, and meanwhile we're still battling every day to offer our customers the best values.”

According to Proulx, some suppliers are providing support for Bashas' promotions, “but we always need more support to help our customers stretch their food shopping dollars.

“Within the last year or so, we've seen the cost of commodities skyrocket, and what suppliers are telling us is they're just beginning to recoup those losses, so they're being a little stingy about revising costs downward. We do have good relationships with our suppliers, and we value those partnerships, but we wish they could find more opportunities to work with our warehouse.”

Since the first of the year, Bashas' has altered the ad presentation for each of its formats, Proulx said, “so they resonate more with customers” — changing the look of its ads by repositioning departments, using different kinds of photographs and changing the primary colors; adding more colors and items to the ads for its Food City banner; and introducing sale pricing for all items for Bashas' upscale AJ's Fine Foods stores.

Asked if the chain has seen improvements, Proulx replied, “We've seen improvements in market shares in Phoenix specifically and across the state of Arizona in general, and we attribute part of that growth to a shift to more affordable pricing and more clearly defined savings that we communicate through our ads.”

He said the chain has been including private-label items in its ads “for quite a while — since the economy turned sour.”

John Catsimatidis, chairman and chief executive officer of New York-based Gristede's Markets, said he has been promoting private-label offerings from both of his wholesalers — White Rose Foods and ShopRite.

Asked whether he has been getting vendor support from national brands for promotions, Catsimatidis replied, “Suppliers are being extra careful themselves, so no, we're not getting support from them for promotions.”

He said he does not contemplate price reductions anytime soon.

“I told our people that until they can show a nice profit, we can't drop any prices,” he said. “How can you drop prices if you're not making a decent profit?”

Inflation Outlook

After an increase in food-cost inflation of 5.5% last year, government forecasters are calling for costs to rise just a little over 3% this year, according to Ephraim Leibtag, an economist for the U.S. Department of Agriculture, Washington.

In a recent webcast hosted by The Food Institute, Elmwood Park, N.J., he noted that food commodity prices have declined by about 30% since last summer, although they are still 25% above the levels of January 2006.

“The strong global demand and higher energy prices drove prices higher in 2008, but those factors have dissipated,” he said.

In general, he noted that trading down by consumers and slackening in the demand for U.S. exports should exert downward pressure on prices in the near term. Lower demand should keep meat prices low, although that category is still “in flux,” he said, and lower prices in dairy products, cereals, eggs, and fats and oils are currently being passed through at retail, he said.

In that same webinar, Kenneth Zaslow, a New York-based food company analyst with BMO Capital Markets, said he expects food inflation to return eventually because of actions to reduce supply, such as the culling of herds.

“There are a number of self-correcting mechanisms in the market,” he said. “The same pressures that created inflation will create a supply response across almost all the facets of the commodity chain.”

For now, though, he noted 2009 could mark the first year since the early 1970s that beef, chicken and pork all experience deflation.

He said a number of variables would determine how quickly inflation returns, including the recovery of the global economy, consumer spending patterns and actions by suppliers to reduce supply.

“It's not a question of if inflation returns, but when,” he said.

30%
Decline in food commodity prices
Source: USDA