How Retailers Benefit From New Cost Dynamics

The business press has been full of articles about a pricing standoff between food retailers and suppliers. As the story line goes, suppliers, particularly CPGs, have been pushing up prices while citing higher costs.

Retailers have been pushing back, and the drama intensified recently when Delhaize in Belgium stopped stocking some 300 Unilever products because of price and other reasons. Retailers seem more empowered by the leverage gained from their private-label programs.

But there's a new chapter to this story. Retailers are beginning to see benefits from more favorable pricing dynamics, and may have less justification to pressure suppliers. On average, producer price increases no longer outpace those on the consumer side, noted Andrew Wolf, an analyst with BB&T Capital Markets, Richmond, Va., in a conversation last week.

This dynamic is particularly visible with commodities. For example, he noted, the Producer Price Index for dairy and related products fell 13% for January 2009 compared to January 2008. Meanwhile, the Consumer Price Index for that segment was up 1.3% in the same period. That means retail prices didn't reflect the sharp drop-off on the supply side.

“That's sticky pricing,” Wolf said. “That won't last too long. But as inflation starts to ease on the cost side, prices at retail don't come down as fast. Retailers are trying to make up some of the earlier gross margin squeeze from higher costs.”

That recouping is already improving retailer financial performance, Wolf added, pointing out that a number of retailers recently reported gross margin expansion in core supermarket business during the calendar fourth quarter. These included Supervalu, Ruddick, Ingles, Spartan Stores, A&P and Winn-Dixie, he said. In general, the margin growth contrasts with the situation in six of the past seven quarters, when margins contracted for the group in aggregate, Wolf observed.

“Now, on average, with PPI inflating less than CPI, retailer gross margins are starting to expand again,” Wolf said. “That's not unfair after two years of retailers not being able to pass through price increases.”

Where does that leave the price tug-of-war between CPG companies and retailers?

“They [CPGs] all got in their last price increases, and there won't be more,” Wolf said. “They'll try to hang onto the increases. Their compromise will be to offer increased promotions to retailers, but to hold to prices.”

Brands prefer those promotions as a way to boost their positions in relation to private labels, Wolf added.

So where is the whole price situation heading? In my opinion, look for things to move toward a new balance. Suppliers that haven't budged on price will have to become more flexible about reductions if commodity costs continue to decline. Retailer pricing, meanwhile, will eventually have to reflect the new lower-cost situation because you can only recoup margins for so long.

This new scenario will benefit the needs of the most important player, the consumer, whose insistence on sharp shelf prices will only intensify as this recession drags into next year.