Food Companies Face Pricing Conundrum

While commodities prices soar, food manufacturers walk thin line between gaining profits and driving consumers away.

NEW YORK (Dow Jones/AP) — Soaring commodity prices are pushing food companies to make some tough decisions.
A sharp climb in costs for wheat, dairy and crude oil has forced firms ranging from cereal companies to cheese makers to hike their prices. But while the higher prices have helped keep profits robust, they also run the risk of forcing consumers to buy less or to look for better bargains.
Makers of that consumer staple — cereal — have been pushing their prices higher to bolster earnings, but at least one measure points to a drop in volumes of ready-to-eat cereal over the past year in many stores.
Cereal companies have been successful in raising prices, but they may be ''forcing their core consumer to other options,'' said Burt Flickinger, managing director of Strategic Resource Group, a food industry consulting firm in New York. Those options could include anything from a fast-food breakfast to frozen offerings, he said.
Data from research firm Information Resources Inc. show that the sales volume of ready-to-eat cereals fell 1.9 percent for the year ended Aug. 12 compared with a year earlier. While those data may have their limitations — they track U.S. supermarkets, drugstores, and mass-merchandise outlets but exclude behemoth Wal-Mart Stores Inc. — they also shine a light on the tightrope food companies must walk as they look to offset commodity pressures with higher prices.
For the past 12 months, prices for cereal and cereal products were up about 3.8 percent, according to the Labor Department's consumer price index. According to the IRI data, Kellogg Co. saw its ready-to-eat cereal volume sales fall about 4 percent for the last 52 weeks. Kraft Foods Inc.'s Post cereals had a 1.2 percent decline, General Mills Inc. saw volumes climb 0.57 percent, while private label companies experienced a 2.9 percent pullback.
General Mills — which makes Wheaties and Cheerios — recently said it was shrinking the size of some cereal boxes as a way of increasing prices. The company's recent price increases came later than those of many of its competitors.
''We think the category is going to continue to grow in (the) low single-digit range. Cereal is a very staple and important part of consumers diets,'' said Ken Powell, chief operating officer for General Mills. He said the company's Cheerios and new products sold well in the most recent quarter.
In a Wednesday conference call, General Mills chief executive Steve Sanger didn't dismiss the possibility of more price increases, saying that the company will evaluate its options if commodity prices rise more than expected.
The higher cereal prices follow a rise in costs for corn, wheat and other grains. Wheat futures are up about 69 percent for the year because of strong global demand, production issues in some parts of the world and some farmers' shifting to corn to tap the greater demand for ethanol.
The pressures that food companies face range from high dairy costs to more expensive sweeteners like high-fructose corn syrup. To add to food companies' problems, oil prices are recently on an upturn, adding to transportation costs. Separately, each of these commodities account for a tiny fraction of the food companies' costs, but their combined ascent has put heavy pressure on packaged food makers.
''To a great extent the food companies have been able to protect margins, which means it is the consumer that is paying for this,'' said D.A. Davidson analyst Tim Ramey.
While higher prices help reduce pressure on profit margins, consumers in some cases are being forced to buy less.
Kraft, for instance, which has been raising prices in many of its food categories, said it saw overall volumes decline 0.7 percent in the second quarter.
The beverage industry also has seen choppy volumes in the midst of price increases. Morgan Stanley analysts recently noted that carbonated soft drink industry volumes declined 7.5 percent for the four weeks ended Sept. 9 as prices moved up 6.4 percent, based on supermarket scanner data.
To be sure, food companies also are trying to curtail their own costs and are hedging commodity prices to help their margins.
''You can't raise prices to the same extent that commodity prices are increasing — you will get push-back from the consumer and retail,'' said Edward Jones analyst Matt Arnold.
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