Article

Corn at center of price increases

February 13, 2011

By Steve Coomes

Mercifully low commodities prices that sustained U.S. restaurant margins for two years are not only disappearing in 2011, their increases will likely minimize profits operators hoped to gain as the economy emerges from the recession.

Multiple factors are driving costs for protein, dairy, grains and edible oils to as much double their 2009-2010 marks. Wheat and corn are both headed toward record territory.

When the USDA reported corn stocks at 15-year lows in early February, it pushed corn prices to more than double their $3.50-per-bushel cost of six months ago. As a result, corn’s role in livestock feeds is sending beef, pork and poultry prices upward while also increasing demand and cost for wheat, a grain whose production has suffered major hits over the past 10 months.

Severe droughts in Russia and Ukraine in 2010 led those countries to stop all wheat exports, and record flooding in Australia in 2011 has claimed at least a third of that nation’s wheat crop. And now China is reporting wheat shortages of its own, which sent buyers scurrying to lock in supplies for the coming year.

Such news led Goldman Sachs to warn investors that restaurant companies such as Panera Bread Co. and similar sandwich peers may struggle due to menus that rely heavily on agricultural commodities. In a Feb. 7 investor outlook titled “Commodities in Crosshairs,” the firm blamed market tightness, for wheat especially, on severe weather across the globe.

Robert Bresnahan sees other factors inflating prices. As president and CEO of Trilateral Inc., in Chicago, he advises foodservice clients on purchasing strategies to manage costs, and he’s telling them that market volatility isn’t truly supply driven.

“There are a lot of large speculators and traders taking positions for safety reasons, not because they want to use commodities they’re buying,” Bresnahan said. World reserves of wheat, he added, are well above 2008 totals when shortage concerns were merited and prices shot up. “Supplies are not the issue right now.”

Similarly, he said soaring U.S. dairy prices have nothing to do with milk or cheese supplies. Rather, rising export demand for non-fat dried milk from emerging economies is sending powder overseas in record quantities. So as spring approaches and the U.S. dairy herd’s production peaks, early February prices of $1.90 per pound cheddar blocks is an irrational market response, he said.

“That’s more proof of outside investors getting into commodities,” Bresnahan said. Milk futures contracts aren’t popular because investors want to make products from the actual fluid, they want to trade them for a profit, he added. “They’re just looking for a rate of return on an investment, and they see some safety in it.”

Time to raise prices?

In a January earnings call, McDonald’s Corp. acknowledged rising commodities prices would lead it to increase menu prices, though it didn’t specify by how much or say which items might see a cost lift.

A request for an interview with the quick-service giant — as well as multiple requests to talk to other quickservice and fast casual players — got no response, a likely indication that McDonald’s and its competitors will keep their pricing strategies private for now. Similarly, in another earnings call, Chipotle Mexican Grill’s David West, CEO of its North American Commercial Group, told analysts, “We just don't like to comment on (pricing) at all.”

According to Goldman’s report, Chipotle and other protein-centered concepts, such as Taco Bell and KFC, may avoid raising menu prices this year. While researchers expect beef, pork and poultry prices to move upward some, they view those increases as manageable for these operators given the prominence of proteins on their ingredient lists. Plus, any recovery-driven transaction increases could help offset fixed costs, providing modest but welcome wiggle room on the P&L.

Surveying a restaurant operation holistically for cost savings and revenue generating opportunities is how Kathleen Wood is advising her clients to weather the looming commodities crisis. As founder of Chicago-based Kathleen Wood Partners, she coaches restaurant companies to find long-term operational solutions rather than short-term answers, such as price increases.

“Raising prices may help now, but you risk driving away customers for good,” Wood said. “Commodities are always going to see fluctuations, so you have to do things that prepare you ahead of time to ride out the high points.”

Wood said it’s time to examine menus and determine what items should go. If a dish isn’t profitable and it’s dependent on a pricey commodity, kill it. If it’s questionable, ask customers what they think.

“One client of ours insisted on sending out a side salad with every entrée,” she said. “But you could see customers didn’t want that because they were throwing them away. Right there was an opportunity for cost savings.”

Wood also recommended every brand revisit its value proposition and look for chances to reinforce its customer benefits.

“A value proposition doesn’t necessarily mean a discount, especially in fast casual where that’s not expected,” she said. “If your clean restaurant, great food, great beverages and great service resonate with guests, you’ve got a great value proposition. Any improvements you make to that will only build sales.”