The drought on either side of the Mexican border is making your pizza more expensive. And you’ll have to eat it, too—higher prices, that is—as manufacturers and retailers offset the skyrocketing costs of raw goods, everything from beef to milk, cocoa to coffee, limes to avocados.
Thankfully, fuel is another matter. A welcome calm appears to have settled over crude-oil markets despite unrest in the Ukraine and Middle East.
But as retailers move further into foodservice, market volatility breeds concern. For Ankeny, Iowa-based Casey’s General Stores, it has meant raising pizza prices about 2% because of what the company calls astounding jumps in the cost of beef, almost 20% to 30% this past spring.
To soften the blow to consumers, Casey’s implemented a few countermeasures. For a slice of pizza, one of the affected menu items, the chain made the portion bigger.
“We do some things like that to try to bring value to the customers,” said Bill Walljasper, CFO of Casey’s, while on the company’s latest investor call. “And certainly we wouldn’t be taking price increases [where there was] an elasticity issue.”
So even though Casey’s upped prices, it’s still competitive within its market areas, Walljasper said. The chain saw no “tradedown or downsize of meals” this past summer. In fact, Walljasper said, double-digit same-store sales increases are happening in all of foodservice. The experience has led to the decision to raise prices another 2% this fall as a way to cover rising cheese costs, he said.
Retailers such as Casey’s are often caught in the middle as volatility on Wall Street runs against what the consumer expects to pay for a cup of coffee or candy bar. While fuel has been a bright spot, price increases in other raw goods have trickled down to the store level. A few examples:
▶ Chocolate: Mars and Hershey implemented 7% to 8% price increases on their chocolate products due to the soaring cost of cocoa, which experienced a 50% spike in prices earlier this year.
▶ Coffee: Single-cup maker Keurig and coffeehouse giant Starbucks have increased prices in recent months.
▶ Milk: Drought in California is partly to blame for recent lower-than-expected earnings for milk supplier Dean Foods.
While Casey’s customers seem to have accepted the price increase, retailers often have to balance margin with the fear of losing volume; that’s why Casey’s talks of market elasticity. But sometimes customers can take the hit. Casey’s saw pizza margins fall at the beginning of the year due to higher costs of cheese and meat toppings. But greater margin contribution from other prepared foods offset them somewhat, and the price increase, which went into effect May 1, also helped.
In all, same-store sales for prepared foods for the chain were up 11.4% in May, led by sales gains (due also in part to an expansion of its home-delivery program) and the price increases. At the time of the investor call, the company was even considering a midyear price increase.
“Right now, the [area’s] economy is solid ... relative to other [parts] of the country,” Walljasper said. “And I think we might have some more opportunities going forward in [pricing].”
Communicating messages of rising commodity prices and increased value is a solid strategy for companies that can pull it off, says Kevin Higar, president of Flying Feathers Foodservice Consulting, Dallas. But most of the time, retailers can lock in prices with long-term contracts, a tactic that puts off volatility for months down the road.
In fact, such contracts, buying power and working with established suppliers are just a few strategies retailers employ.
For Tulsa, Okla.-based QuikTrip, coffee, beef, milk and cheese are “fairly easy for us to deal with. Our response is [to] stay competitive. If we can plan and be successful with the volatility of gasoline, we can handle the items ... mentioned,” says QuikTrip spokesperson Mike Thornbrugh.
For Nice N Easy Grocery Shoppes in Canastota, N.Y., commodities can be a mixed bag. “Some commodities are not that big of a deal because you partner with the right companies that know how to play on the futures market. Also, they may own the farms,” says Jack Cushman, executive vice president of food services. “Others, like coffee, are a commodity where we are pretty much at the mercy of the markets. Going too long can create problems, as well as opportunities, but predicting the future is always part knowledge and part guess.”
If a bright side exists, volatility can also spark innovation, Higar says. “A few years ago, when beef prices were high, chefs began doing more with lower cuts of meat,” he says. “And you began to see an appreciation for preparation techniques like brining or marinating a tougher piece of meat.”
CONTINUED: Good Fuel News
Good Fuel News
Though fuel for the most part has been a well-behaved commodity, prices did increase sharply when Russian president Vladimir Putin annexed Crimea, according to Tom Kloza, chief oil analyst for GasBuddy.com, Brooklyn Park, Minn., and OPIS, Wall, N.J. Weeks later, Iraq’s government fell into disarray and Islamic militant group ISIS reared its head.
Volatility returned in that time period, according to Kloza, predominantly in the form of higher prices for crude and both RBOB (reformulated blendstock for oxygenate blending) and ultra-low sulfur diesel (ULSD). But in the nearly six months prior to those events, Kloza says the industry saw “unprecedentedly low volatility, particularly for the global crude-oil benchmark of Brent crude.”
“Those of us who follow the wild gyrations of the markets were a bit bored,” Kloza says. “And several investment banks pronounced the end of the era of wild volatility in energy commodities.”
The news in Russia and Iraq revived the volatility, amid a backdrop of record speculative activity of $50 billion betting on higher crude prices, especially on West Texas Intermediate (WTI) and RBOB futures. But, as Kloza says, “Speculative traders who bought crude, gasoline and ULSD futures on the Ukraine and Iraqi news were spanked severely by a market that refuses to trade higher unless actual disruptions take place.”
As fears subsided, rack gasoline and diesel prices floated down as much as 30 to 60 cents a gallon from the highs of just a few weeks prior. But retail prices have come down an average of only 15 cents, Kloza says, with the result being a “big inning” for fuel marketers.
“OPIS and GasBuddy have monitored one of the best seven-week stretches for rack-to-retail gross margins on gasoline and diesel since the back half of 2008,” Kloza says. “There’s no question in my mind that volatility rewarded marketers with what has been a spectacular summer for the fuel category.”
Coffee Heats Up
Price spikes in coffee earlier this year forced many manufacturers to raise prices. Though it held off for a while, eventually Seattle-based Starbucks increased its prices 5 to 20 cents, depending on the market. List prices for Starbucks packaged coffee sold at grocery stores was set to rise 8% (about $1 per bag), going from $8.99 to $9.99, according to Bloomberg.
Similarly, Waterbury, Vt.-based Keurig Green Mountain announced a 9% increase on all portion packs for use in its brewing systems, its traditional bagged fractional packs and bulk-coffee products, effective in November.
Price fluctuations have a way of disrupting the entire supply chain, which for many retailers underscores the need for solid vendor relationships as a cushion.
“We’re a 114-year-old company with good connections and a supply network developed over the years,” says Randy Layton, vice president of coffee operations for Boyd Coffee Co., Portland, Ore. “In terms of who we source, I’m not concerned, although I think there will be challenges.”
A drought in Brazil has compromised the country’s coffee crop, which accounts for a strong portion of the world’s supply, Layton says. Added to the climate issues is growth in global demand, especially from Eastern Europe and Asia. These events will soon tip the balance to demand over supply, Layton says. Based on that eventuality, hedge funds and investors are using coffee as a financial tool, creating rabid price volatility.
The developments raise concerns for c-stores, especially as the importance of coffee as a linchpin for foodservice becomes more apparent [CSP—Sept.’14, p. 40]. Not only is coffee a draw, but its customers also tend to expand the market basket with breakfast items and baked goods.
There are potential perks that go along with coffee’s price spike. Cynthia Hswe, director of strategic marketing for Boyd, says customers’ quest for a higher-quality brew may spur retailers to consider richer, gourmet varieties. And with the upgrade comes higher prices.
A way to improve flavor is to increase the amount of coffee mixture actually brewed. (Coffee is mostly water.) Though it’s more expensive, retailers can offset that cost by raising prices, Hswe says, while still remaining below traditional coffeehouses.
“Even if [retailers] spend $1 more per pound,” Hswe says, “and increase their price by a nickel, they can still make a profit.”
CONTINUED: Chocolate, Milk
Chocolate, Milk
As manufacturers of consumer packaged goods (CPGs) respond to rising commodity costs, retailers feel especially squeezed, having less wiggle room with lower-margin items.
Earlier this year, both Mars Chocolate North America, Hackettstown, N.J., and The Hershey Co., Hershey, Pa., raised prices 7% and 8%, respectively, to cover rising commodity costs, mainly cocoa. Futures prices for the ingredient grew 50% earlier this year, causing the confections manufacturers to respond in kind, according to Bloomberg.
Milk has also been an issue, as California droughts have raised the cost of feeding dairy cows. Dallas-based Dean Foods Co. reported an adjusted loss of 14 cents per share in its most recent quarter, compared to earnings of 26 cents a year ago.
Ultimately, retailers concerned about commodity-price volatility continually balance margins with the fickle nature of customer perception. For companies such as Casey’s, the double-edged sword is foodservice: While it makes retailers vulnerable to price volatility, higher margins allow for some play.
Walljasper of Casey’s said its c-store basket “has changed dramatically over the last several months. New stores emphasize packaged beverages and prepared foods. It’s the gradual shift to those types of high-turning, high-margin [products]. … That side of the business is good.”
Food-Fighting Strategies
While commodity price volatility may be an ominous threat to retailers getting heavier into foodservice, the cushion of healthy margins may soften the blow.
“There’s more leeway in foodservice items for increases and decreases,” says Ed Burcher of Burcher Consulting, Oakville, Ontario. “If it’s a [candy bar], that margin is 30%, but typically foodservice is 60% to 65%, so you have the ability to weather the storm if you know what’s going to fluctuate in price.”
Still, pricing is tricky. Some retailers may have a beef sandwich that’s already priced at $2.99, so breaking the $3 ceiling would be ill-advised. And as with fuel, price sensitivity on certain products may drive customers to competitors with the same products at a better price point.
“For c-stores, guest count and footsteps are the No. 1 thing,” Burcher says. “But while losing volume is a concern, selling at a loss is also not good advice.” And neither is cutting quality, he says: “Lowering quality is the last thing that I would do.”
Higar of Flying Feathers agrees, saying leading-edge chains have fought for years to upgrade the perception of foodservice. “From a quality perspective, [retailers] have responded well,” he says. “They’re not going to shortchange the customer and feed into stereotypes.”
One way retailers can ease the sting of rising commodity prices, Higar says, is to rework menu items or shift promotions. “Maybe [as a retailer] I’m going to try to promote products not affected, like a chicken sandwich instead of a burger,” he says. “You may start seeing [limited-time offers] or daily specials on products not vulnerable to commodity costs.”
Another strategy may be portion control. If a company offers a small, medium and large drink, he says, the small might be offered at a few ounces less than usual. The millennial demographic is more open to portion control, meaning smaller sizes are perceived as desirable, Higar says.
A constant review of menu items and rebidding suppliers is also an important part of holding the line on costs while maintaining quality, says Burcher. Even moving from a supplier-branded product to proprietary is a solid possibility.
Internally, making sure that kitchen staff sticks to recipes also helps, as does assessing ingredients. “Perhaps there are blends of cheese that you can try without dramatically changing taste,” Burcher says.
These tips are especially pertinent to c-store retailers, who are more likely to be price followers vs. leaders, says Burcher: “If you’re not a Wawa of the world, you’ll react to what other competitors do. You have to see where you fit into [the larger picture] of commodities in the same way you know where you fit into retail pricing.”
CONTINUED: Profitable Gasoline Markets; Commodity Infographic
Top 10 Most Profitable Markets for Selling Gasoline*
| Metro area | Retail price | Margin** |
| 1 Washington (D.C. only) | $3.73 | 44.0 |
| 2 San Luis Obispo, Calif. | $4.08 | 41.9 |
| 3 San Francisco | $4.06 | 41.0 |
| 4 Santa Barbara, Calif. | $4.04 | 37.0 |
| 5 Bakersfield, Calif. | $4.00 | 34.7 |
| 6 Ventura, Calif. | $4.00 | 34.1 |
| 7 Bismarck, N.D. | $3.55 | 33.6 |
| 8 Salinas, Calif. | $3.97 | 33.2 |
| 9 Orange County, Calif. | $4.00 | 33.1 |
| 10 San Diego | $3.99 | 32.5 |
Source: OPIS/GasBuddy.com ; * Year to date as of Aug. 14; ** Cents per gallon
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