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Business negotiations: when it’s time to throw in the towel

One of the most closely watched metrics in the FMCG industry is consumer price elasticity: the relationship between retail price and volume. Perhaps one of the most asked questions from food manufacturers is, “When will consumers stop paying higher prices?”

COVID-19 fundamentally changed the behaviour of consumers buying packaged food. Slow growing and more mundane commodities such as cereals, frozen foods, and spices, were suddenly propelled into the spotlight becoming essential meal items, as eating at home became a must. Unfortunately, most food manufacturers weren’t prepared for the unexpected increase in demand, as ingredients, shipping containers, and packaging costs skyrocketed overnight. Manufacturers were unwittingly  thrust into a position of power as consumer and retailer demand far outstripped supply. As a result, wholesale prices increased to offset higher input costs and help reduce demand.

Over the months this shift has translated into several different types of consumer inflation. At the beginning of the pandemic, pure price increases meant no change to product ingredients or pack size, but the second phase saw pack size reduction, commonly referred to as “shrinkflation” whereby the ingredients didn’t change but the size of the package shrank. After this, food manufacturers started to alter their ingredients using cheaper substitutes, such as high corn fructose syrup for sugar, in order to lower their costs. This was referred to as “skimpflation”.

Are consumers ready to throw in the towel and say no to cost hikes?

Food manufacturers will be watching very closely to changes in the price elasticity of their brands and overall category volume trends. History tells us one of the first changes in consumer purchase behaviour is the shift from buying branded products to store brand and private label, as the perceived value of brands is no longer high enough to justify paying more. Once this occurs, food manufacturers need to prepare for a shift in the balance of power in favour of their retail partners. This will manifest itself in retailers initiating different types of demands, commonly known in the FMCG industry as “retailer asks”. These can include asking food manufacturers to reduce their wholesale prices now that some of their input costs have moderated, for example, shipping container costs which peaked at $20,000 in September 2021 are down to $9,500 in June 2022.

What is the ultimate lesson to be learned from this analysis of the current situation? It’s very simple: those food manufacturers who are proactively anticipating and planning for these commercial negotiations will be best positioned to capture their share of the profit pool.

Article written by Sal Fiordelisi, Vice President, Head of CPG Consulting at The Gap Partnership