Tucked quietly between Chicago and St. Louis, the town of Shelbyville bills itself as Illinois’ best kept secret. Hosting some of America’s richest farmland, the town’s agricultural roots reach into the 1820s and include the invention of the first commercial pick-up bailer, a marvel of agricultural engineering.
For Dale Short—and indeed many in this central Illinois town—farming runs in the blood. One of the town’s agricultural leaders and a third-generation farmer in Shelbyville, Short oversees 2,000 acres of farmland. Throughout the last 36 years, Short adhered to a standard practice of crop rotation—half his farmland received beans, the other half corn.
When the ethanol boom hit a few years back, Short, as sharp a businessman as he is diligent a laborer, immediately noted the crossroads he faced. He contemplated planting more corn to take advantage of the rising prices he could get for the crop, debating the merits as well as the economic potential. While Short debated his decision, other farmers—big and small—had made theirs and worked to produce more corn. It was, after all, the logical, practical, economical choice.
Across America’s heartland, these individual decisions played a small but symbolic step in the dramatic theater that now has food costs throughout the world rising to unfamiliar heights. Simple economic needs encouraged the nation’s farmers to follow the demand and the money, turning from food to fuel. Sprouting out corn at record levels, other crops were shortchanged; supply shortages led to higher prices in crops such as grain and beans.
Though America’s small-town farmers remain small players in this big-stakes game, they stand as the most compelling dominoes to fall in a perfect storm of swelling global demand, increased energy needs, and a weakening U.S. dollar that have merged to intensify food prices. Indeed, the era of cheap food has reached its end and given rise to a new age, one dominated by trepidation.
The End of the Cheap Food Era
Before World War II, many American families spent approximately one-third of their income on food. Following the war, however, a series of dramatic changes, including a rise in agricultural productivity and a significant post-war economic punch, produced a long, powerful decline in the price of food. Instead of spending one-third of their income on food, Americans’ investment at the dinner table fell to 10 percent.
With the exception of a price upswing in the 1970s, Americans enjoyed much of their food at modest costs throughout the final decades of the 20th century and into the millennium’s opening years. In fact, global food prices, adjusted for inflation, fell by 75 percent between 1974-2005, which delivered smiles to the faces of American households and industry insiders alike.
Still, all fine days must end.
The door on cheap food has now closed. When The Economist declared “The End of Cheap Food” as the title of a December 2007 story, it cited a startling figure: food prices had increased 75 percent since 2005, representing a complete reversal from the favorable times of yesteryear.
But it wasn’t only Uncle Sam’s homeland feeling the pinch; the rising cost of food stretches into all corners of the globe. In January 2007, riots erupted on Mexican streets after the price of corn flour increased fourfold while Argentina has suffered from a series of strikes. Recent floods in England and India as well as a drought in Australia destroyed crops and led to price increases. In Ethiopia, ten pounds of corn flour costs five times as much as it did in 2005. Many wondered how; others questioned now what?
“We’ve had the challenge of rising commodity prices before, but it has been a long time since we’ve had this level of a sustained increase in prices,” says Bill Lapp, an agricultural economist with Omaha-based Advanced Economic Solutions. “The difference today is that these rising prices have been dramatic, sustained, and across the board. We’re not going through one year in which some key commodities are up and others are down.”
Behind the rising costs, economists and analysts cite both controllable and uncontrollable factors, many which began creeping in as early as 2005.
While most of the nation’s corn crop is fed to livestock to produce meat, dairy, and eggs, the amount being marked for energy usage is climbing each year, a fact many analysts trace directly to the U.S. government’s ethanol subsidies. In 2006, for instance, 14 percent of the nation’s corn crop was turned into ethanol; in 2007, that number rose to 24 percent (though an ascent is certain, some claim 2007’s figure sits closer to 33 percent). The decision to put food in gas tanks, a decision many argue was both reckless and politically charged, has led farmers to dedicate increasing tracts of their farmland to biofuels. Meanwhile, the productivity of other crops, namely grain and beans, has fallen and sparked new challenges, including rising prices in those commodities.
“When corn sneezes, other commodities catch a cold,” Lapp reminds.
The financial boom in China and India, the world’s two most populous nations and together claiming one-third of the global population, have also placed a strain on food prices. Throughout history, a rise in personal income has led to a corresponding upswing in meat consumption—termed the “nutrition transition.” The United Nations’ annual assessment of farming trends in 2007 predicts that people in developing countries will be eating 30 percent more beef, 50 percent more pig meat, and 25 percent more poultry within the next decade.
“We have a growing world demand for food and with 30 percent of our pork, cheese, and flour exported, we all end up paying more for the world demand,” says Don Vlcek, vice president of purchasing for Marco’s Pizza. “[The United States is the] prime source to fill the inventory gaps throughout the world.”
As global demand for meat increases, the need for grain follows. It takes 8kg of grain to produce 1kg of beef and 4kg of pork. The increased demand for meat and grain extends elsewhere, including amplified demands on water and oil. Furthermore, grain-designated land risks the transition from human to animal consumption.
“We’re dealing with the realities of becoming wealthier as a planet…and the technologies haven’t caught up to the increasing demand,” says Adam Mussomeli, who heads Deloitte Consulting’s consumer products supply chain analysis.
The weakening of the U.S. dollar has done little to insulate the nation. A potent mix of trade and account deficits, falling Federal Reserve interest rates, a loss of confidence in the U.S. economy, and competition from other monetary markets—the euro, for instance, wasn’t even around one decade ago—have all combined to send the dollar into a downward spiral completely independent of the supply-demand issue.
Other notable factors include the escalating price of crude oil and the wrath of Mother Nature. Oil prices, which hit $147 a barrel in July before the recent nosedive, also contribute to higher commodity prices. Greater oil prices, meanwhile, translate into higher costs to plant, irrigate, harvest, and transport product. Mother Nature shares some of the blame as well. Drought, hurricanes, and floods have all pelted the world in recent years, dealing a devastating blow to crops from Australia to Iowa.
“A lot of factors started this bonfire and now some extra gasoline’s been tossed on it,” Lapp says.
The Impact, Inherent Challenge, and Potential Solutions
While some view the current rise in food prices as little more than the natural order of things, arguing that commodity prices have traditionally taken a quantum leap every 30 years or so, such a realization does little to lessen concern across the restaurant industry. The steep, global increase in commodity prices is expected to persist for years. Two elements analysts agree on: we’re closer to the beginning than the end and demand isn’t likely to diminish.
“Food is still cheap today, but we’re at a period of time where that is becoming less and less of a true statement,” Lapp says. “We need to know there are cycles; now it’s a matter of surviving this one.”
To combat rising food costs, restaurants will have to be aggressive, analytical, innovative, and decisive. Waiting for improvement is not a strategy as restaurants everywhere face this central question: margins or market share? A successful answer will likely mean survival; the wrong answer, closing. Restaurants must be honest about why customers enter their doors and, above all, look beyond the next 12 months and 2-3 years into the future to seek answers.
Restaurants must understand that volatility will be an ever-present antagonist to an operation’s efficiency. As commodity prices proved favorable throughout the last 15 years, inefficiencies weaved into businesses because—to put it bluntly—they could. Winning overshadowed flaws and all seemed well—that is until the pendulum swung back.
“As prices have risen in recent years, it has forced efficiencies and a focus on brand and product that will have to continue,” Informa Economics CEO Bruce Scherr says.
Rather than reacting to the market’s uppercuts, restaurants will have to examine their purchasing habits more aggressively, more strategically. Pull out the spreadsheet, input the numbers, and assess where, when, and how items can be purchased at more reasonable costs. At Marco’s, Vlcek led the company’s savings of nearly $2.4 million in 2008 by competitive bidding, locking in prices, quantity orders, and utilizing local sources.
“It’s at times like these, that purchasing people really have to fill their role,” says Vlcek, who penned a letter to his vendors saying that escalating prices compelled him to investigate competitors and yet simultaneously urged their help to maintain the relationship.
Jack Graves, Chief Cultural Officer at Burgerville, says working with local vendors has helped to diffuse swelling costs at his Pacific Northwest spots. Burgerville’s focus on purchasing locally has proven to be a successful antidote to rising commodity prices. Transportation costs are kept down and the local community benefits from the company’s investment.
“We are aiding in the prosperity of the local region and we believe that others can do the same by following our lead,” Graves says.
Restaurants might also turn to reformulation and substitution, seeking ways to recreate the menu mix without sacrificing quality, perhaps highlighting dishes with products that aren’t as price volatile and can deliver greater margins. For example, at its Consumer 360 Conference in June, the Nielsen Company reported that seafood, dry pasta, and candy are among the products most immune to a recession. Such information allows retailers to better focus on the right categories and brands for success.
While retailers themselves might have initially absorbed the brunt of rising commodity prices, national media is now communicating the changes to consumers, including higher menu prices. Citing a rise in the cost of key commodities, the Wall Street Journal named in September a number of high-profile companies set to raise menu prices, including Olive Garden (owned by Darden Restaurants Inc.) and Yum Brands Inc., parent of Pizza Hut, KFC, and Taco Bell among others. Such debates rage on elsewhere in the industry, including Chipotle Mexican Grill, where rising input costs, mostly attributed to corn, slower sales, and higher transportation costs have put the issue of raising prices in front of the Mexican chain’s leaders.
Lapp believes that consumers can and will pay more if requested. Though challenging to increase price points in tough economic times, he says most customers understand that higher costs get passed onto the consumer.
“The thing to do isn’t to make portions smaller or to dumb down the food, but to increase prices in a well-conceived, managed, and tactful way,” Lapp says.
What restaurants must not do, however, is panic and alter their product for a short-term solution. A focus on the basics must be maintained and executed.
“To make it through this current challenge and to be successful after this, restaurants will have to maintain their principles, including standards of labor and operational execution, as well as the quality of the product that got them customers in the first place,” he says. “There can be no departure from those core components.”
Monday, June 1, 2009
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