Britain's supermarket price wars

Glynn Davis - Tue 19 Dec, 2006

...We all know that the supermarkets have intermittently fought battles on prices over the years...The increased value is now being placed on branded foods is part of a fundamental shift in the food industry away from cheap priced foods and onto better quality goods, with the result that we are seeing the end of the price wars...

 
 
The positive response from the City to Premier Foods’ £1.2bn offer for RHM last week highlights just how keen investors are towards manufacturers of branded foods rather than producers of unbranded private label products.

This significant deal will bring together a whole host of well-known names by uniting Premier’s Ambrosia, Branston pickle, Crosse & Blackwell, Gales honey with RHM’s key brands Hovis, Mr Kipling and Sharwood’s. That increased value is now being placed on branded foods is part of a fundamental shift in the food industry away from cheap priced foods and onto better quality goods, with the result that we are seeing the end of the price wars.

We all know that the supermarkets have intermittently fought battles on prices over the years, which have often ended up focused on little things like the cost of tins of baked beans and bananas. The prices of these products were driven down to silly levels as each grocer fought tooth and nail to offer the very lowest price in the market – whatever the detrimental effect on their profits.

But such tactics have become much less prevalent in recent years as price competition between the major grocers has somewhat dissipated as a result of the changing circumstances in the wider market. We therefore believe it is fair to say that food price wars have become a thing of the past.

Britain's supermarket price wars: Rising input costs are hitting slim margins

So what exactly has happened to signal the demise of the entertaining baked bean and banana price wars? In a nutshell we’re now fully immersed in a period of rising prices for a whole host of commodities and raw materials, which has driven up the production costs of food. This has meant that trying to compete on price has become something of a self-defeating game for the supermarkets as it reduces their already slim margins to an almost non-existent level.

At a recent conference Justin King, chief executive of Sainsbury’s, highlighted just how much the pricing game had changed. Although he acknowledged that it was still very important, he reckons that it no longer represents a competitive point of difference because all the grocers have already competed on it to the point where it is now effectively a given among the major players. If you are not competitive on price then you’re not even in the game was the message.

There’s no doubt that the pressure on costs has been wreaking havoc on both grocers and food manufacturers. So much so, in fact, that research disclosed at the recent annual convention held by international grocery experts IGD showed that rising input costs were judged to be the biggest future headache for 44% of the food producers questioned.

They are contending with a myriad of price increases: over the past three years the market price of potatoes has risen 29%; onions by 27%; eggs by 13%; cattle by 5%; and cereals by 4%. Among the cereals, the likes of wheat and malt have been on the increase as a result of a shortage of supplies caused by either a poor crop or a switch by farmers into more lucrative produce.
This has led Paul Griffiths, chief executive at Interlink Foods – that produces cakes and pastry products. To comment: "In my 25 years in the industry this is the hardest it’s been."

Britain's supermarket price wars: Inflation-busting grocery price rises

But what’s this got to do with the supermarkets you might well ask. Well until recently, not a lot, but along with the food producers the supermarkets are themselves now feeling the pressure of price increases – from the likes of rising energy costs since the price of oil has doubled over the past three years.

Evidence of just how hard this is hitting companies can be seen with the example of Greggs, which has seen its energy costs in the first half of 2006 increase by a hefty 69%, compared with last year. And on top of all this there has been an increase of around 27% in the level of the National Minimum Wage since 2002.

But unlike previously (when the supermarkets would have simply demanded greater efficiencies from their suppliers in order that the prices charged in-store could be maintained), such are the magnitude of the increases in raw materials and energy costs that even the major grocers seem to have finally recognised that they have no choice but to pass on some of these increases to the consumer in the form of higher food prices at the checkout.

These increases can be seen in the latest figures from The Grocer Price Index that reveals the average cost of a "secret" 100-item shopping basket from the top four supermarkets increased by 3.2% during October. And over the past 12 months the basket has jumped by a hefty 6.3%.

Britain's supermarket price wars: End of price deflation

These inflation-busting increases have helped take the supermarkets out of a lengthy deflationary period, which is now helping them (and the food manufacturers too) to recoup the margins that they have been losing while prices have been held down in the name of competition. The price inflation seen in the last quarter – which came after 24 months of declines – has helped margins at Sainsbury’s increase from between 1.5% and 2% two years ago to 2.4% today. At Morrison’s they have moved up from 2% a year ago to 2.7% at present.

David McCarthy, food analyst at Citigroup, suggests: "We are in as benign an environment as we are likely to see in the grocery sector. There was a return of inflation and post-Easter there’s been no major price activity." What has helped make the supermarkets’ price increases possible is the significant change in consumer behaviour that’s been taking place within the UK. There is today much more of a willingness to pay a higher price for food than there has been for some time.

One reason for this is the increased amount of disposable income available in the typical household and the growing proportion of it that people are willing to spend on food – both in the home and on eating out. Consider 10 years ago, for every £10 spent on purchased food, households spent £8 on eating out. But today, for every £10, a healthier £13 is spent on eating out. This willingness to spend represents a significant opportunity for the supermarkets as it enables them now to use products as the key point of differentiation against their rivals now that pricing is no longer an effective competitive weapon.

Britain's supermarket price wars: Riding the rise of "foodie" culture

This has prompted them to jump head first into developing innovative premium-end products – hence the growth of their increasingly successful upmarket own-label ranges such as "Taste the Difference" at Sainsbury’s and "Finest" at Tesco.

They have also been fortunate in having the opportunity to ride on the back of consumers’ current insatiable appetite for the likes of healthier foods, organic foods and Fairtrade products. And all these have higher price points than the products that have typically been found in supermarkets, thereby not only pushing up the average basket size but also enhancing the margins for the supermarkets.

Such has been the demand for these various premium products that they are now worth an average of £890m every four weeks, according to data from the Tesco Clubcard, which found that this value had increased by 19% over the past four years.

Even the hard-discounters such as Aldi have had to take notice of this trend and it has binned its bargain basement pricing stance in order to squeeze more out of shoppers. The opening of its first city centre store, in Manchester, and the further development of its premium range "Specially Selected" and healthier option "Be Light" are signs that it is looking to increasingly tap into the growing demand for premium-priced products.

This move by Aldi highlights that the willingness to spend more is not restricted to a specific demographic. Richard Brasher, commercial and trading director at Tesco, clearly recognises this judging by his comments at a food industry event: "What constitutes value? Our price-sensitive shoppers are trading up and our upmarket shoppers are overlapping not just with Marks & Spencer but with Aldi. The increasing challenge will be to breakdown the stereotypes of the affluent and value shoppers."

What Tesco and the other supermarkets have chosen not to challenge is the stereotypical packaging used on their "Value’s" ranges of products. They have not been revised for years and, to some people, now resemble unappealing United Nations food parcels.

They are not the sort of thing that most shoppers would want to be seen with in their trolleys, and neither are they the sort of thing that the supermarkets particularly want to be selling by the trolley-load because they’d much rather shoppers instead piled their carts up with higher-priced premium goods.

Britain's supermarket price wars: An opportunity for premium food producers

This drive by the supermarkets to shift the battle away from price and onto their differentiated product ranges (predominantly of a premium nature) has provided food manufacturers with an opportunity to develop more innovative goods – with their attendant juicy margins.

However, it has not been easy for all companies to apply the necessary innovation to sate the supermarkets’ new appetites and some have failed to adapt to their changing demands. It has been particularly difficult for the likes of Northern Foods, which has been caught still producing low-margin commoditised goods such as pastries and pies that have not exactly been placed at the healthier end of the market.

But for those that have been able to adapt – such as the branded operators including Premier Foods – there are opportunities for growth. This demand for innovative and interesting foods is also playing into the hands of the smaller manufacturers that are proving much more adept at innovating and have been much more fleet of foot than many large operators that seem hidebound by their size.

Having now recognised this prized quality in many smaller suppliers the supermarkets have noticeably softened their stance towards this once maligned group that were previously unable to provide the necessary commoditised products at a sufficiently low price for the large grocers to show any interest in them.
But with the game having shifted to smaller and more dynamic runs of innovative higher-margin goods the relative minnows of the industry have potentially found themselves in a sweet spot.

As a result, the likes of Sainsbury’s and Tesco have been on something of a charm offensive of late. This has included hosting things like "friendly" meetings between their buyers and small suppliers. Sainsbury’s has even introduced a new payments system that enables it to pay small suppliers within days of them invoicing rather than leaving them to wait the customary 45 days before receipt of payment.

Whether such actions bear fruit and make the supermarkets more attractive organisations for small food producers to do business with remains to be seen, but what we can be pretty sure of is that we have now entered a period where the food war is no longer being fought over price but over product.


Regards,

Glynn Davis
for The Daily Reckoning
 

   Name

  Email

  Comment

I wish to receive the Fleet Street Daily

Thank you for your comment