Five ways food and drink businesses can combat inflationary pressure

Inflationary pressure is the latest challenge to hit the food and drink industry. The issue follows Brexit, Covid, the Russian invasion of Ukraine, poor global harvests, rising energy costs and avian flu which have all tested food and drink businesses. Overall, the sector has navigated these well, but challenges remain, with inflationary pressures, in particular, adding complexity.
 

How significant is the issue?

Although overall inflation fell to 8.7% in April, a smaller drop than forecast by the Bank of England, consumers are clearly still feeling the pinch. Food inflation continues to run much higher than overall inflation, with the ONS putting the rate in April at c.19.1%, the prices of food and non-alcoholic drinks having risen at the fastest rate in more than 45 years over the 12 months to March 2023.

This rate of increase is expected to drop. Lower production and ingredient costs falling from their October ’22 peak will filter through to the products on the shelves, even if these drops are not consistent across the board.

In the world of food retail there is a myriad of trends linked to high inflation, as cost of living pressures are affecting consumer choices and behaviours. Shifts from red meat to poultry, fresh to frozen, and lower overall FMCG brand loyalty, combined with higher price sensitivity, are all examples of changing consumer preference in the current economic environment.
 

How are food businesses responding?

Food businesses are reacting to rising costs in a range of different ways. Depending on the dynamics of the market the business is operating in, we see businesses typically adopting one or more of the following five strategies:

• Passing on the increased costs to customers as much as possible
• Adding value or differentiating product to validate increased prices
• Focusing on efficiency savings in the business
• Substituting the product but maintaining the price point
• Maximising available cash support by applying for R&D relief and grants where possible
   

Passing on increased costs to consumers

Our survey of manufacturers at the end of 2022 showed 59% of respondents expecting to go through price increases for the second time that year. Customers can be understanding of the need for a price increase when the reasons for this are clear, although there is sometimes an expectation that the pain is shared through the chain of suppliers. However, cost increases can only be passed on so far before volumes drop, so thinking through pricing and negotiation strategies can help with this approach.
 

Adding value or differentiating product

Consumers are increasingly discerning about how and where to spend their diminishing disposable income. For instance, they are consuming less in pubs and restaurants, opting instead to spend more time entertaining at home. Nonetheless, opportunities do exist for those businesses that offer a high-quality or innovative experience.

Take for example the recent sale of Hickory’s restaurant to Greene King. Founded in 2010 by Neil McDonnell, Hickory’s is an American style, family-friendly smokehouse and BBQ restaurant with a strong focus on food quality and authenticity. Hickory's highly differentiated proposition - that includes chef’s tables, milkshake bars, cinemas and children’s play areas - ensures that guests of all ages and demographics are catered for.
 

Focusing on efficiency savings

Food producers’ and distributors’ desire for efficiency through new technologies and automation has never been greater. Examples include the growing sophistication of picking software, which businesses use to reduce the time needed to prepare deliveries and avoid shipping errors.

We have also seen continued investment in modern vehicle fleets for food distribution businesses and energy saving technologies for food producers such as solar panels or anaerobic digestion plants. These investments cut costs but also bolster the business’s ESG credentials, something that is increasingly expected by both consumers and investors alike.
 

Substituting the product

The squeeze on consumer spending presents opportunities to businesses that are able to innovate and adapt. In food service, for example, menu re-engineering has had a resurgence of late. The aim is to provide a similar output in terms of costs and volumes using cheaper processes, ingredients or brands - and possibly more local or seasonal produce. Increasing demand for menu innovation around 'free from' alternative offerings also provide opportunities to be creative, nimble in buying and to get ahead of these trends.
 

Maximising available cash support

Food and drink businesses innovating in the face of inflationary pressures should carefully consider whether they qualify for certain R&D reliefs. There are two schemes to consider: the more generous SME scheme, and the Research & Development Expenditure Credit (RDEC) scheme for larger companies, contracted R&D or subsidised R&D. Depending on the accounting period, the benefit could be as much as 33% of the qualifying spend back in cash. Grant funding is also available but can be difficult to track down and time consuming to apply for.

In May 2023, the IMF updated its forecasts to predict that the UK will no longer enter a recession in 2023 and will experience modest growth of 0.4% growth over the year. Inflation is expected to fall back to 5% by the end of the year and below 2% by the summer of 2024 as energy prices fall.

These are just forecasts and many commentators think inflation will be more stubborn. It is unlikely that there will be a return to near zero interest rates and sub 2% inflation that we have seen for much of the last decade. Food and drink businesses will need to adapt to this new reality.
 

M&A opportunities abound in food and drink

Despite the challenges of inflation, the industry continues to show remarkable resilience. The UK food and drink industry is wonderfully diverse and highly fragmented in certain subsectors. These present ample opportunity for consolidation to take place.

Investors and corporates are keen to make acquisitions across the industry, with corporates seeking growth in revenues and economies of scale, and private equity a dominant force. Our own research shows that private equity activity across all sectors surged by 15.2% in the first quarter of 2023. We saw 106 deals, up from 92 in Q4 2022. PE also accounts for 17% of total transactions, the highest proportion for two years.

Recent examples of transactions in the food and drink sector include the sale of pizza dough producer Millennium Dough Company to Aquilla Food Group, the acquisition of Thomas Ridley Foodservice by Bidfood, and LDC’s investment in East Anglia-based milkshakes business Shaken Udder to name but a few.

In an era of rising prices and severe pressure on profit margins, the rapid identification of inefficiencies, potential cost savings, innovation, and the pursuit of a clear well-conceived and thought through strategy have become even more fundamental to companies wishing to grow and prosper.

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