In the spotlight – Rising costs, hiding in hedges
Rising raw material costs have been a feature of numerous companies' results over the past few months. As Jessica Harvey writes, some companies have been able to bolster themselves against this trend by hedging. The longer the rising cost pressures persist, however the more difficult the situation will become while companies prepare to find out how consumers will react to the inevitable rises in retail prices.
In any business where a product is being processed, be it food, clothing, cars or any other, the problem is the same - the rising cost of raw materials is hitting profit margins hard. The drinks industry is no exception as has been evidenced by the plethora of creaking financial results issued in the last month. Raw materials - malt, barley, packaging, glass, aluminium and transportation - the prices of all of these are heading skyward.
Despite the fact that many businesses hedged their positions on such commodity costs, many of these hedges go forward only six to nine months, and, as the upward pressures have been a reality for some time now, we are now coming to the end of what most might have saved for a rainy day.
The pattern has become all too familiar on the pages of just-drinks in the last month as quarterly results poured in. Almost without exception, it seems every company has noted that rising raw material costs have impacted on its results. Even those that have performed well warn that price hikes are certain to make an impact in the coming months.
Over the past few months, higher malt, aluminium and packaging costs have forced the hand of Japanese brewers such as Kirin, Asahi and Sapporo, which have all indicated that prices have exceeded what they can absorb through cost savings.
Troubled C&C Group has declared that rising raw material costs will lead to pressure on its margins going forward, while SABMiller's Czech brewer Plzensky Prazdroj raised beer prices by between 6% and 8% last month after prices for malting barley and hops rose on the European market. Budejovicky Budvar will follow suit, upping its prices by between 4% and 6% next month.
Similarly, across the water, Nick Caporella, chairman and CEO of National Beverage Corp., described the rising costs as "unprecedented", noting that some were up more than 20% to 40% from last year. Meanwhile, Anheuser-Busch also admitted that commodity cost pressures have "made their presence felt" this year.
The pattern taking shape is not region-specific, nor does it only affect brewers. It appears to be happening across the entire drinks spectrum globally. The trend suggests that if raw material prices continue to rocket, a swathe of retail price increases is inevitable. Next year promises to be an expensive one for the consumer, with brand loyalty tested more than ever before.
Retail price inflation could have implications for the drinks industry's favourite trend - premiumisation. Premiumisation is after all about persuading consumers to spend more, and in the current cost climate this is certainly something companies will have to do.
Indeed, one analyst takes a particularly cynical view suggesting that marketing new products to consumers as finer goods and superior qualities is simply a "smokescreen" for sneaking in higher product pricing, and defraying rising costs.
"People are prepared to pay more for what they perceive as a finer product. So you get promotions and levels to work up to, and they are able to sneak some of the price increases through to the consumer," the analyst explains. "If you asked any company, they'd say no, they don't do it. But I would say, yes they definitely do.
However, another analyst disagrees with the idea that there is a connection between rising prices and premiumisation. "Premiumisation has been happening over last 20 years and is not a short-term reaction to cover costs of rising raw materials," he says. "I wouldn't say it is directly linked. However, I will agree that it is interesting that both Diageo and Pernod Ricard have decided to raise their pricing recently."
Even if one disagrees that premiumisation and cost inflation are not directly linked, the longer the current cost trends persist the more grounds there will be for suspicion. Intuitively, one would have to agree that introducing some new packaging or re-branding a product in some way is an extremely convenient way to pass on a price hike to the consumer.
What is certain, however, is that the longer the rising costs trend goes on, the more awkward it is going to become for companies. Even those that have anticipated the cost increases and prepared themselves better cannot hedge forever.
Meanwhile, however companies attempt to justify retail price increases - be it through communicating the rising cost pressures or premiumising existing products - the $64,000 question is, how will consumers react once the full extent of the rise in raw materials filters through to the market?
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