Inflation is cooling, but key costs pose a challenge for food and beverage companies

The U.S. economic landscape continues to stabilize as inflation eases and consumer spending remains resilient despite high interest rates and a tight labor market. Falling inflation has provided some relief for businesses as input costs normalize; however, prices for some key commodities in the food and beverage space remain elevated. While consumers continue to show a willingness to spend, their shift-to-value mindset—embraced over the past two years of high prices—has endured. 

As inflation continues to ease, pressure on manufacturers from retailers and consumers to reduce prices will intensify, limiting opportunities for food and beverage companies to recover profitability lost during the recent sustained periods of high inflation. This pricing pressure, coupled with stubborn input costs, will challenge profit margins and inhibit growth for middle market businesses attempting to offset thinner profit margins by driving sale volume.

Producer prices rose at an accelerated pace in the second half of 2021 and throughout 2022. It wasn’t until earlier this year did the producer price index for finished consumer goods begin to ease, recently falling to .2% in September from the two-year peak of 16% in July 2022. September marked the eighth consecutive month in which producer prices rose at a slower pace than consumer prices for both food at home and away from home. Consumer prices rarely rose faster than producer prices in the previous two years, but the trend reversed in early 2023, fueling consumer expectations for price cuts. 

Even as producer prices recover, other critical costs, including transportation, warehousing and labor, remain expensive compared to pre-pandemic levels. While the growth of such expenditures has slowed, it does not alleviate the challenge they pose to food and beverage companies developing growth strategies in a challenging cost environment. The longer-term impact of inflation will continue to weigh on food and beverage companies, paying nearly 23% more for warehousing and approximately 11% more for freight in September than two years ago. 

Consumers are still spending, but carefully

Consumers’ focus on value—adopted during the pandemic to manage household budgets while juggling skyrocketing prices at grocery stores—has not abated. We continue to see expansion in the private-label goods space due to the popularity of their value proposition, with many big-box stores and large grocery chains consistently announcing new brands or expanding lines of existing private label products.

According to an analysis performed by Circana and Coresight Research, private label brands made up 17.3% of all food and beverage sales through June of this year, up from 17.0% in 2022 and 16.2% in 2021. Shoppers who already have a keen eye for discounts and more affordable private labels will now anticipate steeper price cuts given the disinflationary environment we have entered.

These pricing pressures, coupled with stubborn costs, will erode the profit margins of middle market businesses that cannot drive volume and implement effective cost management strategies in an environment where it will become increasingly more difficult to pass on costs to consumers. 

So what can middle market companies facing slimmer profit margins do to compete?

Growth and savings through M&A

Building customer loyalty and focusing on brand strategy are paramount to driving volume to offset falling price expectations. Top-line sales growth has been primarily fueled by price hikes in recent years; however, as volume declines and consumers push back on pricing, some producers are starting to see a pullback in their retail sales activity. Promotional activity and discounting are pivotal to driving sales volume, but M&A offers a unique opportunity to strengthen key market segments and expand into more profitable target sectors.

The second quarter of 2023 saw some improvement in what was previously a fairly quiet M&A market in the food and beverage space. High interest rates will continue to present a headwind for food and beverage companies seeking growth through acquisitions. However, we have seen multiple proposed or completed consumer-packaged foods and grocery transactions. Acquiring strategic targets can help businesses optimize their product portfolios to maximize profitability, especially in add-on deals, which often provide more seamless integration.