Different approaches taken to navigate rising food costs

Aug. 6, 2012 | by Valerie Killifer
Different approaches taken to navigate rising food costs

While some fast casual brands have relied on menu price increases to offset higher food costs mostly brought on by a widespread drought, some QSRs seem to be avoiding hikes and shifting their focus elsewhere.

Panera Bread and Chipotle both discussed their menu price increases during recent earnings calls, citing the rise in food costs along with an overall economic slowdown.

Although such a strategy helps companies keep up with food inflation, The Motley Fool analyst Jason Moser said restaurants must be mindful of how those increases come across to consumers.

"Chipotle and Panera both possess some pricing power thanks to the quality of the food and experience. As such, they are able to pass along incremental price increases that customers will pay; however it's a fine line they must be careful not to cross," Moser said.

Panera Bread's co-CEO Bill Moreton said in a call that while the company has increased menu prices, the increase is not a "significant" price beyond the rate of inflation.

"What we have seen and what we have done is we've continued to offer people products that they get to choose and that they believe is worth the money we charge for that," he said.

In the case of Chipotle, the menu price increases helped the chain balance rising costs in other areas. Food costs in its 2012 second quarter were about the same as Q1, but were lower when compared to the same period last year "due to higher menu prices."

QSRs taking a different approach

Meanwhile, the lower price-point quick-service segment seems to be holding off passing higher food costs onto consumers.

For example, Dunkin' Brands' CEO Nigel Travis said the company experienced sales gains in Q4 2011 and Q1 2012 because of its strategic menu pricing initiative. However, a same-store sales rise in the chain's most recent second quarter was achieved through no such measures as franchisees have generally held pricing steady.

McDonald's also is taking advantage of its value proposition with a heightened focus on its $1 menu and cheaper commodities such as chicken.

"McDonald's loves these tight times as its right in their wheelhouse as a value-oriented proposition," Moser said. "People will trade down when money is tight and this is when restaurants like Panera and Chipotle need to be careful how they pass on price increases. Too much will send some of their customers elsewhere, making it tough to get them back."

McDonald's has pushed the key words "Branded Affordability" for the past couple of quarters. In its most recent Q2 earnings call, chief financial officer Peter Bensen said the company is employing different tactics to increase the emphasis on value in the short term, which is a "critical element" of long-term sustainable growth.

The company expects the food-away-from-home inflation index in the U.S. to be up 2 percent to 3 percent this year.

"If it ends the year closer to the bottom end of the range, we may have a little less room to take pricing in the back half of the year," Bensen said. "As always though, we will be thoughtful with future price increases speaking to maintain positive guest counts."

Rising food costs

A major factor driving menu price increases across the restaurant industry is the rise in food costs – specifically in regard to corn, which drives up beef, poultry and dairy. Much of this is the result of the country's largest drought since the 1950s. According to the National Climatic Data Center, about 55 percent of the country experienced at least moderate short-term drought in June for the first time since December 1956.

To get a bigger picture of the current commodities market, Bob Bresnahan, founder of Chicago-based Trilateral Inc., said the U.S. was on target to produce in excess of 14 billion bushels of corn this year. However, that number has been reduced to just under 12 billion bushels, which will continue to impact food costs into the fourth quarter and possibly 2013.

The dry weather has also caused wheat prices to jump more than $2.50 in less than a month which has particularly affected the pizza segment as cheese remains volatile as well.

During Domino's most recent earnings call, CEO Patrick Doyle pointed to India as a good example of higher commodity prices. The company's franchisee in that country announced they have taken some price increases to offset that pressure, he said.

Additionally, an unknown variable in costs is the role China will play on the U.S. food supply.

If China decides to purchase its pork from the U.S., rather than import its supply of corn and soybean meal used as feed, the pork supply available to U.S. restaurant operators could be diminished.

Additionally, China is expected to import 3 million tons of corn in the 2011/2012 market year, more than triple the amount for the same period last year. The substantial increase is based on China's population eating more meat than in previous years' and its industrialization, which has decreased usable land for crops.

Alicia Kelso contributed to this story.

Read more about operations management.

Topics: Business Strategy and Profitability, Cheese, Domino's Pizza, Equipment & Supplies, Financial Management, Operations Management, Trends / Statistics

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