The High Cost of Eating

This is the 40th in a series of brief articles that Moye White is sending to its clients and friends to provide practical insights into opportunities and challenges in today's business and financial world.

Restaurant franchises are feeling the pressure of rising food costs. A few startling statistics highlight the issue:

  • The Sysco Corporation, the largest U.S. food distribution company, reports that accelerating food costs are hampering customer purchases. The produce price index was up 4.5% over the past year, spurred by double-digit inflation for dairy, wheat and most proteins.
  • The trend in U.S. food inflation rates during 2011 is expected to continue to rise. According to the U.S. Department of Agriculture, domestic food prices will jump 3-4% this year, with producer prices continuing to outpace consumer prices.
  • As the world population topped 7 billion, the World Bank’s food price index rose by 15% between October 2010 and January 2011. The World Bank attributes this rise to increases in the price of sugar, fats and oils, wheat and corn. Corn prices alone have increased 73% since June 2010.

Some of the causes of rising food costs, such as regional crop failure and political unrest, may be short-term. However, other big picture drivers, including strong economic growth in developing economies and soaring corn prices as more crops are diverted to biofuels and away from feed and food production, foretell higher food costs over the long term.

How will the food price increases impact bottom lines in the food service industry? Most restaurants will be forced to consider raising prices, compromising margins, or lowering food quality. Small restaurant concepts may be particularly hard hit, as they may have more difficulty procuring food at good prices without the scale of bulk purchasing. Whether a business has one restaurant or a thousand, customers will resist paying more for a product today when it cost them less yesterday, fueled by expectations of low-cost eating through successful marketing campaigns like the Dollar Menu® and the Five Dollar Footlong®.

However, restaurants need not watch their margins or their customer count diminish. Some have responded by changing the mix (like emphasizing salads over sandwiches), day-parts (pushing breakfast in addition to lunch), or food build and specifications. Most have taken a hard look at procurement, changing distributors when necessary, locking in prices though forward purchasing and hedging key commodities, or outsourcing procurement to an independently owned supply chain manager. Finally, some have even explored the possibility of promoting a more expensive product that customers value more, like better burger concepts Smashburger and Five Guys Burgers and Fries.

Moye White LLP has prepared this bulletin to provide general information; however this bulletin does not provide legal advice and does not create an attorney-client relationship between the reader and Moye White. No legal or business decision should be based solely on the content of this bulletin.

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