Where Do Grocery Prices Come From?
Food retail prices are going up. The corporate consolidation and profiteering behind these inflationary pressures gives us the opportunity to examine how pricing decisions are made, what factors are used to determine prices and what this all says about our food system. But let’s start with where prices come from.
Prices are set by either retail category managers or pricing analysts according to their category role (competitive, destination, innovation, etc.), market intel, demand elasticity and the corresponding gross margins and sales targets. Any given retailer will have dozens of product categories based on particular purchase occasions, such as milk, yogurt, snack bars, citrus, berries, etc. These staff who negotiate prices with suppliers are accountable to financial targets set by executives. Pricing strategy is a major tool these workers use to achieve or exceed these expectations, lest they lose their jobs. Pricing is skilled work, akin to high stakes gambling with spreadsheets and algorithms.
One basic pricing example is store brand milk, a highly competitive, known value item also subject to some levels of federal and state pricing regulations. Milk is typically priced at low single digit or negative margins to match pricing with every other retailer selling the same stuff in their own brand, such as Lucerne, HEB Select, Good & Gather, or 365. On the other hand, a local, pasture-raised, cream-top, low heat-pasteurized milk will more likely be priced with margins in the 20’s or higher, because it is considered premium and retailers assume customers will tolerate a higher price. The goal here is that the blended average of unit sales and margin rates across all milk sku’s in the category will yield the desired gross margins.
Likewise, a Greek yogurt may be priced low to move volume and create value-perception. But independent of item-level costs, a plant-based, cashew yogurt may be priced higher because customers are willing to pay more for innovative dairy free items. The blended margins derived from the millions of yogurt cups sold daily and their respective margin rates means that yogurt category margins are typically higher than milk, usually in the 30’s. When you zoom out with this same concept across a store with tens of thousands of products, you can gauge the impact of pricing on retailer profitability and sales growth.
Next step upstream for pricing is wholesale. Retailers typically contract with wholesalers to supply them with many products they sell; brands and growers rarely deliver directly to chain stores. Sometimes the wholesaler is a cost center, and a vertically integrated division of the retailer. Much of the time a wholesaler is a for-profit, third party company, either publicly traded, privately held, or cooperatively owned by its members. Respective examples include UNFI, C&S, and Wakefern. The wholesaler carries what retail customers will stock. They derive revenue from selling those products, both through wholesale markups downstream to retailers, and through promotions, advertising and chargeback programs upstream to brands. Due to lack of enforcement of Robinson-Patman, bigger retailers command better costs and better inventory and assortment priorities. Wholesale retail markups can be as low as 2 or 3% in such mass market operations, or up to 25 or 30% for specialty wholesalers. Most often, the wholesale markup is around 5-15%.
Proceeding upstream further, both CPG brands and produce growers, for example, sell their products to a given wholesaler based on what the retailers think customers want. A fruit or vegetable grower will set a case rate price for their carrots, squash or apples depending on what the market will bear, what will cover their labor and overhead, and what wholesalers are willing to accommodate. Growers hope to achieve price parity, where the price they receive covers their operating costs and profits, but that is not always the case. Yet all growers and brand owners also benefit from underpaid and exploited farm labor. Domestic farmworkers are not protected by New Deal-era labor protections, such as overtime pay and collective bargaining. The cost of farmworker labor and how it is factored into retail pricing is much lower than the value that farmworkers contribute to the food system.
For a multi-ingredient CPG company, pricing gets more complicated, and depending on the product, can be much more lucrative. A smaller, emerging brand will likely have higher raw material and production/co-packing costs due to lack of scale and market share. Depending on its stage in the business cycle, such a small brand may not yet be profitable. Their price will be set by estimating what the retailer margins and wholesale markups need to be and what they hope the retailer will set as their shelf price. Also figured is how much trade spend is needed to support advertising and promotions, and what gross margins the brand needs to operate. Pricing for emerging brands can make or break the business; set a price too high to lessen pressure on operating margins and the product may not sell. Set the price too low and the company may miss payroll and go under.
A larger, incumbent CPG company has it much easier, but is yet more complicated. Such companies, like, PepsiCo, Kellogg’s or Mondelez, negotiate large scale raw materials contracts across multiple business units and globalized supply chains. They are able to take advantage of multilateral trade deals and vertically integrated or outsourced manufacturing. They have multiple “buckets” of trade spend that can be allocated across business units to deploy ad dollars to gain and retain customers, as well as fund the expensive slotting, listing and referral fees at mass merchant and omnichannel retailers that optimize placement. Grocery trade spend is a big deal, with transactions of over $225 Billion annually.
But both emerging brands and Big CPG companies factor various elements of cost into their price architecture. As an example, let’s consider a hypothetical line of snack bars made of oats, sugar, soy protein, and a handful of other ingredients. The emerging brand decides to source organically grown oats that are certified glyphosate free, plus organic soy protein and vanilla extract, fair trade sugar and cocoa, and guar gum. The incumbent CPG brand decides that they can undersell the upstart competitor by producing a similar line of products, but with conventional oats, GMO corn syrup and soy, an artificial flavor called vanillin, mass balanced, untraceable cocoa most likely tainted with forced or trafficked labor, and a host of stabilizers, humectants and preservatives to extend the shelf life. The latter product is going to have much cheaper costs, enabling higher margins, bigger trade spend rates and a lower shelf price, probably enabling the Big CPG company to maintain its category dominance despite customer trends pointing towards the emerging brand’s attributes.
Yet this difference in price leads us to a sticky quandary in the supply chain. How are these elements of costs accounted for? Some input costs are pretty standard, such as fuel, shrink wrap, corrugated cardboard, wooden pallets. But what about the ingredients?
Conventional oats tend to be sprayed for weed control upon planting and then again pre-harvest for desiccation, leaving herbicide residue in consumer products. Organic oats typically rely on crop rotation, mulching and other low-tillage practices to reduce weeds and pest pressure, and are not sprayed with probable carcinogens. GMO ingredients like soy and corn are typically Round-up ready, heavily sprayed with glyphosate and other herbicides, or engineered with Bt pesticides in their genomes using viral vectors. These multi-stack traits enable high yields and low labor costs, but also gift us with air pollution and herbicide drift, soil loss, fertilizer and herbicide runoff, algal blooms, polluted groundwater and waterways, Gulf-spanning dead zones, as well as rampant chemical residues in consumer-ready products. And these chemical dependent monocrops crops destined for processing or animal feed tend to be heavily subsidized, with public funds underwriting 20% or more of the income of overwhelmingly white, large scale, land-owning, boomer-aged farmers. These are the externalized cost of cheap food prices.
The downstream environmental, health and economic burdens of these externalities are not factored into the shelf price. They are instead borne by the most vulnerable in society, particularly farmworkers, rural communities and the urban poor. According to a recent study, less than one third of externalized costs are included in pricing. On the other hand, the many environmental, health and community benefits of organic, regenerative and other agroecological systems are not accounted for to lower costs. Sustainability attributes are instead counted as added-values to enable higher mark-ups and profits throughout the value chain, up to and including the retail shelf price, putting such products out of reach of millions of consumers. The good stuff ends up more expensive, despite being much more cost-effective to society and the planet.
Retail price inflation is just the tip of the spear for what’s wrong with our food system. We have the ability ensure good food, clean water, healthy environments and liveable wages for all. But instead, the ongoing food pricing crisis illustrates a system rooted in precarious, transactional relationships and geared towards maximum profit, consolidation and externalized costs. No wonder it is a high-stakes, complicated mess.
