The Cross of Food and Energy Costs

At the National Democratic Convention in 1896, presidential hopeful William Jennings Bryan famously spoke against the country's adoption of a gold standard by arguing that this anti-inflation policy would threaten the livelihoods of farmers and other debtors. In his hyperbolic conclusion, he declared, “You shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold.”

Foodservice operators today might be forgiven for seeing a certain parallel to that issue in the impact that increased volatility in food and energy costs has had recently on their own purchasing power and on that of their customers.

Even as so-called “core inflation” (which discounts food and energy costs) remains tame by historical standards (in 2010, the Consumer Price Index rose only about 1.5 percent), rising food and energy costs have played havoc with foodservice pricing models and have drained significant amounts of the discretionary income that consumers might otherwise spend on foodservices.

The relationship between food and energy is especially insidious. One reason is that ethanol production increasingly competes for corn supplies. Another is that food production and distribution by their nature are highly energy intensive.

The end result is that food manufacturers and suppliers are feeling intense pressure to raise food prices even as consumers, facing their own “non-core” inflationary pressures, are looking for more food value. Operators are caught in the middle.

You can see the impact of this volatility in the two accompanying charts. The first (from the American Institute for Economic Research) shows how food commodity price volatility has increased in recent years, reaching near historical levels. The second chart (courtesy of sister publication Nation's Restaurant News) comes from securities analyst Chris O'Cull at Sun Trust Robinson Humphrey and shows the impact food cost inflation is likely to have on specific types of restaurant concepts.

In many ways, price volatility is more difficult to manage than simple price increases alone. In this regard many onsite operators have more menu flexibility than restaurant chains that can be more highly dependent on individual commodity prices. But they face the same threat when consumers have less money to spend.

The reasons for the volatility overall are complex and global. Now and in the future, they are related not just to weather patterns and crop yields but also to demand for both food and energy in countries like India and China where living standards and populations are rising fast.

The long-term implications are much more serious for developing countries in Africa and Asia, which often have government policies that are counter-productive to increased domestic production. There, hunger and starvation result.

The long and short of it is that there is good reason to believe that we will see more of this sort of volatility in coming years. Wise operators will think long and hard about the ways their menus and operations can be structured to adapt to such pressures as they occur. They are not going to go away.

Restaurants' Commodity Battle

Expected percentage commodity inflation by segment

Source: Chris O'Cull, Sun Trust Robinson Humphrey Research; American Restaurant Association, April 2011