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    Commodities in Crisis

  • Last year’s historic drought is placing lasting pressures on operators as commodity prices jump.

    It was a dark day in September when Britain’s National Pig Association broke the news that pork products—including everyone’s favorite, bacon—would soon become a luxury because of dwindling pork supplies from the ongoing drought in the U.S.

    Though consumers around the world were left clutching their pearls, it was much ado about nothing, as economists and commodity experts quickly debunked the theory. But the media hype did turn a lot of eyes—both consumers’ and foodservice industry insiders’—to the real issue at hand: rising commodity costs.

    Largely because of 2012’s severe drought in the Midwest and other parts of the U.S., it’s become widely accepted that wholesale price increases for animal products like meat, eggs, and dairy are unavoidable. But just how serious the problem is and how detrimental to quick serves’ bottom lines it will be has yet to be seen.

    Suffering through a dry spell

    What started as a promising year last spring, with a record corn crop in the ground, quickly turned to devastation as Midwest farmers saw little to no rain through the summer and fall.

    “We were looking at a 20–25 percent reduction in the original forecast for both [corn and soybeans last year],” says Ricky Volpe, an economist with the Economic Research Service for the United States Department of Agriculture (USDA). “This, of course, has an impact on prices, because it’s a reduction in supply.”

    When natural disasters like droughts strike, corn prices skyrocket, making it more difficult for ranchers to feed their animals, experts interviewed for this story say. To stay above water financially, ranchers are forced to liquidate herds, sending them off to slaughter much sooner than usual. While this momentarily causes an increased supply and drop in prices for items like pork and beef, it’s quickly followed by increased prices as supply fades.

    Because it takes up to two years for farmers to raise, fatten, and send cattle and swine to slaughter, a drought can cause trouble for months and even years to come. “Until such a time that feed prices come down to a point where the producers are making money again, there’s going to be no incentive for them to expand production,” says John Barone, CEO of New Jersey–based Market Vision, a restaurant commodities consulting firm. “You’re in a tight supply situation going forward, and that’s the drought’s biggest impact this year.”

    Since food costs are such a large burden for restaurants, rising commodity prices can directly affect a brand’s bottom line in a dramatic way.

    “When you think about a typical restaurant-industry sales dollar, roughly a third of that goes to cover operator-direct purchases of food and beverages,” says Hudson Riehle, senior vice president of the National Restaurant Association’s (NRA) Research & Knowledge Group.

    “When it’s that large a proportion of operating costs, even modest increases can result in operators needing to reengineer not only their internal cost-operating structure, but also their menu.”

    Protecting the customer

    Though experts expect a share of the resulting price increases to be felt by everyone along the supply chain—including producers, suppliers, operators, and even consumers—many chains are battling to keep the burden off consumers’ shoulders.

    “Normally the way that you deal with commodity costs in the restaurant industry is to raise prices. It’s something that every restaurant has always done and it’s how you keep up with inflation, it’s how you keep up with increases to minimum wage, and it’s how you keep up with increased commodity costs,” says Andy Puzder, CEO of CKE Restaurants, which owns the Hardee’s and Carl’s Jr. brands. “The problem now is that the economy is in such distress that it’s difficult to raise prices.”

    While brands need to tiptoe around price inflation to keep consumers happy, traffic counts up, and sales strong, raising prices may be a challenging but necessary evil. “In the more modest economic environment, obviously operators can’t pass through on a one-to-one basis what happens with their higher input costs,” the NRA’s Riehle says. In fact, while wholesale food prices were up 8.1 percent in 2011, he says, menu prices were only up 2.3 percent.

    Larry Reinstein, president of Charlotte, North Carolina–based Salsarita’s, says the brand will try to hold the line as much as possible when it comes to price hikes, but will likely have to raise prices. “The key is to be modest and strategic, because we want to continue to deliver the best value we can for our guests,” he says.

    Reinstein says the lag time between when the drought took place and when the market will see its pricing effects poses an additional obstacle. “People’s memories are short, and the drought happened this past summer,” he says. “By the time a lot of the effects of what happened with the drought takes place, … I just wonder if the consumer is going to realize what’s going on as restaurants and supermarkets and everybody else is forced to raise prices.”