September 12, 2016
“A steady decline in food prices has delivered a mixed bag for the economy, providing consumers with more disposable income but crimping the already narrow profit margins of grocery operators. If these low prices persist, grocers will see margin pressure, but may adapt by focusing more on higher-margin prepared foods and refining their supply chains.”
- Anthony Buono, Chairman of CBRE’s Global Retail Executive Committee
Key Takeaways
- Food prices have declined steadily over the past year and in July reached their lowest point since April 2014, according to the Consumer Price Index (CPI).
- Continued low prices pose a threat to grocery store profit margins and are expected to impact several major grocery operators’ earnings over the remainder of 2016.
- Consumers, on the other hand, are benefitting from lower grocery bills; much of these savings are likely to benefit restaurants and other retail categories, as consumers shift spending elsewhere.
- Although prices will likely rise in the future as domestic supply adjusts to lower demand, heightened industry competition and growth in e-commerce will continue to exert pricing pressures. Grocers must consider strategies to adapt to these ongoing margin pressures, including supply chain adjustments and more focus on higher-margin areas like prepared foods.
What is driving declines in U.S. food prices?
- Reduced global demand: Demand for food supplies in large markets like China has declined, as the strength of the U.S. dollar makes it more expensive to import U.S. goods. Meanwhile, production among domestic suppliers has continued apace, contributing to a rise in the U.S. food supply and a lowering of prices. These price declines are primarily affecting fresh food categories like dairy and meat products, which are currently in high supply and must be sold quickly.
- U.S. consumer spending shifts: In recent years, U.S. consumer spending patterns have shown a shift from goods to experiences. In the food & beverage category, restaurant sales outperformed grocery sales for the first time in 2015 with growing consumer interest in dining out.
- Intensifying grocer competition: Price wars between grocers have risen in recent years, as companies fight to defend and grow market share. Traditional grocers and supermarket operators are diversifying formats to widen their consumer reach, including small-format concepts to capture urban market growth and low-price stores to appeal to millennials. The recent arrival of international discount grocery chain Lidl, whose business is built on a low-cost offer, puts further downward pressure on food prices.
Consumers:
- Lower prices at the supermarket mean more money in consumer pockets and greater consumer confidence, which will likely translate to higher spending in other categories.
- Retail and restaurants in particular tend to benefit when consumers realize savings in other categories. A study of consumer gasoline prices released by the JPMorgan Chase Institute in July 2016 found that households spent approximately 34% of gas savings on non-gas goods and services[1]. Of those categories, restaurant and retail sectors saw the greatest spending increase.
- The downward trend in food pricing places further pressure on revenues in a grocery industry notorious for its low profit margins. Several of the nation’s large grocery and supermarket chains have lowered earnings outlooks for the remainder of 2016, citing “food deflation” as a key pressure point.
- Although domestic production may be slow to meet trends in demand, the pressures of grocer competition and consumer spending shifts will likely continue to exert pressure on food prices.
- One avenue for grocer growth in the face of low food prices is more focus on prepared foods. The “grocerant” trend—a move towards more prepared foods and some full-service restaurants within grocery store and supermarket formats—enables grocers to incorporate a higher-margin business with greater markups while tapping into consumers’ rising interest in all things quick and convenient. Explored in CBRE’s recent ViewPoint report, “Restaurants: Now Serving Retail Growth,” sales of prepared foods at grocery stores have risen significantly over the past 10 years; grocer sales of prepared foods are expected to reach $30.8 billion by the end of 2016—more than double the $15 billion generated in 2005, according to a study released by Technomic and cited in the Wall Street Journal[2].
- Whether food prices rebound or remain near historical averages, grocers will need to remain vigilant about volatility in supply chain and logistics costs to protect profit margins. Future shifts in transportation modes, price and capacity could raise costs and require grocers to increase consumer food prices or further expand into higher-margin categories like prepared foods. Additionally, future growth in grocery e-commerce could introduce new costs, requiring supermarkets to establish and maintain efficient delivery operations. For now, e-commerce penetration in the grocery category remains low, but shielding margins from potential e-commerce growth will be key.
[1] “The Consumer Response to a Year of Low Gas Prices,” JPMorgan Chase & Co.Institute, July 2016. https://www.jpmorganchase.com/content/dam/jpmorganchase/en/legacy/corporate/institute/document/jpmc-institute-gas-price-response.pdf