Food and drink price rises: Frequently asked questions
12 February 2023
The FDF's lead economist Dr Liliana Danila answers the most frequently asked questions on food and drink price inflation.
- Why is the price of food and drink rising?
Three structural shocks have hit the food and drink manufacturing over the last six years: leaving the European Union, the pandemic and the war in Ukraine. The result has been a higher cost of doing business, both financial and non-financial.
Brexit has increased the non-trade barriers and introduced a significant amount of red tape. This has made it more costly for businesses to either import ingredients or export their products.
The pandemic led to a surge in input costs due to a range of different factors including:
- the strong recovery in food demand which saw above-average demand for animal feed and agricultural products for industrial use, especially from China;
- depreciation of the pound which has increased the cost of essential imported ingredients and raw materials;
- adverse weather events that have impacted production of key agricultural commodities;
- rising fertiliser prices that have contributed to higher farm-level production costs; and
- disruption in global logistics including the blockage of the Suez Canal in 2021 which caused freight costs to rise sharply.
The war in Ukraine has exacerbated existing inflationary pressures, causing significant additional disruption to global grain, sunflower oil, fertiliser and natural gas markets. Increasing global commodity prices result in higher costs of ingredients, packaging and energy, each of which drive up the cost of manufacturing. It also affects the price of transporting goods, both within the UK and where they are traded internationally.
Food and drink companies face increasing energy bills, increasing operating costs and increasing labour costs. Businesses do everything they can to absorb cost increases, but in a sector that typically operates on low margins, it is simply not possible to do this when there are sustained increases in the cost of production. As a result, these increases will eventually feed through to higher prices on shop shelves.
- Why does it take time for falling commodity prices to be reflected on shop shelves?
Retail prices tend to move slower relative to underlying raw material costs. The time lag which exists between commodity prices and retail prices is often the result of fixed-term contracts with suppliers (forward buying) and the use of futures contracts traded on commodity exchanges (hedging).
Food manufacturers can lock in commodity prices for up to 12 months, long enough to cover a season of bad weather but short enough for underlying demand changes to feed through.
The combination of weak pound and commodity prices remain high, affected many businesses in our sector, and SMEs who make up 97% of our sector will be most immediately impacted.
Manufacturers are doing their best to mitigate the worst effects of rising costs through greater efficiency including reducing their use of energy, water and packaging, reformulating recipes, forward buying and hedging arrangements. But there are limits to what can be achieved by such actions. With no return to more normal market conditions in sight, it is inevitable that increased production costs will pass through the supply chain and will eventually reach consumers.
- When will food and drink retail prices come down?
Global commodity prices were rising long before Russia’s invasion of Ukraine and soaring inflation impacted the UK economy. The war has added further pressures. Ukraine and Russia were significant global suppliers of wheat, other grains and sunflower oil, and Russia was a major player in the fertiliser and natural gas markets.
All of this means the costs of everything that is needed to make food, including ingredients, raw materials and energy have increased. Given the time lag involved in changing production costs experienced by producers feeding through to consumers, it is likely that retail food prices will remain elevated throughout 2023.
Food and drink companies are doing everything they can to contain inflation and to limit price rises for hard-pressed households. Energy accounts for a significant proportion of business costs, so the extension of the UK government’s support package is a valuable lifeline.
We continue to engage constructively with the government and have set out low cost and high impact measures that we think can help curb inflationary pressures, in particular by ensuring the government’s planned regulatory activities avoid introducing further unnecessary costs that would further impact UK manufacturers.
- What is the biggest driver of food and drink retail price inflation?
Over the past 20 years agricultural prices have doubled, due to weather and climate conditions, as well as the price pressures of global supply and demand. During the same period, food and drink manufacturers have worked hard to keep costs and prices down. This has been through managing currency risks, investing in technology and streamlining the way food is transported, stored and distributed. As a result, prices have only increased by half even as agricultural prices have doubled.
In a highly competitive retail environment, major retailers have significant market power to place downward pressure on wholesale prices, meaning the profit margins for many food and drink manufacturers have remained tight, particularly among small and medium sized enterprises (SMEs). Manufacturers may not have always liked this situation, but consumers have benefited through competitively priced food.
Food and drink production costs are not limited to agricultural raw materials but will also include labour, energy, packaging and transportation. In a fast-moving consumer environment, food and drink manufacturers invest heavily in research and development (R&D) and their brands to address changing consumer needs. The cost of a finished product will therefore vary depending upon the level of added value, whether it is labour or capital intensive, or requires more or less energy.
Energy prices have been soaring since the summer of 2021. Many food manufacturing processes are gas-intensive and spiralling energy prices have left many businesses vulnerable. Additionally, food and drink manufacturers are facing big rises in standing charges and being asked for sizable security deposits to guarantee supply.
- Why are increasing food and drink retail prices hitting the poorest households hardest?
In the late 1970s, more than a quarter of total household expenditure went to food and drink. This had fallen to an average of 11% by 2019. However, this does not mean that food is equally affordable for all. The poorest fifth of the population by contrast spend over a third more of their household income on food and drink. As such, increased retail prices will disproportionately impact lower income households.
Rising inflation means the average UK household is spending more of their budget on food and drink, alongside rising energy bills, transportation costs, rents or monthly mortgage payments.
While all families have seen a marked increase in how much they spend, the pressures are weighing most heavily on the poorest households, leaving them with invidious choices between heating and eating. The 10% of the UK population on the lowest incomes spent approximately 18% of their disposable income on food and non-alcoholic drink in 2020-21, up from 14% in the previous year, whereas the wealthiest spent 12%. With current food and drink inflation rates accelerating upwards, it can be assumed these figures will have deteriorated further.