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BLOG: Headline inflation figures mask the complex food price challenge

Paloma Kubiak
Written By:
Paloma Kubiak

The key drivers of high inflation over the last year have been surges in energy and food prices, and while wholesale energy costs have fallen significantly since their peak in summer 2022, food prices continue to rise at a rapid pace. Here’s why.

With inflation in the UK remaining persistently high, the cost-of-living crisis shows no sign of easing in the short term.

The headline inflation rate stood at 10.1% in the year to March, but food price inflation over the same period was 19.2% – the highest reading in 45 years.

While the energy price situation has been widely discussed, the particular factors driving food price inflation are less well understood. There are also large differences between the inflation rates for different components of the food price basket.

For instance, the price of milk has risen by 40% over the last year (source: ONS), while eggs and cheese have also seen large price increases. Yet, the price of items such as chocolate and fresh fruit have risen at a much slower rate.

It seems several powerful factors are largely responsible, impacting each stage of the food supply chain – all the way from farm to fork.

The squeeze on cheese

The dairy industry – which has witnessed particularly dramatic price increases over the last year – illustrates these factors well, as dairy products are commoditised, offer thin margins, and involve several different processes in their manufacture.

At the farming stage, the war in Ukraine has had a substantial impact on raw ingredient prices. As a major exporter of food – particularly grains – Ukraine’s supply chains have been massively disrupted, driving up prices globally. Milk prices are highly sensitive to the price of cattle feed, which is generally made from wheat and soy – pushing up costs for dairy farmers.

High energy prices impact every stage of the food supply chain. For dairy farmers, milking equipment needs to be washed thoroughly at high temperatures, then the milk itself must be cooled and transported in chilled trucks to onward processing or bottling, increasing the impact of high energy prices further.

In terms of manufacturing, dairy products such as cheese need several other energy-intensive steps. To produce cheese, milk is re-heated, turned into curds and processed further, then cooled again and kept chilled post packaging. As 1kg of cheese typically requires 10kg of milk, the energy cost effect is multiplied across all these stages. Butter involves similar processes, with 20kg of milk required to produce 1kg of butter.

Of course, these effects are multiplied with more complex food products involving several ingredients. For example, a pie made with meat, vegetables and pastry experiences the cost increases of the individual components, but also the rising costs associated with assembly, cooking, chilling and delivery to the end retailer.

The input costs associated with packaging have also increased. Drinks maker Fever-Tree recently warned it is facing rising costs in the production of glass bottles, given their energy-intensive manufacturing process – the glass for each bottle must be heated to a white-hot melting point of about 1,500°C. The secondary effects of inflation impact the supply chain too – as prices rise, employees’ demands for increased wages drive up labour costs at every stage of the process.

Finally, costs for the end retailer are also rising – particularly energy and wages. Supermarkets are typically quick to respond to changing prices, passing on cost increases to consumers to protect margins. However, with consumers increasingly opting for discount options amid the cost-of-living crisis, there are clear incentives for supermarkets to reduce additional costs where possible to protect market share.

Curbing costs

With high energy prices continuing to create difficulties for businesses, and Government support remaining uncertain, retailers and manufacturers are naturally exploring ways to mitigate cost increases.

According to a recent report from PwC and Make UK, more than half of manufacturers are pricing increasing energy costs into their end products, while 36% are reviewing their energy procurement strategy. In fact, 39% of manufacturers are introducing new green onsite energy generation, and we see this as a powerful trend among retailers too.

In the current climate, producing energy onsite can offer a discount compared to buying from the National Grid. We believe large manufacturers and retailers are well placed to take advantage of their abundant rooftop space by installing solar panels.

With big businesses under pressure to lower greenhouse gas emissions, onsite renewables can play a part in helping retailers reduce their carbon footprint. They can also provide greater security of energy supply, which is vital at a time when 60% of manufacturers are anxious about blackouts.

Some businesses may be concerned about the high initial cost of this approach to energy generation, especially given interest rates and running costs are high.

However, there are some innovative approaches entering the space that can offer fully funded solar installation with no capital expenditure for businesses. One of which is through power purchase agreements, without upfront costs for the solar infrastructure itself, delivering lower-cost, clean energy.

With food price inflation set to remain sticky and elevated energy costs continuing to squeeze margins over the coming months, businesses throughout the food supply chain should consider how to best integrate these solutions to mitigate the impacts of rising prices.

Ben Green is principal at Atrato Group