Wednesday August 17, 2022

Restructuring Advisory Partners, Martyn Pullin and Tony Barrell explore current challenges and opportunities for the food manufacturing sector

Businesses and households alike are facing the highest annual cost of living crisis the UK has seen since 1982. Over the last 9 months, fuel, food and energy prices have pushed inflation rates higher, resulting in recent reports recording the rate of inflation at an eye-watering 9.4%. This is well above the government’s 2% target and the Bank of England predicts inflation will exceed 13% by the Autumn. Supply chain challenges, hyperinflation in raw material costs, rising energy prices and labour shortages, all compounded by the war in the Ukraine, produce an extremely challenging climate within which food producers must operate.

Food manufacturers are seeing the cost for some ingredients far exceed the current inflation rate, with the cost of flour increasing by 36% between March 2022 and June 2022, and pork belly by 26% to name but two. Despite the Grocery Suppliers Code of Practice (GSCoP) calling for ‘fair and lawful dealing’, suppliers in the retail sector are often unable to secure price increases from customers that fully reflect the rise in their costs of business, resulting in losses being incurred on some product lines.

How has the current climate impacted the food manufacturing sector?

The UK’s withdrawal from the European Union, the global pandemic and the war in Ukraine have all contributed to an unprecedented rise in inflation and record high energy prices.

Some of the pressures on the sector are a result of difficulties faced by the agriculture industry. With Russia and Belarus accountable for 40% of global potash stocks (a potassium-rich salt that is an essential ingredient in fertilizer and crucial for crop growth), the sanctions that have come from the war in Ukraine have resulted in a shortage and subsequent rise in prices. The cost of potash has doubled to over $500 per metric tonne since January 2022. This shortage of fertilizer means farmers will see less yield per acreage, impacting the amount of crops they have to feed livestock and produce for food manufacturers.

This has been compounded by the recent high temperatures and water shortages. In July some farmers saw crop failures across fruit and vegetables, with peas, berries and salad lost. If the water shortages continue, then this could have a knock-on effect to next season’s harvest and further food price volatility.

What does this mean for food manufacturing?

Food manufacturers are feeling the pressures from all sides – a shortage of labour, escalating price of production, increasing packaging costs and a significant challenge in passing these costs onto retail customers.

In addition, leading supermarkets ASDA and Morrisons have lowered the price of hundreds of items, but is this passing the issue from consumers to manufacturers, as it is often the supplier that foots the bill for offers?

The purchasing power of the large supermarkets and the structure they have put in place means it is a difficult and often time-consuming process for their suppliers to negotiate a change in pricing. Some supermarkets have improved their payment terms to push cash to suppliers earlier, which is certainly welcome, but must come alongside a realisation that the cost of supply will increase. Manufacturers absorbing the cost can only ever be a short-term strategy. Whilst a focus on cash at a time of crisis is key, maintaining margin is also vital to ensure survival in the long-term.

Four action points for food manufacturing businesses

To ensure survival in such a volatile cost environment, businesses need to proactively review their operations, costs and pricing to ensure they make it through to the other side of the current crisis.

1. Review the costs of the business

It has become essential for businesses in the sector to know their underlying cost basis, and their true product cost (relying on old, outdated data results is poor decision-making). Maintaining forecasts and live details of product cost information expedites discussions with customers, which must now happen more regularly if volatility in business costs remains.

2. Reduce unnecessary costs

Search for suppliers that offer more competitive costs, longer-term contracts, or fixed rates. Benefits, such as collective buying power and supply chain support, can be gained from joining a buying group. Evaluating production processes enables businesses to identify and remove inefficiencies allowing staffing levels to be re-evaluated.

3. Plot budgets against actual cost

Have a clear understanding of where the business is and isn’t making money and create an appropriate budget using this information. Utilise a rolling 13-week cash flow forecast so money in and out can continually be monitored and managed effectively. This will enable businesses to make more strategic short-term financial decisions and spot cash flow pinch points early.

4. Review product portfolio

Maintain open channels with key buyers to allow conversations about product weight/size. If staffing challenges persist, consider rationalisation of product portfolios following client consultation, as this will improve operational efficiency and allow production to focus on high margin SKUs.

How FRP can help

It’s vital that food manufacturing businesses are on top of their costs and have good management practices in place. With significant commercial experience and having led negotiations with major retailers and supermarkets, we can support food producers by:

• Providing experienced crisis managers who can identify and maximise leverage with stakeholders
• Having extensive experience in dealing with retail customers, and being able to support in Cost Price Increase negotiations
• Implementing robust cash flow management procedures
• Assisting with stakeholder management and negotiations
• Providing expert support with forecasting, budgeting and cash management, and helping management to focus on the key priorities
• Through our FRP Transition service, provide access to turnaround specialists to advise on operational, sales and financial management improvements

With costs continuing to rise, seeking expert advice at the first signs of distress will be crucial for businesses to ensure the best possible outcome.