Trump, Tariffs, and the Food Industry: Looking Beyond the Headlines.

Jonathan DeVito with Todd Ruddick

 

Big headlines.

The Trump administration’s move to levy trade tariffs on products imported from various countries around the globe is making big headlines.

To illustrate the scale of these tariffs, newly introduced duties on Chinese goods alone affect nearly 6,000 items and affect $200bn worth of imports.

In many cases, US-levied tariffs will rise to 25% by the beginning of next year.

Further complicating matters, foreign governments have responded with their own tariffs. Newly announced tariffs from Canada, Mexico, China, the European Union affect over $120 billion worth of US exports.

What do these developments mean for food industry suppliers and how they price their products?

In the near term, larger players may not be directly impacted due to preexisting procurement contracts. Others may be unaffected by changing costs as effects are washed out through the supply chain, leaving those that sell to end-buyers or consumers somewhat insulated. And of course, some will obviously need to adjust to changes across their cost of materials.

If one looks beyond the near term, the situation becomes more nuanced.

Our opinion is that tariffs may impact industry pricing enough to create long term changes in customer behavior that fundamentally alter the industry landscape. It is also important to note that implications may not only affect suppliers who are directly impacted by a shifting cost of goods. Other suppliers may be presented with opportunities and risks as a result of secondary effects.

Using restaurant equipment as an example, if overall prices of equipment rise due to the elevated cost of steel imports, manufacturers that don’t use imported steel may also be able to raise prices as some customers become desensitized to new market conditions. This phenomenon is not dissimilar to owning a small home in a gentrifying neighborhood. If a mansion is built next to a hovel the price of the hovel may increase. The reverse also holds true: if one owns a mansion and hovels start popping up in the surrounding neighborhood, the price of the mansion may fall.

Let’s talk about the specifics and what suppliers can do to stay ahead of the game.

 

Behavioral economics, beers, and beaches.

In a perfect world, a business would have one price for a given product. For example, a supplier making a given product would offer this product for the same price to all its customers. In economics this is commonly known as the “law of one price”.

However, in the real world, things frequently don’t play out this way.

Richard Thaler, the famous University of Chicago economist and Booth School of Business professor, explored this in his famous experiment exploring people’s willingness to pay for a beer. Thaler asked people what they were willing to pay for a beer at the beach versus at a luxury hotel. He found that people were willing to pay more at the luxury hotel.

The same principle applies to tariffs. Tariffs have the potential to spread price inflation or deflation across areas of the food industry by influencing behavior, perceptions, and decision making.

 

Pricing in the long run: context matters.

There is no one-size-fits all answer to how products will be affected by trade policy. Immediate effects largely depend on the supplier as well as import/export ratios for specific product categories.

For example, tariffs will likely cause many proteins to decrease in price. About 20% of pork produced in the US is exported and potentially subject to retaliatory tariffs, such as those levied by Mexico and China.  As a result, pork prices may fall due to oversupply in domestic capacity caused by declining exports. The same factors may also impact the beef and chicken markets.

In other cases, tariffs may result in rising prices. For instance, a large percentage of numerous seafood products are imported by the US and many of these items are likely to be affected by trade tariffs.

However, putting aside near term economics, understanding the implications of tariffs in the long run may not be as simple as viewing price as a direct function of cost.

For instance, if restaurant operators are forced to choose between competitively priced land-based proteins and seafood, things become more complicated. Some seafood suppliers may actually need to decrease prices to maintain center of the plate market share despite rising costs.

Another example, as referenced in our introduction, is restaurant equipment. A domestic supplier that uses minimal amounts of imported materials may be able to raise prices, not because of the increased cost of steel, but because of inflation and price desensitization across the industry.Of note, this same supplier could actually decrease prices to aggressively knock competitors, depending on its positioning.

In short, price isn’t simply a function of material cost, at least in the long run. Suppliers should be prepared to align their strategies with changes in customer behavior and the ways in which their competitors adapt to market conditions.

 

Implications and what you can do.

While the way forward depends on the specific supplier, below are some key points that we believe most players should be keeping in mind:

→Generally speaking, implications will likely be different between retail and foodservice: As pointed out in a previous article on private label, buying behavior tends to be very different in retail versus foodservice. Foodservice is driven by rational and economic decision making. Foodservice manufacturers experiencing declining costs may have the ability to engage in aggressive pricing strategies in an effort to convert new customers (operators) and absorb market share. Leveraging low-cost pricing to convert retail consumers may be more difficult since intangible factors, such as identity and branding, play an essential role in this channel. Highlighting this point, in some cases retail branded products with dedicated customers command double-digit premiums over competitively priced private labels.

→Rising and falling with the tide: As previously stated, some manufacturers may find that tariffs result in opportunities to raise prices. Manufacturers that are minimally affected by tariffs, but offer products in categories where competitors are impacted by tariffs, may be able raise prices in line with the overall market landscape. In other cases, suppliers may be able to leverage falling prices to engage in aggressive pricing strategies that push out struggling competitors.

→Contracting product portfolios may be superior to new product innovation: In foodservice, adding “value” to commodity products, unless there is a clear performance benefit, may not be the best way to offset shrinking margins. In past PIVITAS studies we’ve observed that operators across many segments, such as higher education and fast casual, have increasingly been relying on scratch or speed scratch cooking as opposed to relying on value-added items. This is not to say products like shelf stable sauces or heat and serve products are disappearing, but if you are a fish supplier moving heat and serve fish sandwiches may not be the highest growth strategy. Removing slow moving items from portfolios and moving into sensible adjacencies is probably a better way to go. With that said, it is always important to be curious about becoming a one trick pony. As for retail, the case is mixed. Some studies show that having an extensive product line helps to generate sales. However, other studies show that having too many product options can confuse consumers and makes them less likely to make a purchase. More on that topic can be found here.

→Additional pressure on non-essentials: Restaurants and retailers may develop more conservative purchasing practices across categories where prices are rising. For example, increased costs across equipment may curb some operators’ desire to buy new equipment or upgrade operations with additional equipment. While this is a negative implication for some manufacturers, other suppliers will benefit. For example, used equipment dealers or suppliers of aftermarket parts may experience an uptick in demand as customers seek to curb costs.

Heightened M&A activity: If prices fall enough across certain categories, smaller suppliers may not be able to compete while larger firms may seek additional cost synergies. The result may be increased M&A activity and industry consolidation. This is somewhat similar to developments that have been observed in oil and gas over the years. Also of note, in industry areas where prices are rising, some businesses, particularly smaller players, may be “propped up” by high prices and allowed to operate despite poor management or inefficiencies. If prices drop after an extended period of inflation, these businesses may struggle to maintain viability and ultimately face acquisition, turnaround, or even dissolution.

 

Conclusions.

When one looks past the headlines, trade policy has the ability to influence pricing in ways that lead to long term changes across buying behavior and the industry as a whole. Suppliers should be ready to look beyond the direct interplay between tariffs, costs, and pricing as they plan for the future. Tariffs may actually produce a series of direct and indirect effects that lead to developments ranging from unexpected pricing strategies ( prices inversely related to suppliers’ cost of goods) to product portfolio consolidation and even heightened M&A activity.

In short, the potential impacts of tariffs are complicated. All would be well advised to be circumspect, not underestimate the situation, and above all, expect the unexpected.

 


About the authors:

Jonathan DeVito is the Founder of PIVITAS. He works with a diverse group of clients to help them develop actionable product, pricing, and market strategies.

Todd Ruddick is the Managing Partner of Andon Strategic, a ventures and growth strategy consulting firm. He is also an investor and operator at Twisted Hippo, a craft brewery based in Chicago.

Featured image source: Shutterstock.com