What COVID-19 means for the food industry.
Jonathan DeVito, Managing Principal | firstname.lastname@example.org
“All over Italy men were conscripted, and weapons requisitioned; money was exacted from the towns, and taken from the shrines; and all the laws of god and man were overturned.” -Julius Caesar
So reads the back cover of my copy of The Civil War, Julius Caesar’s account of his famed war with Pompey Magnus.
The food industry, a cornerstone of the American economy comprising $1.7tn in annual consumer expenditures, now finds itself thrown into Caesarean uncertainty due to the 2019 novel coronavirus (COVID-19) pandemic. Most states have issued some type of stay at home order, consumers are descending upon retailers, many restaurants face an inability to operate, and regulatory directives remain in flux.
The situation is complex and some channels are faring better than others.
While retailers are experiencing heightened demand, many parts of the foodservice industry are suffering. As an example, CraftWorks, a private equity backed restaurant operator that previously had approximately 350 units across the US, recently shuttered restaurants around the country and terminated 18,000 workers. The firm did have underlying financial challenges, but the this example shows the devastating potential of COVID-19 to push some segments of the food industry, especially those with thin margins and high overhead costs, over the edge.
The question I now have on my mind isn’t whether or not COVID-19 has the ability the unleash widespread economic havoc. This is obviously the reality. The bigger question I have is whether or not the pandemic will alter the food industry beyond the near-term, and if so, how?
From retailers and restaurants to labor dynamics and supply chain issues, the following outlines my general opinion regarding the potential effects of COVID-19 on the food industry.
1) Temporary inversion.
One of the most obvious near-term impacts is that people are increasing their spending at grocery stores. However, this development certainly creates a bizarre scenario given that that food away from home (FAFH) has chipped away at food at home (FAH) spending for the better part of the past two decades. Over the preceding years, foodservice has become the primary mode of American food spending (see below for 2008-2018 changes).
But perhaps a more important topic is whether or not COVID-19 will stimulate a long lasting reversion to FAH purchases.
I do not believe that it will.
Government and regulators have forcibly cut off the restaurant industry making the current situaiton largely synthetic. If history has taught us anything, Americans left to their own devices, seem to have an undeniable desire for foodservice. For example, during the Great Recession of the late 2000s, FAFH experienced only a slight loss of expenditure share, and ultimately continued to erode FAH expenditure share on a consistent basis (for additional reading, see my previous article on food spending).
The other factor to note is that beyond the short-term, the situation may not be so rosy for grocers. FAH has been subjected to commoditization and downward pricing pressure for quite some time. Over half of American food spending goes to FAFH, but FAH still comprises ~80% of the calories that Americans eat. In other words, FAH outlets, like grocers, have been providing most of the food and getting less than half of the money. Pricing pressure has also, arguably, driven the reformation of retail grocery, with traditional grocers losing market share to warehouse stores and supercenters. Near-term demand may increase substantially due to COVID-19, but if we enter a protracted recession, COVID-19 may actually exacerbate preexisting pricing headwinds for traditional grocery players.
Also, consumer packaged goods (CPG) innovation has recently focused on label claims, such as organic, clean-label, plant-based, and local. “Halo-based” marketing has been a primary tactic for many firms to reclaim share and pump up pricing and profitability. If we enter into a long, downward, economic cycle, consumers may be less willing to pay a premium for halo-based products. For example, it’s probably going to be hard for a struggling family to pay a premium for plant-based meat when ground beef is 50-75% cheaper.
2) Labor will be available once again.
Labor is a challenge of epic proportions in the food industry. It’s also one of the drivers of high foodservice inflation (at least relative to retail). For example, in 2017 20% of foodservice expenditures in the US went towards paying foodservice workers and salaries. Tackling labor costs became an increasing hurdle over the past decade as the economy experienced a bull run and the availability of labor contracted. Post-COVID-19 there will undoubtedly, once again, be a surplus of labor. However, the situation is somewhat of a Catch-22. Labor will once again become available, but if operators are forced out of business due to economic hardship, there will probably be diminished labor demand. The situation is almost exactly the same as current declining fuel prices at the pump: gas is cheap, but nobody is driving anywhere.
Perhaps the bright side for foodservice workers is the economic impact of COVID-19 will likely slow demand for automation as labor becomes more affordable. Although it is worth noting that continued wage legislation may complicate things. If labor becomes increasingly available, but businesses can’t get a meaningful discount due to high minimum wage levels, automation may still be attractive. For more on this topic, see our recent article on restaurant automation.
3) Accelerating trends with unexpected results.
COVID-19 may be the catalyst that conditions many consumers to begin using food delivery (retail or foodservice) on a repeatable basis.
Delivery foodservice may have the potential to make the biggest impact. If delivery foodservice becomes a cornerstone of how we eat, the biggest losers may be slow evolving firms across the traditional grocery and limited service restaurant (LSR) channels.
The desire for foodservice is underscored by the irony of retail meal solutions (RMS), or in plain English, prepared foods at the grocery store. In RMS we have two opposing business models existing under the same roof as consumers find themselves visiting grocery retailers to purchase foodservice. Delivery foodservice may be the tipping point whereby some consumers take things to a new level and avoid purchasing groceries at all when they can have prepared food delivered at their doorsteps (all without the need to cook, clean, or visit a store). Note: this isn’t good for meal kit firms either since these businesses still require consumers to cook and clean for themselves.
The risks for some LSRs exist for different reasons than traditional grocers. LSR tends to be less experience-driven than full-service dining (FSR). Of course, someone could take a date to McDonald’s, Chipotle, or Tim Hortons, but it probably isn’t the best idea. The reason for visiting an FSR is to enjoy some type of on-premise experience, in addition to the food itself. LSR has a more functional purpose. The LSRs that don’t begin evaluating delivery models may find that there really isn’t a justification for many consumers to visit their stores. If experience isn’t a key part of an LSR operator’s business model, consumers may simply prefer the convenience of having food delivered. In this scenario, LSRs with delivery capabilities will be well-positioned to take share from their competitors.
And note, I do not believe that the transitioning to delivery foodservice will be easy. Margins may be at stake as players deal with delivery costs and struggle to ensure food quality in transit. And of course, for many grocers, foodservice isn’t a part of their core modus operandi to begin with.
A final point on FSR. FSR is experiencing extreme pain as on-premise dining has essentially been shut down. It also true that the segment has lost expenditure share over preceding years (LSR has actually become a larger expenditure segment than FSR). But the demand for FSR will not disappear. People have a fundamental need to go out and be around other people because we are social animals. One of the reasons for the forced shutdown of Chicago, where I live, was people going out on St. Patrick’s day to drink and celebrate in spite of clear directives not to congregate in large crowds due to COVID-19. Subsequently, the Lakefront and various parks were closed because people would not stop descending upon recreational areas in dense crowds. Delivery and convenience may alter some aspects of food consumption, but FSR will continue to have an important place in the foodservice continuum over the long haul.
4) Inventory and supply chain risk.
“Behind the scenes” elements are at risk of becoming a quagmire. This applies to retail and foodservice.
The food industry is supported by highly perishable products. When the economy goes on hold, inventories don’t necessarily simply sit on a shelf until they are ready to be purchased again. Sometimes they rot. Case in point: meat. Meat, unless frozen, is highly perishable and the amount of meat that Americans eat is, frankly, enormous. If one reads through leading firms reports and SEC filings, the severity of the situation becomes quite evident. In 2019, Sysco sold $8.4bn+ dollars worth of meat (fresh and frozen) per year in the United States and nearly 45% of Chef’s Warehouse’s sales were derived from center of the plate items.
The situation has also lead to extreme fluctuations in commodity prices. Eggs are a good example. With everyone “cooped up” (pun intended) at home, consumer purchasing patterns have changed. The wholesale cost of eggs for grocers has tripled during the crisis, jumping from 94 cents to over $3.00. In this case, egg suppliers may be having a blast, but I’m nearly sure that retailers are incurring most of the downside.
And last, but not least, let’s consider the elimination of many forms of foodservice from the current economic equation. Manufacturers, often selling different products to foodservice and retail channels, are now faced with the challenge of adapting to a lopsided world where consumers’ food expenditures have moved drastically to retail.
5) Consolidation… sort of.
Will the survivors of the economic impact of COVID-19 say say “vae victus” and gobble up struggling firms that are still worth buying? This is hard to predict. However, some segments of the food industry may experience deep scars that don’t leave many clear winners.
For example, consolidation across the foodservice distribution landscape has been a topic of industry discussion over the past decade. The opportunity to acquire firms at attractive prices would seem to be a positive outcome of the current situation, but the ability for large distributors to act on this opportunity is unclear. Many large distributors are facing a cash crunch, tapping lines of credit, and simply battening down the hatches to ride out the storm. Some foodservice distributors are even selling their surplus to retailers to stave off losses. And of course the quality of acquisition targets and their customer lists may be fundamentally damaged as restaurant operators, independents in particular, go under.
The manufacturing side of the equation (retail or foodservice) may be moderately more stable, but once again, niche premium brands may come under pressure if the US economy moves into a prolonged recession. Firms will have to assess whether the industry presents tremendous opportunity or is simply scattered with value-traps.
In the long run, COVID-19 has the potential to drastically impact the food industry from consumers and all the way through the supply chain. Some of the current dynamics may be temporary, but others may have more fundamental effects. While the reversion to FAH spending is likely a function of the current situation, the demand for delivery, the pricing consequences of a recession, and supply chain risks may have more systemic consequences across the industry. As for labor and M&A, the situation is more of a mixed bag with many conflicting elements.
Ironically, I recently wrote that the rise of foodservice and decline in grocery spending share meant that the food industry had turned upside down (that article can be found by clicking here.). For now, it seems that COVID-19 has upended the industry once again.
About the author.
Jonathan DeVito: Jonathan is the Founder Managing Principal at PIVITAS. As a believer that there is no substitute for hands-on experience, he maintains tactical food industry expertise by working at restaurants in the Chicago area. His opinions are those of PIVITAS LLC only, and do not represent perspectives of any other person or organization.