Many restaurant chains have learned the importance of tracking food commodities the hard way, when disease or a shortage of a particular commodity have sent prices soaring. In 2013, for instance, Darden saw its food and beverage costs rise six percent (outpacing an increase in sales) in the wake of a disease affecting Asian shrimp.
Food costs are such a large burden for restaurants that rising commodity prices can directly (and dramatically) impact a company’s bottom line. Even modest increases in commodity prices can require restaurant operators to re-engineer their operating costs and, often, even their menus.
Below, we offer a breakdown of restaurant food commodities, how they’re measured, and current trends based on the most recent data.
A commodity price index is a fixed-weight index or weighted average of selected commodity (wheat, eggs, etc.) prices, which may be based on current or future prices. The value of these indexes fluctuates based on their underlying commodities, and this value can be traded on an exchange in a similar fashion as stock index futures.
Tracking food commodity trends can allow restaurant operators to anticipate cost increases and, if possible, make menu changes accordingly. Still, even with so much data at their fingertips, many restaurant companies – even the most well-established and successful multi-national restaurant chains – have pains with costs, consistency, profitability, and broken links throughout their supply chain. Commodities are one of many avenues that can lead to food cost reduction, and offer clues and insights into what might be burning through a restaurant company’s profits.
Commodities are affected by a number of factors, including weather, global demand, disease, declining reserves, geopolitical conflicts, and energy costs. Oil and food prices show a high correlation: over the last 27 years, the correlation between Brent Crude Oil Price and the FAO Food Price Index has been 91% (100% being perfect association and zero meaning no linear relation between the variables).
This correlation is particularly important in regions of the world that rely heavily on imported food. The GCC, for instance, imports nearly 70% of its food, and hydrocarbons account for at least 60% of its exports.
Oil and gas prices affect restaurants in two ways. On the one hand, they influence demand (lower gas prices generate savings that consumers could use in restaurants) and on the other hand they affect costs, as transportation costs for food are affected by gasoline prices. So far in 2017, gasoline prices in the US have been decreasing (we’ve noted a 9% decrease from April to July). As decreasing gas prices generate savings to households, restaurants are likely to benefit from such trends. With gas prices recently jumping as a result of Hurricane Harvey (the price of a gallon jumped 16 cents in first week of September), commodities will likely take a hit in September.
The FAO Food Price Index (FFPI) is a measure of the monthly change in international prices of a basket of food commodities, consisting of the average of five commodity group price indices. In August 2017, the FFPI averaged 176.6 points, down 2.3 points (or 1.3%) from July, but still 10 points (6%) above its value a year earlier. The August decline reflected generally lower values for cereals, sugar and meat, which more than compensated for increases in the Vegetable Oil and Dairy Indices.
International food commodities prices have increased by 4% on average this year so far: price increases in Dairy (+14% as of September) and Meat (+10%) have been compensated by price decreases in Oils (-10%) and Sugar (-22%).
In July, wheat flour registered the highest price increase (+15.6%, year over year), largely exceeding the forecast for 2017, which anticipate a growth between 3% and 4%. Vegetables registered a year over year decrease of 1.2% in July, which matches the forecast for this year of a total decrease of price between 1% and 2%.
While beef prices have declined 1.1% as of July (year over year), they are expected to finish the year with a slight increase of up to 1%. Pork, on the other hand, has seen price increases of 7.3% (year over year, in July) but the increase for the entire year is expected to be lower (below the 5% range).
When natural disasters like droughts, fires, or hurricanes strike, commodity prices skyrocket, making it more difficult for ranchers to feed their animals or farmers to tend to their crops. Farmers are often then forced to liquidate their crops or herds which momentarily causes an increased supply and drop in prices, but is quickly followed by increased prices as supply fades. Though the resulting price increases can be felt by everyone along the supply chain, chains often fight to keep the burden off of consumers.
Chipotle is one chain currently bearing the brunt of rising commodity costs. Even as the chain struggles to revive sales in the wake of yet another food safety scandal, rising avocado prices are also threatening the bottom line. Surging demand — coupled with a smaller crop in Mexico and California — mean that avocado prices are likely to remain substantially higher than usual for the remainder of the year.
That 75% increase in prices (compared to 2016) will likely have a substantial impact on margins at the chain, which uses some 60 avocados in each batch of its guacamole (that’s roughly 97,000 pounds of avocados per day). It’s already affecting the company’s stock, with analysts saying every 10 percentage-point increase in avocado prices would lower Chipotle’s earnings-per-share by 30 cents on an annual basis.
For the thousands of restaurant chains like Chipotle, whose menu and guests depend and rely on certain ingredients, tracking the prices of those ingredients and what’s affecting them — labor issues, unforeseen weather events, etc. — is integral. That’s obvious, of course, and yet many restaurants don’t look to commodities to determine how they might affect operations in the future. Continually keeping commodities in mind (by pricing to accommodate fluxes so menu price changes don’t happen too often) ensures a chain is maintaining its menu and consistency without losing major margin.
Aaron Allen & Associates is a leading global restaurant industry consultancy specializing in growth strategy, marketing, branding, and commercial due diligence for emerging restaurant chains and prestigious private equity firms. We have helped helped restaurant companies around the world drive revenues, increase profits, and enhance the guest experience through improved marketing, messaging, and menu engineering. Collectively, our clients post more than $100 billion, span all 6 inhabited continents and 100+ countries, with locations totaling tens of thousands.