Why Consumers suffer due to Higher Prices on Fmcg products during war?

March 22, 2022 Team DigitalGumma

Russia-Ukraine: How will Indian Markets Deal with a War?

While the Government’s decision isn’t clear nor the role in so much as a correction is concerned, it is now faced with the effects of a commodity price surge, global instability, sharp foreign investor outflows and rattled domestic sentiment.

Consumers may have to pay more for their daily essential items with FMCG companies mulling another round of price hike to offset the impact of an unprecedented level of inflation in commodity prices such as wheat, palm oil and packaging materials.

Besides, the ongoing war between Russia and Ukraine has also added another blow to FMCG makers as they expect a rise in the prices of wheat, edible oil and crude.

The Ukraine-Russia war has set the fast-moving consumer goods (FMCG) players on a tightrope.

The companies on the one hand have to battle inflation, which has resulted in high input costs, and on the other, they have to absorb as much as costs as possible, given that a slowdown in demand does not support price hikes.

“Several FMCG companies in December-January were in margin improvement mode, which is now again getting disrupted with the war,” says research and consumer analyst. “Given the low demand scenario, most companies, however, will be cautious in passing on the entire cost increase to the consumers.”

The cautious stance, though, will hurt their margins, indicate analysts. They expect the impact of price rise in various commodities to show on the performance of these companies in the first quarter (Q1) of financial year 2023.

“Q1 is more likely to get impacted due to the rise in crude oil prices as in Q4 (of FY22), companies like HUL (Hindustan Unilever), Britannia have taken price hikes and there is a lagged impact of inflation due to inventory, forward contracts. Also, the full impact of price hikes taken in Q3 will show in Q4, especially for paint companies,” said Abneesh Roy, executive director, institutional equities, Edelweiss Securities.

The FMCG industry has been grappling with increased input costs on account of price rise in several key commodities for several quarters now. A tepid demand scenario has worsened the matters for these companies as they are unable to pass on the cost increase to consumers fearing an impact on consumption. In the third quarter, companies such as HUL, Godrej Consumer Products, Emami and Marico registered low to flat volume growth as demand for their products declined. HUL reported volume growth of 2 percent in the quarter ended December compared with 4 percent growth in the second quarter. Godrej Consumer Products, Emami and Marico reported flat year-on-year volume growth in Q3.

Among companies that are affected significantly because of rising crude prices are fast-moving consumer goods (FMCG) players.

Crude-linked derivatives such as Linear alkyl benzene (LAB) and high density polyethylene (HDPE) act as crucial inputs for consumer goods companies.

An increase in price of these inputs, says G Chokkalingam, founder, Equinomics Research & Advisory, will mean that production costs will increase putting pressure on companies to raise product prices. “In the event they do not raise product prices, as they could suffer an impact on their margins, notably, operating margins,” says Chokkalingam.

LAB, for instance, is used in making detergents and constitutes almost 60-70 per cent of the latter’s input cost. HDPE is used in packaging material for all essential consumer items from soaps to detergents, hair oils, creams, shampoos and toothpastes. Packaging costs of these products constitute 15-20 per cent of overall production cost for companies.

“We are expecting a 10-15 per cent hike by the industry,” Parle Products Senior Category Head Mayank Shah told PTI.

Shah further noted that the prices are witnessing high fluctuation and hence it would be difficult to tell about the exact increase due to volatility of price.

The price of palm oil had increased to Rs 180 per litre and now has come down to Rs 150 per litre. Similarly, crude oil prices had risen to nearly USD 140 a barrel and has now slipped below USD 100 per barrel.

Grocery has already shown price increases and we will start to see a significant shift in apparel and footwear. Comfort categories, performance brands, synthetic fabrics and petroleum based textiles will have a significant raw material price increase which will impact the end-consumer. Price of oil and gas, the Russian/Ukraine war impacting the tech gig economy, and overseas factories where COVID-19 still impacts factory workers will continue to disrupt the supply chain and tremendously impact cost of goods.

In the end, the consumer will either pay the price or stop shopping. They will spend less and become more frugal. Consumers will second guess getting in their car with increased gas prices and avoid the shopping mall and their favorite online stores. Groceries will be streamlined and consumers will look for deals more than ever.

Operating margins are likely to suffer as crude-linked derivatives act as key inputs for consumer goods companies

Higher gas prices mean less driving (for consumers), so rural areas might see a drop in frequency of store visits. Places where people have to make a day trip out of going to the nearest Walmart. On the other hand, this might push up online sales and deliveries. We should see further price-increase pressure on UPS, FedEx, and other last-mile delivery services as they rack up the miles running on $4-plus gas. Anything with a long-haul logistics trail will be impacted as well as services which will show up at POS. Even my pool guy has raised his price 6.4 percent to account for higher gas prices. If wages don’t keep up we may be in for a tough couple of years.

As inflation climbs, premium-tier grocery, beauty and apparel sales will decline as more shoppers become price-conscious. Unlike Q4 2021, cross-category luxury sales have made fewer headlines lately.

Conversely, retail giants, discounters, dollar stores and off-price retailers will win traffic as inflation erodes consumers’ purchasing power.

Expect more retailers to prioritize private labels, especially in high-frequency categories like grocery. Retailers will also emphasize deals and discounts to encourage shoppers to switch for better value.

Crude’s FMCG Connection

Key inputs used by consumer goods companies are derivatives of crude oil

This includes linear alkyl benzene (LAB) and high density polyethylene (HDPE)

LAB goes into making detergents and HDPE is used as packaging material

Any increase in the price of crude oil will mean prices of these inputs will move up

This puts pressure on companies to raise prices or take a hit on margins

A number of things are likely to happen based on what we have seen over the past 15 years or so.

Product size will drop with pricing staying the same – dubbed “shrinkflation” by the media.

Consumers may well shop “one tier down” – this could either be with the type of product (buying mid-range instead of top tier) or with the actual retailer – discount grocers could continue to take a larger slice of wallet share.

Some more luxury categories are likely to be at risk of reduced sales – for example premium beers, luxury desserts, and high-end meat products. Equally consumers may seek to move to retailer own-labels more than before.

Some categories could well increase in sales – after the global financial crisis, grocers selling at-home fine dining type products saw an increase in demand for these products as people sought to emulate a restaurant experience in their own home.

Consumers may also look to buy bigger pack sizes of non-perishable items – cleaning products, laundry and dishwashing liquid, and toilet paper.

At the same time, retailers and manufacturers will need to seek opportunities to streamline overall operations further. Retailers and manufacturers will need to respond rapidly to changing consumer buying patterns. As is so often the case the companies that respond fastest to change will be the biggest winners.

Premium priced brands will be impacted the most by inflation as consumers trade down to private label or discount brands. While consumers will consciously reduce spending on discretionary merchandise and services, the demand for essential items is inelastic. However consumers will trade down to private label brands.

Restaurants also I feel tend to take a hit as consumers shift to eating at home to save. Clubs and dollar stores seek to benefit from this as well.

For the customers who eat at good restaurants, they will now be making more food at home, buying quality food to cook at home to save money and still have a great experience. For the grocery customers who were eating better cuts of meat, quality produce and pricier center store items, they’ll be looking for more in-store deals and coupons and private label foods to keep the grocery bill in check. For grocery customers who don’t have much of budget to spend on food, watching for deals, clipping coupons, and understanding product value (nutrition value for the money) is key to keeping their family fed.

Grocers would be wise to educate customers, help them make good food choices for their budget and nutritional needs during tough times. Shoppers will stay loyal to grocers who are honest and who will take care of them.

Categories that require financing will be first hit by inflation – large appliances, furniture, and motor vehicles. The secondary hit will be based on increasing fuel prices to categories requiring long distance transportation or large package sizes. Rapid delivery and e-commerce across the board may also see an increase in shipping costs. Lastly, there is a bit of a hidden cost to the retail euphoria as retailers see higher spend, about 1 percent of retail growth can be attributed to inflation. Fundamentals are still high across the board including consumer sentiment, low unemployment, faster wage growth, and more discretionary income. U.S. consumers are spending more on goods as well, by about 6 percent according to insights from Cushman Wakefield.

Retailers will embed the new cost into prices, increase shipping costs, and reduce markdowns across the board. What this means is a slightly higher price at the store. For a Rs 200 Ice cream pack, a 7.5 percent hike will be barely noticeable, but it will add up in monthly budgets. It will be most noticeable for higher price items.