Driving the Dairy Business

Convenience store operators nationwide are grappling with nearly unprecedented food inflation, particularly involving bakery and dairy products, that is sending tremors throughout the retail supply chain.

Recent price volatility fueled by a weak dollar, rising energy costs, consumer wariness, competitive pressure and other factors is making it difficult to market staples like bakery and dairy items, primarily fluid milk.

Analysts are calling this the worst food inflation in nearly two decades, and many expect things to get worse. Food prices rose by about 4% in 2007, compared with an average 2.5% yearly increase over the last 15 years, according to the Department of Agriculture (while USDA says milk and other dairy products jumped by 13%). The agency says it fully expects 2008 to be even worse, with prices as much as 4.5% higher.

Wheat, which has traditionally been fairly immune to price bumps, has reacted strongly. Wholesale flour prices have tripled since November 2007, according to most estimates, thanks to what may be the lowest supply in 60 years, heightened global demand, skyrocketing transportation costs and a generally weak dollar.

Secretary of State Condoleezza Rice said in late April that setting aside farmland to produce bio-fuels like ethanol may be partly to blame for driving up world food prices. There has, she noted, "been apparently some effect, unintended consequence from the alternative fuels effort" when asked about the administration’s view on skyrocketing food prices.

The International Dairy-Deli-Bakery Association’s (IDDBA’s) "What’s In Store 2008" annual trends report found that retail bakeries are offering consumers more products that are trans-fat free, feature whole grains, and come in smaller portion sizes.

As the report noted, "Smaller households are less likely to shop (a supermarket or convenience store) in-store bakery, in large part because they don’t want to deal with waste or spoilage from products that are too big for them to consume."

Retailers can accommodate this growing customer base "by packaging smaller portions of products." Beyond that, a 2007 study by Perishables Group, West Dundee, Ill., found that 31% of respondents regularly purchase organic or all-natural breads and rolls.

 

Driving Prices

"The price of milk went up sharply in April, but it’s already heading back down," reported Carl Byrne, president of Byrne Dairy Inc., a 54-store chain operator based in Syracuse, N.Y. "The main thing that makes up the cost of milk is obviously what we have to pay for the raw material itself. If that was $22, then it’s going to $16."

In addition to its stores, Byrne Dairy sells to a few hundred convenience stores ranging from large chains to single-store operators. What his customers tell him, Byrne related, is that they have their eyes focused on their competitors’ pricing.

"The price of fluid milk is decreasing as we speak," said Gary Warren, vice president manufacturing for Stewart’s Ice Cream Shops in Saratoga, N.Y. What’s driving prices today are "the same things that always drive prices," he explained, "the dairy commodity markets."

As the categories in cheese and nonfat dry milk are weakened on the commodity side it ultimately drives the prices for dairy in general. Simply said, the larger categories, which would be cheese and powder markets, have softened, so now the fluid milk category is following that down. It’s passed its peak; prices are now coming down. Stewart’s operates 325 stores in New York and Vermont.

"For most of them it’s just what the market is doing around them," Byrne noted. "If the larger stores like Costco, Wal-Mart and Price Chopper are moving prices down, overall market prices are moving down with them. A lot of the big stores–the club stores, the large supermarkets and the mass merchandisers–will move their milk price each month, going up or going down."

The c-stores, at least in his market areas and throughout New York State, "try to remain very competitive or even priced better than the larger mass merchants," Warren said. "They would be watching it pretty closely. In a period where when it’s headed down they’re going to be headed down."

The record high milk prices that were reached in 2007 were driven as well by the ethanol corn factor (corn drives feed costs, and has contributed toward higher dairy prices), and the increase in dairy exports. "Because of the weak dollar and strong demand overseas for dairy, we have been exporting a lot of cheese and powdered milk," Warren said. "That’s how we got to the record prices."

Depending on the strength of the dollar long term, Warren added, "we could see export continue to be very strong, or we could see them taper off. If you could predict those things you would have a better read on future dairy prices."

It has, Warren conceded, "been a rollercoaster ride. We had record dairy pricing in 2007, which has been good for farmers. Farmers needed relief after a terrible year in 2006. Those who were able to weather through the storm have been able to pay down some debt they incurred the prior year, and now they’re back above the water level."

That said, Warren and his colleagues did not see any drop in dairy consumption. He believes the downward price trend will continue through the summer months. Beyond that, he projects "there will be some stronger pricing in the fourth quarter as we get closer to colder weather," which together with the holiday season always tends to drive stronger dairy prices.

"I’m sure there are many different reasons for dairy price volatility," said John Schaninger, vice president of sales and merchandising for Quick Chek Food Stores in Whitehouse Station, N.J., a family-operated chain of more than 100 convenience store locations in New Jersey and New York. "If you look at what’s going on with the price of grain, which of course effects (dairy and bakery), plus the price of energy and the price of fuel, they are working together to drive costs up over the long term."

While prices over April were steady, Schaninger added, "my guess is that as fuel costs continue to rise we’re going to see further escalation of costs."

 

Good and Bad News

For convenience retailers the pricing trend is "good and bad news," Warren said. "Dairy is a staple item that has been subjected to some record retail price points. That is now softening, which may be good news for the consumer. The flip side is that it will hurt the farmers in the short term so we may see further attrition in the agricultural community because of that."

Pricing clearly "tends to go in cycles," Warren said, "and I have to look at it both ways because I’m concerned with the farm supply as well as keeping our consumers happy. We don’t want this to go too deep or soften too much because then we start losing farmers. So customers need to be careful what they ask for. You may get it, and you may regret it long term."

 

At Store Level

C-store operators are in a good position to capitalize on the dairy business, experts believe. "In some cases, dairy in particular, products fall into the loss leader category," said Alan Hiebert, Education Information Specialist IDDBA. "Retailers will compromise their margins on those products in order to get shoppers in stores. But I know that on the convenience store side of things the thought is that you make it up by selling gas and other items.

"The problem we’re having now is that gas prices are going up, too. It’s kind of a vicious cycle. Obviously, increased fuel prices drive up other food prices because you have to use fuel to get the food where it needs to go."

Hiebert’s research indicates that consumers appear to be combining trips to c-stores so industry operators are coming out a little bit ahead. "If you drive, you have to go to a gas station, so that’s where people are tending to purchase more of their staples and fill-in items rather than making a separate trip to the supermarket."

What should operators be doing now to take the advantage of the price fluctuations? "It’s still a very strong category for the stores," Byrne said. "Milk is an item people need to buy two or three times a week, so any promotion and activity, whether it’s tied to price or not can be effective. Just letting people know that you have the product, that it’s fresh, that it’s competitively priced with a Wal-Mart is going to be good for your business."

Some c-store players, he noted, "are saying, ‘Look, I have a fair price: here it is. I have a good selection, it’s easy to get in and out of my store, and I’m priced competitively with the big boys.’ The folks who do that, who don’t give up on milk for six months or a year when it is going up, come out of the highs with stronger numbers."

And later on, when prices inevitably head back up? "You need to be consistent," Byrne said. "Some stores don’t promote very much at all; it’s not part of their strategy. If dairy is part of their strategy they shouldn’t throw their hands up when the prices go up because they’re just going to lose tonnage, and when the price goes back down they’re going to have to try and recover customers."

It’s a base operators just can’t ignore for six weeks.

"One thing operators can do is some due diligence to ensure that you are paying the best possible price," Schaninger said. "The second thing is to work on your product mix. If you’re mixing in things in the lower gross area then you need to focus on higher-gross areas to drive the profit that you need."

In other words, operators whose systems are not as lean as possible must get on the ball. "The big thing," Schaninger stressed, "is that for a family, milk, dairy and bread are all staple items, and they continue to take a good chunk out of everybody’s pocket. Combine that with filling up a gas tank and it really puts a hurt on the average consumer, which is why people are really looking for value today."

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