May 23 2013
As Americans become increasingly concerned about the negative health effects of certain foods, manufacturers are introducing a greater variety of healthier products. This move has expanded profit margins throughout the food industries because health-conscious consumers are generally willing to pay more for food that they believe is healthy for them. In particular, large companies that have been providing Americans with foods for years have established brand loyalty, so when they introduce healthier, more-expensive products, they typically do not experience significant declines in demand for their products because people view them as high-quality brands. As such, these companies can realize higher profit margins than companies that do not have well-established brands.
Food producers must purchase a variety of commodities, such as feed, corn, milk, wheat and sugar, to produce their goods. The prices of these commodities help determine how producers in a variety of food industries price their goods. So when the price of a commodity fluctuates rapidly from year to year, the cost of manufacturing products becomes volatile. Volatility, in turn, leaves producers less able to anticipate cost increases and often they’ll pass these costs on to consumers in the form of higher product prices. Although this move does not bode well for consumers, many will still pay the higher prices, especially for foods that are staples in their diets. And producers end up benefiting because the higher input prices aren’t eating into their profit margins, while demand from consumers stays steady.
Americans embrace health consciousness
The number of Americans with preventable afflictions, such as diabetes and heart disease, has reached an all-time high. Because diseases like these have been linked to certain foods, such as those with high sugar content and red meat, more Americans have become concerned with the types and quality of food they put into their bodies. In addition, thanks in part to the media, Americans are growing more informed on health matters and know that diseases like these can reduce the quality and longevity of life, so they have become more wary of how foods affect their health.
As more Americans become health conscious, they are seeking out new and healthier versions from their favorite brands, instead of giving up the foods they love altogether. In line with this shift, producers in the Candy Production industry, Cereal Production industryand Chicken and Turkey Meat Production industry are increasingly promoting products based on health claims or their nutritional content. For example, Kraft Food Group’s subsidiary Cadbury PLC launched Strike Spark, a chewing gum that is advertised to contain about 25.0% of a person’s recommended daily intake of vitamins B6 and B12. And Kellogg’s heavily advertises its healthier foods, such as its Kashi cereal line, which contains whole grains and protein. These and other efforts have been met with success, evidenced by producers’ expanding sales and profit margins throughout various food industries. During the next five years, as the media continues to highlight the negative health effects of eating certain types of foods, Americans will continue to place pressure on manufacturers to produce healthier foods.
Brand loyalty and technology benefit producers
Within the top 10 most profitable food industries, larger and well-established producers are typically more profitable than lesser-known small to medium-size producers. For instance, in the Cereal Production industry, Kellogg’s and PepsiCo generate profit margins of 17.9% and 19.0%, respectively, which is well above the industry average of 13.3% of revenue. Because these companies invest a lot of money in advertising and have prominent displays in grocery stores throughout the United States, they experience a high volume of sales for their products. In addition, they are typically better able than smaller companies to pass rising commodity costs on to consumers in the form of higher product prices. The result is much smaller margins for the smaller companies, even forcing some to exit the industry altogether when commodity prices spike.
Food producers, particularly larger ones, are also able to expand profit margins by investing in technology, such as equipment and machinery used in the production process. Technology helps companies lower production costs through greater efficiency and automation in the production process, allowing them to expand profit margins. Similarly, investing in technology allows some producers to reduce the need for workers while increasing levels of production, enabling them to reduce wage costs.
Commodity prices to become less volatile
Commodity prices are expected to be less volatile during the next five years, which presents even more opportunity for producers to expand their profit margins. Most notable is the price of corn, which is an input in all 10 of the most profitable food industries. During the five years to 2018, the price of corn is anticipated to decline at an annualized rate of 2.6% to $5.71 per bushel, reversing its 6.7% annualized ascent from the past five years. Consequently, producers will be able to increase the volume of products they manufacture and price them more favorably for consumers.
Declines in the price of corn will also make the price of feed less volatile during the next five years since corn is a primary input into feed for livestock. Lower feed prices will help producers in the Chicken and Turkey Meat Production industry and the Meat, Beef and Poultry Processing industry cut costs related to producing animals for slaughter. As a result, the industries’ respective profit margins are expected to expand to 23.3% and 12.8% in 2018.
The price of sugar is also an important commodity in several of the most profitable food-producing industries and it is expected to be less volatile during the next five years compared to the past five. This trend is expected to especially benefit producers in the Candy Production, Chocolate Production and Ice Cream Production industries. In fact, lower sugar prices are expected to help industry profit margins expand to 18.0%, 17.2% and 24.1% of revenue, respectively, in 2018.
Lower volatility in the price of sugar will allow producers to more effectively anticipate price increases from year to year, and as a result, they will be better able to pass on slight rises in commodity costs to consumers in the form of higher product prices. In addition, as per capita disposable incomes improve over the next five years, consumers will be more able to afford higher product prices from these confectionary industries as well as from other food industries that experience input price increases. For sugar in particular, many of the top food-producing industries are key buyers for the Sugar Processing industry. So if the price of sugar increases, snack and food producers can pass on these increases without drastically hampering demand for their products.
Profitable but moderately risky
The top 10 most profitable food industries have a risk rating ranging from low to medium-high in 2013, with an average weighted overall risk score of 4.57 out of 9 (with 9 representing the highest risk). The primary drivers affecting risk in these industries include demand from supermarkets and grocery stores and the price of commodities. Because consumers’ incomes are improving, they will be more likely to purchase goods from supermarkets and grocery stores, including discretionary goods, which is driving demand for food manufacturers.
The price of corn is expected to decline 2.6% over 2013, which will help producers cut costs associated with production and expand profit margins. The price of sugar, however, has been volatile and has actually raised the cost of manufacturing many food products. Additionally many of the industries have high levels of competition, which makes it more difficult for smaller companies to compete and realize the high profit margins that larger, well-established companies achieve. Competition, combined with contrasting trends in demand and input prices, are largely responsible for the sector’s moderate risk rating overall.
Food producers aim to strike a balance between providing Americans with the food that they love at a reasonable price and maximizing company profitability. During the next five years, profit margins in these already-profitable food product industries are expected to expand as commodity prices become less volatile and operators cut costs associated with production. In addition, if prices do rise, they will be better able to pass off cost increases in the form of higher product prices to consumers because disposable incomes are improving in line with the economy. In particular, larger and well-established companies produce brands that millions of Americans are familiar with and loyal to. Still, Americans will look to their favorite brands to introduce healthier food products as they strive to live healthier lives. Producers that introduce and advertise healthier products are likely to be rewarded with greater sales, thus benefiting margins further.