After Another Strong Year, What’s Next for Food Manufacturers?

Posted on October 04, 2017 by Erica Kuhlmann

There’s a lot to be optimistic about in the food and beverage industry. Manufacturers have continued their solid run over the past year, and the near-term outlook looks bright as well. But in an industry as broad and dynamic as this one, changes in one segment can have widespread effects.

As a recent BMO Capital Markets report points out, industry-wide profit margins have risen to their highest level in years, consumer demand has been fueled by lower grocery prices, and the industry has benefited from an improved trade balance. Earnings among U.S. food processors has been particularly strong, reaching a record high $57 billion in the year leading up to the first quarter of 2017.

But what’s been good for processors has been difficult for those on the agribusiness side. Those strong earnings were driven in large part by a severe drop in agriculture prices, which helped boost processors’ margins despite a moderate decline in selling prices.

While farmers have been stung, the drop in both costs and selling prices has been partly passed along to consumers, who have used the savings to increase their purchase volumes. That’s why earlier this year, we saw real food spending grow at its fastest pace in 16 years. Falling food prices have also helped boost exports while imports have scaled back.

There are signs, however, that the current situation isn’t sustainable in the long term. Maintaining higher margins in a highly competitive environment—along with the prevalence of large downstream buyers—is not a recipe for long-term success. And as BMO Capital Markets Senior Economist Aaron Goertzen points out, a crop failure—even one overseas—could quickly send costs higher, eroding the great margins processors currently enjoy.

Of course, there’s one wild card that has everyone anticipating what’s next: Amazon’s recently completed acquisition of Whole Foods Market. We’ve already seen Whole Foods significantly slash prices on some items, and other cuts are likely to follow. While consumers (predictably) responded  favorably, the full impact of price cutting—and other changes—on producers and manufacturers leaves many questions, including:

• Will the small, local farms that have supplied to Whole Foods be able to survive in a low-price environment, especially if recent price cuts lead to an industry-wide price war?
• With Whole Foods now centralizing its buying operations and barring local brand representatives to promote their products, where does that leave the smaller local food brands? Does that create an opportunity for other grocers?
• Will Amazon open up new distribution channels, providing more opportunities for small suppliers?

We’ll get more clarity on these and other issues in the coming months. In the meantime, food manufacturers should continue to enjoy strong results—even if there’s a sense that the game is about to change.