At Mother Nature’s Mercy
Marion Kujawa, an Illinois farmer, looks over his drought-ravaged land. Drought has affected several regions in the U.S., from the Midwest to the Plains to California, leading to climbing commodity costs. THINKSTOCK IMAGES / SCOTT OLSON / GETTY IMAGES
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Kevin Kester’s family has been farming in the U.S. for generations. And it’s not just a couple of generations they’ve been farming; more like generations upon generations, way back to the 1600s, specifically in California since the 1860s. Today, Kester owns a 22,000-acre beef cattle ranch in California’s Monterey and Fresno counties, near Paso Robles. In the middle of the state, it’s at the “bull’s eye,” he says, of the worst drought that he—and several generations before him—has ever seen.
“It’s been devastating,” Kester says. “Because of the drought, with a lack of feed and lack of water out in the hills, we’ve had to reduce and sell off our cow-calf [breeding] operation very significantly, in fact more than half. … It’s a very significant impact on our income.”
Kester is one of thousands of farmers who have been affected by drought in a state that is the largest agricultural producer in the country. Data from the California Farm Water Coalition suggests California could lose a total of $5 billion in agriculture revenue from the drought, which entered its fourth year in 2015.
But farmers aren’t the only ones feeling the pinch. Restaurant operators, especially those in the tight-margin limited-service industry, are also taking a hit, helpless as some food costs have soared to unprecedented levels. It’s been a frustrating reminder that in a world of big data, enhanced technology, and efficient supply chains, Mother Nature still has the final say on the state of our food supply.
The new reality
As of December 30, about 32 percent of California was in “exceptional drought”—the most extreme designation for drought—according to the U.S. Drought Monitor. Nearly 78 percent of the state, meanwhile, was experiencing at least “extreme” drought conditions. University of Minnesota researchers reported that the ongoing California drought is the worst the state has seen in 1,200 years.
California suffers from two big problems: First, water demands are immense in the nation’s most populous state; some 38 million people call California home, according to the U.S. Census Bureau, applying astronomical pressure to the state’s water supply. Second, the last few years have been some of the driest on record, with very little rain and snowfall in the winter, the state’s wet season. Without the rain and water from the Sierra Nevada Mountains’ snowpack, the state’s reservoirs and groundwater are drying up. The National Oceanic and Atmospheric Administration (noaa) reports that natural oceanic and atmospheric patterns are driving the drought, from which many say it will take several years—and perhaps an El Nin~o–type wet weather event—to recover.
In other words, the supply and demand for water is out of whack and could be for some time. For farmers in the state who rely on water to maintain their operations, it’s a tough pill to swallow. “When it comes down to it, you have to have grass and water,” Kester says of cattle ranches. “That’s the bottom line. When you run out of those, technology can’t replace that.”
California isn’t the only state that’s been hit by drought in recent years. Texas and Oklahoma suffered through a severe drought of their own in 2011, while the Midwest was faced with unseasonably hot and dry weather in 2012.
Drought in these states is dangerous to quick-serve operators for several reasons. The Midwest is the largest producer of corn and soybeans in the U.S., and a hit to corn in particular hikes up feed costs for chicken, pig, and cattle farmers, thus affecting commodity costs for meat, dairy, and eggs. And Texas, California, and Oklahoma are the Nos. 1, 4, and 5 largest producers, respectively, of cattle in the U.S.; combined with No. 2 Nebraska and No. 3 Kansas, which also felt the effect of drought in the last four years, those states account for about 50 percent of the nation’s cattle supply, according to the National Cattlemen’s Beef Association (NCBA).
Beef might be where limited-service operators take the biggest hit from the recent droughts. The burger category is a $75 billion–plus industry, according to Technomic, and the better-burger segment continues to explode. Beef prices hit an all-time high in 2014, with the U.S. Department of Agriculture (USDA) predicting that beef and veal costs ended 2014 roughly 11–12 percent higher than the previous year and will rise between 4.5 and 5.5 percent this year.
“Since we’re not looking to impact the quality of our raw materials, we had to look in different directions,” says Josh Kern, chief marketing officer for better-burger chain Smashburger, in an email, referencing the cost increase’s effect on the company. “To decrease freight cost, we implemented a new distribution model that created better freight efficiencies along with expanding our supplier base so that our FOB points are closely aligned with their destination points.”
Beef prices are climbing because droughts, especially in cattle epicenters like Texas, force ranchers to downsize—sell off or slaughter—their herd, thus reducing supply; the number of cattle in the U.S. today is the lowest it’s been since 1951, according to the NCBA. It takes a few years to recover the supply as ranchers breed calves, says Mike Miller, senior vice president of marketing and research at the NCBA. He believes beef will stabilize by 2016 or 2017 now that the drought in Texas has improved.
“The thing that makes beef unique is that the climate is always an issue for beef because the cattle spend most of their lives outside,” Miller says. “So ranchers fundamentally are beholden to whatever Mother Nature provides.”
Mother Nature provides more than just drought. Flooding, deep freezes, and any number of other unseasonable weather patterns can have a profound effect on cattle, poultry, produce, and the rest of the raw materials that make up restaurant menus. And these days, those patterns appear to be increasingly severe.
The U.S. Global Change Research Program reports that rainfall events are becoming heavier and more frequent, and that property and crop damage from flooding averaged around $8 billion per year between 1981 and 2011. The program also says the average U.S. temperature has increased nearly 2 degrees Fahrenheit since data started being recorded in the 1890s, most of the increase occurring since 1970. Meanwhile, 2014 was the hottest year on record, 2013 and 2010 tied for the third hottest on record, and prolonged (more than a month) extreme heat in the U.S. is worse than it’s ever been, according to the program. Higher temperatures are contributing factors to drought conditions.
Even last year’s frigid winter might become a more common occurrence; a group of scientists recently published a report in the journal Nature Communications that connected the Polar Vortex to melting ice in the Arctic Sea. According to the USDA, fresh-fruit prices were up 4.5–5.5 percent in 2014 partly because of frigid temperatures on the East Coast last winter.
“Weather does go through cycles and it can impact agriculture and therefore impact the cost of goods for anybody who relies upon agriculture, like restaurant chains and grocery stores,” says Jim Greco, chief operating officer of Mississippi-based fast casual Newk’s Eatery. “Then there’s the other thing that’s going on here, and that’s the whole issue of long-term climate change and what impact that might have on agricultural commodities. That’s a lot harder predict. And of course the impact on a chain like Newk’s would be very, very gradual, so there’s really not much we can do about it.”
The U.S. Global Change Research Program does show that climate changes over the long term could pose a problem for restaurant operators. It found that climate disruptions to agricultural production have increased in the past 40 years and are projected to increase over the next 25 years. The climate uncertainty has created a volatile food-cost environment that is keeping restaurant executives up at night.
“When we survey restaurant operators, currently their top challenge remains food costs. About one out of three operators reports that food costs are their top challenge,” says Hudson Riehle, senior vice president of the National Restaurant Association’s Research and Knowledge Group. “If you look at a year ago, it was under one out of five restaurant operators who reported that food costs are the top challenge. So it’s come close to doubling over just the past year.”
USDA data shows operators are right to be worried. In its “Food Price Outlook, 2014–2015” report issued in December, the agency reported that, to go along with record-high beef costs, pork prices increased 8.25–9.25 percent in 2014 and were expected to rise 4.5–5.5 percent in 2015; poultry prices were up 1.5–2.5 percent in 2014 and should climb 2.5–3.5 percent in 2015; egg prices increased 7–8 percent in 2014 and are expected to be up another 1–2 percent in 2015; and dairy prices climbed 3–4 percent in 2014 and should finish 2015 another 2.5–3.5 percent higher.
Some chains have already raised their menu prices because of climbing food costs. In-N-Out Burger, Chipotle, and Starbucks all bumped prices up at least slightly last year in response to the new cost reality.
Traditionally, restaurant companies have sustained volatile food costs through hedging, in which they lock in prices on certain commodities—often through futures contracts—for an extended period of time. But one industry expert believes this model exacerbates the climate problem. Arlin Wasserman is a partner with the sustainable food consultancy Changing Tastes, as well as the chair of the Sustainable Business Leadership Council for Menus of Change, a sustainable food conference for chefs and operators held by the Culinary Institute of America and Harvard. He estimates that climate issues in the U.S. have become a $40 billion problem; food-cost volatility in the last five to six years has been unprecedented, he says, a volatility that he chalks up to climate changes, sourcing foods from marginal lands at risk of poor output, and financial trading on commodity markets.
“The problem is harder to manage than ever; food costs have been going up since 2007 more than ever,” he says. “Part of that is we’re buying food from other countries that are having food shortages. The second is that the volatility, the up and down moves, are greater, so making a wrong bet on hedging, or when to lock in a price, can have a more significant consequence to business performance.”
With that traditional model becoming more unreliable, operators and their supply partners have been left to figure out the best way forward to protect both the future food supply and the bottom line.
“It really is a situation whereby the entire supply chain has to respond,” Riehle says. “But in the end, the restaurant community has proved themselves quite innovative in how they deal with some of these longer-term food-cost challenges.”
In concert with nature
Since raising prices is one of the last things operators ever want to do, quick-serve and fast-casual brands are getting creative with their menus to minimize the hit taken with food costs. For its part, Newk’s is avoiding a big investment in beef until the price becomes a little more favorable, Greco says.
“We use beef in a couple different things, sandwiches and salads; we’re not going to promote those items in any kind of LTO or any other kind of special while beef prices are this high,” he says. “We’ll promote some other item. We’re not going to take them off the menu yet, either; we’ve never gotten to a point where we take them off the menu. But we will push other items to try to drive traffic to things where costs haven’t escalated.”
Other operators are doubling down on supply chain management to hedge against the climate’s threat on food supply. Eric Pfeiffer, senior director of supply chain integration for HAVI Global Solutions, a supply chain consultancy, says many companies are working with suppliers to be more strategic on the growing regions from which they’re sourcing product in order to manage the risk of availability and price.
But while flexibility is key to cooperating with the climate, Changing Tastes’ Wasserman says, it’s not necessarily flexibility in sourcing locations. Rather, he says operators must stay flexible with the products they menu. The days of locking in a menu a year or two in advance, he says, are over.
Wasserman uses Brussels sprouts and kale as an example of ingredients that can help serve restaurants’ needs. Both have tough outer skin and don’t require much water to thrive, he says, which makes them fairly drought resistant and a good alternative to other produce options that might have increased in price because of the drought. “If you’re running an operation where you’re locked into baby spinach or something else year-round, you may find unexpectedly high costs,” he says. “If you’re nimble enough to say, ‘We’re serving greens,’ you can switch to kale or something else that’s available.” He adds that sourcing those ingredients locally can also help insulate the restaurant from volatile food costs.
Michael Stebner, director of culinary innovation for the Washington, D.C.–based salad fast casual Sweetgreen, says maintaining an identical menu across the country is an “old mentality” and says Sweetgreen strives to be “consistently inconsistent.” He works on menu innovation six months prior to roll-out, and Sweetgreen leverages seasonality on its menu by featuring three rotating seasonal salads at all times. Sweetgreen sources locally whenever possible, Stebner adds; depending on season and availability, the share of ingredients sourced locally fluctuates between 10 and 70 percent at certain locations.
By staying flexible with the menu and shifting sourcing partners according to supply, he says, the brand is able to maintain its core product. “We absolutely have to be nimble because we can’t just not serve salads. We have to be nimble in who we’re buying from. We might have to pull the trigger on bringing the stuff in a little earlier because of weather,” Stebner says. “When things like climate effects come into play, we’re sort of used to it, so we’re ready to make a move when we need to.”
Last year, Sweetgreen announced plans to open an outpost in Los Angeles, its first on the West Coast. A group from the company traveled to California to visit with supply partners—Sweetgreen already sources some produce from the state—and Stebner says farmers from the Sacramento Valley were struggling with drought conditions, adding that products like almonds, olives, avocadoes, and citrus were a handful of the ingredients affected by the dry conditions. He anticipates the price of almonds, for example, to go “through the roof.”
“You’re going to take it on the chin once in a while when this happens, especially when you’re a produce-focused concept like Sweetgreen,” he says. “The upside is it’s a shorter beating. Produce regenerates so quickly. Most crops take 20 days, 30 days, 40 days [to grow back]. So you take a beating for a month or two and then things sort of normalize. Those are things you just have to build into the business model.”
Other operators in California are similarly shifting their business model to accommodate the local suppliers they work with. Glenn Cybulski, executive chef and COO of Persona Neapolitan Pizzeria, a fast-casual pizza concept based in Santa Barbara, California, says his company regularly sources ingredients from nearby farmers, and has recently seen some of his suppliers cut back on their production by as much as half to manage the drought conditions.
But Cybulski says it hasn’t necessarily been a bad thing; farmers, he says, are more focused than ever on creating as top-notch a product as possible. “Based on the changing conditions and forecast and things like that, you have to be willing and able to cultivate what you have into a resale product that people want to buy,” he says. “I think that’s where the real creative chefs come into play. I think that’s important. And it’s definitely going to differentiate your offerings to the public.” Cybulski adds that it’s also forced Persona to increase prices slightly, but that customers have been willing to pay extra because they recognize the high quality of the local product.
Ariel Nadelberg, chef at Seed + Salt, a vegetarian fast casual in San Francisco, helped create the same kind of model in her concept. In operation since the fall, Seed + Salt opened its doors in the thick of the drought, and Nadelberg says that by proactively designing its supply chain around seasonality, the business has been protected from dangerous cost swings. What’s more, she says, the seasonality and menu flexibility even supports the bottom line because the restaurant is able to play the market, so to speak.
“When you’re buying things in concert with nature as she provides, and your menu reflects that, I think on your bottom line, it helps,” she says. “In our kind of [quick-service] format, that’s unusual, but we built in seasonality so we could respond to those kinds of things, those shortages as they come up.”
A sustained effort
Many quick-service restaurant operators are trying to approach climate issues with a long-term perspective. But varying opinions exist on what the foodservice industry needs to do long-term to minimize the effect Mother Nature has on the planet’s future food supply and demand. Some are striving for more eco-friendly initiatives to reduce any man-made threats to the climate.
“The World Bank estimates that food production is responsible for anywhere between 14 and 51 percent of all man-made greenhouse gas emissions,” Wasserman says. “The food industry is uniquely positioned to do some things that go right to the bottom line and also address climate change.” He adds that restaurants can do their part to help the climate by increasing the amount of fruits, vegetables, and whole grains on their menu and decreasing their meat options.
But reducing meat production is not likely something a burger brand like McDonald’s would enthusiastically support. That’s why McDonald’s is taking a proactive approach to potential climate issues with its new sustainable beef initiative, hoping to spark conversation that will lead to a more sustainable global beef supply.
McDonald’s research found that around 70 percent of its greenhouse gas emissions were coming from its supply chain, about 40 percent of which was related to beef. So the company launched the Global Roundtable for Sustainable Beef, in conjunction with the NCBA and corporate partners like Cargill and JBS, to come up with a solution that would help prevent potential harm to the environment. The Roundtable hosted its first conference in Brazil in November, in which it hoped to establish global principles and set up targets for purchasing sustainable beef, which McDonald’s hopes to be able to do in 2016. By working with farmers, processors, and suppliers, McDonald’s is aiming to create a system that optimizes cattle’s impact within ecosystems, cares for the cattle’s welfare, and positively impacts the lives of ranchers and their communities.
The NCBA’s Miller says this kind of improved communication is critical as the foodservice industry explores supply chain innovation in the wake of climate issues like the California drought.
“At times of extremely tight supply and high price, there’s a lot of interest on the part of restaurateurs to have conversations with the supply chain. And at times of low price and high supply, producers really want to get in and have a visit with restaurateurs,” he says. “But it’s the sustained effort on the part of both to keep one another informed as to what’s going on both in the supply chain and what operators are seeing from both their consumers and some of the different trends they see.”
Will improved communication and sourcing patterns help the industry withstand droughts, flooding, freezes, and other climate patterns? For now, only Mother Nature knows.
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