Top Products Survey 2016: The Great British Brexit Bust-up

In grocery as in politics, 2016 will be remembered as a year of bust-ups. The big four have continued to fight the discounters (with mixed results). Retailers have locked horns with suppliers over range rationalisation strategies. And the biggest bust-up of all - Brexit - looks like shaping the market for the rest of the decade and beyond. But what does Brexit mean for Britain’s Top Products? Supplier demands for price rises to cover currency-related cost increases have already hit the headlines and will lead to many more tense conversations with their retail customers in the weeks and months ahead. Suppliers who misjudge their approach to pricing negotiations risk an additional bust-up - with the public.

The price of food has become more politicised than at any point in recent memory and reputations are on the line for businesses that lose the PR war. The Eurosceptic tabloid press gleefully cast ‘Anglo-Dutch giant’ Unilever as the European bad guy in its efforts to push through price increases with Tesco, whose British heritage was repeatedly referenced in articles. Unilever took some hits for what some media commentators described as its use of Brexit and the weaker pound as “a smokescreen” for “fleecing” UK consumers. You could argue the resulting 61% spike in sales of Marmite meant Unilever won the war, but it seems doubtful many suppliers will be willing to risk a public backlash. Far from being cowed by the prospect of Brexit, if anything consumers seem emboldened by the vote to leave the EU. Mike Watkins, Nielsen’s UK head of retailer and business insight, predicts a lucrative Christmas with consumers trading up and spreading their spend between different retailers. “Consumer confidence remains high at the moment,” he says. “They have felt OK about their job prospects, comfortable with their disposable income and comfortable about spending, and we don’t see that changing in the near future. We should expect a continuation of volume growth over the next six to 12 months.”

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Four commodities set to increase in price…

Olive oil

Poor harvests in Southern Europe and currency fluctuations have led to warnings of a rise in supermarket prices after Christmas. Spanish extra virgin olive oil prices have jumped from €3,200/t (£2,751/t) to €3,600/t (£3,095/t), and suppliers fear Italian EVOO prices - currently trading at €6,000/t (£5,158/t) - could return to the peaks seen in 2015.

Tea

Peter Dries, director of customer & shopper marketing for Tetley, says it is impossible to provide an accurate prediction of how the tea market will change post-Brexit. “What we do know is that commodity prices are being affected by exchange rate movements.” Both tea (traded in dollars) and herbal infusions (traded in euros) have been impacted by the weakening pound, notes Typhoo marketing controller Adil Hamid.

Bread

Will Hovis’s pledge to source wheat from the UK pay off post-Brexit? UK wheat prices have risen significantly since June in line with sterling’s fall, which has made British wheat more competitive and led to a surge in exports. But global prices are expected to remain low due to high stocks, meaning Warburtons, sourcing from Canada, and Kingsmill, mostly from Europe, may not be so disadvantaged after all.

Prosecco

“We believe Prosecco pricing will increase over the next 12 months at entry level,” says Ian Thomson, creative director at Thomson & Scott. He worries that the UK has engaged in a “race to the bottom” on the quality and price of Prosecco, which is not sustainable in view of the recent movements in currency. “This will prompt consumers to trade up and try spending a little more to get a higher quality Prosecco,” he predicts.

…and one commodity set to benefit

Milk powder

One of our fastest growing exports, as demand for infant formulas grows in China. Weaker sterling has given manufacturers a big advantage. “Thanks to sterling’s weakness, price increases that Kendal Nutricare has incurred in some ingredients bought in the Eurozone have been passed on without overseas customers seeing any change once they convert back to their local currency,” says a Kendal spokesman.

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Winners and losers

Indeed, 2016 has been an excellent year for some product categories. Fresh fruit, for example, has seen impressive growth of £175.6m (+4%) driven by demand for avocados, blueberries and raspberries, making it the fastest growing category in this year’s report. The roll-your-own, free-from, and sparkling wine categories have all added over £100m in sales, while bottled water, chilled ready meals and spirits are among those that have delivered both value and volume growth.

There have also been losers, most notably fresh meat and cigarettes, sales of which have plummeted by over £300m and £200m respectively. Bread, spreads & margarine, and cereals have also suffered uncomfortable value and volume declines. For these categories in particular, the threat of input cost hikes putting further pressure on margins next year must be cause for concern. Listening to suppliers, it’s impossible to avoid the conclusion that several years of food price deflation are at an end, and a return to inflation in 2017 is inevitable as the drop in value of sterling against the dollar and the euro feeds through into the supply chain.

Few if any suppliers say they are immune to inflationary pressures. Even for products manufactured in Britain (Unilever was criticised for demanding a price rise on UK-produced Marmite) many overheads, notably fuel, are priced in dollars, while as Justin King pointed out on the BBC’s Newsnight in November a lot of international brand owners have dollar and euro denominated earnings.

Currency pressures

Part of the reason suppliers such as Unilever, Birds Eye and PepsiCo have been so public in talking about currency pressures is to prepare consumers for the price hikes that lie ahead. “A lot of the apocalyptic talk is about softening people up for price increases,” says Greencore chief executive Patrick Coveney, who estimates the total impact for his company in the current financial year will be around 3% to 4% inflation on raw materials and packaging.

Warburtons says that although shopper sentiment is still broadly positive, “there is an expectation of rising food prices”. One branded cheese supplier is more forthright in his analysis: “There’s absolutely no chance prices will stay the same. They’ll go up for sure, it’s just a question of how much.”

Own-label suppliers find themselves in a similar position. One company that supplies most of the UK supermarkets notes: “We cover forwards in currency - as such we’ll aim to hold prices until the end of this calendar year. We have already been advising and in the main been relatively successful in obtaining price increases from the beginning of next year.”

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Top five category bust-ups

The discounters are tearing strips out of the big four’s market share, with Aldi and Lidl’s combined value sales soaring 14% in the past year. So which categories are growing fastest for the German discounters and how is this affecting the mults?

Fruit & Veg

▲ 18% in Aldi & Lidl

The mults have seen £58.2m (1.3%) wiped off their veg sales, thanks to price cuts to compete with Aldi and Lidl’s growth in fresh. Volumes rose 2.1% for the mults (see p130). Fruit & veg is the discounters’ fastest growing sector and now accounts for 15.2% of sales. The mults’ fruit sales are up 4% on volumes up 3%, as pricier products such as berries and avocado boom.

Meat, Fish & Poultry

▲ 17% in Aldi & Lidl

At £327.8m, meat has been the mults’ biggest loss, and small wonder given the discounters’ growth in this area - though it’s worth noting that bacon’s fall from grace (see p131) also hurt. Almost 50% of Aldi & Lidl’s growth has come from chilled, notes Nielsen’s Mike Watkins: “This reflects how their ads continue to focus on price, quality and now provenance.”

Health & Beauty

▲ 16% in Aldi & Lidl

Granted, health & beauty still accounts for a slither of Aldi & Lidl’s sales (2.2%), but it’s growing ahead of their overall grocery sales. As the supers convince shoppers to pay more by pushing premium products from big brands in their cosmetics and personal care aisles, the discounters are ramping up their limited period deals.

Soft Drinks

▲ 15% in Aldi & Lidl

Anything the big four can do, the discounters can do cheaper (and at least as well, they claim). The 3.5% fall in the average price for Tropicana, the top juice in the mults, is partly explained by Lidl ads pushing Vitafit Orange Juice with the claim it’s 60% cheaper than Tropicana Original. Aldi is playing a similar game, with its own-label drinks undercutting the big brands.

Dairy

▲ 14% in Aldi & Lidl

The average price of milk may have stayed flat in the mults, but that doesn’t mean competition has eased in dairy. As the discounters have waged war in the chilled aisles, prices have been pushed down elsewhere by the mults: the price of cheese is down 3% and butters & spreads by 2.6%. All in all, the major multiples have seen £213.2m wiped off their dairy sales.

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Two types of inflation

If the conclusion from the supplier side is that food price inflation in 2017 is a done deal, other industry experts, such as HSBC analyst Dave McCarthy, remain unconvinced. “There are two types of inflation, there’s cost inflation and selling price inflation - cost push and demand pull - and what we’re talking about here is quite simply cost push inflation,” says McCarthy. “What we’ve also got going on is a long-term price re-adjustment by the retail sector, which is correcting the price mistakes of circa 2008 to 2012. During that period there was high food inflation, which was all passed on to consumers and sowed the seeds of the mess the industry is in today. And no retailer is going to make that same mistake again.”It’s been instructive to note how careful retailers have been in not declaring food price inflation as unavoidable. Fielding a question from analysts on inflation following Sainsbury’s interim results announcement in November, Mike Coupe said: “Our job is to be agents of our customers, to push back on our suppliers, to work out if there are things we can do to source alternatives, to look at our own business in terms of how we reduce our costs to make sure we do everything we possibly can to limit any impact on our customers.”

Tesco boss Dave Lewis has been similarly reluctant to entertain the prospect of inflation. He told analysts following Tesco’s interim results in October that based on a relative price position Tesco was assuming that deflation would carry through until 2020. “What changes in the marketplace, we don’t know,” he added, “but the way we build our thinking is that there’s a need for us to enhance the competitiveness of the business. So we stay in a place that is looking to sharpen our competitiveness and therefore we assume a level of deflation. We won’t give a number but you should know we think that actually there’s still more to be done.”

Range simplification

A ruthless focus on reducing baseline prices has been key to Tesco’s recent revival. Another factor, replicated across the big four, is a programme of range simplification that has seen the number of Tesco SKUs reduce by 23% over a two-year period, with freed up space being dedicated to higher quality own-label lines. McCarthy believes this strategy will allow Tesco to resist supplier calls for price increases by promising volume growth to those that remain on shelf. “If you are Tesco you are giving suppliers some good growth, so it is fair to say to those suppliers: we want reward for the growth we are giving you, which is coming at low marginal cost.”

Rationalisation has created some big winners, and even bigger losers among this year’s Top Products. The likes of Budweiser (+£34.6m), Corona (+£34.4m), Pepsi Cola (+£29.6m) and Kinder (+24.3m), have all reaped handsome rewards. But for those brands, like Carlsberg, that have been on the wrong side of range reviews, it’s been a year to forget. Carlsberg sales are down £73.6m, making it the biggest branded loser of the year. Other notable losers are Warburtons (-£53.4m), Coca-Cola (-£48.2m) and Pampers (-£40.5m).

Rationalisation strategies are set to continue into 2017, giving the largest retailers even more leverage in their dealings with suppliers. Yet even smaller retailers are trying to hold back the tide of inflation, despite warnings from suppliers that business models will become unsustainable without price increases. “We have some smaller customers where some of the buyers were almost in denial when we went in and said we needed a price increase,” says Stephen Barlow, MD of Euro Food Brands, which imports international brands such as Hershey’s. “These are some of the issues we have come up against. It’s about understanding what [currency devaluation] really means. In a business like ours the impact on currency is more than our wage bill and we employ 110 people. Without price increases our business, like many others, would not continue.”

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Top five fastest growing products

A qualification: 2016’s five biggest growers are all cheap tobacco (B&H Blue, Player’s, Chesterfield, Lambert & Butler Blue, Amber Leaf). Rather than tell five times the story of smokers trading down to avoid duty, the list is limited to one product per sector.

Tobacco: B&H Blue

▲ £333.9m (+350.1%)

Growth worth a quarter of a billion pounds should be cause for celebration, but this victory is as shallow as a chain smoker’s breath. It’s all down to price. B&H Blue is the second cheapest cig on the market, selling for nearly a fifth less than the market average. Only Player’s is cheaper and that’s scored the next greatest growth, of £273m.

Fresh Fruit & Veg: Avocados

▲ £49.9m (+35.0%)

Fresh fruit is the fastest growing food & drink sector in this year’s report, with sales up £175.6m. Avocados’ value surge of more than a third has a lot to do with that. Prized as a source of ‘good’ fats and lauded by food bloggers such as Deliciously Ella and Gwyneth Paltrow, avocados are now Britain’s eighth bestselling fruit, having entered the top 10 in last year’s report.

Beer & Cider: Budweiser

▲ £34.6m (+11.5%)

Until September, AB InBev stablemate Corona was in line to take the title of fastest grower in the resurgent lager category, but in the end Bud pipped the Mexican to the post with a little over £150k between them in terms of growth. The same factors have driven both: the shift away from cheaper lager, the use of on-pack promotions and the summer’s hot weather and sport.

Fresh Meat: Prepared Fish

▲ £30.1m (+5.9%)

With more and more Brits cutting down on meat and the backlash against bacon and sausages in full swing after the WHO report that classified some prepared meats as carcinogens, fish is flying. Viewed as a healthy source of protein by those concerned by satfat levels, prepared products such as breaded fillets have delivered the most to a category in rude health.

Carbonated Soft Drinks: Pepsi

▲ £29.6m (+7.1%)

Pepsi’s done it again! Not only has the world’s number two cola defied a market that’s lost £21.9m and the so-called war on sugar, it’s continued to whittle away at the share of Britain’s only £1bn-plus brand, Coke (see p184). It’s done it through keen pricing (a litre sells for an average of 29p less than Coke) and savvy digital marketing. Pepsi Max contributed £27.6m to growth.

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Imports

Filippo Berio is another supplier that believes the status quo is unsustainable. “Supermarkets will defend their position but ultimately they need products on shelf and nobody in the commodity market has the margins to absorb what has happened,” says MD Walter Zanré. He notes that exchange rate volatility, which is adding up to 20% to the cost of imported goods, is not the only factor affecting commodity prices. Poor olive harvests in Southern Europe have resulted in big increases in spot market prices for European olive oil.

Average tomato prices rose almost 10% between late July and September as adverse weather across key producing regions hit production. Robusta coffee prices have been on an upwards trajectory due to droughts caused by El Niño in Vietnam and Indonesia, while a tightening in global production, particularly in China, is putting pressure on poultry prices.

Cheese and butter suppliers, meanwhile, are warning of shortages as a result of tightening milk supplies. A lack of supply has combined with the impact of higher input costs from the weak pound to create a spate of farmgate price increases. Suppliers say price pressures will be particularly pronounced in the premium end of the dairy market as exports become more attractive.

Despite the talk of inflationary pressures there’s no evidence that consumers are picking up the tab just yet, though there are signs that the rate of food price deflation has slowed since the EU referendum. Figures from the GPI showed fmcg prices overall in November were 1.4% lower than a year earlier, compared with a 3.1% decline at its low point in May, before the seismic Brexit vote in late June. The level of price falls in November was the lowest it’s been since December 2014, when prices fell 1.3% year-on-year.

Although the past year has seen hikes in the average selling price of some brands, such as Nutella, Aptamil and Cadbury Creme Egg, the overall trend for Britain’s Top Products has been towards lower prices. Brands such as Kleenex, Pampers and Fairy are trading around 10% cheaper than a year ago with brands like Kingsmill, Country Life and John West also seeing a substantial fall in their average selling price.

It’s unlikely such a pattern will be repeated in 2017 with few products completely immune from the devaluation of sterling. “It doesn’t matter what you talk about, most items are affected,” says Barlow. “Most of the things we bring into the country, like coffee, are traded in dollars. Most of the pasta consumed in the UK is coming out of Italy.”

Exports

Suppliers mostly sourcing ingredients from the UK will of course be less affected than, say, ABF, which sources spices for Patak’s, wheat for Kingsmill, and sugar and nuts for Jordans and Dorset cereals internationally (Twinings tea is somewhat less exposed as its UK factory supplies the British market).

Other suppliers who face being squeezed by retailers say they plan to focus on growing their export business in light of Brexit. “Some people have said they owe their export business to the aggressive buying strategy of the UK retailers,” says one branded cheese supplier. “What this devaluation has done has given [exports] a bit of a turbo boost and given people much needed funds to drive growth a bit faster in those regions.”

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Top five fastest falling products

Four of the five fastest falling products are again cigs (JPS, Windsor, Lambert & Butler and Richmond). The fifth is another carcinogen (at least according to the WHO’s 2015 report): bacon. As previously we’ve limited the top five fallers to one product per sector.

Tobacco: JPS

▼ £161.2m (-19.2%)

JPS isn’t expensive. Nor is it cheap. Therein lies the problem. Selling for almost bang on the market average, it’s being undercut by budget cigs such as Player’s (up £273m) and out-cooled by premium offerings such as Marlboro Touch (up £7.1m) and Natural American Spirit (up £1.1m). That its price was driven up 7.4% by rising duty didn’t help either.

Fresh Meat: Bacon

▼ £122.6m (-11.3%)

Fresh meat has suffered the greatest decline of the year: £327.8m. Much of that is price driven, a result of retailers piling high and selling cheap to compete with the discounters, but not all of it. Bacon volumes are down a hefty 5.6%, thanks to the 2015 WHO report that linked it to cancer. Bacon’s decline has been greater than all but one cigarette brand (see above).

Beer & Cider: Carlsberg

▼ £73.6 (-35.6%)

The biggest branded loss of 2016 illustrates the might of Britain’s biggest retailer. Tesco’s axing of Carlsberg in 2015 contributed to more than a third being wiped off its value, as retailers have prioritised premium lagers. Standard rivals such as Foster’s and Carling have also benefited from Carlberg’s loss of space, up £2.6m and £10.2m respectively.

Bread: Warburtons

▼ £53.4m (-10.6%)

With bread still in the firing line in the supermarket price war, Britain’s biggest loaf has taken a big hit. Volumes are down 11% for Warbies - the priciest of the big three bread players - while Kingsmill has managed 5.3% volume growth by lowering prices and regaining listings. It’s not all bad for Warbies, though, with good growth for bread alternatives like crumpets.

Carbonated Soft Drinks: Coca-Cola

▼ £48.2m (+4.2%)

Only Coke Zero is up, by £7.2m, and its growth is still dwarfed by Pepsi Max’s £26.7m gain. Red Coke is down £28.6m and Diet lost £12.8m, suggesting Zero’s gain was partly cannibalising. Life is down 56% to just £11m. One Coke source says a cut to the mid calorie cola’s sugar content had no impact on sales and the variant’s days are numbered.

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Future trading relationships

Long-term, a strategy based on exports is risky given the uncertainty surrounding Britain’s future trading relationships with Europe and the rest of the world. Most suppliers want continued access to the single market in some shape or form. More than that, they want clarity on tariffs and quotas with non-EU businesses. As one supplier says: “If you’re importing prawns from India, the tariff is set by the WTO but in addition to that you have a quota. No one can tell me whether post-Brexit the tariff or quota are going to stay the same.”

As for retailers, HSBC’s McCarthy is in no doubt which business he believes is best placed to successfully navigate the post-Brexit grocery market. And it’s not Aldi or Lidl. “I think the discounters will level off at around 15% market share or maybe a bit more, but that’s mainly because Tesco are doing their job properly. Is it any coincidence that a few months after Tesco has done Farms brands that discounter growth is slowing and Tesco growth is accelerating? Is there more to come from Tesco? I would think so. The maths would tell you there is much more to come.”

The big four’s prospects

McCarthy is bearish on Asda’s prospects. “You go to Asda for price. Everything else is round the edges. If you’re the price leader and you lose price leadership, if you lose it to someone who has 1% market share it doesn’t matter, if you lose it to someone that’s got 12% you’ve got a problem.”

Morrisons, meanwhile, is confident its vertically integrated supply chain model will help insulate it against future cost pressures. In announcing its latest round of price crunches, Morrisons customer & marketing director Andy Atkinson said: “We are British farming’s biggest supermarket customer, which means we can better control our prices.” McCarthy is inclined to agree: “Morrisons has got the opportunity to put more product through their supply chain at low marginal cost. If you’ve got something that’s at low marginal cost, it brings your average cost down the more you do.”

Brexit will undoubtedly create winners and losers in the grocery sector, yet there remains a sense that it’s too soon to predict how shopping habits may change. “We need to be very cautious about labelling any behaviour against Brexit because there’s actually nothing we see that suggests it’s not business as usual,” says Nielsen’s Watkins. Coveney, too, says it is important not to dial Brexit up into a drama bigger than it is. “It’s manageable,” he says. “And, crucially, there’s not been any impact on consumer demand or volumes.”

For any branded supplier looking to use Brexit as an excuse to push through unwarranted price increases, Sainsbury’s Coupe has a loaded message. “Our job across our entire portfolio whether it is branded or own label is to do everything we can to mitigate those costs. The manufacturing companies, if they allow that gap [between branded and own label] to get too wide, generally speaking they will suffer as a result.”

Brands be warned: the biggest Brexit bust-ups are surely yet to come.

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