Food may take a bigger bite out of your budget

Grocery shoppers have more reason to dislike running their errands in 2008. Their food bill will be larger.

"That's painful when you're on a budget," said Michael Collier, a 50-year-old Chicagoan, about his expensive grocery bill. "When I looked at the bills for a six-month period I saw a $30 to $40 increase in what I paid. It's such a gradual thing that you don't notice it while you're waiting in line. I thought I was buying more in volume, but instead I was paying higher prices."

The average Chicagoan should expect to pay an additional $260 for groceries this year, according to the U.S. Census Bureau. The Bureau's American Community Survey estimated that Chicagoans spent approximately $6,500, or 15 percent, of their $43,436 salary on food in 2006. Statistics for 2007 are still being calculated.

The price of food is forecast to rise 3 percent to 4 percent in the U.S. in 2008, in addition to the 4 percent rise that occurred in 2007, according to the U.S. Department of Agriculture's Economic Research Service.

"The last time the food industry experienced increases in food prices similar to 2007 was 15 or 20 years ago," said David B. Vermylen, chief operating officer for TreeHouse Foods Inc., a Westchester-headquartered provider of private label foods.

"If you talk to a retailer about pricing," added Vermylen, "You'll learn that every food processor is talking to them about re-pricing products."

Since late 2007 food company CEOs have mentioned "aggressive pricing" as part of their strategy for 2008. During the Feb. 19 conference of the Consumer Analyst Group of New York, Kraft Foods Inc., announced a 7 percent increase in its prices; Sara Lee Co. Inc., repeatedly mentioned "pricing the product to market"; and Archer Daniels Midland Co. was sarcastically named "the bad guy" for the sustained leap in prices of corn and wheat.

While a confluence of events led to 2007's price inflation - increased demand from China and India and droughts reducing supply from other wheat-producing countries - many agricultural economists blame the price inflation on increased ethanol use. "What's driving it, in my view, is energy," said Brian Stevenson, a consultant and general manager of B. Stevenson and Associates LLC in Kansas City, Mo. "The use of corn carbohydrates and other things for energy."

Ethanol is expected to divert a larger percentage of corn in 2008, rising to 31 percent, or 4.1 billion bushels, from 25 percent, or 3.2 billion bushels in 2007, according to the U.S. Department of Agriculture. Ethanol consumption of corn in 2007 was more than twice the level of consumption in 2005, Stevenson said.

"The current expansion of in the use of corn for ethanol is unprecedented in its speed and magnitude," said Paul Westcott, an analyst at the USDA's Economic Research Service.

To meet surging ethanol demand, U.S. farmers planted a record number of corn acres in 2007. "Typically, 80 to 82 planted acres of corn is big planted acres for corn in the United States," Stevenson said, referring to millions of acres. "And that number jumped up by 12 million acres this past year to 93 million acres."

Despite the increased supply, corn prices rose during 2007. According to Stevenson, for the last 10 years, if 2007 prices were excluded, the price for corn ranged from $1.80 to $3.10 per bushel. But in 2007 corn prices ranged from $3.10 to $4.36.

The increase in corn acreage led to a decrease in wheat acreage. Consequently, the price of wheat increased. "For the last 10 years the average price of wheat futures, excluding this past year, was $3.70," said Stevenson. "The price range for 2007 was between $4.83 and $9.50."

In February 2008, prices for Minnesota wheat, typically used for making bread, soared above $22 per bushel.

"The effects extend to other crops, livestock, and to prices consumers pay at the grocery store," emphasized Westcott.

"Think of corn as the basic feed that is used to make meat," explained Stevenson. "It is the least expensive carbohydrate. It takes eight pounds of corn to make one pound of beef. It takes four pounds of feed to make one pound of pork. It takes two pounds of feed to make one pound of chicken." Stevenson sees 2008 as a difficult time for animal herders because of the increased feed costs.

If 2007 commodity increases were applied to meat production, according to Ephraim Leibtag, another USDA analyst, the retail prices of beef would increase 8.7 percent, pork prices would rise 4.1 percent and the price of chicken would grow 2.5 percent. The increases assume that farmers continue to feed animals the same mixture of grains, meaning 55 percent of corn is used to feed livestock, said Leibtag.

Mistakenly, many food makers last year believed that historically high commodity prices would come down to earth. Typically, food processors such as Sara Lee, Kraft or TreeHouse Foods Inc., don't increase prices immediately when commodity costs change. They try to stabilize costs for their profit margins, retailers and customers.

"There's some lag in the market," said Brenda C. Barnes, CEO of Sara Lee, during an earnings call. "There are contracts with grocers or sellers that lock in a certain price for a period of time."

In addition, food manufacturers use futures contracts as hedges to secure a specific price for a certain amount of time. "As those hedges expired and commodity prices continued to increase, companies were forced to buy more expensive hedges," explained Stevenson.

The increased costs quickly ate into company profit margins. "We're definitely feeling pressure and, after a certain amount of time, you have to deal with that input cost inflation," said David B. Vermylen, chief operating officer of TreeHouse Foods during an earnings call.

As the prices for the raw materials remained at historic highs, the larger food makers have slowly raised their prices. "Without a doubt, we are taking the pricing action that is required," said Barnes during the Feb. 19 conference in New York.

One would think that consumers would change their shopping habits, purchase less expensive food products from private label food makers instead of brand name products, but the according to industry analysts smaller food makers raised their prices more quickly than their larger counterparts.

"If you look at the syndicated data, it looks like private label processors got the pricing last year," commented Vermylen. "For a hundred private label companies, in aggregate, their percent increase in pricing was quite a bit higher than for the branded companies."

Consequently, consumers will see more price increases in branded foods than in private label foods in 2008.

"The world has really changed in the last 12 to 15 months," Vermylen said. "Everyone is going to see the same increased input costs. But not everyone has the experience to manage through and in taking the needed steps for this time."

Shoppers will find ways to cope with the higher prices. "I'm on a budget. I just won't buy as much," said Collier. "Instead of buying two containers of milk, I'll buy one. Some people eat for gratification. I'll just eat for nourishment. The body really doesn't need that much to sustain itself."