Economic Insight

Feeding inflation: high food prices

After a long period of low food prices, sudden and significant price increases are impacting consumers, businesses and policymakers in both developed and emerging markets. In order to respond to this new reality, businesses will need to broaden their view of what constitutes sustainability and work with policymakers more closely in the future.

 After a long period of low food prices, sudden and significant price increases are impacting consumers, businesses and policymakers in both developed and emerging markets. The nature and degree of that impact varies, but increased levels of poverty, social unrest and price inflation are just some of the consequences being seen around the world. At the business level, food-related industries are facing the most direct impacts. But many sectors will need to weather reductions in discretionary consumer spending and upward pressure on wages. Accenture believes that, in future, businesses will need to take a broad view of what constitutes sustainability and devise strategies to manage the impacts of increased food price volatility.

According to the International Monetary Fund, the price of food (including cereals, fruit, meat and sugar) has increased by more than 70 percent over the last three years. Figure 1 shows how staple crops such as wheat, maize and rice have increased rapidly in price over the last three years, although these increases have occurred within the context of historically low food prices. In some developing countries, such as Bangladesh, Egypt and Haiti, sudden increases in food prices have led to social unrest and threaten to reverse poverty reduction of recent years. Across the world, food price inflation is fueling overall inflation. Over the last year, food prices grew by 5.3 percent in the United States and by 7.1 percent in Europewhile general inflation was 5 percent and 3.7 percent respectively.2 Food security has now become perhaps the most fundamental manifestation of the global battle for resources. The impact, however, extends beyond resource management to encompass far-reaching economic and social
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concerns. A sustainable approach to food security must address all these issues, underscoring the need for businesses and policymakers alike to integrate sustainability into their core operating models. How businesses adapt their sustainability strategies to navigate through these changing times will be an important determinant of their long-term profitability.

Drivers
So why have prices of food risen so strongly? Our research shows that, in essence, the problem is largely one of supply and demand. However, the factors underpinning both sides of the equation are far from simple.

well as increased demand for specific products such as meat and related animal feeds, as tastes and preferences among these large and more affluent populations have evolved. Historically, demand growth for food has been about 1.5 percent each yearhowever, it has now risen to 2 percent and could reach 2.6 percent within the next decade.4 The World Bank estimates that food production will need to grow by 50 percent by 2030 to meet expected demand.5 Furthermore, the impact of the global economic downturn may have played a role, with some commentators believing that investors who sought safety from a weak dollar and falling equity and bond markets have invested in commodity markets instead. This may have pushed up demand for food commodities and prices even further.

Demand
On the demand side, the most important factor at work is the rapid increase in population and average incomes in China, India and other emerging countries. In China, for example, private consumption per head has increased nearly fourfold over the last 10 years.3 This has raised the absolute level of food demand, as

Supply
On the supply side, important factors that have contributed to this situation are: Higher oil prices (see Figure 2), which have doubled in the last 12 months and

Figure 1: Food prices (index: March 2005 = 100) 300 250 200 150 100 50 Wheat

Maize Rice

Mar-05

Mar-06

Mar-07

Mar-08

Source: International Monetary Fund, Primary Commodity Prices

recently touched US$139 per barrel. Given the increased reliance of modern agriculture on machines, fertilizers, pesticides, and transportationall highly oil dependentfood production costs have been driven even higher. Stagnation in the aggregate production of grains in 2006 and 2007, partly due to more severe weather conditions such as drought and, potentially, the reduced capacity of certain land to grow food, as a result of climate change. In countries such as China, the process of desertification has further reduced the capacity of agricultural land at a time of intense urbanization. Furthermore, the rapid increases in crop yields of the last generation, at the time of the green revolution, have slowed, and the cultivation of genetically-modified crops, which offer the prospect of increased yields, is still controversial in many parts of the world. The expansion of first-generation biofuels usage, with many governments across the world having actively encouraged the growth of biofuels to provide a substitute for oil and

to stimulate domestic agricultural industries. Although this has contributed to the increase in food prices, the extent of that contribution has probably been overstated, as it is not always the case that land used for biofuel production would otherwise have been used for food purposes. In

future, most countries will increase the development of second- and third-generation biofuels, which are produced from non-food grade biomass and are less crop-intensive than first generation, ensuring more efficient biofuel production.

Figure 2: Food and oil price indices (index: March 2005 = 100) 200 180 160 140 120 100 80 Food index Crude oil index

Mar-05

Mar-06

Mar-07

Mar-08

Source: International Monetary Fund, Primary Commodity Prices

Figure 3: Summary of key impacts of rising food prices Socio-political

Shifting balance of political power Pressure on global institutions

Economic
Improved terms of trade for food-exporting nations Transfer of rents from consumers to producers Reduced discretionary income Inflationary pressures Social & political instability Increased poverty levels

Regulatory
Export curbs Trade policies Market intervention to control costs Incentives to invest in R&D Relaxed tariffs/quotas Trade liberalization Subsidies Competition policy

Wage bargaining

Rising food prices

Industrial
Rising costs Increased investment in food and food-related industries

Technological

Global competition for food resources

Increased acceptance of GM foods/crops

Growth of food-technology industry

Industry consolidation

Impacts
As shown by Figure 3, the rise in food prices is having a number of impacts across a range of dimensions. For example: Socio-political: the distributional nature of the rise in food prices means that among those economies affected there will be both winners and losers. While many countries may experience social and political instability as a result of food shortages and increased poverty, those countries that are net food-exporters will gain in political strength. Regulatory: a number of regulatory responses have already been witnessed, from measures to increase trade liberalization (e.g. relaxation of tariffs) to more protectionist steps such as curbing exports. Looking ahead, one positive consequence of the rise in food prices is likely to be stronger incentives (such as subsidies and grants) to encourage research and development in agriculture.

Technological: developments in agricultural technology are likely to accelerate in the search for more sustainable and reliable supplies of food. Government incentives will play an important role in stimulating this investment. Industrial: wage inflation may increase the costs of doing business in a number of economies. Economic: the rise in food prices is already placing pressure on the general level of inflation in some economies. Not only will this reduce further levels of discretionary income, it will also increase the pressure on wages to grow at a commensurate rate. These impacts present challenges as well as opportunities for businesses and policymakers alike. Companies best positioned to thrive in this volatile environment will be those that integrate sustainability into their business models and take appropriate actions to protect the environment, enhance social wellbeing and achieve continued economic growth.

Figure 4: Potential government responses in the medium to long term Emerging market Increasing investment in agricultural science and technology as well as rural infrastructure in order to improve market access Reviewing trade policies to reduce market distortion and ensure greater openness Adopting policies to preserve agricultural land in the face of rapid urbanization Seeking greater representation and influence in global institutions of governance Developed market Reducing agricultural trade barriers and subsidies to ensure a more liberalized global market Expanding the concept of foreign aid to cover agriculture, science and technology and rural services Reviewing the role of financial markets and commodity speculation in driving up certain food prices Accelerating food R&D programs (e.g. research into genetically-modified crops) Increasing dialogue and joint policymaking with emerging-market counterparts to assess impact of new initiatives and policy instruments

Policy implications
Short term
Beyond emergency assistance and the provision of short-term food aid to the hardest-hit regions, an important early concern for policymakers is likely to be an assessment of the precise impact of biofuels growth on global food price levels. A better understanding of their potential contribution to environmental and economic sustainability in its widest sensecomprising food security and economic security as well as environmental securityis beginning to emerge, although policymakers will want to ensure that any reduction or removal of subsidies neither obstructs progress towards renewableenergy targets nor clouds public understanding of the potential of the next generations of biofuels. More widely, the signals that policymakers send out could have a bearing on the overall trading environment in which businesses are operating. While more protectionist policies (such as imposing export

curbs and tariffs) could help alleviate domestic shortages in the near term, in the long term this could restrict the ability of suppliers to meet demand quickly and undermine national economic competitiveness.

Medium to long term

Looking further ahead, the responses from governments are likely to vary between emerging and developed markets (see Figure 4), although there are likely to be common elements between the two, such as an increased focus on agribusiness and rural development, as called for at the United Nations World Food Summit in June 2008.6 More broadly, the reform of agricultural trade remains one of the principal stumbling blocks of the stalled World Trade Organization Doha round of trade talks. The rise in food prices could provide the impetus needed to break this deadlock, although the most recent round of talks in Geneva failed to reach a breakthrough. Ultimately, the most sustainable solution to the rise in food prices could be the creation of a more

level playing field for farmers from emerging and developed economies. Ensuring an easier flow of food between areas of supply and demand would help ensure a more efficient system of distribution. Furthermore it could help achieve a more competitive global economy in which businesses from both the developed and emerging economies can operate.

Figure 5: Strategic responses for food retailers and processors

Response
Market focus and positionbusiness strategy decisions regarding where to compete Customer-centricity: improve the use of marketing analytics and consumer data (often already collected by storecards) and develop more flexible and innovative pricing structures to keep aligned with changing customer tastes and preferences. Own-brand product lines: as consumers shift away from more expensive, branded products, retailers will need to ensure they have well-developed, lower-cost, own-brand products. Establishing middle-range own brands may also be helpful in managing the transition for consumers, as well as avoiding the erosion of profit margins in the long term. Green branding: retailers will need to assess how they can ensure that their environmental credentials underpin their brand and appeal to consumers concerned about the origin of their food and its impact on the environment. Distinctive capabilities hard-to-replicate capabilities that define how businesses compete Backward integration: by acquiring suppliers and agricultural producers, retailers can help ensure security of food supply, control prices more closely and potentially strengthen environmental credentials. M&A: larger players will be able to absorb price volatility more easily than smaller businesses, leading to the squeezing out of smaller outfits and increased opportunities for growth through M&A. Supplier review: renegotiate contracts to avoid taking on extra costs and/or enter into longer-term, fixed-price contracts. Furthermore, diversify supplier base to ensure security of supply. Performance anatomycommon mindsets relating to culture, leadership and the workforce Leadership development: especially in consumer goods companies, ensure that the rise in food prices and its implications (as well as other sustainability issues) are integrated into learning and leadership development frameworks. Performance management: for businesses that have integrated sustainability into individual performance contracts and company balanced scorecards, ensure food price impacts are reflected appropriately. Recruitment: for the food industry in particular, maintaining a reputation for sustainability will be an important factor when attracting environmentally conscious talent.

Key capabilities
Customer relationship management, marketing, information technology, data management

Product development, pricing, marketing

Brand management, sustainability strategy, marketing

Mergers & acquisitions (M&A), supply chain management, post-merger integration M&A, post-merger integration

Contract management, strategic sourcing and procurement

Leadership development, human resources

Sustainability strategy, human resources

Sustainability strategy, recruitment

Business implications
The rise in food prices and the government responses to it have a number of implications for specific industry sectors, as well as businesses in general. For example: Agribusiness: the increased focus on and government support for agricultural science and technology will present opportunities in many emerging economies. Energy and automotive: the likelihood that new biofuels projects will need to pass a broader test of sustainability will place new demands on them as well as others that are seeking to substitute biofuels for existing sources of energy. Freight and logistics: the importance of developing rural infrastructure (e.g. transport routes and storage facilities) in emerging economies as a means of improving the efficiency of food supply chains is likely to present growth opportunities in this industry sector. Food-related industries (such as food producers, suppliers and retailers): there are a number of direct impacts that are already changing the business landscape in this sector. All through the value chain the increases in input costs mean that the simplest response is to try to pass the cost on to the consumer. But in competitive markets where demand is relatively elastic, this risks reducing market share. Indeed, Nestl has already signaled that while it has generally managed to pass its cost increases to consumers, it is struggling to do so in emerging markets, where pockets are not as deep.7 While the whole value chain has a role to play, food retailers will be important in determining how much of these cost increases are passed on to end-users. To reduce this potential impact they can seek efficiencies elsewhere, undertaking actions such as: - Improving supply chain and store operations to minimize wastage and time spent transporting or storing goods. - Understanding areas of relative pricing power, reducing the price of other products and implementing new promotions, offsetting the overall consumer impact.

- Reducing the expensive elements of specific products, for example, by using less meat or dairy products in certain lines. - Undertaking more green initiatives, such as using less packaging, improving the performance of refrigeration units and reducing the mileage of the transport fleet. As well as cost reduction, Accenture has identified a number of further operational innovations and strategic responses that retailers in the food industry can make in order to ensure their long-term sustainability and drive high performance (these are summarized in Figure 5). Accentures ongoing High Performance Business research has revealed market focus and position, distinctive capabilities and performance anatomy as the three building blocks of high performance. As food retailers look for more sustainable approaches to businessand food security, in particularthey will need to align their goals for sustainability with their key capabilities and their overall vision for high performance. Perhaps the most fundamental response to higher food prices could potentially involve some form of backward integration, whereby retailers attempt to reduce costs and secure supply by acquiring or re-purposing land for agricultural development. In this way, they would be following the upstream migration of the economic rents, potentially insulating the consumer from the full force of price rises and preserving competitiveness. Similarly, we could see more retailers starting to move into the distribution of those products, enabling a tighter rein on costs, as well as, potentially, strengthening green credentials through closer control of food miles (ensuring optimal transport routes and reducing emissions). Business in general: across all sectors, though, increases in the cost of living may put pressure on employers to increase wages. Furthermore, a reduction in the overall levels of discretionary spending will impact a range of sectors such as the retailers of higher-end products (e.g. cosmetics and clothing), who are likely to face falling sales unless they can devise more competitive pricing strategies or diversify into new, lower-end product lines.

Conclusions
The rise in food prices has occurred because of the confluence of many different factors, from increased wealth and associated changes in consumer habits in emerging economies to adverse weather conditions and the influence of high oil prices throughout the food-related value chain. These interrelationships present significant challenges for policymakers, where well-intentioned interventions can result in unintended and negative consequences. Governments will need to ensure that policy measures aimed at managing the crisis, such as imposing export restrictions or quotas, do not exacerbate the problem. For many businesses, the issue of rising food prices may have been one that they had not envisaged as part of their sustainability strategies, which may primarily have been born of the need to address the more publicized impacts of climate change. But the current crisis underlines the need to take a broad view of what constitutes sustainability, as well as ensure that businesses work with policymakers in order to understand the impact of new policies. A more integrated approach appears to offer the best chance of managing the impact of this episode and, indeed, managing the risk of similar price increases in the future.

References
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International Monetary Fund, Primary Commodity Prices. United States Bureau of Labor Statistics and Eurostat, June 2008. Economist Intelligence Unit. Goldman Sachs, presentation by Jeffrey Currie, March 2007. United Nations Secretary-General Ban Ki-moons speech at the HighLevel Conference on World Food Security in Rome, June 3, 2008. United Nations Food and Agriculture Organization, World Food Summit Declaration, June 6, 2008. Financial Times, Nestl warns over rising food prices, April 21, 2008.

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This study was prepared from sources and data which Accenture believes to be reliable but it makes no representation or warranty, express or implied, as to their accuracy or completeness. The overall analysis, conclusions and views expressed in this publication are those of Accenture only. Such opinions should not be construed as providing professional advice, as such as they meant only to stimulate thought and discussion.

About Accenture Policy & Corporate Affairs

This study was produced by Accenture Policy & Corporate Affairs. The group is Accentures macroeconomic and geopolitical think tank, analyzing key trends and their implications for business leaders and policymakers. The group uses a combination of primary and secondary research, strategic analysis, scenario planning and ongoing dialogue and debate with senior executives, clients and outside experts. For more information contact mark.purdy@accenture.com.

About Accentures Sustainability Practice

Accentures Sustainability Practice helps organizations achieve substantial improvement in their performance through integrated programs that maximize the positive and minimize the negative effects on social, environmental and economic issues and stakeholders. We work with clients across industries and geographies to integrate sustainability approaches into their business strategies, operating models and critical processes. To learn more about the Accenture Sustainability Practice contact peter.lacy@accenture.com.

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About Accenture
Accenture is a global management consulting, technology services and outsourcing company. Combining unparalleled experience, comprehensive capabilities across all industries and business functions, and extensive research on the worlds most successful companies, Accenture collaborates with clients to help them become high-performance businesses and governments. With more than 180,000 people in 49 countries, the company generated net revenues of US$19.70 billion for the fiscal year ended Aug. 31, 2007. Its home page is www.accenture.com.

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