The big squeeze

If you're looking for low cost ingredients, then nothing comes cheaper than air, water and salt. But with pressure from the health lobby to reduce salt in food, that just leaves air and water as the lowest cost reformulation route to counter soaring raw ingredient prices that have hit food manufacturers hard over the past year, in some cases doubling in price.

With grain, oil and other core ingredients demanding record prices, the pressure is on - either to find cheaper sources of supply from different parts of the world or use cheaper ingredients to maintain product margins in these difficult times. 'Value engineering' of product formulations has well and truly re-emerged as an issue. Manufacturing giant Unilever is the latest firm to announce plans to change recipes and production methods to ease the effects of more expensive ingredients.

While some brand owners have been able to pass on increasing prices directly to the consumer without tinkering with their products, many own-label manufacturers have found themselves in a far trickier position. They have come under intense pressure from their powerful supermarket customers to absorb costs wherever possible. And when it comes to negotiating with such powerful customers, size matters: it all depends on how much clout you are able to exert.

Before own-label suppliers can re-engineer products using use cheaper ingredients, they must get agreement from the supermarkets. "It is incredibly difficult for you to try to recoup cost increases," says one new product development (NPD) specialist. "Retailers will not just let their suppliers opt for cheaper sources of supply."

No value left to engineer out

But even with their consent, the problem remains that, in many cases, value engineering has already been so exploited over the past few years in the inexorable drive to shave costs that there is very little left to cut.

"Much of the value engineering has already been done," she says. "The only way to get better prices is to develop new ranges with better margins."

Angela Mitton, from NPD consultancy Beetroot & Orange agrees: "Money saving initiatives have been going on for years. There is nothing new there."

However, she notes that companies are currently revisiting the raw materials - particularly fruit and vegetables - that they use in recipes. "Can we look, for example, at using frozen rather than fresh ingredients without compromising the quality?" was a question being asked, she says. "Sometimes it works, sometimes it doesn't. Peppers, for example, can be quite slimy if frozen rather than fresh." And because of problems with sourcing peas last year, some manufacturers are engineering these out of their recipes, she adds.

There are some people in the food industry who fear that such value engineering has already gone too far - sometimes causing serious damage to well established brands. "Cost engineering is a false economy, because you devalue the product," said another NPD source.

Robert Kedzlie, md of product development consultancy NPD Direct, adds: "I was at a conference several years ago at which some people were very proud of a Quiche Lorraine they held up as a monumental success. They had still managed to maintain fantastic product quality but had reduced the raw material costs by about 25%."

Kedzlie agrees that today there is a lot of value engineering underway. However, he believes it is easier to take out costs from premium ranges rather than those at the value end. "Cheaper products are more difficult," he says, because in many cases costs have already been cut to the bone.

"Take the salad market, for example," says Kedzlie. "We know there are three or four cycles throughout the year where product categories are being redeveloped. So hidden away within that the retailers and manufacturers are obviously looking to re-engineer product they want to keep on shelf and any new products that are going to be coming into the market. And any new innovations have to bear the brunt of the current raw material prices increases."

Kedzlie predicts that towards the end of this year products of poorer quality will start to emerge on shelves across all sectors. "You are talking about an inferior product in a lot of cases," he says. Kedzlie expects the next nine months to be critical.

One way some manufacturers achieve cost savings without completely compromising the taste of their products is by working to the lower end of product specifications. "If times are tight people will be told to work to the lower end of the spec," says another NPD source. "So they will skimp a little bit on the chocolate or skimp a little bit on this or that ... there are ways like that of saving money."

One area this has been witnessed is within confectionery where, for example, polyglycerol polyricinoleate, an emulsifier made from castor beans which reduces the viscosity of chocolate, has been used to "thin it down a bit so you can get a thinner coating of the chocolate", says the source.

And, it is well known that injecting or tumbling of protein such as chicken, hams and bacon to bulk it out with water is a widespread practice. There is nothing illegal about this, provided it is clearly labelled. However, with pressures on costs, some will be tempted to increase the amount of water they add. "Where there is a cost saving to be made, either by adding more salt or adding more water, someone will abuse it," says the source.

Meanwhile, some manufacturers are seeking to replace expensive cuts of meat with cheaper ones in their products, such as cheaper cuts of beef, lamb and pork.

When all else fails

But if you can't pass on your costs or cut your ingredient costs, you are left with making your working practices more efficient or cutting waste of your ingredients, according to another insider. "One area that can be looked at in this respect is managing the shelf-life of ingredients," she says.

Mitton gives another example where companies are looking to engineer costs out: reducing labour on the production line by incorporating more ready meal and sandwich components in sauces rather than hand depositing them.

She also notes that, as well as seeking cheaper sources of chicken from countries such as Brazil and Thailand, manufacturers were now looking at adding extra value to these products at source: for example, by adding different coatings, batters and marinades to reduce the cost.

When all else fails, you can always reduce the size of product. There have been a number of very successful examples where by clever marketing and repackaging in more convenient formats or by targeting different social eating occasions, higher prices are now being commanded by certain confectionery items which contain far less product!

But, from whichever perspective you view it, rising ingredient costs have and will continue to cause much pain. Take Premier Foods' bakery subsidiary RHM, for example. It came under much criticism last year for not making better use of 'derivatives' - futures and options mechanisms for fixing its forward wheat prices. This might have helped it stem the loss of business it experienced to competitor Kingsmill when it was forced to increase the price of its Hovis loaves. Unlike RHM, Kingsmill's owner Allied Bakeries was believed to have purchased its flour at more favourable forward prices.

When you're talking about similar products, where shoppers have a direct on-shelf price comparison, such errors in forward planning can prove to be very costly. As one industry source said: "Consumers will just drop you as soon as you increase your prices."

Derivatives may be an option for smoothing ingredient cost fluctuations for products such as bread, which have consistently large volume production runs, and for other long shelf-life and ambient products. But the same is not true for many chilled products and those dependent on more seasonal ingredients.

For these sectors, there is the additional problem of short-term weather-related price fluctuations and shortages, which can exacerbate underlying price rises. Condiments manufacturer English Provender Company, for example, expects tomato prices to rise by 50-60% this summer on top of an expected hike in rape-seed oil prices.

"It will be an interesting year in retailer own-label chilled foods," says Kedzlie. He also cites the problem of decentralisation of operations and purchasing teams, which make it more difficult to renegotiate better prices for ingredients. "I feel it is to their detriment," he adds.

The next year will definitely put a lot more pressure on food developers. In recognition of this, the Food and Drink Innovation Network is planning a conference on June 19 in Birmingham, UK, called 'NPD in an uncertain economy', while the Westminster Food and Nutrition Forum has one planned in London on June 25 called 'Food prices, competition and efficiency in the supply chain'.

With prices now rising across the board, however, more shoppers are reluctantly accepting that the days of cheap food may be gone. But that doesn't mean retailers are just rolling over when their suppliers claim a price rise is needed. In all cases a strong justification is required that everything else has been done to absorb costs before they will accept price increases.

A problem highlighted by a number of industry sources is the shortage of people who are skilled in negotiating price increases with customers. "It's the character of the individuals that will make or break," says one source. "Some guys can get price increases through very easily and others can't."

He went on to say: "If you're in commodity products, you're in trouble, because there are just too many people supplying the same thing. If it is something that has consumer brand loyalty, it's a slightly different matter. However, if you are in something like sausage rolls you are buggered."

If high input costs are here to stay, some believe that the only way for some suppliers to survive will be for a system of open book costing to operate. Under this arrangement, the true input costs and profit share between manufacturer and customer would be clearly calculated and agreed at the outset of any supply deal.

Whether there is sufficient trust for such collaboration to work at present, however, is doubtful. While a 80:20 carve up of the spoils between retailer and supplier might in some cases be acceptable, the common arrangement where the retailer takes all is definitely not.

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