Rising Costs Take a Bite Out of Profits

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Rising Costs Take a Bite Out of Profits

Feeling the familiar squeeze of diminishing margins in fuel and cigarettes, convenience retailers are looking more to foodservice as the holy grail of convenience retailing -- the "miracle" category they can rely on to boost sales and recoup gross profits.

In recent months, however, operators have had to watch and worry as the profitability of their foodservice programs is challenged by skyrocketing commodity prices, as well as increased packaging and transportation costs due to record-high petroleum prices.

"Retailers are eternal optimists. A lot of people, including us, ignored it for a while, hoping it would go away. But it's obvious that it's not going away," said Steve Loehr, vice president of operations support for La Crosse, Wis.-based Kwik Trip Inc., which offers an extensive food offering in its 350-plus stores supported by a company-owned commissary.

"Unlike other years when you'd always have cyclical spikes by season, the increases this year are so broad-based, impacting everything from flour to poppy seeds," said Loehr. "Every ingredient is going up, and substantially -- not 3 to 4 percent, but 30 to 40 percent or more."

When Kwik Trip signed a contract with its flour supplier in January, the agreed price was $35 per 100 pounds. Six months earlier, it was $24 and two years ago, just $10.

Figures from the U.S. Department of Agriculture (USDA) show that the average farm price for wheat -- a staple for doughnuts, bread and pizza -- jumped nearly 60 percent in less than a year from an estimated $4.26 per bushel in 2007 to $6.80 per bushel this March.

Likewise, the average farm price for corn posted a 39.8-percent increase over the same time period, going from an estimated $3.04 a bushel in 2007 to $4.25 per bushel in March, according to the USDA. Like wheat, corn is an ingredient crucial to many foods, and is also used by ranchers as the primary feed for livestock.

"When you look at everything that has wheat and corn in it, that covers a lot," Loehr said.

As expected, suppliers are passing the increased commodity costs onto retailers in the form of higher prices. Village Pantry Foodservice Director Chad Prast told Convenience Store News that all of his vendors have tried to implement some type of increase, with recent proposals ranging from 3 to 5 percent and in certain cases, as high as 15 percent.

The 188-store chain based in Indianapolis offers a variety of foodservice options in its locations from fresh doughnuts and fresh-made deli sandwiches, to fried chicken, and pizza and breadsticks, and is continuing to intensify its focus on the category.

"We've been seeing this [pricing trend] for the last three to four months, but it's picked up a lot more lately," Prast said, noting that he hasn't seen increases like these in a long time. "Through negotiations, we've tried to keep [the increases] right around 3 percent, but with some vendors, we haven't accepted any increase," he explained.

Village Pantry, in a number of cases, has decided to switch vendors altogether to save money. The retailer is now using a different company to supply its condiments.

"The new company is more aggressive for business and was willing to make a better deal," Prast said. "These days, it's easier for somebody to get new business with a cheaper cost than it is for somebody to keep existing business. For the most part, we're always shopping around for vendors if it's a product that's more commonplace."

Like his larger c-store counterparts, single-store owner Lee Emond Sr. is also searching for better deals. The owner of Dodge City BP in Hanceville, Ala., currently splits his foodservice purchases between two companies so he can use one against the other as a bargaining tool. "This practice has helped me in several instances," he said. "Vendors have got a lot more flexibility than they let on when they're going to lose a sale."

When it comes to changing the ingredients he uses, though, Emond said he's extremely cautious. He won't sacrifice product quality and is concerned what impact a switch will have on the taste and texture of the menu item. He always does testing first to judge the result.

"If it has a minimal impact, I'll make the change," Emond said, noting that he recently switched suppliers for his fryer oil and condiments after successful trial runs. "Once customers are used to a certain quality, you can't back out of that. Otherwise, you get away from what it was that made you money in the first place."

Getting By

Seeking out new vendors is just one way convenience retailers are coping with the rising food costs. Some operators, like Kwik Trip and Village Pantry, are also reworking their portion sizes in an attempt to make up declining gross profits.

Village Pantry, for instance, moved from a 16-ounce potato salad container to a 12-ounce package -- a difference that Prast said saves costs, but without consumers noticing.

Similarly, Kwik Trip's Loehr reported the chain is downsizing select ready-made sandwiches, and considering reducing the size of its grab-and-go fresh salads from roughly 12 ounces to 8 ounces. The retail price points will be reduced somewhat, as well.

Even by making such changes, many c-store retailers have found it necessary to raise the retail prices of their foodservice offerings. "We were reluctant, like a lot of retailers, to raise prices because of the economy and high gas prices. But over the last month or two, we've taken a number of modest price increases," Loehr said.

After holding the line for as long as he could, single-store owner Emond said he's been edging his retail prices up, too. "It's a real dilemma: Do I move or do I not move? You have to give it a lot of thought," he explained. "I don't want to give my customers a reason to go somewhere else, but sometimes, you just have to bite the bullet."

By not skimping on quality, Emond reasons it's a fair trade-off for customers. "I serve top quality and charge top quality. You have to decide what kind of face you're going to put on your company, and I prefer to serve someone who is desiring of quality, and who is willing to spend more for higher quality," he added.

Some items prove more challenging than others when it comes to increasing retail prices. Village Pantry is raising retails where it can, but Prast noted in certain foodservice segments, the company has opted to take a cut in margin instead.

"Fountain and coffee are the most difficult to raise retails because they're the most noticeable to consumers," he said. Instead of boosting fountain retails, Village Pantry absorbed a 5-percent price increase. Meanwhile, for coffee, the chain decided to reduce costs by servicing its equipment in-house.

C-stores, of course, are not the only ones raising prices. Consumers are feeling the pinch everywhere. Food prices -- both at-home and away-from-home -- increased 4 percent between 2006 and 2007, the highest annual increase since 1990, according to the USDA. The trend is expected to continue through this year. Food prices are projected to keep rising and end 2008 at 3.5 to 4.5 percent above 2007.

Looking ahead, retailers have mixed opinions as to what the future holds. Prast believes commodity prices, for the most part, have peaked and will either remain stable or drop. Wheat is the one commodity where he fears prices will keep climbing higher.

Loehr, on the other hand, thinks the worst is yet to come. "Corn plantings are going to be less this year and there's increased demand for corn because of ethanol. I think it's going to get worse before it gets better," he said. "It's going to be a tough year for our industry."

If things don't improve relatively soon, Emond foresees consumers reaching a breaking point, and when that happens, he's certain foodservice sales will suffer.

"Sales have been steady. But we're right on the edge of people saying, 'That's it; I can't stop there and eat,'" he said. "I'm investing all this to build foodservice, and if I don't have that, then I'm right back where I started."