Food manufacturers, in the current situation where it is impossible to fully pass on rapidly rising costs to product retail prices without losing customers, are forced to seek every possible solution to stay afloat in the market.
Undeniably, consumers are the ones who, through their purchases, make the choice in favour of buying either domestic or imported food. Under conditions of rapid inflation, shoppers tend to choose lower-priced products, which are often offered specifically by foreign manufacturers. In turn, domestic producers are caught between a rock and a hard place, where the increase in production costs outweighs purchasing power. Strategies and solutions for tackling the biggest challenge – inflation – are varied.
A difficult situation
“There is no recipe for a situation where costs are rising and their future prospects (changes in electricity and pork exchange prices) are shrouded in fog. However, we have not used, and will not use, solutions based on deceiving people – the buyers,” comments Guntis Piteronoks, Chairman of the Council at SIA Rēzeknes gaļas kombināts. He predicts that consumption, expressed in kilograms, will fall, while producers' costs per kilogram produced will increase, which means difficult times for the sector as a whole. “The situation is very difficult,” says G. Piteronoks.
Hands tied
“Everyone’s hands are tied. For manufacturers, electricity, fuel and raw material prices have already risen, but only a small proportion have managed to include 100% of this in their selling prices, which is why state support will be essential, especially if, for example, Poland is providing such support to its own manufacturers. Consumers only have so much money in their wallets, and this situation will become especially acute with the first heating season bills,” analyses Normunds Štāls, Director General of the Latvian Meat Processors' Association. He points out that different manufacturers may have very different recipes.
“A drop in the consumption of meat products in Latvia is inevitable; the question is just who will be best able to adapt to the situation – those who continue to produce quality products, even if expensive, or conversely, the manufacturers of the cheapest products,” says N. Štāls. He predicts a difficult winter for both food producers and consumers. “To hope that electricity prices in Latvia will return to a normal level, that natural gas will be available to everyone at a reasonable price, and that feed prices and consequently food raw material price levels will see a significant drop, is in current circumstances tantamount to waiting for a miracle, but that can only happen in fairy tales,” adds N. Štāls. He suggests that those working in the food sector who have significant export markets might be in a better position.
“Even then, in foreign markets, increasing sales prices to the level of profitability required by manufacturers may not be as easy an undertaking as one might imagine,” says N. Štāls. In his view, in such a situation, there will be a revision of product ranges and, at the same time, the postponement of expansion plans until better times, while investing in every stage where energy and raw material consumption can be reduced. “Today, one can observe an unusual scene on Latvian shop shelves, where a product that is similar in both appearance and recipe differs significantly in price (euro/kg), with the Latvian-made one being significantly – by 20% and even 30% – more expensive than the foreign-made one. Why? Because in neighbouring countries, subsidies and reduced VAT rates are already working from the first step – feed production and animal fattening,” N. Štāls highlights regarding the poor competitiveness of Latvian manufacturers. In his opinion, as long as there are radically different state support mechanisms and volumes in the single market, it will be difficult for domestic producers to compete even in the local market. “This is a question for the government regarding equal competitive conditions; otherwise, it is more economically profitable to produce abroad and sell in Latvia, thereby taking local shoppers’ money to other countries,” says N. Štāls.
Selling milk without covering prime costs
One of the most difficult situations is faced by milk producers, as evidenced by the cessation of operations of the companies Elpa and Limbažu siers. Most of the largest manufacturers are currently refraining from direct comments on company operations, so Dienas Bizness questioned Jānis Šolks, Chairman of the Board of the Central Union of Latvian Milk Producers (LPCS), about the situation in the sector as a whole. “In milk production, the situation is complicated by the duration of the crisis. While in other sectors energy prices and raw material prices began to affect operations in the spring of this year, in the production of milk and dairy products, doubts about the existence of individual companies already existed last autumn,” points out J. Šolks, stressing that the purchase price of milk has seen the greatest growth over the last year specifically in Latvia, but the price increase on shop shelves is more modest. “Currently, the majority of milk processors are working below their production costs, and I know that in certain cases company owners have mortgaged their private property in the hope that the business will survive,” says J. Šolks, pointing to the fact that with the rapid rise in the milk purchase price and insufficient prices in retail chains, an unpleasant scissors effect is forming. “There are no possibilities to change other items, for example, packaging or product technologies. That is restricted by regulations, and the only opportunity is to seek export markets or find the possibility of producing new products,” points out J. Šolks.
The LPCS directs serious criticism towards the creation of reserves, which is currently based on the principle of business continuity. Namely, reserves are tied to production in strategic companies, and there are simply no reserves for a longer period. “God forbid, but if the 'X-hour' arrives and production cannot be continued, the reserves are negligible; they cannot be taken into account,” emphasises J. Šolks. Finally, it is precisely in the trade of dairy products that there are harsh competitive conditions, which apparently do not exist in neighbouring countries. “In Latvia, half of the drinking milk sold is from other countries – Poland, Lithuania, Estonia. This seriously reduces the capacity of local manufacturers, and we are also losing out on volume. In Lithuania or Norway, where the same retail chain brands are found, such a situation does not exist. Latvian milk might not be offered there.
This situation has existed for years, and at the moment, increasing volume would be a significant relief. There is a significant difference whether a company produces 20 tonnes or 50 tonnes!” emphasises J. Šolks.
Costs that cannot be amortised
Gunta Duka, Executive Director of the Latvian Bakers' Society, refrained from commenting on the potential increase in bread prices because grain and flour prices are not yet known. Iveta Švarce, a representative of Rīgas Dzirnavnieks, confirms that in new contracts with clients for the purchase of flour, the price increase is from 10% to 30%, which will likely also mean an increase in bread prices. Hopes that state support for the entire food production sector of around 10 million euros will have any impact are minimal.
Much more direct is Orkla Latvija representative Lineta Mikša, pointing out that efforts to absorb price increases are likely not possible. “In recent years, we have been able to absorb the rise in costs through internal reserves or by implementing a series of efficiency projects, avoiding price increases. However, it is undoubtedly clear that no food manufacturer has the kind of internal financial reserves to continue absorbing rising costs in existing product prices, therefore manufacturers are adjusting product prices in line with the new market situation. It should be emphasised that the final price is always determined by the retailer,” says L. Mikša. The Orkla Latvija group, which includes brands such as Laima, Selga, Staburadze, Ādažu čipsi, Spilva, Gutta and others, has already previously made huge investments in energy efficiency and the improvement of the work environment, which helps the company to reduce total production costs.
Adapting to the new situation
Ināra Šure, Chair of the Council of the Latvian Federation of Food Companies, emphasises that the sector is working and adapting to tight external factors. “For many, this will definitely be a year of survival, and many investments have been postponed to cover current costs. One of the biggest challenges for food companies is the lack of cash to make changes to adapt to the new situation, to find new sales markets and new raw material supply channels, because profit and loss accounts were not built for wartime conditions. Loan interest is also rising, so companies are freezing investments and not taking on new credit liabilities,” says I. Šure. She reminds us that the overall situation in the market is such that changing suppliers means an increase in the cost of raw materials.
“Manufacturers are looking for alternative raw materials that are analogous in terms of recipe, but there are simply no alternative cheaper raw materials on the market – that is the reality. For example, at the beginning of the war, the challenge was the diversification of glass packaging, because the sector previously imported it largely from Russia, but companies are creative and were able to find solutions and other suppliers, although it made the end product more expensive. Currently, packaging costs for various types of products have increased by as much as 30%,” says I. Šure. She also points out that changing recipes is not a matter of a day or a month. In the long term, it can be changed, but it must be worked on over several months; it is important to preserve taste characteristics and ensure shelf life. “It is technologically complex, and furthermore, packaging has already been ordered according to the existing recipe,” explains I. Šure.
What food companies are actually doing is giving up everything possible and looking in the direction of optimising energy resource consumption. “For example, organising shift work in such a way that production consumes fewer energy resources; shutting down production lines during peak hours,” explains I. Šure. She stresses that even more attention than before is being paid to implementing LEAN principles, which helps to see losses in the company’s production and administrative processes and to gain access to preventing them. Working groups are being formed with employees from various departments, listening to their ideas on where and what can still be saved, because it is clear that a financier at Excel spreadsheets will not know what is happening on the lines – the employees who work there day after day know that.
Freedom of invention
“Packaging alternatives and reducing it is also a direction manufacturers are looking into. For example, if the packaging is a cardboard box, then reducing it, if production lines allow. If the packaging is a 28-gram PET bottle, perhaps a 23-gram bottle is sufficient. Or reducing the closure tab for bread packaging – there are no limits to invention and creativity, though these measures may also require some investment,” explains I. Šure. She notes that manufacturers are looking for every minor opportunity to reduce costs so that every small thing adds up to some economy.
“Alongside this, bigger steps are also being taken – buyers must count on the fact that the range of food products will narrow in such conditions. Manufacturers are evaluating the assortment and giving up the production of less demanded products. If a consumer is fond of a certain item that is not among the most popular, then it may happen that the company has currently stopped its production,” says I. Šure. Similarly, the development of new products has slowed down significantly because it requires investment. “This autumn will not be a time when we will expect new and innovative products from food manufacturers,” warns I. Šure. In her opinion, investments have essentially been completely stopped, concluding only vitally important projects.
Reducing the VAT rate
“If we look at the state's side, then we remain convinced that the VAT rate must be reduced for staple food products – bread, milk, cottage cheese, sour cream, eggs, butter, meat, fish. This would simultaneously be a way to support Latvian manufacturers, raise their competitiveness and also reduce the rise in food prices, thereby maintaining the purchasing power of the population and reducing the pressure on employers to raise labour wages,” recommends I. Šure. She reminds us that usually the Ministry of Finance has objected that a reduced VAT rate is not the best fiscal instrument because it will cause losses to the state budget. “I would like to emphasise that in conditions of high inflation, the state budget treasury is filling up much faster than was anticipated; revenue from VAT rolls into the state treasury every day. And on the map of Europe, Latvia is that rare country that does not use such an opportunity,” says I. Šure.
Opinion
Entrepreneurs will think about how to lose less
Andris Bite, President of the Latvian Employers' Confederation, co-owner of SIA Karavela*
Over the last half year, the issue of energy resource costs and sufficiency has become much more relevant both in the organisation as a whole and in my company. The primary question is about the sufficiency of energy resources, and the second question is about the price and ways to amortise it in the prices of one's services or goods. The question of sufficiency is currently being solved in the government, but it is tougher with the price issue. Currently, many companies are not thinking about energy efficiency, but globally thinking about the transition from one energy carrier to another.
Previously, there were calculations about equipment, trying to save some percentage. Currently, gas costs have increased tenfold, and the actions of entrepreneurs are not related to insulating buildings or purchasing more efficient equipment, but rather to changing the energy carrier. For example, switching from gas to diesel, then from diesel to propane, because every month is a cost increase of hundreds of thousands of euros. Manufacturing, processing and transport companies, where energy consumption is high, suffer the most. What will we face in the near future? These will still be energy resource prices, which, fortunately, have already experienced their peak, namely, they are decreasing. We will face a decrease in demand activity in our export markets, and most likely also in the local market. This will be a great challenge. In the near future, entrepreneurs will not be thinking about how to earn more, but rather – how to lose less. This will be a version of survival.
The government, both the current one and the next one, should start listening to what entrepreneurs are saying. About what we are talking about now, we were already talking about last autumn. We said there would be problems, starting with materials and ending with energy resources. Much could have been done, purchasing gas reserves more cheaply, listening in time and thinking about the fact that manufacturers will need them! Another thing that we lack is quality analytics in energy issues, both in terms of how much we will need, how many processes are influenced by panic, and what the real consumption actually is. Thirdly, we lack technical and practical knowledge for the rapid change of energy carriers. Namely, how to do it best and most successfully. Every entrepreneur is currently doing it individually with the method of trial and error. Everyone was used to gas being there, and nobody allowed even the possibility that it would suddenly not be there, or that it would cost so much. This is the help from the state that is necessary. Only after that follows the task of extinguishing the increase in energy resource costs. Currently, the support rules are very strict, possibly with the goal that only a few companies participate in the programme. We will not be able to do without fiscal help for energy-intensive companies.
* From the Altum discussion on entrepreneurs' challenges and practical help in conditions of energy resource and geopolitical crisis
Opinion
Will change neither recipes nor technologies
Normunds Skauģis, owner of Lāču bakery
Lāči will, in principle, change neither recipes nor technologies – we bake and will continue to bake bread in a wood-fired oven. We will not back away from that, otherwise it will no longer be real bread. It is proven again that we can only trust our own natural gifts – we have our own rye, wheat, barley, our own firewood and our own values – bread, nature, work. This is an algorithm for survival in the modern world as well. Whatever the situation, we will not change our recipe and will not spoil our products. The rise in costs applies to everyone, not just manufacturers, therefore one must correct the price and work on efficiency in the production cycle itself, which we are doing. We are looking at the possibility of reducing costs for packaging, for example, if there is equivalent quality packaging for a lower price, then we use that offer as well.
Namely, retailers are not in a hurry to increase the price, they ask for as long shelf lives as possible.
Opinion
Crisis provokes changes
Laila Vārtukapteine, Commercial Director of SIA ELVI Latvija
Product manufacturers are always looking for various solutions to make their products competitive, and, of course, at a time when the population’s purchasing power is decreasing, that is especially important; however, we do not yet have information that manufacturers are massively changing product recipes or changing raw materials to keep the product price unchanged at a low level. In most cases, we receive news about product price increases because it is no longer possible to ensure production at the previous quality with previous costs.
The production of food products in the European Union is controlled by very strict regulations, and possible changes in product quality or production technologies are limited.
Previous experience allows us to conclude – in time periods when the population’s purchasing power rapidly decreases, manufacturers implement more of those types of changes that are not related to the quality of the goods themselves, because they realise – in most cases, shoppers buy products because of their taste characteristics and quality. By significantly changing these parameters, shopper trust will also be lost. Instead, other solutions are more often sought – cheaper types of packaging are chosen, the weight of the products contained in the packaging is reduced. It seems that, at the moment, no one is confused anymore by butter in a 180 g package instead of the previously usual 200 g, or sour cream that weighs 450 g, not 500 g, but only a few remember that these changes appeared massively during the previous economic crisis.
For the time being, there is no basis to believe that goods manufacturers would begin to significantly change their product specification – perhaps it happens at a level that it is impossible to record in retail companies, for example, raw material suppliers are being changed, but it is worth remembering that competition in the food product market is always fierce and the question of cost reduction is always relevant.
In conditions of intensified inflation, manufacturers simply have to put in more effort to reach their goals and look for more solutions.
Opinion
The way out – new products and market diversification
Irēna Holodnaja, General Director of Food Union in Latvia
In the local market, we are continuing innovations, namely, we are developing new products for the autumn and winter season. We are continuing close cooperation with milk suppliers and retail chains. We are scrupulously working with suppliers and evaluating the increase in raw material prices; often, we are also looking for another supplier of equivalent quality and reliability if the offered price does not match market economics. Likewise, we are carefully reviewing the need for product price corrections, only partially reflecting costs in the final product price, compensating for part from our own profit and savings.
At the same time, we are actively diversifying our operations. In the existing market situation, we are looking for other development opportunities – in the production of private label products, in the production of industrial products, in the development of export markets. Regarding the latter – over the last half year, we have concluded new cooperation agreements and are in the process of starting cooperation with large retail names in Europe.
Norway, Kazakhstan, Germany, Ireland, the USA are countries where we have concluded new cooperation agreements over the last year for the export of cottage cheese, yoghurt or ice cream products.
Consumer price changes
%, in July 2022, compared to July 2021
Food 24.6 Bread and cereals 28.7 Rice 30.9 Flour and other cereals
56.8 Bread 28.3 Other confectionery 20.6 Pizzas and pies
21.6 Pasta products 35.5 Meat and meat products 20.0
Beef 32.7 Pork 10.8 Poultry 24.8 Dried,
salted or smoked meat 20.2 Fish and seafood 22.7 Fresh
or chilled fish 34.7 Frozen seafood 14.8 Canned or
processed fish and seafood products 17.8 Milk, cheese,
eggs 33.5 Milk 36.6 Yoghurt 29.9 Cheese and cottage cheese 33.7 Eggs 20.4
Consumer price changes %, in July 2022, compared to July 2021
July
Oils and fats 36.0 Butter 36.1 Margarine 34.8 Olive oil 20.2
Other edible oils 79.9 Fruit 13.2 Fresh fruit 13.1
Canned fruit and fruit products 24.9 Vegetables 12.3 Fresh
vegetables 12.2 Frozen vegetables 6.2 Potatoes 7.5 Chips 29.8 Sugar,
jam, honey, chocolate and sweets 25.8 Sugar 36.7 Jam
and honey 18.1 Chocolate 24.4 Sweets 13.1 Ice cream 32.1 Elsewhere
unclassified food products 26.3 Sauces and condiments
35.1 Salt and spices 29.6
Source: Central Statistical Bureau inflation calculator