World Economic Trend Analysis

Friday, 21 January 2011

Huge Margin Squeeze: Restaurants, Hotels, Cruise Lines Unable to Pass on Rising Food and Energy Prices; China's Role in Commodity Bubble

Energy, meat, vegetable and coffee prices are up. Pricing power is not. The result is a huge margin squeeze that affects profits at restaurants, hotels, cruise lines, and travel-related businesses in general. The Wall Street Journal picks up the story in As Food Prices Soar, Eateries Scramble

Soaring global food prices, particularly for meat, sugar and coffee, are putting pressure on the restaurant, travel and hotel sectors as they pursue a fragile recovery. In a bid to offset added costs without passing them on to price-sensitive consumers, many companies are scrambling to renegotiate contracts, find cheaper suppliers and reconfigure menus.

Marriott International Inc. has been coping with higher prices for beef, fish and chicken over the past six months, says Brad Nelson, a vice president andthe global corporate chef for the hotel chain. The company is also paying higher prices for sugar and arabica coffee beans, which have both soared over the last year. "It's a global challenge," says Mr. Nelson.

The company swung to a profit in the third quarter but, like many of its peers, struggled to raise room rates, doing so for the first time in two years in the second quarter. So far, it has ruled out raising food prices at its restaurants, instead re-engineering its menus to offer alternatives to popular and pricey cuts of beef such as filet mignon and New York strip.

Restaurant chain Johnny Rockets, known for its burgers, uses about eight million pounds of ground beef a year, and its prices have risen 20 cents a pound over the last two months, says Ray Masters, senior vice president of purchasing and distribution. To offset part of the increase, the privately held company has renegotiated its poultry costs, cutting them 5% for 2011, and its ice-cream prices are down 4%. Still, this won't offset the higher beef costs, Mr. Masters says.

While cruise operator Royal Caribbean Cruises Ltd. hedges against increases in cattle prices, that hasn't fully offset its rising costs for beef, says Chief Executive Richard Fain. Since the fall, meat prices have risen steadily for the cruise operator, which serves about 53 million pounds of beef, poultry, lamb, veal and pork a year. The most popular restaurants on the ships are steakhouses, Mr. Fain says.

"Meat is important to our guests," Mr. Fain adds. "We aren't prepared to sacrifice the quality and we can't raise prices enough to reflect it, so it ends up being a cost we have to absorb." Royal Caribbean is also paying more for citrus fruits and fish, particularly shrimp, another popular dish on its cruises.

Norwegian Cruise Line began using e-auctioning last year to find better food prices as commodity costs rose, says Chief Executive Kevin Sheehan. The company, which uses 34 million pounds of meat and 9.5 million pounds of seafood a year, has had higher costs for dairy items, meat and fish, he says.

Through e-auctioning, the cruise operator can specify what food items it needs and accept bids from suppliers. The competition keeps prices lower, says Mr.Sheehan.

PPI Index Up Again

Please consider the Producer Price Index Report for December 2010.

The Producer Price Index for Finished Goods rose 1.1 percent in December, seasonally adjusted, the U.S. Bureau of Labor Statistics reported today. This advance followed increases of 0.8 percent in November and 0.4 percent in October and marks the sixth straight rise in finished goods prices.

Finished Goods

About three-fourths of the December rise in the finished goods index can be traced to prices for energy goods, which increased 3.7 percent. Also contributing to the broad-based advance in the finished goods index, prices for consumer foods and for goods other than foods and energy moved up 0.8 percent and 0.2 percent, respectively.

Finished Energy

The index for finished energy goods climbed 3.7 percent in December, its third consecutive monthly advance. Roughly sixty percent of the December rise is attributable to a 6.4-percent jump in gasoline prices. Increases in the indexes for home heating oil and liquefied petroleum gas also contributed to higher prices for finished energy goods.

Finished Foods

The index for finished consumer foods rose 0.8 percent in December after moving up
1.0 percent in November. Over three-fourths of the December advance can be linked to prices for fresh and dry vegetables, which surged 22.8 percent. Higher prices for meats also were a major factor in the increase in the finished consumer foods index.

At the Crude Goods Level, producer prices are up 15.5%
At the Intermediate Goods Level, producer prices are up 6.5%
At the Finished Goods Level, producer prices are up 4.0%

Every step of the way, a decreasing portion of costs are passed on. Even less passes through to consumer prices. This is why those screaming about "rampant inflation" always point to raw commodity prices.

Those prices, as I continue to point out, are primarily a reflection of unsustainable credit expansion in China, not a falling US dollar.

US Dollar Weekly Chart

click on chart for sharper image

For all the paranoid screaming, hyperventilation, and hyperinflationist nonsense concerning the US dollar, the chart shows the US dollar to be almost exactly where it was a year ago, and higher than it was three years ago.

Amusingly, a monthly chart shows the US dollar index is where it was in 1990, 1992, and 1995.

US$ Monthly Chart

click on chart for sharper image

To be fair, the US$ index was at 164.72 in 1984. It is half that today. In that sense, the dollar has already crashed. However, from the point of view of 1990 on, it is at a point it has touched in 8 different years.

Hyperinflation? Please be serious.

To understand commodity prices and the PPI, one needs to look at China. Here are a couple of posts to consider

Is the Yuan Undervalued?

"Consensus Nonsense"; Is the Yuan Undervalued? Who Wins a Currency War?

Vacant China City Stories