Inflation will have impact on food industry as well

Rajat K. Baisya

Inflation is now well above 7 percent. Basic food items are much costlier now. Government actions to stop steel export and tightening the money supply has not yet made any impact in the reduction of inflation rate. Although finance ministry and planning commission is still hopeful that the inflation rate will soon come down but market is yet to see any impact of the initiatives taken so far. There will be thus direct and indirect impact of the rising inflation rate on the performance of the processed food industry as well. Let us examine the kind of impact inflation can have on our processed food industry.

Firstly, the rise in input cost will increase the cost of production and entire escalation in cost cannot be passed on to the consumers resulting in lower profitability of processors. The lower profit will force the manufacturers to cut down on other costs such as R&D, advertisement and promotion as well as the manpower cost. These are short-term measures to maintain the bottom line performance of the company in tact to keep the shareholders confidence as well as market price of the stock at desired level otherwise the value of the company or the shareholders' wealth and return on investment will go down which would not be an acceptable proposition. These are however, counter productive in the long run in the sense that there will be consequential impact on the product performance for temporary withdrawal of promotional support.

Secondly, manufacturers will not be able to absorb entire cost escalation and therefore will resort to price increase which will reduce the demand for the products. As processed food products do not fall under essential goods and therefore consumers will use discretion to spend in this product category. The result is sales number will be difficult to achieve which will force people (sales and marketing staff) to look for alternative employment to avoid working under constant pressure. This will force organizations to constantly restructure the sales system and even work with less experienced people. The exodus will have impact in the business.

Thirdly, consumers in general, will have less cash surplus (disposable income) to indulge in buying products, which are sometimes impulse purchase. Middle class population that constitutes the large part of the market will resort to drastic reduction in budgetary allocation for purchase of processed food products. School children will get lesser amount as daily allowance to buy snacks and ready to eat foods from school canteens. The end result is that the demand will come down impacting the sales of the products.

Fourthly, the rise in prices has also resulted into short supply of the basic agricultural input. This is also partly the result of low growth in agricultural sector. The manufacturers will have difficulty to get the regular supply of the basic agro commodities of uniform quality and price resulting into fluctuating manufacturing programme in the process plant or the fluctuating cost of production which makes the supply chain management issues more complex.

Fifthly, the rising cost of production will impact the exporters of processed food products. Those who are highly dependent on the export sales or those who are in the international trade of processed food are already passing through difficult phase as rupee started becoming stronger in relation to dollar. A weak dollar coupled with the rising cost of production will have greater impact on the export trade. There are new generation processed food industries that have come up post liberalization. They are largely dependent on the large overseas contract with the giant global retailers. They will have difficulty if there is no escalation clause built into the contract linked with rise in cost of production arising out of inflation. For example, Capital Foods in Gujarat and Satnam Foods in Haryana largely depend on the supply contract to Tesco. They are likely to pass through difficult phase. Government also stopped rice export as part of the measures to control inflation as well as to maintain supply line in the domestic market. What will these rice exporters do? Will they be able to switch to any other agro commodity so easily and fast? Merchant exporters will have more difficulty than the manufacturer exporters, as they are likely to face more problems in procurement of products at competitive price and still make money.

Sixthly, as we all know that processed food industry is consisting of mainly small and medium players. The large and established players are very few. Although small players have more flexibility they cannot have capacity to absorb shock and thus have less staying power which large players have. Small players often survive as being subcontractors. These days more than sixty to seventy percent of production of large domestic players are outsourced and when cost pressure comes the same is passed on down the line to contract manufacturers and as they are helpless. They even start bleeding or there are cases when they are forced to even close down.

We can thus see the ripple effect of inflation in the entire business of processed food. Of course, some of these observations will be true for other categories as well but processed food industry is going to experience direct impact, which others are not possibly experience.

The energy situation is going to create very difficult scenario for the industry now and processed food industry will not be an exception. The oil marketing company will no longer be able to absorb subsidies any more with crude costing more than USD 130 a barrel. In last three months itself it has gone up by 30 percent. And if subsidies at current level continue the oil marketing companies like IOCL, BPCL and HPCL will go bankrupt. The prices of energy will have to go up in immediate terms. This will have spiraling effect on the economy and industry. I intend covering energy policy for the processed food industry in a separate article. There is significant possibility in the area of clean development mechanism (CDM) and carbon credit to encash upon by the processed food industry. We all know that sugar industry is going through the crisis period but carbon credit has kept them floating and profitable. That will be the subject matter of yet another article.

I would like to conclude by saying that task ahead is to be innovative to remain profitable. If you are not profitable you cannot afford future and if you are not innovative you have no future.