Businesses and consumers alike are feeling the impacts of inflation, and food is near the top of the list. With historic inflation rates, every stage of the grocery supply chain is seeing price increases, from ingredients manufacturers through shoppers. But what about discount grocery stores? How is inflation changing the way that food manufacturers work with secondary sales channels?

Historic rates

Inflation has been a common topic in recent months, and for good reason. In January, inflation rose to 7.5%, a rate higher than the U.S. has seen in 40 years. Food was right in the middle of it all. While not the fastest-growing category, food had an overall inflation rate of 7% in January.

While sales haven’t yet dropped off due to the higher prices, some fear that they soon could. Coca-Cola CEO James Quincey recently warned that consumers may be growing weary of price hikes, while Pepsi CFO Hugh Johnston said the company has plans to address shifts in consumer elasticity.

Impacts on manufacturers

Of course, food processors and manufacturers aren’t simply raising prices for fun. Instead, they’re reacting to increases in prices themselves.

First, ingredient costs are rising, and ingredient manufacturers hold power in many pricing negotiations. That means processors are facing higher raw ingredient costs that must factor into the equation.

Second, freight rates continue to increase. As of January, global shipping costs were up 140% over the same time last year, while U.S. East Coast rates were up about 274%. Increased fuel and labor costs, coupled with reduced capacity in the trucking industry, have driven up costs. These freight costs can put heavy strain on every stage of the supply chain, leading to higher costs for manufacturers.

Third, labor costs are rising. Whether unionized workers are negotiating new collective bargaining agreements or employees are changing jobs due to more competitive offers, wages are on the rise. In many cases, these trends stem from the same inflation we’ve already addressed – workers need to buy food, clothing, and other goods too, so when prices go up, they expect wages to match.

Discount retailers holding the line

As we’ve already seen, inflation at one stage can create a domino effect. Ingredient prices go up, so manufacturers have to raise prices, and then retailers have to raise prices too. Each player tries to “hold the line” and mitigate costs wherever possible to maximize profits and remain competitively priced. However, things can be a bit different in the discount world.

Many secondary retailers and opportunistic buyers rely on pricing as a key differentiator. The business model relies on low prices to draw in customers, often on very small margins. For that reason, discount retailers are more hesitant to raise prices on consumers and less likely to pay higher prices to manufacturers. Even still, discount stores are beginning to budge on prices. The Dollar Tree recently increased the price of most items to $1.25. The change is difficult for some consumers to swallow, but also allows for increased wages to attract workers in a competitive market.

The result for brands is a frustrating one. Excess inventory being sold to discount retailers simply won’t have the same value recovery rate that it used to. As costs rise but discount price per case holds steady, cost recovery rate will fall.

There’s one key thing to keep in mind here: this is temporary. While experts disagree on exactly how long we’ll continue to see high inflation rates (with some arguing it will continue into 2023 and others saying rates will fall this year), they generally agree that it won’t last forever. Eventually the supply chain will start to achieve an equilibrium again. Either inflation will drop back to typical levels, or discount retailers will raise prices, bringing cost recovery rates back up. Wall Street experts expect the Federal Reserve to raise interest rates four times this year in an attempt to rein in inflation, so a return to normal may be on the horizon.

Increased consumer demand

We’ve already discussed how consumers aren’t yet turning away from grocers due to price increases. However, there’s also strong evidence that more and more shoppers are turning to dollar stores, discount grocers and other low-cost avenues for their food shopping. Dollar General, for example, plans to add fresh produce sections to over 10,000 U.S. stores in the coming years, while discount grocer Aldi celebrated the opening of their 2,000th store in 2020.

As consumers face inflation higher than wage growth, they’re likely to turn to these types of discount stores for groceries. That means that the liquidation market has massive growth potential. So while the cost recovery rate might not be as high, manufacturers have an opportunity to increase sell through rates and identify more sales opportunities in the secondary market.

Importantly, these buyer relationships will last beyond the current inflation period. By working with discount buyers now and working to accommodate some of their pricing needs, you can establish a foothold for the future. Then, when the market stabilizes a bit, you can rely on those relationships to keep an increased sell through rate and minimize any potential losses in the liquidation process.

The takeaways

In short, there are three key things to remember:

1. Inflation is real at every point in the supply chain, but the discount retailer business model demands that they resist price increases as much as possible.
2. Price per case sold is likely to increase, but might trail increases in manufacturing costs, leading to a lower cost recovery rate in the short term.
3. This is only temporary, and it’s an opportunity to establish yourself as a supplier of choice for more secondary channels, which will pay dividends in the future.