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Not price rise! FMCG players find other ways to fight inflation

Why and how the recent surge in FMCG prices is hurting middle class home budgets and company balance sheets

Illustration by Raj Verma Illustration by Raj Verma

Thirty-five-year-old Kajal Roy has over the past few months been paying almost 50 per cent more for a five-litre can of edible oil. "It's become extremely expensive. I checked out other brands but they are as expensive. One can't run the kitchen without edible oil," the home-maker says, while pushing her shopping cart through a neighbourhood supermarket in Mumbai. "My grocery bill has gone up substantially, but all of us are home-bound because of the lockdown, so we are hardly spending on anything else. Therefore, I am not complaining."

In Nagpur, kirana store owner Rajesh Reddy has seen 70 per cent lower revenues for the past three months. He is not sure if the second wave of Covid-19 has led to a dip in consumption or it is the rise in prices of day-to-day essentials such as oil, pulses, tea, detergent and soaps that have resulted in lower spends.

"Consumers who used to earlier purchase five-litre jars of oil are buying one-litre packs. In detergents and soaps, they are either buying smaller packs or opting for cheaper brands," says Reddy.

Covid 2.0 has not just consumed livelihoods, but an enormously high number of lives as well. This has dampened the urge to spend and consume, but as life begins to return to normal, the rise in grocery prices is hurting consumers. Commodity prices have been at all-time highs, making grocery products costlier by over 20 per cent.

Price hikes are the easiest way to counter commodity price increases. However, fast-moving consumer goods (FMCG) companies, already battling lower demand for products, are steering clear of any knee-jerk reaction. Instead, companies are squeezing margins, reducing grammage, prioritising key stock-keeping units (SKUs) and cutting down on advertising spends and distribution costs to fight inflation.

"We have not passed the entire cost to consumers. We have taken a hit on margins. There is a fine balance to keep between impact on the consumer, price elasticity and competitive dynamics. We have to make sure our volume momentum also grows," explains Sunil D'Souza, Managing Director and CEO, Tata Consumer Products.

Rising Prices

Oil has been the worst hit. According to data compiled by the Department of Consumer Affairs, prices of six edible oils - groundnut, mustard, vanaspati, soya, sunflower and palm - have risen between 13 and 52 per cent in the last one year, and hit a decade high last month. Mustard oil prices, for example, have risen nearly 40 per cent from Rs 130 per kg (packed) to Rs 184 per kg in the last one year. Similarly, soya and palm oil prices have increased by 40 per cent, while in the case of sunflower oil, the rise is steeper at over 50 per cent.

While tea prices have risen 20 per cent, atta is costlier by 10 per cent. Though sugar and rice have seen a moderate increase of 5 per cent and 7 per cent, respectively, toor dal has shot up by 19 per cent, masoor dal has increased by 14 per cent and urad dal by 10 per cent.

"Margins in commodities such as oil, pulses, rice and tea are wafer-thin and companies can't afford to absorb them. Bulk of the price hikes have happened in commodity categories. As far as brands are concerned, most companies are yet to pass on price hikes to consumers. They are waiting for the lockdown to be completely lifted," says Arvind Mediratta, CEO, Metro Cash & Carry.

While soaps are dearer by 15-20 per cent, detergents are costlier by around 7 per cent. On the other hand, prices of biscuits and coffee haven't increased at all. Even in soaps, prices have gone up for bigger packs and not for the smaller, economy ones. The 10 per cent increase in atta prices, or even tea (15-20 per cent), has largely been for premium or large packs.

Another category that has bore the brunt is LPG. The price of a liquefied petroleum gas (LPG) cylinder has gone up over 20 per cent to over Rs 800 in the last one year. It has doubled in the last seven years, from Rs 410.5 in March 2014 (for a 14.2 kg cylinder).

The Oil Problem

India is the largest consumer of edible oils in the world. Rising incomes over the last two decades led to a change in food habits, boosting consumption of edible oils even further. Between 1993/94 and 2004/05, monthly per capita consumption of edible oils increased from 0.37 kg to 0.48 kg in rural areas, and from 0.56 kg to 0.66 kg in urban areas. By 2011/12, it had increased further to 0.67 kg in rural areas and 0.85 kg in urban areas.

However, there has been a demand-supply mismatch. According to official records, while demand for vegetable oils was in the range of 23.48-25.92 million tonnes between FY16 and FY20, supply was only 8.63-10.65 million tonnes. No wonder India has to import almost 56 per cent of its edible oil needs.

In 2019/20, import of edible oil stood at 13.35 million tonnes (worth around Rs 61,559 crore). It comprised palm (7 million tonnes), soyabean (3.5 million tonnes) and sunflower (2.5 million tonnes). Major import destinations included Argentina and Brazil for soyabean oil, Indonesia and Malaysia for palm oil and Ukraine and Argentina for sunflower oil. Imports are estimated to be in the same range during Oil Year 2021 (November 2020-October 2021).

A combination of factors has come together to create a global supply side constraint, leading to an increase in prices in international markets. These include labour shortage in palm oil plantations of Indonesia and Malaysia, drought in Argentina and lower production of sunflower crops in Ukraine. On top of these, China has also been buying edible oils rigorously. As a heavy consumer, the average Indian household is paying the price for all of these.

"Changes in palm oil prices generally impact all edible oil prices. It has resulted in increase in oil prices. The other option is soyabean oil, which has also seen a similar price rise," says Prashant Vasisht, Vice president and Co-head, Corporate Ratings, ICRA Ltd.

"The reason is supply disruptions owing to poor weather conditions and shortage of labour due to Covid in Indonesia and Malaysia. Also, demand has been higher from the soap segment (due to hygiene consciousness) and edible oil segment (since people are eating more at home these days). Prices are expected to remain firm on concerns of supply owing to wet weather in January and February 2021," he adds.

The government has been trying to shore up domestic production, but it will not yield results overnight. It also lowered the import duty on palm oil from 27.5 to 15 per cent in Budget 2021, which has not really worked. Another round of duty cut is under consideration.

"The increase in edible oils prices can be attributed to domestic demand coupled with higher cost of imports amid lower supplies in major exporting nations. We expect price pressure on this account to continue for the next four-five months," says Kavita Chacko, Senior Economist at CARE Ratings.

Scramble for LPG

LPG prices in India mirror international trends. Global LPG prices move in tandem with crude oil prices, which have more than doubled from $30.61 per barrel in May 2020 to $66.95 per barrel in May 2021. But what is actually hurting consumers is the removal of subsidies on LPG.

India has around 28.95-crore LPG consumers. The numbers have grown steeply by over 95 per cent from 14.8 crore in 2014/15 largely due to the launch of the Pradhan Mantri Ujjwala Yojana (PMUY) in 2016, which sought to increase the penetration of LPG by giving free connections to Below Poverty Line (BPL) households. Under the scheme, around eight-crore connections at an expense of Rs 12,800 crore have been given, taking the LPG penetration in the country to 99 per cent, against 55 per cent in 2014.

Alongside the eight-crore consumers under PMUY, another 18-crore are technically eligible for subsidy as their annual household income is less than Rs 10 lakh. In March 2020, for example, they received a subsidy of around Rs 252 for a cylinder that costs Rs 805, nearly the same as today. While PMUY users are still eligible for three free cylinders during the pandemic - a one-time provision that was made at a cost of Rs 9,710 crore - it is this segment of Indias households that is bearing the brunt of subsidy elimination.

"With gas cylinders being essential items across most households, the increase in LPG prices directly feeds into the overall expenditure, impacting consumption as well as savings," says Chacko of Care Ratings.

"When oil prices fell to record lows in April 2020 it eliminated the need for subsidy. When they went up again in the second half of 2020/21, however, subsidy was not brought back and the price hike was transferred to consumers," says an official in the Ministry of Petroleum and Natural Gas. "The only subsidy being provided right now is for PMUY users," he adds.

Despite the higher number of users in the fold and free cylinders being doled out, high prices have impacted consumption. LPG consumption declined by 3.8 per cent year-on-year to 25.13 million metric tonnes in FY21.

Managing Costs

Increase in commodity prices, especially oil, not only has an impact on edible oils, but also on a host of other products such as soaps, shampoos, snacks and biscuits. While soaps have seen a 15-20 per cent hike in prices, the price hike passed on to consumers is nowhere close to the over 50 per cent increase in palm oil, one of the key ingredients. "The pricing call has to be made in a way that consumption, demand and volume doesn't get impacted. We can't hike costs at the expense of volume," says Sunil Kataria, CEO, India and Saarc, Godrej Consumer Products.

The dilemma for most companies is to hike prices at a time when consumption and affordability are at an all-time low. "On one side you have to increase prices and on the other side there are issues with demand. If brands are not careful it could lead to stagflation. They have to find a way to continue to promote consumption, but at the same time absorb some of these commodity price increases," says Anand Ramanathan, Partner, Deloitte India.

Most brands are therefore trying to rationalise costs across operations. One of the first steps has been to reduce trade discounts. "Discounts and schemes offered to retailers have virtually dried up," says Prem Kumar, Founder and CEO, retail tech company SnapBizz. While discounts in categories such as edible oil have vanished, in other categories, the trade discount reduction has been in the range of 8-20 per cent."

Kataria of Godrej says that in India, trade discounts cannot completely dry up. "Trade margins are led by competitive intensity, so when margins are under pressure, companies reduce discounts. Due to the lockdown, shops were opening only for three-four hours, therefore, trade rationalisation happened in terms of SKU rationalisation. With shops opening up, competition intensity will be back as well."

Godrej has embarked on a strategy of cross-category management of pricing and margins. Since a large chunk of its volume growth comes from low-unit packs (which is price sensitive), in a category like soaps, the company got rid of some grammage, but did not tamper with the price. However, it has increased prices of its premium packs, since those consumers have higher purchasing power and the category in general is price elastic.

"We have also played with pricing within brands. We have increased prices of premium brands such as Cinthol, but in case of Godrej No.1, we have shaved a bit of grammage, but not meddled with pricing at all. The idea is to focus more on hard volume growth so that we can concentrate more on absolute margins than percentage margins," explains Kataria.

Tata Consumer, too, has consciously tried not to increase prices of its 100-gm packs, but has raised prices of 500 gm and 1 kg packs of Tata Tea. The company has tried to cut costs by removing layers within its organisation as well as in its partner network. "We used to have super-stockists, who we have removed, and that has saved us 1.5-2 per cent of our costs. We have done things which will not impact the retailer or the consumer in terms of discounts," says D'Souza.

Last year, Tata Chemicals and Tata Global Beverages were merged to form Tata Consumer. "At the time of integration we promised the Street we will take Rs 150 crore of the cost out of the system in 18-24 months and we are well on track. We took off layers in our organisation internally. We consolidated C&FAs (cost & factory accounting systems) and logistics. We cut down the number of warehouses by half. Since we have the advantage of scale between the two businesses, packaging costs have come down as well," he adds.

Dabur India, on the other hand, increased prices by three per cent across brands. However, CEO Mohit Malhotra, like his peers in the FMCG business, believes that price increases will not be enough to mitigate the impact of inflation. The company has launched a cost optimisation project called Project Samriddhi. "Last year, we saved around Rs 50 through this initiative. This year we plan to save another Rs 100 crore."

Grammage Reduction

Most FMCG brands have resorted to reducing grammage whenever they had to deal with price rise. In 2018, Parle Products reduced grammage of its iconic Parle G brand by five-six per cent to offer the product to its price-sensitive consumers at Rs 5. Nestle India has also resorted to similar tactics of reducing grammage of its Rs 10 pack. This time, the food major has reduced grammage of the Rs 10 pack of Maggi Noodles from 70 gm to 60 gm, according to a report by SnapBizz.

In soaps, Godrej has got rid of grammage in its mass brand, Godrej No. 1. However, FMCG experts believe that cutting down grammage can't be adopted any longer. "Brands have overdone it and there is hardly any room left for any more reduction," says Mediratta of Metro Cash & Carry.

He cites the example of Cadbury's chocolates, which gets over 60 per cent of its revenue from the smaller pack sizes priced at Rs 5-10. "The company can't increase the price from Rs 5 to Rs 5.50 (as there would be coinage issues), and they have already optimised the grammage and trade margins. If they try to optimise grammage further, there will hardly be any chocolate left to consume."

Grammage reduction takes time to implement, says Ramanathan of Deloitte, as companies also need to change packaging. Therefore, a lot of them have started to bundle not so well-performing products with their popular categories. "Since they were not able to predict demand very well and stocks were building up, brands took to liquidation. Some of the liquidation came through bundling. When they did it on their D2C (direct-to-consumer) platform and on ecommerce marketplaces, price economics improved. A lot of companies are resorting to bundling strategies instead of cutting down grammage."

Effect On Ad Spends

FMCG companies are among the largest spenders on advertising. During last year's lockdown, when demand completely dried up due to supply constraints, most FMCG majors stopped advertising. This time, they have cut down ad spends by 10-25 per cent not because of the dip in demand, but to conserve costs. "FMCG companies are cutting down above-the-line advertising and marketing spends as well as below-the-line promotions," says Mediratta of Metro.

Godrej Consumer, says Kataria, has cut down on advertising mostly for discretionary categories such as hair colour. "In a category like home hygiene, we have done three times more advertising a year ago." While advertising for soaps has dipped at an industry level, Kataria claims he has ensured that his share of voice doesn't dip.

Tata Consumer's D'Souza, however, says his company got back to high-decibel advertising soon after Q1FY21. "Last quarter our ad spends went up substantially. Building brand strength and equity is the core proposition of how we are going to build our business and grow market share."

Normalcy A Far Cry?

With markets opening up, FMCG business heads are looking forward to a revival in volume growth. But they are not sure if they will be able to control further price increases. "We will look at another round of price hikes, going forward. We expect inflationary pressures to be prevalent in the first two quarters of this fiscal, and then to soften in the second half," says Dabur's Malhotra.

Though milk prices haven't gone up, higher logistic and packaging costs have increased dairy major Amul's costs by Rs 1.50 for every litre of milk. Like most other FMCG companies, Amul, too, has tightened trade incentives and schemes, and has tried to absorb the cost increase by squeezing margins. "The costs of farmers have gone up too and we are neither able to reduce the procurement cost, nor pay farmers more. We are watching the situation, beyond a point we may have to increase prices," says R.S. Sodhi, Managing Director, Amul.

Mediratta of Metro Cash & Carry says the days of FMCG companies operating on 60-70 per cent margins are over. "It's high time they realise that the days of making super-normal profits are over. They have to consider rationalising other spends such as staff salary, marketing budgets and headquarter costs."

"With domestic demand dropping following the surge in cases in Covid 2.0, we expect pricing power to remain muted for some time. We believe the transmission of vaccine optimism-fuelled high global commodity prices will remain restricted to WPI inflation, and pass through will be limited for CPI inflation," says Aditi Nayar, Chief Economist, ICRA Ltd.

Though companies are trying their best to pass on the best-possible value to consumers, the latter would do well to prepare themselves for yet another round of price hikes.

@ajitashashidhar; @sumantbanerji