How Profit Inflation Made Your Groceries So Damn Expensive

The Federal Reserve has been raising interest rates at an unprecedented rate. This attempt to tamp down inflation is geared towards reducing demand and increasing unemployment as the global economy navigates high demand amidst supply chain challenges. And while the Biden Administration has taken some steps to address supply chain pressures and expand infrastructure funding, the Fed has no tools to contain skyrocketing food prices.

When New York poet laureate Willie Perdomo wrote “Where A Nickel Cost A Dime”, he may have been onto something. Food-at-home prices increased 13.1% since July 2021, the biggest jump since March 1979. Data from Numerator showed a 15.4% YOY increase in grocery prices and data from IRI revealed a 14.4% jump, with producer costs soaring double digits in eggs, flour, butter, crackers, bread, milk, and chicken.

Root Cause: Labor Costs or Profits?

Robert Kapito, president of asset manager BlackRockBLK
, which owns vast swathes of food conglomerate stocks, had a hot take on inflation and the supply chain crisis, “For the first time, this generation is going to go into a store and not be able to get what they want. And we have a very entitled generation that has never had to sacrifice.” What triggered Kapito must be the 47 million people who quit their jobs in 2021, forcing employers to compete for workers by raising wages and improving benefits. This dynamic has raised the ire of Fed Chair Jerome Powell, a former hedge funder, who stated recently that “What you have is 1.7 job openings for every unemployed person. That’s a very, very tight labor market… If you were just moving down the number of job openings so that they were more like 1 to 1, you would have less upward pressure on wages. You would have a lot less of a labor shortage.”

Yet there is little evidence of labor dynamics causing inflation. Real wage growth for most workers have been declining, despite some modest wage gains in frontline sectors such as retail and hospitality that experienced high rates of illness, death and turnover due to Covid-19. 75% of middle income families have seen their wage growth fall behind inflation and 71% are cutting back on spending. Stimulus money is long gone from households and nearly 60% of it was spent on basics like food and rent. Over 60% of Americans are living paycheck to paycheck and 1 in 10 households are struggling to feed their families, while millions more are buying less meat, produce and alcohol, using more coupons, or trading over to store brands and dollar stores.

Meanwhile, the average CEO to worker pay ratio was 324 to 1, up 23% from 2019, or nearly twice the rate of inflation. CEO earnings grew 18%, 4 times the rate of wage growth. S&P 500 profits rose by 17.6% in 2021. Profit margins crested at 15.5% in 2022, the most profitable year since 1950, while corporations issued more than $300 billion in stock buybacks to institutional shareholders like Kapito’s BlackRock. The timing with price inflation is uncanny.

Companies have 3 choices when they receive cost increases. They can absorb and take a hit on their margins. They can pass through and share the pain with customers. Or they can put an additional mark-up above and beyond the rate of cost increase, padding their margins at the expense of customers. Up and down the value chain, this profit-driven model is responsible for over 50% of consumer price inflation. And without profit inflation, price increases would be tracking more closely with wage growth.

Oil and Gas:

Despite tight supplies, gas prices are finally coming down from topping $5 a gallon. Major oil companies posted $46 billion in earnings in Q2. 2021 profits exceeded over $75 billion at Shell, ChevronCVX
, BP and Exxon, enabling $6.6 billion in stock buybacks as firms bragged that customers “expect and accept” high gas prices.

Freight:

Shipping conglomerates are expected to top last year’s profits by over 73%, or $256 billion. 80% of global merchandise uses the Big 3 shipping alliances whose on-time delivery rates are hovering at an abysmal 40%. And the 5 largest railroad freight lines increased operating margins by over a third in the last 6 years as they cut their workforce by 29%, as part of a shift to lean, just-in-time operating models with fewer and longer trains that cratered on-time delivery rates. A contract dispute with 115,000 railway workers could lead to a massive strike.

Commodities:

Just 4 companies control 70% of the global grain trade and 4 companies control up to 85% of meat and poultry processing. Cargill belongs to both groups. 2021 was Cargill’s most profitable year ever, with almost $5 billion in net income and up to a 70 basis point increase in margins; meanwhile over 4700 Covid-19 infections and 25 employee deaths occurred at Cargill meat processing facilities the previous year. The other top grain traders, including Archers-Daniels-Midland, BungeBG
and Dreyfus also saw record sales growth and profits due to rampant speculation in early 2022. Tyson’s net income soared 47% to over $3 billion while spending $700 million in shareholder buybacks, while 30,000 Covid-19 infections and 151 deaths occurred at their facilities. JBS passed 17% higher prices onto consumers, and even though volumes decreased, posted a 345% net income increase.

CPG:

After waves of price hikes, CPG conglomerates, such as Coca-ColaKO
, Hershey’s, PepsiCoPEP
and Mondelez, surpassed earnings estimates with revenues up between 7% and 16%. Coca-Cola attributed price changes to increased net operating revenues. Mondelez increased profits by $800 million, issued $4 billion in shareholder payouts in 2021, and raised prices again in 2022. Proctor and Gamble increased prices on all of its major segments, including Tide and Bounce, raking in $14.7 billion in net earnings and paying out over $19 billion to shareholders. General Mills increased prices 5 times in the past year; Q4 profits increased 97% to $823 million, with a 16% jump in FY 2022 profits and over $2 billion in shareholder handouts.

Retail:

The top 10 retailers increased their combined profits by over $10 billion over the past 2 years and issued over $15 billion in shareholder buybacks. Comp sales and profits at the chains responsible for almost 65% of grocery sales, including WalmartWMT
, KrogerKR
, Costco, TargetTGT
, Albertson’s and Ahold, have stayed strong despite recent margin declines, as retailers faced the pressure of passing costs on to consumers while managing erratic consumption patterns. Still, food retailer profits are expect to grow 8% in 2022. Cash-strapped consumers are also driving sales and profits at ubiquitous dollar store chains such as Dollar General and Dollar TreeDLTR
.

The Price-Profit Spiral:

An economic analysis by The Roosevelt Institute concluded that shareholders favor conglomerates with large market share because they are able to both raise prices and retain customers: “Firms increased their markups substantially in 2021, both to their highest level and with the largest single-year increase since 1955. Firm profitability, both before and after taxes, also increased to its highest levels… a phenomenon that could be described as a price-profit spiral. The decision-makers in publicly traded firms are sensitive to shareholder pressure to consistently meet short-term earnings expectations and to distribute large proportions of these earnings in share repurchases and dividends. In an inflationary environment, firms that enjoy the discretion and power to adjust markups are more attractive to financial analysts and asset managers.”

Robyn O’Brien, co-founder of RePlant Capital and author of “The Unhealthy Truth”, recently reminded me that “the executives inside of these companies legally are obligated to meet shareholder return above everything else.” The price-profit spiral is literally Robin Hood in reverse, redistributing the gains from consumer-facing price hikes upwards to shareholders.

Adam Smith, author of The Wealth of Nation recognized this dynamic early on in the development of capitalism. “High profits tend much more to raise the price of work than high wages. Our merchants and master-manufacturers complain much of the bad effects of high wages in raising the price. … They say nothing concerning the bad effects of high profits. They are silent with regard to the pernicious effects of their own gains. They complain only of those of other people.”

Yet key Republicans Senators, including McConnell, Blunt and Toomey, have dismissed this price-profit spiral. Coincidentally, they are stock owners and donation recipients from companies that have profited from price inflation.

Policy Solutions:

There are policy measures that may ease the pain. The Emergency Price Stabilization Act, introduced by Congressman Jamaal Bowman (D-N.Y.), would tackle supply side price hikes and recommend the use of price controls to limit price increases in key goods and services. Price controls during WW2 kept profits in check while strengthening consumer spending power. Windfall profit taxes and expanded unionization could redistribute the gains more equitably. The USDA has rolled out compelling programs to develop regionally distributed food supply chains. The FTC has stepped up antitrust scrutiny, alongside Congressional hearings investigating grocery consolidation. And worker representation on corporate boards could bring some balance to corporate governance above and beyond timid ESG measures.

Despite monetary policy having no sway over food prices, the Federal Reserve’s interest rate hikes may plunge the economy into a growth recession, punishing working people who carried the nation through the pandemic. What we need instead is to rein in the corporate capitalism strip-mining a food system in crisis.