Buying chicken for Burger King: End-user perspective on protein costs

CEO at the company in charge of buying meat and poultry proteinsfor Burger King North America outlined strategies for dealing with risingcosts.

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The Consumer Price Index for meat, poultry and eggs is up 27 percent since 2010, while the CPI for beef and veal is up 45 percent.
The Consumer Price Index for meat, poultry and eggs is up 27 percent since 2010, while the CPI for beef and veal is up 45 percent.

Keeping 7,100 Burger King restaurants in the U.S. supplied with everything from beef trimmings that go into Whopper burgers and chicken breast filets in Tendergrill sandwiches to fries, soft drinks and packaging, as well as premiums like Pokeman toys for the chain’s younger patrons, is no simple operation.

George Hoffman, CEO of Restaurant Services Inc. (RSI), the buying cooperative for Burger King restaurants in North America, has responsibility for the supply chain management that includes global sourcing from suppliers in the U.S., China, Australia, New Zealand and Canada. Just negotiating and managing the 1,500 freight lanes, which are the connections between the suppliers, distribution centers and restaurants, is, on its face, a labyrinthine business.

But there’s one supply challenge for Burger King and its restaurants that now rises above all others – the four-year climb in the price of beef, chicken and pork, which are the staples of the chain’s menu. The Consumer Price Index for meat, poultry and eggs, he noted, is up 27 percent since 2010, and the CPI for beef and veal is up 45 percent.

Surprising strength in meat prices, demand

Speaking at the Informa Economics Animal Protein Seminar during the Oilseed & Grain Trade Summit, Hoffman said, “Are animal protein costs a big deal? Are we concerned about rising protein costs? Are we doing anything about it? The answer to those questions is yes, yes and yes."

He cited a USA Today report which quoted USDA economist Annemarie Kuhns: “Beef  and veal prices are on track to rise 8.5 percent in 2014, a bigger increase than previously forecast, while pork prices will grow 8 percent and chicken 3.5 percent, according to the Agriculture Department. ‘We weren’t so much surprised that we had to raise beef prices as we were that demand has remained high for beef,’” he quoted Kuhns.

Beef and chicken prices play critical role in profit and loss 

Hoffman confirmed demand remains strong for beef at Burger King restaurants, and he discussed the challenge higher prices pose for restaurant margins.

Beef is the single-largest item of all food and packaging purchases ($2.6 billion) for North American Burger King restaurants. Beef purchases at $495 million account for 19 percent of the total spending for food and packaging. Soft drinks rank second among Burger King’s food and packaging purchases, with chicken the third largest at $280 million (11 percent) and pork at $111 million (4 percent).

How restaurants respond to rising meat costs

Responses to rising meat protein costs are similar at all fast food restaurants, according to Hoffman, but a chain’s menu profile and other factors influence execution of strategies.

“There are basically only two options for responding to rising protein costs,” he said, “raise the top line of the P&L through price increases, or reduce costs.”

He outlined possible responses to rising protein costs:

  • Raise the P&L’s top line (sales). This means passing through higher costs of goods to customers with higher menu prices, either by raising prices for menu items directly impacted by cost increases (burgers) or raising menu prices, generally on all or many menu items.
  • Reduce expenses by targeted cost-reduction initiatives on the menu items whose costs have escalated, by either reducing costs of the ingredient with cost inflation or reducing costs of other ingredients in the menu item to offset.
  • Reduce costs of other food items to maintain gross profit margins.
  • Reduce the cost of non-food items to maintain bottom-line restaurant profitability.

“Depending on the restaurant brand, and depending on its concentration of the different protein products, a brand may respond in a slightly different way or at a different pace, but all of us are dealing with the same dynamics. For Burger King, with almost 20 percent of our cost of goods in the beef category, the increase in beef costs is really a big deal,” he said.

Factors influencing profit margin management

At least four factors play a role in any fast-food chain’s actions to maintain bottom-line restaurant profitability in the face of cost increases in meats and poultry:

  • General economic environment (national and local).
  • Timing factor: Are cost increases expected to be short lived or long term? Short-term increases in costs tend not to be passed through in retail prices.
  • Pricing power (global and regional/local) in the economy, the region and at the restaurant-level in the community plays a role. Emerging brands like Chipotle or Five Guys, for example, have pricing power. Mature brands like Burger King and McDonald's do not and can't easily pass cost increases through to the customer, Hoffman said.
  • Competitive environment: What is the competition’s expected response?

“These factors play out in different ways for individual restaurants and the overall brand,” Hoffman said. “Margin management occurs on the part of the restaurant operators with the brand in tow as operators attempt to offset or compensate for cost increases by making adjustments in their restaurants’ P&Ls to try to protect the bottom line.”

Competitive environment impacts margins

Margins at Burger King restaurants have been squeezed over the past two years due to the relatively high percentage of beef on the menu. Not all competitors have experienced the same degree of commodity cost pressures during the period. For example, a competitor such as KFC, with a chicken-oriented menu, would not have been subject to the same cost pressures as Burger King at a time when beef prices are escalating more rapidly than chicken prices.

Beef’s share of the cost of goods at Burger King, for example, is 19 percent but might be closer to 15 percent at many quick-service restaurant (QSR) hamburger chains and 10 percent in some other types of QSR chains.

Nonetheless, passing through cost increases in the form of higher retail prices is not always an immediate option.

“If a restaurant takes its menu prices up, its competitor might not, and it could be at a disadvantage in the marketplace. So the options for raising prices or just passing through cost increases may be limited,” he explained.

Timing of price changes in the prevailing economy

Hoffman said, however, that foodservice retail prices – after being stuck in neutral for months – may be poised for a significant rise.

“Particularly in the last 24 months, food-at-home prices experienced significant year‑over‑year increases, and the pace of those increases have accelerated in the last six months. The restaurant industry, however, has been absorbing these cost increases, and when it’s clear these commodity pressures are not going to back off, restaurants will begin to pass through some of these increased costs with price increases. My expectation is that restaurant menu price increases are about to start. Probably over about the next six months we will see some significant menu price inflation,” he said.

Non-price actions to improve sales margins

Not every response to higher meat and poultry prices will be passing through costs to the foodservice consumer. Hoffman named two actions that can improve foodservice margins without resorting to prices increases:

  • Change the menu mix to products with lower relative costs
  • Introduce new “premium products” that have better profit margins (even beef) due to higher menu prices

Burger King and other fast food chains have been taking advantage of these kinds of approaches in recent months. Chicken has been the “turn to” product in some menu changes but not all. Examples include the following:

  • McDonald’s launched a limited-time breakfast burrito using chorizo made with chicken and seasonings including paprika, chili and chipotle pepper. The burritos, which were available at about 2,000 restaurants in three markets, included scrambled eggs, Roma tomatoes, green chilies, onions and white cheddar cheese.
  • Wendy’s tested and rolled out a menu of premium-priced pulled pork items to 6,000 restaurants nationwide.
  • White Castle was surveying its regular customers this fall to find out if the 180-calorie vegan burgers they began testing in July would be more popular with spicier toppings such as harissa or chipotle lime sauce.
  • Burger King featured the return of chicken fries to the menu this summer along with the slogan, “Get ‘em while they’re here!”

Impacts of soaring beef prices on product development

“High-cost products are going to get less new product focus than relatively lower costs ones,” Hoffman said. “In the Burger King system, for example, today, we have two burger‑related SKUs in the kitchen. We have got a large burger and a small burger. On the other hand, we have 11 different chicken SKUs in the restaurant and they're dynamic. We'll add new ones and discontinue some older ones. But you'll see fewer burger-related new product introductions, promotions and discounts.”

Foodservice cost reductions to protect the bottom line

In the face of continued high prices for meat proteins, foodservice companies are reducing costs to protect their P&L’s.

“There are dozens of ways to reduce costs,” Hoffman said, “any of which depends on marketing strategy, relative costs and timing.”

He described the following cost-reduction strategies:

  • Resize portions of the product that is causing the cost increase
  • Modify the specification of the offending product and/or other unrelated products
  • Use ingredient “extenders” (cheese, seasonings, etc.)
  • Apply pressure on suppliers to control costs
  • Increase the intensity of commodity hedging and risk management activity
  • Reduce costs of other non-food items in restaurant P&L – cost reductions of last resort are labor (second to last) and facilities maintenance (last resort)
  • Combination of the above

Cost-reducing product modifications can, in some cases, be attractive to foodservice patrons.

“One such offering at Burger King is a stuffed burger that includes cheese, pickles, pimentos, and a number of other things in the burger sandwich. There's a lower percentage beef and higher percentage of other things. The sandwich actually has a higher weight, but cost is reduced and it can be sold as a premium product."

More hedging and risk management with chicken

In the current cost-inflationary environment, Burger King has stepped-up activity in purchasing organizations for forward contracting and hedging of raw materials. This is usually done along with manufacturers of finished goods. It includes cross hedging raw materials with futures contracts plus buying and holding of raw materials for future manufacturing.

“RSI is doing a lot more proactive forward contracting for raw materials, particularly on non‑beef products like chicken and eggs, dairy products and others,” Hoffman said, “However, opportunities to cross-hedge, forward contract or implement fixed-pricing contracts are more limited on beef than almost any other product,” he explained.

It’s all about margin management

“In summary, it’s all about margin management through a combination of possible actions to protect the bottom line,” Hoffman said.

He explained the hierarchy of margin-protection action moves from the top of the P&L to the bottom, with the first action preferably taken in the sales area and the last in facilities maintenance. However, in most cases, foodservice restaurants take a combination of margin-protection actions.

Relief in sight for QSR chains in 2015?

Lean beef trimmings prices in 2015 are critically important for Burger King restaurants, Hoffman said. This means, among other things, little or no new product development involving beef items, he added.

“Given the supply and demand and price pattern in place, RSI expects another serious increase in lean meat trimming prices in 2015. With more price increases in the queue, and likely to be sustained for some period of time, this is being built into the marketing calendar, brand strategies, new product development and marketing programs for the entire year ahead.”

Hoffman, however, told listeners, “We think we're going to get some price relief on pork and chicken products in 2015.”

Not surprisingly, he indicated new product development will continue to be almost entirely non‑beef but instead focused first on chicken and secondly on pork products.

The Oilseed & Grain Trade Summit 2014 was hosted by HighQuest Partners and Informa Economics.

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