General Mills to use pricing power to maintain margins in 2022.

General Mills had a fairly good quarter, continuing a string of success that most branded consumer goods companies have had over the pandemic. It had $5 billion in revenue over the last three months, 6% higher than the year before. However, profit declined 13%–caused mostly by inflation. How does the Minnesota-based company plan to get that profit back? During its’ recent investor call, General Mills made it clear it will use its pricing power.

What is pricing power?

There’s a lot of different technical definitions of pricing power within the consumer goods industry. It’s a high stakes game with billions of dollars at risk. At a high level, brands want to charge as much as possible for products, but not too much where it impacts the overall demand for it. This interplay between price and demand is called elasticity.

Products whose demand doesn’t change much with price are considered inelastic. When demand for a product is heavily influenced by the price it is considered elastic. Products that feature an inelastic demand have pricing power.

Given increased inflation, it’s a great time to have pricing power. General Mills has it. In the last few months, the company has increased prices by an average of 9% across North America. Executives don’t comment on forward-looking prices, but CEO Jeff Hermening said more increases are coming. “We have pricing already in the marketplace that we’ve already announced to our customers,” he told investors, “and so we’re confident that, that it will be higher in the second half of the year. “

Why are higher prices coming? Quite frankly, they can, so they will. 

Pricing, reality vs perception

According to General Mills, price increases are due to inflation. “We’ve seen about half a billion dollars more in costs than we were expecting this year,” chief executive Jeff Harmening told investors. This is more or less standard across the consumer goods industry. But what are the costs specifically? Kofi Bruce, General Mill’s CFO explained:

About 55% of our input costs are sitting in raw packaging materials, 30% in manufacturing and the remainder in logistics. 

And what we really saw that kind of accelerated was our raw and packaging materials moving out to double digits, logistics which we now expect to was already in the double digits, continued to survive the loss of that base, and in fact remained in the low single digits. 

This is certainly true. A look at General Mill’s margin waterfall shows inflation has a large impact on margins. It also shows that it’s been able to offset inflation through a mixture of pricing and HMM (holistic margin management).

Contrast this experience to TreeHouse Foods. General Mills was able to increase prices and still maintain healthy margins of above 30%. TreeHouse, one of the largest private label food companies, has seen its’ margins drop to about 15%. Why can’t TreeHouse foods raise its prices to combat inflation? 

Pricing Power and the Reference Price

In How Brands Grow, Bryon Sharp explains the concept of a reference price.

The academic research on pricing emphasizes the notion of a consumer reference price—especially the consumer’s internal reference price, which is the memory or expectation of what prices should be. 

In the case of TreeHouse Foods, it manufactures products that compete strictly on price. Its reference price will always be of a low-cost alternative. Its demand will always be somewhat elastic. General Mills competes on quality and brand. Its products are more inelastic.

Sharp continues:

This expectation of price is thought to be generated by exposure to prices in the past, either by purchasing or observing communications such as ads. The idea of a reference price is that ‘past prices matter’ and if consumers encounter a price above their reference price, this dampens their propensity to buy.

In this case, the reference price is distorted, not through advertisements, but through media talk about inflation. The image below shows Google searches for “inflation”. As you can see, it’s skyrocketed over the last few months. People believe inflation is widespread, and so they’ve adjusted their attitudes to expect price increases. 

Since General Mills has inealstic products with pricing power, they’re exercising it. TreeHouse Foods isn’t so lucky.