Hard Cheese – The Baffling Behaviour of Branded Cheddar Sellers

Dairyco have just published figures for cheese sales in the 52 weeks to end December 2009. The top line picture is that total cheese sales are up, by 4.2% in tonnage, helped, as Dairyco points out, by a very modest price rise of just 1p per kilo.

The detailed figures reveal one startling change, namely that the price of branded cheddar dropped by 29p per kilo or 5% whereas that of supermarkets’ own label increased by 1p. This means that branded cheddar is 7% cheaper than the supermarket equivalent, whereas all received wisdom would say that it ought to be at least 10% dearer to pay for the advertising and promotional costs that accompany a branded product. At the end of 2007, branded cheddar cheese sold at £5.63p a kilo versus own label at £5.21p, a premium of 8%. At the end of 2009, branded cheddar sold at £5.99p versus supermarket own label at £6.42p.

The branded guys will no doubt be celebrating spectacular sales. The price cut meant that their volumes grew by 21% in 2009 and their sales value by 16%. The own label people acted very differently. On their standard cheddar they took a modest price rise and achieved increases of just under 1% in volume and value.

So what might be the right strategy - to maintain price, volume and profit margin, as retailers did with their own brands, or to cut prices, get higher volume, but sacrifice margin.

We will never know exactly what the financial outcome of these heavy promotions is. All we will hear during investor presentations is that brands saw terrific growth. However, the chances are that the branded sellers made much less money than own label.

Here’s why. At a price of £5.99p per kilo, a 30% margin to retailers and a 50% cost of goods the volume increases achieved would deliver the same profit as holding the price at 2008 levels. If either the cost of goods or retailer margin is higher then the promotions lose money. Add to this a likely payment to the retailer to run the promotion, a possible demand for cash margins to be maintained even though prices are reduced, and overtime running at factories to produce the incremental volume then losses increase.

The supermarkets will be laughing their socks off. Their total cheese sales are up, and their profits will be too as all the expensive price cutting promotion costs will have been borne by the brands.

The branded processors behaviour is baffling. Deep price cuts are a zero sum game, for as soon as one company breaks ranks the others follow to avoid losing market share, and they are generally ruinous to profits.

We can speculate as to how any shortfall in profit might be made up. The reasons for declines in farmgate milk prices get lost in a terrific snow job from processors who blanket us with tales of unfavourable exchange rates and world commodity prices. But one is left wondering whether the drop in liquid milk prices went some way to funding all these cheese promotions.