Penny-Pinching Consumers Pose Challenge for Retailers

Rebecca Sumrow is one of the customers food and restaurant company executives have in mind when they consider raising prices to offset higher costs as meat and milk soar to record highs.

The 30-year-old from San Clemente, California, was out of work for a short time last year and saved money by moving in with her boyfriend and cutting back on clothes shopping and dining out. Though she now has a good job working for an investment firm, she's maintaining her frugal ways.

Consumers "have gotten really good over these last four years at stretching a penny," said Pat Conroy, leader of the U.S. consumer products practice at Deloitte LLP. Referring to the recession, he said, "Our hypothesis was that this thing was going to leave a scar, not a bruise. So far, we've been right."

According to Deloitte's annual survey of food shoppers released last week, 94 percent agreed they would remain cautious and keep spending at the same level even if the economy improves. That's about the same percentage as it was in 2010 in the aftermath of the credit crisis.

So Chipotle Mexican Grill Inc, McDonald's Corp , Hillshire Brands Co and Kraft Foods Group Inc , all of which are raising prices, will be trying to retain consumers stuck with stagnant incomes and unhappy memories of the recession. Faced with little choice but to boost prices to cover the spike in costs for products like milk and meat, companies often are taking extra care to justify or soften the increases.

COLD CUTS AND BACON

Kraft has raised, or will soon increase, prices on about 45 percent of the products in its portfolio, including cheese, cold cuts and bacon. Hillshire raised the prices on Jimmy Dean sausage and Ball Park hot dogs as retail pork prices hit a record high of $1.99 a pound in March, from $1.40 a pound a year ago, according to the U.S. Department of Agriculture. McDonald's eliminated its "dollar menu" last year to give it flexibility to raise prices to offset high costs for meat and other ingredients.

Chipotle is one of the few companies expected to have the power to raise prices due to its popularity with higher income diners. The burrito chain is increasing menu prices this quarter, but only after giving customers a benefit by removing almost all food ingredients made with genetically modified organisms, or GMOs.

"You're hearing that they want to, but the question always becomes: Can it stick?" said Prudential Financial market strategist Quincy Krosby, referring to raising prices. "What the consumer has been very good about is going on strike."

That's happening now in the dairy aisle. As U.S. milk prices go up, shoppers buy less, according to Dean Foods Co, the largest U.S. milk processor. Fluid milk industry volumes fell 2.1 percent in the first quarter, according to Dean.

"There are certain price thresholds that we can't cross, or it starts to impact the demand," Dean Chief Executive Gregg Tanner said on a conference call with analysts last week. "We experienced additional softness in our volumes during March and April."

The wholesale price for beverage milk was about $2.10 per gallon in May, a record, and up 38 percent from a year ago, according to dairy analyst Jerry Dryer. In March, retail milk prices were up only 6.5 percent, suggesting that retailers are eating much of the cost increase, he said.

INFLATION TARGET

U.S. consumer prices rose 1.5 percent in March from the year earlier, led by food and housing rental costs. An index of inflation tracked by the Federal Reserve is running even lower at 1.2 percent, against the central bank's target of a 2 percent inflation rate.

Many consumers are still struggling in a tough labor market. Labor force participation remains depressed. Private-sector wages were unchanged in April and over the past 12 months have averaged monthly increases of just 0.16 percent.

"There's still a large swath of the population that just doesn't have the spending power," said Mark Luschini, chief investment strategist at Janney Montgomery Scott.

Pricing issues already have changed the fortunes of Whole Foods Market Inc and McDonald's, which are battling rivals that emerged from the recession willing to start price wars.

McDonald's raised prices late last year in a bid to protect profits from higher meat costs. Its customers, who tend to earn less than those who frequent Chipotle, voted with their feet and U.S. sales at established restaurants have not posted a monthly gain since October.

Whole Foods, the leading natural and organic grocer nicknamed "Whole Paycheck" because of a perception among some consumers of high prices, has seen same-store sales growth cool as mainstream food sellers add more organics and undercut it on price.

Its most aggressive rival could be Wal-Mart Stores Inc , which in the United States will introduce 100 Wild Oats-branded organic packaged food products ranging from olive oil to black beans in about 2,000 stores in coming months.

Walmart, which tends to cater to lower-income shoppers and sells more groceries than any other domestic retailer, said those products would be priced on par with conventional rivals and at least 25 percent below branded organic foods.

"It's really hard for Whole Foods to start a price war. It's really easy for Walmart," said Wolfe Research retail analyst Scott Mushkin.

For her part, Sumrow says she's spending more time in the dollar store produce aisles and less time in upscale places like Whole Foods, though she still splurges on things like unpasteurized milk for about $6 a gallon and fresh spinach, kale and chard for her daily juicing ritual. She's not inclined to loosen up her spending anytime soon, even though she's making more money.

"We have to be very careful with our finances to be able to get anywhere," she said, adding that neither she nor her sister plan to have children because it doesn't make financial sense. "We have to tighten our belts and invest wisely and try to get established when everything is working against us."