A recipe for disaster

For seven years, the market kept a lid on food inflation. That started changing about 18 months ago

JIM Walker has been looking at the prospects for Scotland's food industry and they are not good. "The food industry, for many manufacturers, is in a state of crisis. This has emerged in the past few weeks."

Walker, who runs the Walkers shortbread company, Scotland's biggest food exporter, is a quietly spoken man who is not given to exaggeration. When he issues such a warning, something is up.

In the past month, manufacturers have been hit by a combination of raw materials price hikes - flour up 50%, milk powder up 35% and soya ingredients up 40% - which have come too quickly to be absorbed through efficiency improvements or small price rises.

For Walker, who runs a company employing 1,200, mostly in Scotland, there is worse to come. He has been told that the price of butter will double over the coming year. Butter makes up 60% of Walker's costs, so he must get his customers to accept price rises ahead of inflation or risk his firm's future.

"We just have to hope that the trade and customers will be reasonable. But competition in the grocery trade means that the retailers are always very reluctant to accept price increases."

Walkers' brand image is of a traditional product swathed in tartan. But behind the scenes, the company is a modern, efficient food producer investing for the future.

The family is spending about 6m on a new shortbread and biscuit factory in Elgin and has plans to turn its spiritual home, a bakery in nearby Aberlour, into a development laboratory for new biscuits.

But that kind of investment will be hard to sustain in the future if Walker's margins are wiped out by higher flour, sugar and butter prices.

A number of factors are conspiring to push up the price of basic foodstuffs. These include poor harvests caused by unpredictable weather, the increasing use of crops for fuel rather than for food, growing demand in China for dairy products, and a decline in UK dairy farming.

Julian Hunt, a spokesman for the Food and Drink Association trade body, says: "For seven years, the market pretty much kept a lid on food price inflation. It was quite a benign climate. That started changing about 18 months ago, when we saw massive hikes in energy prices, which spread to packaging costs and transportation.

"More recently we have seen the same thing happening with raw materials. It makes it very tough for manufacturers and retailers. We have entered a difficult time for everybody.

"Our feeling is a lot of customers recognise that these are genuine price rises, and if not, they need to be aware of that. Otherwise, smaller manufacturers run the risk of being caught between things they can't keep a lid on."

The situation is worse for companies, like Walkers, which export to the US. The weak dollar makes British-made treats expensive luxuries stateside. That has an impact on companies such as Walkers, which has a contract to make shortbread characters for Disney theme parks around the world.

Tough market conditions last week forced Tunnock's, maker of the traditional Caramel and Teacake treats, to issue the first profits warning in the Uddingston firm's 117-year history. Managing director Boyd Tunnock said he faced "the worst situation I have witnessed in my working lifetime".

As well as rising raw materials prices, the firm has had to contend with a trebling of its Scottish Water bill in two years and a 66% rise in gas prices in a year.

Tunnock says: "Nothing focuses the mind more than when profits start to go down. It's like having a leaky pipe. You have to sort it out, and that is what we are doing.

"You have to do what you think is best. We have just managed a price rise, but the general public are very price sensitive."

Lees Foods, the Aim-listed company famous for Macaroon bars and Snowballs, has done better than most in the industry, managing to increase its profits in the first six months of the year. But chief executive and industry veteran Raymond Miquel says it was not easy: "It is very competitive out there. We have not been able to pass on all of our increased costs to the supermarkets. We have to come up with other ways and means like coming up with new products."

The new products include mini Snowballs and a low-calorie raspberry meringue bar which is due to hit the shop shelves this summer. Meanwhile, profit margins on the company's traditional product range continue to be eroded.

Other companies which have hit problems include Grampian Country Foods, the meat empire chaired by Fred Duncan, which recently crashed to losses of 40m and had to sign a deal with the government's Pension Protection Fund to avoid collapse.

Baxters, the soup and pickles maker, reported a drop in profits this year despite rising sales and overseas expansion.

This adds up to a tough starting point for Scotland Food & Drink, a "leadership organisation" which was launched last month with a rooftop party at Glasgow's City Inn hotel hosted by Rural Affairs Minister Richard Lochhead.

The agency, combining food manufacturers, farmers and agencies such as Scottish Enterprise, was set up to identify problems to be tackled and then to push improvements through.

Margaret McGinlay, director of food and drink for Scottish Enterprise, says: "One of the big issues for the food and drink industry has been how to keep the cost base down, because getting any kind of increase out of the supermarkets is difficult."

Early ideas include more consistent branding for Scottish products, and getting companies in the supply chain to work more closely together. McGinlay says: "Consumers want to know where their products are coming from. They like the assurance of family businesses, and at the same time we are seeing the rise in premium products. All these things favour Scottish companies."

But some in the industry are sceptical about the new body, which is expected to unveil its chief executive this week. One said: "We have had this before with Scotland the Brand [the promotion agency], which came to nothing. There were too many interest groups with their own agendas and that could happen again."

Scotland Food & Drink has set out a modest target, increasing the industry's turnover to 10bn by 2017 - implying a growth rate of just 3% a year. Some expect Scotch whisky, which is included in the figures, to grow faster than that - implying little or no growth for food.

McGinlay says the group was right not to aim too high: "10bn was felt to be ambitious but achievable. What we will also be doing is looking at how the industry is performing against UK food and drink, and against the Scottish economy as a whole. It is very much about harnessing knowledge. We have seen the same thing work in Denmark, New Zealand and Ireland."

But Scottish Enterprise's own figures cast doubt on whether this is a growth industry. Futureskills Scotland, the agency's job forecasting arm, last month published a series of forecasts. They included a projection that the food and drink manufacturing sector would lose 2,000 jobs to employ 47,000 people by 2017.

If the industry continues to be squeezed by raw material prices on the one hand and by supermarkets and cash-strapped consumers on the other, the job losses may come rather sooner than that.