Corporate America will need to stop raising prices for inflation to come down to the Federal Reserve’s 2 percent annual target rate, but companies aren’t eager to let go of record profit margins that have soared amid historic inflation.
Nonfinancial corporate profits reached at an all-time high of $2.09 trillion in the third quarter of last year, according to Commerce Department data.
That’s more than double their pre-pandemic level of $1.29 trillion in the first quarter of 2020.
In recent investor calls, scores of corporate executives noted that price hikes are driving their massive earnings. And while many executives said they aren’t planning to raise prices this year, some indicated they’ll continue to test the spending limits of the U.S. consumer.
Nestlé CEO Mark Schneider recently announced a series of price increases for 2023 after the world’s largest food company underperformed analysts’ expectations. He told investors that Nestlé’s price hikes in North America have helped to “more than offset” higher costs for the company.
“I have no regrets about the pricing action that we have taken,” Schneider said earlier this month, noting that he expects demand to keep up.
Will companies keep hiking prices even as inflation rises?
Inflation has eased in recent months, but some categories continue to rise, raising the question of whether U.S. consumers will suffer from high costs for longer than expected.
Grocery prices rose 10.1 percent annually and 0.5 percent in January, according to the Labor Department’s consumer price index, outpacing broader 6.4 percent annual inflation rate.
Consumer staples such as cereal, soup and household products saw some of the largest gains over that period.
That coincided with a series of price hikes from major consumer staple companies, including General Mills, which last week reported huge profits driven by higher prices.
“I mean, look, I’m frustrated by pricing. I’m sure consumers are too, but that’s the environment that we’re living in,” General Mills CEO Jeff Harmening said at an investor conference last week, adding that he expects consumers to keep buying the company’s products.
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Other industries are leaning on high prices, too. Stellantis boasted in a recent earnings call that its Ram trucks have the “all-time highest U.S. average transaction price” as the cost of new cars and trucks continues to break records.
Companies prefer to keep prices high to buoy their profit margins and attract investors. But that strategy relies on consumers playing along.
Kraft Heinz Co. executive vice president and global chief financial officer Andre Maciel told investors earlier this month that the company’s growth in 2023 is “all driven by price.”
But while the food giant increased prices by 15 percent in the fourth quarter, its sales volume fell 5 percent, prompting executives to caution against further hikes this year.
“We need to keep actively monitoring and we are because throughout this year, we can see maybe consumers will change their behavior,” Maciel said.
Are consumers starting to reject price hikes?
PepsiCo, Keurig Dr Pepper, Clorox and Procter & Gamble said in recent weeks that the decision to hike prices isn’t as easy as it once was. Those companies raised prices several times last year but are now seeing their sales numbers start to fall.
“A key focus point for us in 2023 is the financial health of American consumers,” Keurig Dr Pepper CEO Robert Gamgort told investors last week.
Americans have used up most of the savings they accrued during the pandemic, forcing them to reduce their spending. They’re starting to shift away from big label brands, opting for cheaper alternatives such as store-brand items and discount grocers, retailers say.
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“There is definitely some acceleration to private brands in the last 90 days,” Walmart U.S. CEO John Furner told investors last week.
Still, that practice isn’t widespread, and wealthier households continue to spend big. A recent study from the Kearney Consumer Institute found that 64 percent of consumers are still buying the same brands, despite higher prices.
Do corporate profits drive inflation?
Businesses have dealt with higher labor, transportation and raw material costs throughout the pandemic, driving up prices for consumers. But for many of the largest U.S. companies, profits have more than made up the difference.
Moreover, the share of prices attributable to profits has been increasing since the pandemic started while labor and input costs have been falling.
Data from the Commerce Department shows that profits represented 12 percent of prices in the first quarter of 2020 while they were 15.7 percent of prices in the third quarter of 2022, which is the last time they were measured, according to calculations by The Hill.
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Meanwhile, labor costs have fallen from 60 percent of prices to 58 percent over the same period, and input costs for component parts have dropped from 27.9 percent to 26 percent.
That challenges the narrative of many companies and private-sector economists that inflation has been solely the result of discombobulated supply chains and extra demand for goods in short supply.
The United Nations has also named company profits as a primary driver of inflation, stating in a 2022 report that higher costs “are being amplified by price-setting firms in highly concentrated markets.”
The U.S. Chamber of Commerce, the largest business lobbying group in Washington, told The Hill that “profits do not factor into the problem at all” when it comes to inflation.
“Inflation is driven by too many dollars chasing too few goods and services,” Chamber of Commerce head economist Curtis Dubay said, referring to fiscal support during the pandemic.
Rate hikes are ill-suited to trim profit-led inflation
Economists like to say that the cure for high prices is high prices, because eventually they’ll deter people from making purchases, which will incentivize companies to charge less or lose their customers to competitors.
That’s the logic behind Fed rate hikes, which make it more expensive to transact through the economy, sapping demand and finally lowering inflation.
But higher interest rates may do little to curb profit-driven forces behind inflation.
“[Central bankers] must know that monetary policy is a very, very blunt tool to deal with profit-led inflation. But the perception of central bank omnipotence over inflation means that spin will have to dominate over substance,” UBS banker Paul Donovan wrote in a note to investors on Monday.
And according to a January report from the Federal Reserve Bank of Kansas City, following long-term trends in higher markups, companies also raised markups during 2021, “contributing substantially to inflation.”