With costs rising, restaurants debate price increases

Restaurants' choice of strategy in Atlanta and across the country will influence where Americans eat next year, and how much they spend.

Some operators say they plan to raise prices gradually if consumers give them the go-ahead. Others want to hold prices steady and see what their competitors do.

"We're obviously in a very cost-sensitive industry," said Robby Kukler, partner at Atlanta-based Fifth Group Restaurants. The company has seen prices rise for beef, chicken and, especially, butter. But Fifth Group has held prices down on most meals, such as fried chicken at South City Kitchen Vinings, fajitas at El Taco, and baked manicotti at La Tavola in Virginia-Highland.

"We know people are sensitive to it," Kukler said. "We just made a conscious effort, because of the times we're in, to hang steady."

Bonnie Riggs, restaurant analyst at The NPD Group, said the restaurant industry has suffered two years of traffic declines, the worst streak in at least 34 years. Raising prices now would just drive customers away, she said.

"What has kept the industry from suffering steeper declines is restaurant operators offering really good deals," Riggs said. "They cannot pull away from that -- they're going to have to wean consumers off of that gradually. If restaurant operators try to raise prices, in my view, you can't really do it right now."

Global factors are roiling the notoriously unpredictable food markets. A drought in Russia caused wheat prices to rise and more corn was used to make ethanol, pushing grain and corn prices up 40 and 60 percent, respectively.

Demand from China has raised the price of soybeans, a key part of animal feed. Coffee and sugar are at 13- and 30-year highs, respectively. Beef is up 19 percent this year, according to Bloomberg. Higher feed costs are also expected to push up the price of chicken.

Restaurants are not the only companies weighing whether passing along higher prices risks alienating customers. Big food brands such as Dean Foods, Del Monte, Dole and Chiquita Brands are among those at the greatest risk from coming price increases, according to Consumer Edge Research. With agricultural commodities up about 50 percent in the six months leading to November, price increases or smaller profits seem inevitable, according to the Connecticut-based research group.

"The market is saying it expects pretty high prices for the foreseeable future," said Darrel L. Good, professor in the University of Illinois' Department of Agricultural and Consumer Economics.

Hedging strategies, with buyers locking in ingredient prices at set rates for a certain period, have helped some companies reduce their exposure to higher costs.

Historically, restaurants have not immediately passed on the full extent of cost inflation to their customers, analyst Sara Senatore of Sanford C. Bernstein said. Typically that means meal prices lag for several quarters, squeezing profit margins in the short term.

Profits are defended zealously in the restaurant industry. Profit margins at Wendy's restaurants are 15.4 percent this year and 11.6 percent at Arby's, for example. Coca-Cola's, by contrast, are nearly 30 percent.

Executives at McDonald's said menu prices could rise if the economy improves. The Ohio-based chain has said its commodity costs will increase by only about 2 percent in the fourth quarter.

"That's a very manageable number for us, and nothing that we're terribly concerned about," said chief financial officer Peter Bensen. "We feel pretty good about heading into 2011."

Cheryl Bachelder, chief executive of Atlanta-based Popeyes Louisiana Kitchen, said she expects costs to rise next year. But with the U.S. unemployment rate at 9.8 percent, she doubts that fast-food companies can raise prices much.

"Our customers are still experiencing very high unemployment," she said. "Our customer will still be pinching pennies next year."

In negotiations with shrimp suppliers, Popeyes kept shrimp costs flat for 2011, said Alice LeBlanc, chief quality, supply chain and commercialization officer. This year the company added two new seafood suppliers, giving it more options to find good deals. The company also wants to add to its ranks of chicken suppliers.

"Introducing alternative suppliers has helped in terms of mitigating any increases" in costs, LeBlanc said.

Similarly, a purchasing co-op helps roughly 1,900 Applebee's restaurants in the U.S. restrain ingredient costs, said Michael Archer, president of Applebee's Services. Menu prices rose 1.7 percent in the third quarter, widening profit margins at company-operated Applebee's restaurants.

Other restaurants say they are well-protected against current cost increases. Ruby Tuesday Inc. said its commodity costs were relatively stable in the most recent quarter. A representative of Ruby Tuesday said the company makes long-range purchasing commitments and aggressively solicits multiple bids.

Dallas-based Brinker International Inc., which controls Chili's Grill & Bar and Maggiano's Little Italy, enjoyed better prices for meat, seafood and poultry in the quarter ending Sept. 29. In the current quarter, about 90 percent of Brinker's "food basket" is under contract, meaning costs don't depend on fluctuations in the open market. But much of that protection expires later in 2011. That could put pressure on steak prices.

Executives at Atlanta-based Wendy's/Arby's Group say some Wendy's restaurants will raise prices on selected products this month. The increases will be tailored to places recommended by a software program that crunches data from transactions.

"We think it will have a much more positive impact to our profitability than if we were just taking a blanket price increase," said Roland Smith, chief executive.

Some increases have come already. Some Wendy's franchisees bumped the Junior Bacon Cheeseburger to $1.29 after the company switched to a more expensive type of bacon. "We think it was the right thing to do," Smith said.

Wendy's/Arby's, one of the largest fast-food chains in the country, said its commodity costs are 2 to 3 percent higher this year than in 2009. The first half of 2011 is not expected to bring much relief from high beef and pork costs.

Even so, at Arby's, executives want to bring prices down, not up. A new value menu, with prices starting at $1, has boosted traffic and lowered the average customer payment to about $6.80, more in line with other fast-food companies. Before the introduction of the value menu, an average meal at Arby's went for $7.50.

Ernie Bower, a business consultant who lives in Lilburn, said he and his wife like to eat regularly at places like the Metro Cafe Diner in Stone Mountain, Mary Mac’s Tea Room in Atlanta, and Johnny's New York Style Pizza in Snellville. He doesn't typically adjust his choice of meals based on price and doesn't really plan to cut back next year.

"With us it is the old dictum: quality, service and price, usually in that order," Bower said. "That said, there are some restaurants that are cutting back on portions and quality and will be out of business soon if they continue."

Feedback from customers such as Bower, multiplied many times over, seems to have convinced restaurants to be cautious with prices.

Denver-based Chipotle Mexican Grill is prepared to raise prices if necessary, Chief Financial Officer John Hartung said on a recent conference call. But first it wants to see how customers respond to competitors' price increases.

"We'll be patient and watch things play out a little bit before we rush into it," Hartung said. "It's been two years now since we have raised prices in most of our markets. We know that others have raised prices. We think that we've got as much, if not more pricing power than other restaurant companies."

Darden Restaurants Inc., the parent company of Olive Garden, Red Lobster and LongHorn Steakhouse, has raised prices about 2 percent this year. It's important to raise prices steadily and consistently instead of delaying them for years, said Andrew Madsen, Darden's president and chief operating officer. Sudden price increases can shock guests, he said.

Stan Friedman, senior vice president at a Virginia-based franchising company and a fan of Italian food and wings, said the experience of a good meal is more important to him than the price.

"Businesses may need to charge more to deliver the experience," said Friedman, who works in Alpharetta. "If the experience is still there, I won't hold it against them. But if I pay a little more and get a little less, that's a problem."