Unilever PLC (LSE:ULVR) last week impressed investors with its full-year results, showing the consumer goods firm managed to pass on price inflation to consumers and continue to perform strongly – the next question is whether Reckitt Benckiser Group PLC (LSE:RKT, ETR:3RB) can repeat the trick.
Reckitt is set to publish full-year results on Thursday and the City is predicting a similar performance.
Looking further ahead, however, investors will soon wonder how much higher prices of branded consumer goods can go before shoppers start to substitute to lower-priced alternatives.
It’s a quandary, typically referred to in textbooks as ‘the price elasticity of demand’, which should be familiar to anyone that’s read even a semester of economics.
Price elasticity can be expressed as a number (the result of an econometric equation) though the basics of the concept are quite simple doesn't really need arithmetic. It describes how much a change in consumption follows a change in price.
Cigarettes, for example, are described as inelastic for an addicted smoker as their buying behaviour will be detached from price changes, whereas other products are more easily substituted and are much more sensitive to price changes. These are said to be elastic.
Unilever and Reckitt produce and sell wide range of so-called consumer staples – food and hygiene ‘necessities’.
On the face of it, many such products may seem to lean towards inelastic, though the 'big brand' labels are propped up by marketing and advertising spend which are seen to interfere with the text-book elasticity theory.
Nevertheless, as household budgets are squeezed certain product lines will inevitably see customers swap out leading brands for cheaper, less recognisable, or unbranded products.
The City outlook on Reckitt so far doesn’t price in such a problem.
“On a like for like basis, 9-month revenues saw a rise of 3.6%, showing that like its peers, Unilever and Procter and Gamble, it has been able to pass on price increases to its customers without adversely affecting sales,” Michael Hewson, CMC Markets chief market analyst, said.
“In terms of its guidance the company said it now expects to see like for like revenue rise between 1-3%, up from 0-2%, and says it remains on course to meet its guidance of the margin improvement that it outlined in July,” Hewson added.
Unilever owns several well-known brands and staples including PG Tips, Colman’s mustard, Helmann’s mayonnaise, Marmite, and Vaseline to name a handful.
Reckitt meanwhile owns some brands like Durex, Finish dishwasher tablets, and Air Wick home scents.
Many of the brands under these two huge conglomerate umbrellas have a built great deal of brand value and reputation, and with that comes customer loyalty and repeat purchases and perhaps suggests price increases to date haven't impacted sales – indicating low elasticity.
“When comparing similar products with different price points, consumers may purchase the higher-priced product if their brand loyalty to that product is high," according to Investopedia.
“Because of this, a 5% increase in the price of well-known brands—such as Coca-Cola drinks or Nike shoes—has less impact on demand than a 5% increase in a lesser-known and less-trusted competitor.”
However, some products have plenty of competitive substitutes, so there is a chance that consumers may switch to alternatives should prices rise too much.
What remains to be seen is how much of a price rise will be too much, and, moreover, how much impact will there be from surging energy bills and other bills.
Certain brands are perceived to be so dominant in their markets that they could almost be seen as monopolies – think Marmite, Vaseline, Helmann’s, or even Durex.
Other brands are far more elastic, and open to substitution.
Unilever, for example, owns the soft drink brand Lipton (albeit as a maker of Icetea its admittedly a bit niche) and soft drinks are generally estimated to have a price elasticity of around 0.7, which means if the price rises by 10% demand will decrease by 7%.
But for the big brands like Coca-Cola and Pepsi such a ratio simply doesn’t apply. Marketing spending is too high and substitutes are generally too dissimilar.
So, with food inflation increasing to 6% in January there will undoubtedly be some consumers that are contemplating the switch to cheaper supermarkets or own brands, especially with higher energy prices and interest rates and national insurance rises scheduled for April.
But large well-marketed companies with highly-reputable brands and high customer loyalty are less likely to see a fall in sales, which is to be reflected in Reckitt's results on Thursday.