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Smucker vs Starbucks illustrates commodity buyers' dilemma

Should commodity buyers hedge, or pass on price volatility to consumers?

That dilemma came to the fore as JM Smucker, the biggest US coffee roaster, ground a little deeper into its decision earlier in the week to raise prices of most if its coffee by 9%.

It doesn't look like Starbucks, one of its main rivals, will follow suit.

While Starbucks declined to reply to's question on its pricing plans, the word on Wall Street is that the Washington coffee giant it is to hold fire, so Deutsche Bank analyst Eric Katz revealed to Smucker managers.

After all, Starbucks - which was caught out by the 2010-11 spike in coffee prices, which helped cut its operating margins by 10 percentage points - hedges a massive amount of its needs ahead, as has reported.

While Smucker is less open on how much coffee it purchases forward, the proportion is believed to be significantly less, meaning it relies more on altering its own prices to protect margins.

Starbucks strategy

"Our restaurant analyst was out there [at Starbucks] earlier," Mr Katz told the conference call to discuss Smucker's full-year profits.

"It didn't sound like they were really interested in moving on pricing," he said, referring of the grocery sector where Starbucks clashes with Smucker, rather than in the stores.

So what of Smucker's strategy, based more on passing on to customers movements in coffee costs, through change in prices, of perhaps one or two a year?

"Do you see the pass-through mechanism as still being kind of fairly efficient?" Mr Katz asked, noting that the last time Smucker put its prices up, in May 2011, thanks to rising arabica coffee bean costs "the volume elasticity was pretty tough".

In plain speak, higher prices did deter some customers.

'Truly the best lever'

Mark Smucker, the head of Smucker's US retail coffee division said that, "the short answer is we do feel that our ability to pass through is efficient.

"We did take a 9% increase earlier this week, we did feel that as we have seen sustained increases or realised cost increases in our costs that we needed to do that."

Moving the price "in this instance was truly the best lever to pull being more transparent with our customers".

As for the higher price deterring trade, Vince Byrd, the group's chief operating officer, reminded that last time the company raised coffee prices, was as arabica futures were near a peak at some $3 a pound.

"Of course we are not at that level today."

Sales vs profits

The comments came as Smucker unveiled a 10.1% drop to $124.0m in group earnings for the February-to-April period, its fiscal fourth quarter, on revenues down 7.9% at $1.23bn.

The drop in sales reflects the group's last cut in coffee prices, in February last year, reflecting the weakening market, with the drop in profits an indication that customers got this quarter something of the better of the deal.

"The expected lower net price realisation more than offset the benefit of lower green coffee costs," the group said.

Mr Byrd said that the fourth quarter profit decline "primarily due to timing of the net price realisation versus cost.

However, "we continue to manage the business with an annual perspective and the price to cost timing impacts have and will continue to occur from quarter to quarter."

On a full-year basis, profits in coffee retail rose 5.7% to $641.9m, despite a 6.3% fall in sales, reflecting the lowered prices.

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