As the world grappled with high inflation over the past several months, businesses hiked prices to offset rising input costs. In the US, both politicians and economists raised concerns over corporations using the cover of inflation to overcharge their customers and rake in profits. 

US Senator Elizabeth Warren wrote letters to CEOs of major American grocery chains, asking them to “explain their rationale behind the price hikes” and any steps taken to protect consumers. Warren said that “giant corporations are using inflation as cover to raise their prices and boost profits. In industry after industry, we have too little competition & companies have too much power to increase prices”.  

Many American corporations increased prices in the past few years, in products from detergent to cars. In 2017, there were 36 car models priced below $25,000. In 2023, fewer than ten car models are below the $25,000 price point. 

American businesses seem confident that consumers will accept these price increases - according to reports, the impact of inflation on the top 40% of earners in the US has been relatively muted, as they have amassed more than $1 trillion in extra savings. This provides American companies with a large pool of consumers willing to pay more. 

Premiumisation has caught traction in India as well, with many FMCG and retail giants focusing on it. However, the trend seems to be largely focused on premium products as demand from consumers of mass products still remains sluggish. Indian companies have been selective and strategic in increasing prices.

Gunjan Shah, CEO and Managing Director of Bata India, said, “Our premiumisation strategy will continue, but on a case-by-case basis where we see benefits.” He added that the company will carry out premiumisation based on competitor action as well. The rising popularity of luxury brands in India have businesses sensing an opportunity, but India has historically been a highly price-conscious market. As they move forward on this, businesses will be keeping a close eye on volumes.  

Divergence in consumer trends as inflation bites

In the post-pandemic era, India like many other economies is witnessing a K-shaped recovery, where certain segments see robust growth while others don’t. Despite high levels of inflation, demand for premium products has grown rapidly, while value or mass products struggle as spending power of lower demographics falls.   

Over the past couple of years, revenue growth for Indian retailers and FMCG companies has been led by price hikes and rise in sales of their premium products. These premiumisation efforts also helped the companies cushion the impact of high input costs and even aided in margin expansion. 

On a broad scale, FMCG companies were more conservative with price hikes on consumer products. In Q3FY23, growth in price hikes fell nearly 200 bps QoQ to 7.9% as commodity prices started to cool down. In fact, many FMCG companies passed on the benefit of falling palm oil prices to customers. Given how price-sensitive most consumers are on the middle and lower-end, these companies focused on retaining their market shares by strategically pricing their products.  

However, Tata Consumer Products managed to increase its market share and sales volumes in the salt segment, despite increasing prices of its salt products by 33%. The company carried out premiumisation of its salt offerings across price ranges and saw a 90 bps gain in the salt market share. 

High input costs still eat away at gross margins

Half of the companies in focus saw their gross margins under pressure due to high input costs. Although prices of some key commodities have been reducing, they have not normalised yet, impacting the margins of some companies.

Among the companies in focus, only Britannia Industries, Godrej Consumer and Metro Brands have seen their gross margins rise YoY and QoQ. Britannia’s margin expanded on the back of its low-cost wheat inventory, while Godrej Consumer’s improved due to falling input costs, led by the dip in palm oil prices. 

Metro Brands’ margins rose on the back of rising average selling price, superior store economics and robust sales of premium products.

Operating margins improve due to operational efficiencies

All companies (except for Aditya Birla Fashion & Retail (ABFRL)) saw their operating profit margins rise QoQ, driven by declining commodity prices, premiumisation and cost management initiatives. Britannia and Bata India saw their margins improve both YoY and QoQ. Bata’s operating margin growth was led by operational efficiencies and lower employee expenses as a percentage of revenue.

Despite ABFRL’s premiumisation and cost management efforts, its margin fell YoY and QoQ due to a 2.3X YoY rise in marketing expenses and higher losses in its emerging businesses. The firm improved its pricing mix and controlled discounting of its premium offerings (Madura Fashion & Lifestyle) to protect its margins, but the sluggish growth in its value brand (Pantaloons) dragged down the operating margin. 

Vishak Kumar, CEO of Madura Fashion & Lifestyle, pointed to the contradictory behaviour in consumer demand, saying, “When you look at the premium end and the value end, we see resilience at the top and challenges at the bottom.”

Retailers focus on premiumisation of higher-end products

Metro Brands and Bata India are largely focused on premiumisation of their premium products. While Bata India’s average selling price (ASP) has risen 13% YoY to Rs 772, Metro Brands’ ASP stood at Rs 1,450, the highest among its peers. For Bata, sales of products  priced over Rs 1,000 drove the growth of ASP. In Q3, 96% of Metro Brands’ revenue was contributed by products with ASP greater than Rs 500, while the product segment with ASP over Rs 3,000 led growth. 

Profit growth led by cost optimisation and demand for premium products 

Except for ABFRL, profits of all other companies have risen YoY and QoQ on the back of robust sales growth and cost optimisations. The premiumisation drive and price hikes, along with rising demand from high-income customers, improved revenue growth for all the companies in focus.  

However, premiumisation has not yielded the same results for all. In Q3FY23, ABFRL’s net profit fell 58.1% QoQ. Although the company’s lifestyle and value segments grew 23.9% and 8.7% YoY respectively, its net profit fell 91.7% YoY mostly due to higher input costs, employee costs, rental expenses and marketing expenditures.  

The management plans to improve its footprint across India and expects demand conditions to improve going forward. This explains the company’s massive push toward increasing its marketing expenses and expanding its network.

Recovery in demand for value products necessary for higher profitability 

Premiumisation efforts have been successful in improving profitability and cushioning the impact of high input costs for Indian businesses. But companies will find it relatively difficult to expand their market presence by premiumisation alone, given the inflationary environment, thus limiting the scope of this strategy. Expansion will slow down if demand is only robust in one segment, and the others are relatively flat. 

India’s value-conscious demographic remains its biggest consumer segment. Although margins on mass products are smaller, they tend to make up a major chunk of the sales volume. If demand sentiment from the lower end does not improve, gains made from selling higher-margin products will wear down. In the medium-to-long term, the overall recovery of these companies’ performance is contingent upon the revival in demand for mass products.

This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation.