Trendy Chipotle burritos show pricing power belongs to the hip
Corporate America can learn a lot from a chicken burrito. As many companies struggle to boost prices without alienating consumers, they may want to study Mexican-food chain Chipotle, which has managed to do both.
Companies including Chipotle Mexican Grill Inc., Apple Inc. and PepsiCo have shown they're able to take advantage of quality, trendiness, and, in the case of Pepsi's snack foods, market dominance, to maintain high prices or even raise them faster than the inflation rate, now at about 2.1 percent in the U.S. Chipotle raised chicken-dish prices by 5 percent this year after leaving them untouched since 2011, and sales went up 29 percent last quarter.
The Denver-based Mexican food specialist "has done a great job cultivating a brand that commands pricing power," especially among millennials, who are mainly people in their 20s, said Morningstar analyst R.J. Hottovy. "They've developed a very loyal following."
As the U.S. economy remains sluggish - full-year growth may now struggle to reach 2 percent - other companies such as mass market automaker Hyundai Motor Co. have felt the squeeze, with earnings under pressure from deep discounting in the U.S.
Hershey Co. is raising candy bar and other product prices by an average of eight percent because of higher cocoa and dairy costs, even as it acknowledges the move will hurt its short-term sales. M&M maker Mars is following suit with a 7 percent increase.
Chipotle is prospering even as it raises prices on burritos that are already expensive - about twice as much as those sold by Taco Bell. Besides its naturally-raised meats and organic ingredients such as beans and avocados, the company occupies the center of fast-casual dining - the booming "sweet spot of the restaurant industry," according to Hottovy - in which customers order at a counter but eat quality products inside a hip space.
And Chipotle is still growing. The chain runs about 1,700 restaurants in the U.S., and analyst Stephen Anderson at Miller Tabak estimates that it could grow to 3,100, expanding in less populated areas beyond its urban strongholds.
Chipotle hadn't raised menu prices for three years, but the higher cost of ingredients compelled it to roll out up to a 6.5 percent average increase in the second quarter.
To be sure, the hike did not go unnoticed: some customers said goodbye to steak burritos because their price jumped on average 4 percentage points more than Chipotle's chicken-based dishes, the company said.
Other fast food chains haven't fared as well. Dunkin' Brands Group Inc. cut its outlook for the year on Thursday, while quarterly profit fell more than expected at McDonald's Corp.
The world's largest hamburger seller and other fast food chains have become "hooked" on discounting, Anderson said. While they built their reputations by delivering quick bites, new menu additions have often slowed their service, frustrating customers.
"What [McDonald's needs] to do is further simplify the menu. It is too operationally complex, and I think that leaves a lot of potential for errors," Anderson said.
In the last year, McDonald's converted its dollar menu to a "$1-plus" selection in its roughly 14,000 U.S. restaurants, but Anderson says increased competition both from convenience stores and the likes of Chipotle hurt its sales.
Still, the tepid economy has mostly made consumers reluctant to spend on food, analysts say. In the absence of robust market growth, only the best and trendiest stand out, sometimes thanks to a more affluent customer cohort.
Chipotle patrons tend to earn more than McDonald's customers, said Dan Greenhaus, the chief strategist at BTIG, making them "more tolerant" of higher prices.
DIVERSE PRICE COMMANDERS
Another pricing powerhouse, Apple, has studiously cultivated its high-end aura for years, and its iPhones and iPads continue to command a higher price tag on average than its rivals. In 2013, the company briefly turned to discounting to fend off competition by Samsung Electronics Co., but analysts say Apple has so far stuck to its knitting in 2014 - save for recent price cuts on its MacBook Air and iPod Touch.
"Do they have a price premium [compared to the] competition? Absolutely," said Cross Research co-founder and analyst Shannon Cross. While she explained that Apple has refrained from hiking prices except when major currency movements occur, she said, "In the consumer electronics world, keeping pricing flat is impressive."
Apple has now exceeded Wall Street gross-margin projections for three straight quarters - topping forecasts for around 37 percent with near-40 percent gross margins in the June quarter, as reported Tuesday - which contributed to its fastest earnings-per-share growth in seven quarters.
PepsiCo recently succeeded in raising prices, too.
Second-quarter sales rose 5 percent in its snack business and 2 percent for beverages, both buoyed by price increases. New product launches and inflation in regions such as Latin America caused the hikes, the company said.
"For the balance of the year we feel comfortable that we can sustain pricing," PepsiCo chairman and CEO Indra Nooyi said Wednesday in a conference call.
At Coca-Cola Co., on the other hand, juice drink sales slowed after it raised prices to account for higher ingredient costs, the company said. Coke has no presence in the snack business, a fragmented market that PepsiCo dominates, according to Owen Fitzpatrick, head of U.S. equities at Deutsche Bank Asset and Wealth Management.
"Snack foods are growing in terms of consumption, but when you look at carbonated soft drinks, people are moving away from them," Fitzpatrick said.
Pepsi's snack strides suggest another source of pricing power: market dominance. Airline consolidation and fewer flights have also allowed for a steady increase in prices in that industry, according to Fitzpatrick.
Yet competition is the reality that most face. While U.S. companies are hiring - the government said unemployment had reached a six-year low in June - many consumers still lack the confidence to spend unless a business truly gives them value.
"If the [business] concept is old and tired, people just stop going to them," Anderson said.
(Additional reporting by Edwin Chan in San Francisco and Anjali Athavaley in New York.)