how huge food companies like Cargill and Mcdonald’s, etc. protect themselves from extreme price changes.
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They have a lot of buying power. McDonald’s isn’t buying 10lbs of potatoes, they’re buying them in the millions of pounds. Farms exist solely to provide them their food. So if someone raises prices on them, they could take their business elsewhere and basically ruin that company.
Another factor: vertical integration of some ingredients.
ELI5 on vertical integration – I’ll raise my own cows, then I control price of beef.
Cargill controls the market by influencing supply and demand. Cargill is a very big company that helps get food from farms to the stores where we buy it. They can’t make the prices, but they can tell the players how much they want to pay for things. If they say they’ll pay more for wheat, the farmers might grow more wheat and that could make prices go down on the mercantile.
IMO, McDonald’s isn’t a food company They’re more of a real estate company with a restaurant franchise. But same idea, supply & demand in massive volume makes for better pricing.
When you buy five potatoes you go to the store.
When you buy five hundred million potatoes you have to hire a bunch of farming and transportation and warehousing companies to produce and deliver the produce over a period of many years.
The potatoes being delivered today weren’t paid for yesterday, they were paid for months or even years ago.
All these long-term contracts help insulate the company from short term price shocks.
Eventually it will catch up when it’s time to renegotiate. Even then McDonalds can still get a much better deal than you because they’re guaranteeing large volumes for a set time period.
McDonalds buys products in such high quantities that it gives them a lot of control over their supply chain.
They aren’t buying potatoes 10lbs at a time, there are buying them 10 million pounds at a time.
McDonalds has dedicated farms, logistics chains, and processing plants so they control their own supply chain. This helps them control overall costs.
You can protect yourself by buying futures of most commodities. Want to buy fuel at a certain price? Futures. Potatoes? Futures.
When you buy enough of a product, you get a lot of say into how much you pay.
McDonalds has a contract with a company called Simplot to supply potatoes. Lots and lots of potatoes. Simplot has contracts with farmers to supply the potatoes to them for processing. When the farmers plant on a contract like that, they know what price per ton they will get when they harvest. This can be a good thing or a bad thing for the farmer. The farmer knows that no matter what the market price is, they are going to get a fixed amount. In years with an abundant harvest, market price is usually below contract price, but in years with poor yields, the contract price is lower than market. Because Simplot produces a frozen product and sources from all over the world, if Idaho has poor weather and bad yields and Manitoba has a bumper crop, it all evens out. They can also hold product longer than fresh and ship farther without any major quality losses.
Beef is a little different. The processors like Cargill and JBS make the biggest profits. If the price of a cow goes up, the processor will go to their customers and say “Prices are up 10%, so we’re increasing ours by 15%”. Most of the customers (retail grocery and wholesale restaurant) say “Sounds good, we will increase ours too” and then pass on the costs. Companies like McDonalds purchase enough beef (and a type of beef) that means they can say “We’ll accept a 2% increase”, and the processor will go with it. They have accounted for this in the price increases to their other customers (usually retail grocery, so we pay for it) so they can keep their huge contracts happy and still make record profits year over year.
In the end, consumers and farmers pay the price for all of this. The price we pay at the grocery store is the result of many companies squeezing the people who have limited other options for the sake of profit. The same companies that will tell farmers that even though input costs are up 20%, they are paying 7% less. Farmers that may have made huge investments in equipment to meet the processor’s demands and have built the entire farm around that one contract.
They locking in prices with futures contracts on ingredients, are buying millions of dollars worth at a time to lock in best pricing. Also, the raw material cost relative to sale price is pretty minor. An order of Fries that sells for $3 may be 20 cents of potatoes, so even a 20 or 50% fluctuation in price of potatoes means relatively little to overall cost of item (rest of the price is transportation, processing, marketing, store overhead like rent and employees, profits). Companies also operate on cost-plus production costs, eg. McDonald’s pays their processors, production companies a set rate for their service on top of the cost of the raw material, eg. $10 per 1,000 hamburger patties on top of the cost of the beef used to produce them, so even if commodity prices fluctuate, the production costs on top are more stable.
Actually McDonald’s is the world’s largest buyer of potato futures.
For simplicity I’ll skip a lot of details. Basically the futures we are talking about basically say something like “On Oct 16, 2023, 2000 pounds of potatoes will be delivered to the owner of this contract”. McDonalds buys a lot of those contracts, and they will buy them sometimes years ahead of time.
This allows McDonald’s to know the exact price they will pay for potatoes for the next few years.
The result of this is that McDonald’s buys very little on demand, when prices change quickly.
Big buyers like McDonald’s use this for everything, even salt is dealt with like this.
They own the means of production from farm to end user. This provides them great flexibility to maintain price/profit controls of really ANY portion of this particular supply chain business.
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