July, 2010

Fruits of Thought

Higher Taxes Will Sharpen Focus On Produce In Foodservice

The Bush tax cuts expire this year and so on January 1, 2011, there will be a significant tax hike, probably the largest in U.S. history. People who pay tax at the 10 percent rate will pay 15 percent; people who pay tax at the 35 percent rate will pay 39.6 percent. Capital gains and other financial income will be taxed more heavily and a whole host of taxes related to the Health Care Bill starts to phase in.

All of this is very bad news for the foodservice industry. When tax rates are low, people can choose to “outsource” food preparation by going to restaurants or buying take-out. As tax rates rise, it becomes prohibitive to do so and people eat out less frequently. In other words, if dinner costs $70 dollars and the tax rate is 30 percent, one can buy dinner with $100 of gross earnings. If the dinner costs $70, but the tax rate is 50 percent, the dinner requires $140 of gross earnings.

So the tax increases of January 1, 2011, and those scheduled to roll out with the health care plan over the next several years, are a dagger pointed at the heart of the foodservice industry, and, indeed, all service industries will find themselves struggling as it starts to make more sense for people to mow their own lawns, wash their own cars, clean their own homes, baby-sit their own kids, etc.

All this is certain. A casual glance at countries in Europe that have higher personal income tax rates shows that there is typically a lower utilization of services, including at restaurants. The much-vaunted European lifestyle is typically admired because it provides more leisure time as expressed in fewer hours worked. Not as often noted is that Europeans require more vacation time so they can do lots of projects themselves that Americans typically outsource.

What is uncertain is precisely how the higher tax rates will filter through the culture. The produce industry may benefit if the pressure to keep costs down leads restaurants to replace high-priced protein with less expensive fruits and vegetables. It is also possible that the opposite may occur and that the culture will shift to see restaurants as more “special occasion” dining — and the typical restaurant will become more, not less expensive. This is the European pattern, where the top restaurants are as good as anything in America and quite expensive. Of course, Europeans also have their share of fast food, but they lack the large roster of medium-priced dinner houses that we have in America — the Outback’s and Applebee’s, etc.

If higher taxes mean that people will dine out less, then the foodservice sector is likely to be smaller in the future than was projected just a year ago. Which means that meeting the goal that the Produce Marketing Association, the National Restaurant Association and the International Foodservice Distributors Association announced a year ago to double consumption of produce in foodservice over a 10-year period will be more difficult.

Obviously, this is all going to mean some tough sledding ahead for both foodservice operators and distributors; but for many producers, the corollary to tough times for foodservice caused by higher tax rates — namely, more sales at retail — will be a cause for celebration.

The relationship between the production sector and foodservice has always been problematic. Part of it is traditional business practices in produce made few companies expert in the kind of product development, recipe development and menu planning skills that are important to increasing sales in this sector. More fundamental, though, is that foodservice relegates produce to the status of an ingredient and for most national shippers, this means selling at commodity prices.

Obviously, the foodservice sector is enormously important. It uses immense volumes and is the heart of the business for many fresh-cut processors. Most marketers, however, want to find a way to produce superior returns on their investments. This is what makes foodservice and private label both so challenging. The business is there, one hates to leave it on the table, but it typically drags down returns.

This should be a concern among operators. The sexy side of the business, what gets talked about in newspapers and mentioned on menus, tends to be some small local farm that the chef visited, one with which he can tout a relationship. For white tablecloth restaurants — maybe 1 percent of the total market — this may be meaningful. For most in the foodservice industry, it is just marketing — it is the sizzle, but the national shippers of produce are the steak.

How to sell more fresh produce at foodservice has traditionally been seen as a problem for producers. This makes sense; we usually think the customer is king and catering to the customer is the responsibility of the producer and marketer. But the world is changing.

The National Restaurant Association aligned with PMA to announce the 10-year goal last year because, seeing anti-tobacco legislation and noting America’s obesity problem, the board and executives at NRA wanted to position restaurants as part of the solution — not part of the problem.

Yet if restaurants want more than a PR announcement — if they sincerely want to tap into the creativity and capacity of fruit and vegetable producers and marketers — they need to focus on making sales to foodservice sufficiently profitable to incentivize a creative focus on helping restaurants better serve the consumer with fresh produce.               pb