Nestle has seen a strong start to 2008, partly thanks to its strategy of increasing product prices quickly in line with commodity price increases.
The food manufacturer said in an update on its organic growth outlook for the year that "sharp upward movements and increased volatility" in the commodity markets in the past year forced it to advance price increases for finished goods so as to partially absorb the higher input costs.
"Combined with the pricing effects in place at the end of last year, this accounts for a strong pricing element in organic growth for the first two months of 2008."
Consequently, Nestle is predicting that growth for the whole of the year will approach that of 2007.
Last year it reported sales of CHF 107.6bn (c €5.8bn), up 9.2 per cent on the previous year, and organic growth of 7.4 per cent. This exceeds its long-term trend target of 5 to 6 percent.
Nestle spokesperson Francois-Xavier Perroud told FoodNavigator.com that although the company reacts quickly to fluctuations in costs, there is a time lag between commodity prices rising and the knock-on effect on finished products because the products are already in the shops with their price tags on them.
However since the manufacturer actually makes its sales to the trade weeks before the goods are sold to consumers, it can see the benefit of the higher prices a while before they are effectively passed on to consumers by retailers.
Moreover, product price increases the same across Nestle's geographical markets and product lines. The effect of commodity prices varies from country to country and from product to product, so finished product prices are not decided centrally but by market.
Where Nestle responds to commodity price increases, it also responds to fluctuations in the other direction and may lower prices again accordingly.
Nestle chairman and CEO Peter Brabeck-Letmathe said: "We expect our raw material cost pressures to abate somewhat in the course of the year, and foresee foresee price increases to trend lower in the second half of the year."
Other growth factors
The Switzerland-based multinational cited several other factors that have contributed to the good start to the year.
These include the additional day in February because 2008 is a leap year, and the fact that, this year, Easter falls unusually early.
This has meant that trade sales of Easter products, such as chocolate bunnies and eggs, took place correspondingly early and the revenue is therefore counted earlier on in the year than usual.
Nestle will report its Q1 2008 results on April 21.
Passing on commodity costs is not the only strategy Nestle employs when faced with high commodity costs.
Indeed, where it makes no sense to increase finished product prices to cover its own costs, the company has simply withdrawn stock-keeping-units (SKUs) from sale.
For example, in a country which has no milk production of its own and therefore all dairy goods must be imported, at some point the cost of dairy becomes prohibitively expensive. In such scenarios Nestle has dropped some SKUs because the price it had to charge was out of reach of consumers' spending power there.
To reformulate, or not to reformulate
Perroud said that Nestle has worked to reformulate some of its products, replacing some commodities with other, cheaper ones.
But he stressed that the choice of raw materials is not based exclusively on price - there are quality and nutritional considerations to be borne in mind too.
If it is not possible to reformulate a product and maintain the same standards, the company will either keep it as it is and increase the price, or drop the SKU.
Where a product has been reformulated, it will be changed back when the commodity cost has dropped only if there are clear advantages to doing that,' Perroud said.
For example, if wheat, which has become very expensive, is replaced with rice in a breakfast cereal, the lower price could be a means for it to increase market share.
If the company were to decide to source an ingredient from somewhere where it is cheaper, the question needs to be asked whether this would affect the image of the finished product.
For instance, Nestle's Nespresso brand has a top-of-the-line image, and the company "would not think of replacing it with another coffee" even if the price of the premium coffee beans it uses increases.