What 'Excuseflation' Is Doing to Prices and Corporate Profits 

Companies can keep their prices high by taking advantage of one-time disruptions.

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“Whether it’s rye flour that impacts eggs or bird flu that impacts eggs, whenever it makes national news like this, Ken Jarosch, owner of Jarosch Bakery, says that running a business is an opportunity to raise the prices without having to deal with a whole bunch of complaints from customers.”

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Jarosch was expressing late last year his philosophy of when it is safe for a business like his — a mid-sized bakery in the Chicago suburbs — to raise prices on cookies, cakes, and other carbs. It isn't something you typically hear a business owner expressing publicly, but he was simply stating what he believed to be the best time of year to do so. He had the idea long before Covid upended supply chains, realizing that he could quickly push through price increases when news breaks in the media about some big shock to the economy because there will be less pushback from customers at the time.

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There is now increasing evidence that this pattern is being played out across corporate America, with companies using disruptions as an excuse to raise the price of their goods and services, thereby allowing them to expand their profit margins, as a result of unusual disruptions.

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A number of businesses have been able to point out that in the last few years, a number of “once-in-a-lifetime” emergencies have erupted as a result of the pandemic and the Russian invasion of Ukraine. As a result, everything from semiconductor manufacturing to commodities markets to shipping has been impacted by these events.

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It would be interesting to see how sticky this 'excuseflation' proves to be in an economy where consumers continue to spend freely, and to what degree the Federal Reserve will need to raise interest rates to force businesses to lower prices or at least stop raising them in the future. Inflation is currently at 6.4%, which is well below the Fed's 2% target for the year, although it is still well above the number of last years.

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"Many companies had these one-offs or very, very rare excuses to raise prices and try to figure out how much the consumer would accept," Samuel Rines, a managing director at Corbu LLC, was quoted in the most recent episode of the Odd Lots podcast saying, "A lot of companies had these one-offs or very, very rare excuses to raise prices. Getting that price push, finding out that the consumer is willing to pay it, that is margin expansion over time, as your input costs normalize.”

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He cites a large number of companies that have opted for a price-over-volume strategy, or a 'POV' strategy, as he has dubbed it in his book. Among some of the most popular retailers are PepsiCo Inc. and Home Depot Inc., as well as Walmart Inc. and Dollar Tree Inc., both of which are well known for offering discounted prices.

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It is natural for any company to want to always be able to raise prices without having to take a serious hit to market share. However, in a period of low unemployment, with average hourly earnings that are increasing by over 4% annually, consumers are by and large willing to tolerate these price increases. As a result, customer demand has typically been affected only modestly by the changes. Consequently, that explains why the Federal Reserve is so focused on cooling off the labor market - and wage growth in particular - in order to bring inflation under control once again. 

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However, one of the defining characteristics of this excuseflation - and the reason why it's proving difficult to put an end to it - is its ability to provide companies with a cover to raise prices together, thereby limiting the power customers have to vote with their feet by shopping elsewhere.

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Pepsi Pricing Power

“The new PPP is what we call it,” says Rines, short for “Pepsi Pricing Power.”

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It effectively allowed the soft drink giant to raise prices, he says, as a way to compensate for the volume sales losses that occurred in Russia following the invasion of Ukraine. Compared to the traditional narrative of the war hastening inflation because it rocked a number of key commodity markets - especially the oil, gas, and wheat markets - this is very different.

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Rines believes that Pepsico consumers around the world have begun paying higher prices in order to compensate Pepsico investors for the loss of the Russian consumer market to Coca-Cola. Despite the fact that traditional economics would say that consumers would eventually turn to lower-priced alternatives or to Coca-Cola Co. at some point, that hasn't really been the case in recent years. 

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Ideally, you shouldn't have Pepsi being able to push the price as much as it does, right? Pepsi and Coca-Cola should be competing against one another, and there should be very few price increases because they don't have the ability to really catch up with inflation," according to Rines. "Unfortunately, that does not seem to be the case at the moment."

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During a recent call with analysts, CEO Ramon Laguarta was asked if Pepsi might consider rolling back price increases if the demand weakens. He responded that Pepsi had been trying to create brands that stood for greater value to consumers and consumers were willing to pay more for these brands.

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In short, no. (Pepsi refused to comment).

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Having imposed higher prices on consumers, there doesn't seem to be a lot of motivation for companies to reverse those decisions.

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Both Pepsi and Coca-Cola have seen their profit margins increase as a result of this, and so have major companies across the board.

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In fact, it's a point that was picked up by two UMass Amherst economists (and frequent guests on Odd Lots) Isabella Weber and Evan Wasner. As evidence that companies are going beyond simply passing on higher input costs to their customers, they cite an increase in corporate profit margins in the second quarter of 2021 to a record 13.5%.

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This phenomenon was termed "sellers' inflation" in a new study published last week, which noted that an array of "overlapping emergencies" in recent years have effectively given companies the peg they need to increase prices collectively as a result.

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The existence of bottlenecks can lead to the creation of temporary monopolies, resulting in a situation where it is safe to increase prices, not only to protect but also to increase profitability," Weber states. There is a great deal of evidence that market power is not constant, but can change dynamically depending on the supply environment in which it operates. Supply chain bottlenecks and cost shocks, if publicized, can also create credibility for price hikes as well as generate an acceptance on the part of consumers to pay higher prices, thus making demand less elastic as a result."

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Due to the fact that these disruptions and shocks have generally affected whole industries, companies can raise prices without fear of losing market share, even if they are well-known competitors such as Pepsi and Coca-Cola.

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The company doesn't lower prices because, according to Weber, doing so may spark a price war among the competitors. There is competition between firms for market shares, but if companies lower their prices in order to gain territory from their competitors, they must expect their competitors to respond by lowering their prices in return. There is a risk that this can produce a race to the bottom, which will ruin profitability in the industry. That means that there is little motivation to roll them back once they have been enacted.

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“Firms can safely increase prices if these cost increases are not specific to individual companies but are experienced by all competitors,” she explains.

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Wings won’t stop

Amongst the examples of corporate actions that have contributed to the rise of inflation, Rines always likes to cite the chicken-wing chain Wingstop as a good example.

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Back in 2021, when the wholesale cost of wings was surging - 125% on an annual basis over a 12-month period - Wingstop "began to push prices, push prices, push prices, and they had zero pushback from consumers," he says. “Consumers just continued to buy chicken wings, and there are plenty of places to buy spicy chicken wings, so it's not like there's only one place to go buy spicy chicken wings.”

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There was no reversal of course in Wingstop's policy when wholesale wings prices started to fall from their recent high. Rines says the cost of the service has dropped by about 50 percent, but "Wingstop is not exactly slowing down its price-raising efforts.". On the contrary, Wingstop is indicating and guiding toward a typical price increase of 2% to 3%. (Wingstop did not respond to a request for comment).

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As a result, the chain's profit margins are up, and the stock price has soared almost 250% from where it was during the depths of the Covid-sparked market rout at the beginning of 2020.

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The mismatch between the decline in wholesale prices and the stubborn rise in retail prices may assist in explaining why inflation has proven so hard to contain even as many of the one-off shocks - such as the pandemic fiscal stimulus or the initial commodity effect of the war - fade into memory. It also poses a challenge for economists who may assume margins should dissipate as a result of competitive pressures over time. 

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"The majority of economists have thought about the return of inflation from the standpoint of the dominant interpretations of the 1970s: Inflation originates from macro dynamics, whereas the (New) Keynesian interpretation posits a matter of excess aggregate demand in relation to capacity on the one hand, and the classic Monetarist postulation positing that too much money chasing too few goods on the other hand," Weber writes. “The fact that costs play any role from either perspective makes it clear that it is only a matter of inflated wages that plays any role in the equation.”

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According to Lael Brainard, a former vice chair of the Federal Reserve, who now leads President Joe Biden's National Economic Council, there are a few signs that policymakers are starting to take corporate behavior into consideration as a key factor in driving prices, as she stated in January, “There has been a material increase in retail markups in many sectors in what could be referred to as a price–price spiral in which final prices have risen more than input prices have increased..”

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As much as it may appear that higher profit margins would benefit investors at first glance when every company is in a position to raise prices, that's what keeps the Federal Open Market Committee ratcheting up interest rates time and time again, putting a lid on the price of stocks. This is why members of the Fed's Federal Open Market Committee keep raising interest rates.

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Policymakers are going to have to fight much harder in order to stop raising interest rates "until they begin to actually see corporations decelerate their pricing," Rines says. “When Smuckers says that the inflation rate for 2023 is going to be 8%, that is not good for the FOMC. Cracker Barrel is claiming that wage increases will be 5% to 6% in the next two years, which is not good for the FOMC. As you know, one is a consumer good, and the other is a raise for middle-class Americans. When Walmart raises its minimum wage, again, it's a pretty big deal when it comes to consumption on the lower end of the market."

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“People will be fooled” by CPI prints indicating slower inflation in coming months, Rines says, and then get surprised when corporations push pricing, trying to find the elasticity of their margin.”