Stacked Costs and Second-Order Foods: A New Way to Think About Rising Food Costs

My goal for today's post is ambitious. I want to give you an entirely new way to think about, and take advantage of, the food industry. After reading this article, you should have a new framework for understanding why some foods have become so expensive relative to others, and you'll also have several new practical ideas for beating food price inflation.

Before I get started, let me provide a brief warning for attention-span challenged readers: this essay approaches 1,600 words. If you don't have time to wade through it right now, feel free to come back later.

New Definitions
First, I'm going to use two new descriptive terms to define food in a totally different way: first-order foods and second-order foods.

First-order foods are the basic building blocks of our diets. Fruits, vegetables, unprocessed grains, beans and legumes, nuts, basic juices and even water are all examples of first-order foods. These foods require little processing and they come to you in basic form.

Second-order foods are simply foods derived from first-order foods.

Examples: TV Dinners, Doritos and Meat
Let's go over some brief examples to help illustrate this further. We'll start with the frozen dinner, which is an obvious example of a second-order food. The company that manufactures Lean Cuisine frozen dinners takes a combination of first-order foods, combines, packages and freezes them, and ships them to your local grocery store. The result? You can stand in the frozen foods aisle, shivering, and choose from a wide variety of frozen dinners, elegantly displayed in conveniently microwaveable cardboard boxes. Of course, you end up paying a premium for this convenience in the form of higher prices.

How about Doritos--one of my very favorite guilty pleasures? Unfortunately, that's another second-order food. A snackfood manufacturer takes corn, processes it into chips, mixes it with salt and other spices, and then packs it into plastic bags and ships it to your store.

Finally, meat is a more complex example of a second-order food, with several added process steps. The meat producer has to feed first-order foods (grain or feed corn) to his cows, chickens, hogs or other animals. He has to pay to clean, heat and/or air-condition the pens. Somebody has to pay to power and operate the plant that slaughters and processes the meat. Then, that meat is packaged in plastic wrap, frozen, and shipped to your local grocery store.

The Cost Stack
By now I'm sure you're figuring out where I'm going with this. Thinking about foods as either first-order or second-order gives you a simple model to explain why the prices of some foods are going up a lot more than others.

Let's use meat as an example. If corn prices (a primary input for animal feed) increase meaningfully, of course it's obvious that chicken or beef prices will increase too. But what if energy prices also increase? Suddenly, costs start rising for several steps involved in the making of second-order foods. Powering the farm and the meat processing plant gets more expensive. Transport costs increase for shipping grain, feed and supplies to the farmer. And of course the cost of freezing and shipping the meat to your local store increases as well.

If you think about this for a minute, it becomes quite clear that all second-order foods have a shocking number of layers of stacked costs:

1) Input costs for first order foods plus a reasonable profit margin for the suppliers,
2) Costs for food or meat processing, plus a reasonable profit margin for the processor,
3) Input costs for energy at all points of the production process, plus a reasonable profit margin both for the energy producer and the utility company,
4) Costs for transport, plus a reasonable profit margin for the transportation company,
5) Costs for branding and marketing, plus a reasonable profit margin for the advertising agency,
6) Costs for packaging.


You've just read through a sextuple-whammy of stacked costs, and I'm sure I left out a few.

You Shoulder the Cost Stack
I now have some terrible news for you: When you choose to purchase and consume second order foods, you end up shouldering the entire multi-layer cost stack.

It gets worse. These layers of extra costs tend to be multiplicative rather than additive, because each company throughout this supply chain passes their increased costs through to the next company, which passes those costs through to the next company, and so forth. Further, each participant in this supply chain (unless it wants to fail as a business entity) will need to tack on at least a little bit of profit margin above and beyond those extra costs--which then of course also get passed through to the next player.

This cost stack is what causes the prices of many second-order foods to increase monstrously, far out of proportion to the increase in the costs of their component first-order foods.

And of course meat products--because they are the most levered to energy costs and they typically have the most layers in their cost stack--give us the most monstrous examples of second-order food price inflation. This is why, with a 30% increase in the cost of a first-order input like chicken feed, and a 30% increase in the cost of energy, the price of the end product (let's say frozen plastic-wrapped chicken breasts), can easily increase by 100% or more.

Solutions
Let's stop with the bad news for a moment and switch to talking about solutions. At this point, you now have definitions of first- and second-order foods, an explanation of cost stacking, and you've seen an example of how cost stacking can drive substantial increases in second-order food prices.

And by now I'm sure you're squirming in your chair with your hand up, wanting to shout out the painfully obvious solution for beating food price inflation: eat more first-order foods and eat fewer second-order foods.

Yep. I knew all along that I had really smart readers.

Let me encourage you still more. The cost advantage of first-order foods over second-order foods is a non-linear function: the savings you get from eating first-order foods gets more compelling as food inflation worsens. Sure, the cost of all food (including the cost of first-order foods) may be going up, but because of our cost-stacking phenomenon, the cost differential between first- and second-order foods gets larger the more food and energy costs increase. Which gives you all the more incentive to bias your diet toward first-order foods.

Health Benefits
How about some more good news? As first-order foods become the foundation of your diet, you'll capture benefits beyond merely saving money.

For example, first-order foods are typically far healthier than second-order foods. They haven't been processed, so they retain more antioxidants with their massive health benefits. They aren't buried in salt, high-fructose corn syrup or sodium hexametaphosphate like many second-order foods. And there is an enormous body of evidence suggesting that if you limit your intake of processed foods, particularly those containing refined carbs and hydrogenated fats, you will have dramatically lower chances of becoming obese, developing cardiovascular problems, or developing Type 2 diabetes.

Practical Applications
So what are the practical steps you can take to focus your diet on first-order foods and take advantage of this new way to look at the food industry? At the risk of being overly prescriptive, here's a list of ten solutions to help you to break the grip of second-order food price inflation:

1) Adopt part-time vegetarianism.
2) Make basic staples, like beans, lentils, grains and white and brown rice, the foundation of your diet.
3) Eat more raw foods.
4) Cook more at home. Restaurant food has an enormous cost stack, including the restaurant's overhead expenses, branding and marketing costs, staffing costs, the air-conditioning bill, and so forth. And don't forget the cost of a
generous tip for high-quality table service.
5) Bias your diet away from prepared foods (especially TV dinners).
6) Drop the traditional American conception of a "square meal." Vegetarians of course figured out this secret long ago, but the entire concept of having meat as the focal point of every meal is an obsolete construct.
7) Ruthlessly cut junk food and sweetened beverages out of your diet.
8) Buy foods grown locally, or near-locally. These foods will have lower embedded transport costs.
9) Grow your own food. This is ultimate example of a first-order food.
10) Refuse to pay for "excessively branded" products (full disclosure: we own shares in both Coke and Unilever so you can justifiably call me a hypocrite here). There is no reason to shoulder the cost of a national (or worse, global) advertising budget, especially if you can find equivalent generic products as substitutes.


Readers, if you have additional solutions, feel free to leave them in the comments section below.
******************
Epilogue
Let me take the liberty of adding one final wrinkle to this essay on first- and second-order foods. Don't worry--it's yet another piece of really good news, in my opinion anyway.

Just think: processed meat-like products such olive loaf and liverwurst are third-order foods, because they take high input cost second-order foods (mostly meat, I hope) and apply still more processing, energy, packaging and branding to create yet another level of "food."

So now, I have an airtight excuse never to eat olive loaf or liverwurst, ever. And with any luck, these so-called foods will soon become so expensive that they will go completely extinct, and no one will ever serve them to me ever again.

Who said there aren't advantages to rising food prices?

Related Posts:
Seven Ways to Get Faster at Cooking
All Casual Kitchen posts filed under "Vegetarianism"
All Casual Kitchen posts filed under "Laughably Cheap"
The Dinner Party: 10 Tips to Make Cooking for Company Fun and Easy
Cooking Like the Stars? Don't Waste Your Money
Ten Strategies to Stop Mindless Eating
Mastering Kitchen Setup Costs

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17 comments:

Rich and Col said...

1600 of the best words I've read lately! (1200's usually my limit!) Incisive, well-made points. This should be a front page article somewhere - R

Daniel Koontz said...

Thanks Richard, really appreciate the compliment. And of course, thank you for reading!

DK

Anonymous said...

I would like you to display a typical cost stack for first-order foods. They do exist.

Daniel Koontz said...

Anonymous,
Thanks for your comment.

Of course there's going to be cost stack for first-order foods too. Nearly all foods embed some degree of energy, transport or processing costs. The only exceptions might include perennial-type foods you grow and pick yourself (like asparagus, potatoes or rhubarb).

The raw carrots you buy in the grocery store still need to be picked, sorted, washed, packaged and trucked in from the farm. They don't magically appear on your kitchen table ready to eat.

The point, however, is that first-order foods contain far fewer layers of costs than second-order foods.

DK

Tom said...

Great post, but aren't you neglecting efficiencies of scale, especially re: applications 8 and 9? I'm in particular thinking of this:

http://freakonomics.blogs.nytimes.com/2008/06/09/do-we-really-need-a-few-billion-locavores/

Daniel Koontz said...

Hi Tom,
Thank you for your question--very thought-provoking.

I like Dubner and enjoy reading him, but he really whiffs in that article in my view. Ah yes, show the world that you're incompetent at making ice cream (really, who makes orange sherbet?) and make universal generalizations from that.

Sure, there are clearly economies of scale that hold sway in some instances. I didn't make my own operating system for this computer (although sometimes I wish I had). I don't grow my own cows or chickens (yet).

You have to be reasonable about what's economically sensible to do yourself. What's enjoyable to do AND worth it in terms of time and money?

And Dubner's a really smart guy, but he clearly knows nothing about cooking. It takes practice to make things sometimes. Sometimes your first cut at a new recipe sucks and you end up throwing out three-quarters of it. But cooking is a highly scalable skill (so is gardening).

Try again, you'll get better with practice. Be a little bit more creative about ingredient costs, rather than buying them all at the Whole Foods on Columbus Circle and whining about the costs per scoop.

Finally, just as one final example, there is an enormous difference in quality between your local farmer's market tomatoes and the industrially grown styrofoam-like facsimiles imported by truck from California. And the price is often the same or even less for the local stuff.

Thanks for reading!

DK

Lena said...

Wonderful! Very persuasive and well thought-out. I'm forwarding this to my husband right now to further help convince him that there's more to life than a Meat Dinner with Meat Sides served on a Meat Plate.

Chase Saunders said...

I think you dismissed Tom's criticism too rapidly. You are clearly suggesting that buying "lower in the stack" i.e. closer to raw materials is going to save folks money. By this logic we should be growing all our own grains, preparing all meals 100% from scratch, etc.

Dismiss "economy of scale" if you wish, but it's as plain as the difference between a subsistence agriculture society and modern societies with wonderful benefits, such as Harry Potter and the macarena. People only have time to read Harry Potter and dance the macarena because they're NOT spending 80 hours a week growing their own grain, milling it, baking their own bread, etc.

Also, your claim that first-order foods will go up less in price than second-order foods is objectively false. Many commodities are up 20-40% but Doritos haven't seen that level of increase. Meat has gone up in price less than corn for 2 years running, based on my data.

Daniel Koontz said...

Hi Chase, thanks for your comment. Yet another thought-provoking one.

I think many things which are rational and logical on a smaller scale can start to look irrational and really dumb when taken to an extreme.

Thus if we all grow our own grain and make our own bread, yes, we'll have much less time to read Harry Potter (and worse, you won't save any money in that example either). You got me there.

However, have you ever tasted a garden tomato? Or have you ever made a batch of your own lentil soup and compared the price, quality and sodium levels to the canned stuff available in your store?

You've got to choose which of these types of cooking and eating examples are of interest you AND are reasonable to do from an economic standpoint.

Regarding Doritos prices, I'll share another irony with you: The day after I posted this article, I saw Doritos on sale (actually buy one get one free) in my grocery store! Talk about getting wrong-footed. I guess I better write up that essay predicting the housing crisis now, huh?

But seriously, I think Frito-Lay (and my grocery store too) is making a decision, over the short run, to sacrifice margins in order to maintain sales volume. Also, who knows, Frito-Lay might have long term contract price agreements in place with their corn suppliers, and thus they haven't been touched by corn price increases (yet).

I thought about discussing these sub-issues, but decided they were beyond the scope of the article. Just consider the Doritos example as a useful, albeit stylized, illustration of the concept of stacked costs.

Thanks again for your comment.

DK

Chase Saunders said...

I think you hit the nail on the head with your comment about extremes. Historically it has been one extreme or another. What I'm trying to figure out is how to decide where the logical middle ground is... I'm planning to raise chickens, plant an 'edible forest garden' because I do believe the extreme industrialization isn't the most efficient way (at least not how it has been done). At present I'm not sure how to really make the decisions. It's so easy to make bad investments in doing this stuff yourself (due to the lack of economy of scale).

Great blog BTW

Daniel Koontz said...

Hi Lena, I'm sorry I missed you with all this heavy debating going on. Thanks for your comment, and I definitely sympathize. It was an adjustment for us to change the way we thought about meat too. We still eat meat, but it's not a fundamental centerpiece of our overall diet anymore. And we're healthier and fitter as a result.

Thanks for reading!

DK

Mumsicles said...

Liverwurst, YUCK!! Bad childhood flashback!

But liverwurst and olive loaf are always cheaper than the fresh deli turkey that we choose to use in our kids lunches. I know, I know, roast your own turkey and slice it up - but with the oven on for hours, I would have to crank up the air-conditioning since it's 100 degrees outside, and I guarantee that negates any savings on the turkey.

I guess it would make the post too long, but I think you could add that it is important to buy what's in season locally. Unfortunately, that would be okra and watermelon here right now, and if we want strawberries or apples or grapes, well, they're gonna cost more than Doritos.

The point about the economy of scale is very important and when you start your garden you will probably write a post about a Thousand Dollar Tomato.

Good post - lots of food for thought, ha ha.

Daniel Koontz said...

Thanks for your comment Mumsicles!

The Thousand Dollar Tomato is an excellent name for a gardening blog. Excellent. You should copyright it. :)

I probably should have addressed that issue on buying fruits and vegetables in season. It definitely takes a little bit of practice to get the rhythm of which fruits are best, cheapest and most widely available at what times during the year.

Thank you for reading.

DK

Carlos from London said...

Hi Dan,

It's Carlos. Read your article and find it worth and insightful; however, whenever I try to buy locally grown products ( at least here in London) they are far more expensive than at the big chain supermarket ( which, by the way, is in walking distance from my home), so feeling very sorry for the local farmers, I end up betraying my principles and being realistic about the depth of my pockets.
Totally agree with the rest of your article, though

Daniel Koontz said...

Hi Carlos!
Thanks for reading.

I hear what you are saying, and I think huge cities like London or New York skew the economics of "locally grown" food.

First of all, there really isn't much farmland within a 50 mile radius of NYC, so food still needs to be trucked into the city. Thus "local" produce isn't all that local.

Furthermore, the cost of the land in the general area of major cities like these skews the cost of the food planted on that land.

So I would agree that if you live in a megacity, the tip to buy foods grown locally or near-locally will not be all that effective for you.

Thanks for the thought provoking comment.

DK

Varun Prasad said...

Nice post, but I think your optimism regarding third order foods going extinct is unfounded.

The problem is that when the second order food gets more expensive, the manufacturers respond by lowering the quality of the second order food they use in their third order products.

So, for example, your olive loaf price wont increase, because the manufacturer will use a worse cut of meat instead, going so far as to use crushed bits of bone, etc.

Daniel said...

Varun, thanks for your thoughts. I suppose if you are correct, then it's all the more reason to bias your food purchases toward first-order foods.

DK