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.
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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?

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