Many brands are seizing on the current inflationary environment to raise prices. It’s a vicious circle — inflation expectations (or reality) leads to rising prices, which then leads to higher inflation, which leads to higher prices...you get the picture. Like the classic chicken and the egg problem, how do we figure out the relationship between inflation and price increases?

And, when a company raises prices, where does the extra money go? An inflation-driven price increase is supposed to be a result of increasing costs. If this is the case, all else equal, we might expect to see constant profit margins on increasing revenue to keep up with rising costs. Do we see this?

Unilever, the maker of everything from Ben & Jerry’s ice cream to Dove soap and so much more, recently announced its prices were up 11% in the previous year. This is on top of consistent previous price increases. With the exception of early 2018 and the initial COVID quarters, prices have typically grown about 2.3% per year.

As a diversified Consumer Packaged Goods (CPG) company, Unilever’s pricing represents a diverse set of products that in many ways is representative of the goods that Americans buy on a weekly basis, and therefore is likely to move at a rate generally around inflation. We can use this assumption to pair up Unilever’s price increases with US inflation data.

Bringing together these two pieces of information, the data suggests that Unilever price increases have historically pre-empted or stayed above inflation, at least up until the last year or two. For example, look at the area shaded in gray in the graph below. Unilever prices (black line) peaked then dropped, and 2 quarters later inflation (light gray line) showed a similar trend. Then Unilever prices rose, and so did inflation. In the last two years, Unilever has been playing catch up as inflation has risen at historically fast rates.

While Unilever is a global company and the US is just one component of their business, it’s certainly an interesting relationship to explore, along with how it has changed over time. For example, between 2017 and 2018, Unilever had slower price appreciation even as inflation rose. Between 2015 and 2017, their price increases outpaced inflation, suggesting aggressive pricing strategy or more differentiated product offerings.

In the period between 2019 and mid-2020, Unilever pricing was almost a 6-month indicator of inflation (trends in pricing show up 6 months later in inflation), but as inflation has risen at historically fast rates, the pricing has been playing catch up but still rising quickly along with broader inflation measures.

Where does the money go?

An Econ 101 view of the world will tell you that as a company raises prices, they’re likely to sell less products unless the product set is so differentiated, unique, or necessary that there are no alternatives at lower prices. Many of Unilever’s markets are competitive, though. Competitive against other brands, and in many cases cheaper store brand items.

Indeed, in the previous decade, despite the consistent price increases, revenue declined then stagnated.

Despite the stagnating revenue, profits are trending up both from an absolute dollar value perspective and from a profit margin perspective, albeit modestly.

The diverging path of revenue and profits suggests that the decrease in sales was more than the increase in prices, leaving them with less — but more profitable — revenue. Other major factors impacting profitability during this time were a reduction in headcount and in annual R&D spend.

Headcount was down nearly 25,000 employees from as recently as 2015 (a ~15% reduction) and annual R&D spend is down ~€400M compared to 2012.

If we assume that an average employee costs about €50,000 between salary and benefits, this would mean that costs were at least €1.25B lower per year as a result of the drop in headcount. Some back of the envelope math would say these savings amount to about 2% of Unilever’s 2021 annual revenue (or, in other words, the equivalent of a 2% price increase). The €400M reduction in R&D would equate to about 0.6% of revenue.

Collectively, these two line items are the equivalent savings of raising prices 2.6%.

The combination of increasing prices and decreasing headcount (plus R&D) costs raises the question of where the extra money was going. If it wasn’t going to higher employee costs, nor to maintaining product investment, where was it going? One answer is likely the cost of goods to make the product. Given the general trend of expanding margin, though, it seems like that isn’t the full story.

Said another way, it’s unlikely that both the 2.3%+ price increases and the 2.5%+ savings from headcount & R&D reduction were going toward trying to keep up with the cost of the product. The cost of raw inputs is just one component of the cost of a product, so the raw inputs would have needed sustained, and very high, increases to warrant this.

One area where there was substantial growth in costs during this time period was stock-related items. Since the first quarter of 2020, the dividend per share has been consistently about 36 pence or higher every quarter. Between 2012 and 2015, the dividend was no higher than the low 20’s, representing a substantial increase in the short time period since 2016.

This is despite the lack of revenue growth and a much more modest increase in profits. Buybacks have meant there are less shares in the market, but the total spend on dividends has steadily increased. Unilever earned about €8.7B in GAAP reported profits in FY2021 and spent about €4.5B on dividends, representing more than 50% of its profit

Since 2017, Unilever has also announced more than €17B in stock buybacks, with most of the buybacks already completed. In the last 18 months alone, as the company has said it grappled with fast rising costs, there have been €6B worth of stock buybacks announced, with the first €3B already completed and the second half announced this past February.

Collectively, Unilever has reported ~€53B in GAAP profits since 2017 and has spent ~€21B on dividends and ~€14B (and announced €3B more) on stock buybacks. This suggests that for every €3 in profits, €2 are going to buybacks or dividends.

The above metrics are not a comprehensive view of business performance and investment. As a large, global company, the story of how Unilever earns, spends, and invests money is complex. As a public company, it has a fiduciary duty to its shareholders, which oftentimes might mean balancing business investment with shareholder “investment”.

That said, all consumers reach a breaking point when it comes to prices, particularly in competitive markets like the ones in which Unilever competes. At what price increase do people buy a pint of Ben & Jerry’s less often? How much longer can price increases and headcount reduction support an increasing dividend?

While increases are messaged as a way to keep up with costs, the data suggests that there has been a split purpose of the proceeds in the past 10 years in this case. Some of the increases have undoubtedly gone to product costs, but much of it as well have gone to appeasing shareholders.

The rapid and sharp inflation of the past year and a half has been different than the previous decade. How might this change the way that the funds from price increases are used? If they do indeed have to go to direct costs, rather than dividends or buybacks, how will they continue to support the now-elevated dividend levels? How the company navigates its price increases, profitability, and use of profits over the coming years will be interesting to watch play out.