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Dr Christian Wulff
Head of Retail and Consumer at PwC Germany
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Global warming puts the industry under pressure
The global food and beverage industry is particularly vulnerable to the consequences of climate change: climate-related risks directly affect their sales and profits. In the dry summer of 2018 agricultural yield for cereals per hectare in Germany, for example, fell by 16 percent compared to the three-year average of the previous years. Assuming further global warming, such patterns could increase in frequency and severity and put business models in the food and beverage industry under pressure and, consequently, require manufacturers to integrate climate risks more closely into their decision-making processes. To do this, companies have a useful tool at their disposal to review strategic resilience under different assumptions: scenario analysis.
"The food industry should in future explicitly integrate climate risks into all strategic decision-making processes. The effects of climate change will be equally reflected in demand and cost structures – much more so than is already the case today."
The study at a glance
There are two types of climate risks:
- Physical risks primarily affect agricultural production, because climate change has a direct impact on crops and livestock. Events such as long periods of drought or violent storms can also interrupt the supply chain and negatively impact production processes.
- Transition risks mainly arise from the transition towards a low carbon economy, for example through introducing a price on CO2 emissions. They can result in rising prices for raw materials and energy.
TCFD recommendations for climate reporting
The recommendations given in the Task Force on Climate-Related Financial Disclosures (TCFD), published in 2017, provide guidance on how to consider climate risks. This framework makes concrete recommendations on how companies can consistently integrate the consequences of climate change into their reporting. The TCFD refers to the scenario analysis as a useful tool to improve understanding of climate-related risks and opportunities and to assess the consequences.
“Using traditional methodologies makes it difficult to predict how climate change will affect the business models of food and beverage manufacturers in the future. Scenario analyses can support companies in analysing how global warming and climate action might impact business models and financial performance.”
Less than half of companies report on climate-related risks and opportunities
The regulatory pressure for scenario-based climate reporting is increasing as well: Signatories of the United Nations Principles for Responsible Investment (PRI) will be required to report on climate indicators – which include the application of scenario analysis – from 2020 onwards.
In its status report from 2019, however, the TCFD states that only 45 percent of the reviewed companies in the agriculture and food industries currently report on how climate-related risks and opportunities affect their business, strategy and financial planning. Only 4 percent evaluate the resilience of organisation’s strategy taking into account different climate scenarios.
Climate change is one of many trends that pose challenges to the traditional business models of the industry
- Health-consciousness
- Regulation
- New competitors
- Mergers and acquisitions
- Risk management
Health-consciousness
In supermarkets, the demand for low-fat, low-sugar and vegetarian food will increase, because consumers are increasingly adopting a healthy lifestyle and are paying more attention to climate protection.
Regulation
Regulatory pressure in the industry will increase because governments want to protect their healthcare systems from the rising costs resulting from an unhealthy diet and implement measures that mitigate the effects of climate change.
New competitors
Innovative manufacturers are challenging the big food companies since in the digital age, access to consumers and the ability to innovate no longer depends on the size of the company.
Mergers and acquisitions
The industry will experience more mergers and acquisitions. Consolidation among food manufacturers and food retailers is progressing.
Risk management
Risks connected with procurement and raw material prices are growing – a direct consequence of climate change and current trade disputes.
A holistic climate strategy is supported by three pillars
To effectively mitigate climate risk and adapt towards the changing environment, a climate strategy should be implemented that considers both its own impact on climate change and the effects of climate change on its own company, based on three pillars:
- Climate impact: How can I as a company reduce emissions cost-effectively and in line with the requirements of the Paris Climate Convention?
- Climate risks: How will risks related to society's response to climate change and the physical effects of global warming affect my company?
- Climate Opportunities: What opportunities and business opportunities will arise for my company in the context of climate change?
Scenario analysis presents a useful tool to better understand the world’s impact on companies’ operating in the food and beverages sector.
Scenario analysis in a 2°C world
An exemplary analysis conducted by PwC strongly based on specific assumptions shows that companies who fail to adapt to a changing environment affected by climate change could experience negative performance development even if the target of limiting temperature rise to 2°C is achieved. In this scenario, climate-related risks could negatively affect financial performance, caused for example by a steep increase in production costs due to carbon pricing or extreme weather events. To better understand this development, it is necessary to look at sector-specific risk and opportunity drivers. Moreover, the relationship and individual market power between traders and farmers, manufacturers and retailers are of great relevance, as they impact the ability of companies to pass on their costs to downstream actors in the value chain.
Companies should also inevitably consider a scenario in which the global temperature rises by 3°C, as experts now think that this scenario is more likely. In this case, the transition risks would decrease, but physical risks would significantly increase.
Companies should ensure their strategic resilience also in face of climate change, in order to preclude adverse financial effects and remain competitive.
Strategic considerations could address for example the following questions:
- Will climate-related risks have an impact on availability and pricing of resources needed for production processes?
- Is water risk sufficiently considered in planning processes for production capacities?
- Could new technologies support cost efficiency and reduction of CO2 emissions?
- Should adaptations of the product portfolio be considered?
"Scenario analysis is a useful tool for both identifying strategic priorities and meeting the requirements of regulators, investors and other stakeholders who are paying more attention to the climate risks of their investments."
Methodology
The report is based on desk research that builds on current findings, including scientific research on climate scenarios. The analysis was conducted using the PwC Climate Excellence Tool for scenario analysis. The methodology was designed by The CO-Firm, refined in cooperation with leading financial institutions and tested in the market over seven years. The tool is based on scientific research, sector knowledge of PwC experts and additional expert interviews.
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