Steep Cheese Prices Have Pizza Industry Crying in the Mozzarella

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The cheese still goes on thick but pizza parlor bosses are giving employees a new edict when it comes to managing the mozzarella — don't waste, it's not so cheap, capische?

"Yeah, I hear that a lot," says Sherwin Kannukkaden, wiping his brow as he waits to pull another pie from the pizza oven at a suburban Mellow Mushroom.

While cheese prices fluctuate like any other commodity — because of weather, energy prices, supply, demand, herd conditions and countless other factors — high cheese prices this summer are eating into the bottom lines of the pizza industry.

"Oh man! I can cry for a week on that," says Jim Fox, the founder of Pittsburgh-based Fox's Pizza Den, with 215 franchises in 17 states. "It's just brutal and there's no rhyme or reason for it."

Cheese accounts for nearly half a pizza's cost, which makes restaurateurs extremely sensitive to price changes. And few in the industry are willing to hedge the cost by buying the perishable in advance because the market is so volatile.

In their second-quarter earnings reports, Pizza Hut and Domino's cited higher cheese costs as a factor for lower operating margins. Papa John's International said it expects to pay more for cheese later this year, which will pressure margins.

Smaller players without those behemoths' leverage have been squeezed even more.

"It's knocked us pretty badly and there's nothing really we can do," said Michel Panos, who owns three Mellow Mushroom franchises, an Atlanta-based regional chain.

Customers won't pay more for his pizza, Panos said, even though his market research tells him that people consider the company's pizza more upscale than the national competition.

"It's like cheese prices go up and (people) say, `What's that got to do with us?' They just see what the price of the pizza is. They don't really know what all goes into it."

Pizza operators are accustomed to regular swings in cheese prices, which jump in midsummer when schools resume buying milk and when drought often curtails the supply. And Americans tend to buy more cheese around the winter holidays, which also gooses prices, pizza veterans say.

Cheese is traded in 40-pound cheddar blocks and 500-pound barrels on the Chicago Mercantile Exchange. Restaurant buyers' prices for mozzarella and other varieties are based on the block pound price, which was $1.68 this week. Back in November, the cheddar block price had fallen as low as 98 cents a pound.

In 1998, cheese prices surged briefly to $1.90. Many pizza people say they're bracing to pay high prices for several more months as an increase in production has lagged.

"I've been in the pizza business for 40 years. And just every year it's just up and up and up," Fox said. "You know, everything goes up every year, but cheese just seems to be the one thing that goes up way more."

The largest pizza player, Dallas-based Pizza Hut, and Papa John's International, based in Louisville, Ky., have begun cooperatives to handle purchasing for their franchises.

The co-ops help franchise owners smooth price swings, pooling members' funds when cheese drops and absorbing costs when it rises, although "in the long-term that buying co-op doesn't change what the system pays for cheese," said Barry Stouffer, an analyst with BB&T Capital Markets in Nashville, Tenn.

"I don't really understand what drives cheese prices," Stouffer said. "Nobody really seems to have a good explanation."

The industry faces a unique dilemma because it's unable to pass along many higher costs. For example, when timber prices rise, things such as toilet paper and lumber often cost more, just as crude oil prices largely drive gas pump prices.

Such relationships don't work so neatly for pizza, said Tim McIntyre, a spokesman for Domino's, based in Ann Arbor, Mich.

"The price of everything else in the world seems to go up. But a pizza has always been between $9 and $11 bucks," he said. "That's what people think they cost. It's a challenge."

Part of the issue lies with consumer expectations developed by pizza makers' aggressive marketing. Half-price specials and bundled deals have become the norm in an industry with such price sensitivity and ferocious competition.

Market research shows enormous differences in pizza sales with "three-digit pricing" -- people buy lots more of the gooey stuff when it's $9.99 rather than $10.99, McIntyre said.

To help combat squeezed margins, pizza chains are pushing new products to add to their delivery mix, such as sandwiches, chicken wings and soda. Salad or cinnamon sticks, anyone?

Domino's — which experimented with a breakfast pizza in 1985 but discovered no one orders before noon — is sponsoring a contest for franchise owners to suggest products that could potentially be delivered with pizza.

Pizza makers say they won't skimp on cheese because customers would notice and might not return, but some concede that high prices have prompted some to look for bargain alternatives.

"We work hard not to have the commodity drive the price of the pizza," Pizza Hut spokeswoman Patty Sullivan said. "You have to learn to manage your business in other ways."

Fox buys about 30,000 pounds of a provolone-mozzarella blend each week for the three stores he operates near Pittsburgh. He conceded that some of his franchisees "are buying just the cheapest stuff they can out there on the market and mixing it with the good stuff."

"Thank God it's not all of them," he said.

Alfonso Orefice, who owns Alfonso's Pizzeria in Tampa, Fla., raised his price for extra cheese to $3, nearly double the $1.60 for other toppings. Orefice says he'll likely raise pizza prices, too, if the cheese stays pricey.

"It's getting tough," he said. "The cows, they are driving us crazy."