The 3 Factors Leading to the Demise of Hostess

Posted on November 19, 2012

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The U.S. Government Contributed to the Lack of Sustainability at Hostess

By Holly A. BellHostess

There’s been a great deal of speculation about why Hostess was not able to maintain their operations. Like most business issues, the demise of Hostess is not as simple as it appears on the surface. While there were three primary factors, there was one root cause.

Government Distortions. A government distortion is any action taken by the government that disrupts the natural price mechanism of a market based on supply and demand. In this case the market that was distorted was the sugar market. Wholesale sugar prices in the United States are remarkably higher than the rest of the world due to quotas and tariffs enforced by the U.S. government. In 2011 the average wholesale price of sugar in the US was 56.22 cents per pound compared to 31.68 cents for the rest of the world (see source article here). Economics 101 tells us that as the prices of inputs rise, and profits are eroded, the amount that suppliers are willing to produce is reduced and the aggregate supply curve shifts to the left. In this case Hostess was pushed to the point of being willing to produce zero. And there goes that aggregate supply curve shift to the left.

Unions. Yes, the unions have to take some blame here as well. Labor, like sugar, is an input and the input prices were just too high to be sustainable. Since the government was controlling the price of sugar, the only place to reduce input costs was through labor.

Product Quality. Several people have blamed the demise of Hostess on changing tastes and the quality of their products. I’m not convinced this was a significant factor, but it may have contributed a little, but for a slightly different reason.  American’s love their junk food, as long as it’s cheap. However, rising input costs did not allow Hostess to compete on price with some other brands that may be of similar quality.

Ultimately government distortions in the sugar market contributed to the other factors that led to the demise of Hostess. So what happens next? Hostess (or its brands) will most likely be purchased by a company that manufactures their products outside the U.S. This company will have a competitive advantage over Hostess as it will be able to purchase sugar in the world market and be much more efficient. This is yet one more example of a government policy forcing U.S. jobs overseas.

There is one additional point worth mentioning. There have been several articles discussing that while Hostess was asking employees to take an 8% pay cut, executives were getting significant pay raises and bonuses. This did not cause the demise of Hostess, it was simply a symptom that the end was inevitable. The executives knew the model was not sustainable and that the unions would most likely not be willing to participate in the austerity required to continue operations. The salary and bonus increases indicated that the executives knew they were going to be out of a job soon, so they designed their own severance packages. I’m not saying this was the right thing to do, but it didn’t worsen the health of Hostess, it was already dying.

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Demise of Hostess image courtesy of Grant Cochrane

Posted in: Economy, Politics, Trade