Structural change in the food industry

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Structural change in the food industry

• Lecture 31
• Economics of Food Markets
• Alan Matthews

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The food chain
Input suppliers
Farmers
Processors
Retailers
Consumers
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Lecture objectives

• What are the main trends in the food chain at
  consumer, retailing, manufacturing and input
  supply levels?
• We focus on changes in market structure and
  implications for market power
• The growth in horizontal concentration
• Changes in vertical coordination and growth of
  retail buyer power

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Readings

• Connor
• US Senate
• Lang
• Henchion and McIntyre

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Consumer trends

• Drive for more convenience and added value foods,
  eating away from home
• Demographic and lifestyle changes
• Women working outside the home
• Food consumption more a lifestyle choice
• Nutrition and health issues
• Positive (functional foods)
• Negative (obesity)

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Market power

• Companies exert market power if they can raise
  prices above marginal costs

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Market power price exceeds marginal cost
Price
Pm
AC MC
Pc
D
MR
Quantity
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Market power in the food chain
Input suppliers
Farmers
Processors
Retailers
Consumers
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Concerns raised by concentration

• Market power reduces consumer welfare
• Farmers are at greater risk of exploitation in
  the prices they pay or receive
• Traditional price discovery fails under
  consolidation and vertical integration
• Contract producers are vulnerable to arbitrary
  behaviour by integrators

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Structural changes in the agri-food sector

• Horizontal consolidation
• The merger or combination of two or more firms in
  the same industry engaged in the same stage of
  the production cycle
• Vertical coordination or integration
• When one firm acquires or allies with another
  firm in the same industry but at another stage in
  the production cycle

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Measures of concentration

• The share of the total market held by an absolute
  number of the largest firms in the market, e.g.
  the largest 4, 8, 20
• CR4 ratio over 60 generally taken as
  representing a concentrated industry
• Herfindahl-Hirschman Index
• The sum of squares of market shares of firms
• For example, an industry consisting of two firms
  with market shares of 70 and 30 has an HHI of
  70²30², or 5,800
• Markets with HHI over 1,800 are considered highly
  concentrated

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Concentration in food manufacturing US evidence

• In the 1980s, concentration particularly evident
  in beverages, tobacco products and heavily
  advertised packaged food products
• Industries making industrial foodstuffs (flour,
  sugar, vegetables oils etc) or undifferentiated
  consumer products (such as fresh meats) were
  generally at low to moderate levels of
  concentration
• Average concentration levels have continued to
  rise since then, with marked changes in the
  undifferentiated consumer foods sector (e.g. meat
  processing)

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Source Connor 2003
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Growing concentration in food processing

• Traditional concentration concern is with food
  processors as sellers
• But increasingly it is their role of buyers which
  is coming under scrutiny
• Agricultural commodity markets will be narrower,
  and thus concentration higher
• Geography farm products are bulky and transport
  costs are high
• Perishability of farm products producers cannot
  respond to market power by threatening to
  withhold products until price improves

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Growing concentration at retail level

• once largely fragmented, consisting largely of
  independent retailers
• even though there is variation in levels of
  retail concentration across EU member states,
  consolidation has now occurred all countries
  (Dobson)
• major retailers have also been expanding
  internationally (Wal-Mart). Top ten retailers in
  the EU now account for over 30 of sales of all
  food and daily goods.
• tables do not give full indication of the
  concentration facing suppliers in terms of retail
  procurement markets because of role of buying
  groups in many European countries.
• when cross border alliances between buying groups
  are taken into account, adding the 5 largest
  retailers and the five largest alliances means
  that the top ten buying group account for just
  over 50 of all EU food sales (Dobson).

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Source Dobson, 2003, measured in national markets
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Source Dobson, 2003, measured across all EU
markets
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Source Dobson, 2003
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Source Forfas, Dynamics of the Retail Sector in
Ireland, 1999
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Changing nature of the food supply chain

• nature of the supply chain has changed
  considerably. Traditionally manufacturers have
  driven distribution by developing brands and then
  using a network of wholesalers and retailers to
  distribute goods to consumers
• now large retailers control of shelf space and
  limited retail competition offering few
  alternatives for suppliers means they are
  gatekeepers to consumers. Gives them the
  potential power to extract more favourable terms.
  

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Vertical coordination

• Partial integration (captive supplies)
• Does meat factory ownership of live cattle and
  pig supplies adversely affect prices received by
  livestock producers? Does this type of backward
  vertical integration cause live cattle prices to
  be lower and more variable than in the absence of
  such arrangements?
• Integration increases price instability in the
  non-integrated channel, and probably also lowers
  prices
• Integration may benefit integrated producers, but
  at the expense of unintegrated suppliers
• A packer ban operates in a number of US states
  and passed US Senate in 2002 (Connor 2003).

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Vertical coordination

• Full integration (e.g. contract production)
• Contrasts with open markets where coordination is
  done by price
• Improves logistics, quality control..
• but reduces value of open market prices
• and can leave producer vulnerable to
  exploitation
• Vertical chain management discussed later

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Motivation for these structural changes

• The desire to capture economies of scale and
  economies of scope (horizontal)
• Reducing uncertainty and controlling quality in
  the supply chain (vertical)
• Competition in the food industry in future will
  be more between alternative supply chains than
  individual firms
• Should we be concerned about the threat of market
  power from growing concentration?