Structural change in the food industry

Lecture 31

Economics of Food Markets

Alan Matthews

The food chain

Input suppliers

Farmers

Processors

Retailers

Consumers

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

Readings

• Connor

• US Senate

• Lang

• Henchion and McIntyre

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)

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

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 70²+30², or 5,800

– Markets with HHI over 1,800 are considered highly concentrated

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)

Source: Connor 2003

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

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).

Source: Dobson, 2003, measured in national markets

Source: Dobson, 2003, measured across all EU markets

Source: Dobson, 2003

Source: Forfas, Dynamics of the Retail Sector in Ireland, 1999

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).

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

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

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.

Market power

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

Market power – price exceeds marginal cost

MRD

AC = MC

Pm

Pc

Price

Quantity

Market power in the food chain

Input suppliers

Farmers

Processors

Retailers

Consumers

Buyer power

Buyer power

Seller

power

Seller

power

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’• Should we be concerned about the threat of

market power from growing concentration?