Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Chapter 6 The Food Marketing Channel

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Purpose of this Chapter Understand the entire food marketing channel:  Provide an overview of the food marketing channel and the role of each sector in the food marketing channel  Discuss how firms at various points in the food marketing channel coordinate their activities  Build a supply and demand model able to accommodate multiple stages of the food marketing channel

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Marketing Margin Marketing Margin can as be called Marketing Bill Marketing Margin or Marketing Bill: The cost of transforming farm production into a consumer good.  Going from a raw form to a finished product Figure 6.1. The Marketing Bill and Value of Farm Production Over Time Source: Economic Research Service (b).

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure 6.2. Farmer’s Share of Food Expenditures Over Time

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure 6.3. Breakdown of the Food Dollar Source: Economic Research Service (c) and Elitzak.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Utility Utility: Farm production, food processing, and marketing activities all create food value Production is the creation of utility, or value or happiness. Utility can be grouped into four distinct types:  Form Utility  Time Utility  Place Utility  Possession Utility

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Utility continued… Form Utility: This refers to the form that consumers want to purchase food products.  i.e. People are going to buy steaks not the live cow. Time Utility: The activity of delivering food products at the time consumers desire  i.e. Turkey and cranberries on Thanksgiving Place Utility: The activity of delivering food to a convenient location for purchase  i.e. Food in grocery stores Possession Utility: Consumers want a convenient method for taking possession of the good.  i.e. Paying for food with a credit card

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure 6.4. The Food Marketing Channel

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Value Added by the Food and Fiber System Each component of the food marketing channel depends on the others.  i.e. Grocery stores can not sell grits if farmers do not plant corn, and corn farmers can not sell their corn unless there is someone transforming the corn into grits. Source: Harris et al. Figure 6.7. Value Added by the Food and Fiber System in 2000

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Vertical Coordination In Agriculture Vertical Coordination: The act of coordinating activities between sectors along the food marketing channel.  Can be done through: Average pricing Grid pricing Production and marketing contracts Vertical integration

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Vertical Coordination Through Average Pricing These activities rely on prices as information signals.  High Beef prices signal that consumers want more beef than is currently produced. Producers respond to high beef prices by producing more beef.  Average Pricing: paying a price for each animal based on the perceived average quality of the group

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Vertical Coordination Through Grid Pricing This is used in assigning a unique price based on its quality characteristics Grid Pricing: Used because the premiums and discounts assigned to each carcass are based on a table or grid, reflecting the value processors place on different carcass traits.  Example: Figure 6.8. Each carcass starts at a base price. This base price will differ as supply and demand conditions vary.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure 6.8. Example of Cattle Pricing Grid (prices are in $ / cwt of carcass) Source: Lusk et al. Reprint permission made available by Blackwell Publishing.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Vertical Coordination Through Production and Marketing Contracts Spot Markets: markets where commodities are sold “on the spot”  Prices are negotiated at the same time ownership is transferred. Production Contracts: Arrangement where the food processor supplies the animals, feed, and other inputs, and the farmer supplies the farm facilities and is responsible for animal grown. (i.e. Tyson Foods)  The farmer is paid a flat fee or a fee based on animal performance. Market Contracts: Contract specifying the amount, price, and type of good to be exchanged in advance.  Dairy, fruits, and vegetables, sugar beet, and cotton industries rely on market contracts.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Vertical Coordination Through Vertical Integration Vertical Integration: Process by which two or more steps of the production process are under the same ownership.  Example: Braums, fast-food chain and ice cream store in the Oklahoma area. Braums owns the cows that produce the milk, the processing facilities that turn the milk into ice cream, and the retail outlet that sells the ice cream. Downstream integration: Where one firm begins producing inputs, which they previously purchased in a market. (i.e. Braums) Upstream integration: Where firms begin performing the function of a firm that previously purchased their production. (i.e. farmer cooperatives)

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Reasons for Contracting and Integrating There is little difference between vertical integration and production contracts.  Both are referred to as vertical control.  Vertical Control: The extent to which one sector of the food marketing channel controls activities in other sectors. i.e. Poultry and egg industries

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Incentives for Vertical Control Reduce Transaction Costs  If the products are under vertical control, the transaction costs (fuel costs, opportunity costs of time involved in traveling, etc) are lowered. Risk-Sharing:  Contract growers share part of the risks of production. Efficiency Gains:  If production can be controlled through all stages, the machinery needed for processing can be made specifically for extreme proficiency.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Why Not Beef? Long biological cycle Multiple stages of production Disperse geographic concentration Reliance on land.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Successes of Vertical Control Goals of Vertical Control:  Reduce Production costs  Improve Product Quality Results in higher quality meat at lower prices Figure 6.9. Impact of Vertical Control on Meat Prices Source: Martinez

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure Actual Versus Simulated Broiler Demand Source: Martinez

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Contracts, the Farmer, and Market Power Many have claimed that processors gain market power when they exert vertical control through marketing or production contracts.  i.e. There are very few markets for independent hog producers to buy and sell hogs in North Carolina. To be a hog grower in NC, you will want to grow under a contract. There are only 2 processors in NC, and they are talking about merging together. These markets are best described as an oligopsony.  Oligopsony: Many sellers but only a few buyers. Results in a lower price for sellers compared to perfect competition.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Cooperatives The farmer’s share of the food dollar has declined.  Higher processing costs because consumers demand more processed and convenient foods.  Farmers are allowed to “collude” in ways other businesses cannot.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Government Acts helping Farmers Sherman Act of 1890: Prevents the formation of monopolies, with some exceptions.  A firm can exist as a monopoly if it derives its market power by producing at the lowest cost or providing a superior product. Clayton Act of 1914: Provided more specific details on what type of activities constitute unfair business practices.  Prohibits tying contracts, which are contracts that prevent purchasers from buying a rival’s product. Capper-Volstead Act of 1922: Protected farmers from antitrust laws.  “Magna Carta of farmer cooperation”---The act allowed farmers to form a co-op or cooperative, in which they may improve their bargaining power by communicating and coordinating their activities.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Cooperatives Basic forms of business organization in the U.S.  Proprietorship: One person owns and controls the firm. The business is not taxed but the owner’s income is taxed.  Partnership: Two or more individuals own and control the business. The business is not taxed but the income made by the partners is taxed.  Corporation: Accounts for most of the business income generated. A Corporation is legally a person (an artificial person), even though it is only an organization. It is owned by stockholders.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Cooperatives Cooperatives are a special type of corporation.  Patron: Anyone who does business with a cooperative.  Cooperatives compensate stockholders with dividends.  A cooperative is to exist as a nonprofit organization serving the farmer.  It is in the farmers’ interest to replace all firms in the food marketing channel with a farmer-owned cooperative. (All profits in the food industry will belong to the farmer and farmer alone.)

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Multi-Sector Models Expand the Supply and Demand Model. Consider the Beer Industry:  Pure beer is made from barley, hops, yeast, and water.  Beer processors or brewers purchase barley and hops from farmers and water from various sources and maintain yeast colonies themselves.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Beer Industry Example Assumptions:  Fixed Proportions Technology: for every unit of good produced there is a fixed proportion of input used. i.e. For every galloon of beer produced a fixed amount of barley is used to produce that beer.  Marketing Bill: the cost of taking barley and transforming it into beer, on a per unit basis is constant.  There are enough buyers and sellers of barley to model the barley market as perfectly competitive.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure Consumer Demand for Beer and Derived Demand for Barley

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure Increase in the Marketing Bill (oval = old equilibrium; triangle = new equilibrium)

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure Increase in Consumer Demand (oval = old equilibrium; triangle = new equilibrium)

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. An Alternative Interpretation The previous model provides a key result that the difference between the farm price and the retail price equals the marketing bill.  The marketing bill (MB) creates a “wedge” between retail and farm prices. Figure Multi- Sector Model Equilibrium

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Cost Transmissions Along the food Marketing Channel Figure Impacts of Larger Marketing Bill (oval = old equilibrium; triangle = new equilibrium)

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure 6.16.

Norwood and Lusk: Agricultural Marketing & Price Analysis © 2008 Pearson Education, Upper Saddle River, NJ All Rights Reserved. Figure answer