The U.S. Food and Fiber Industry Chapter 2 Discussion Topics Review of index numbers and real value of money What is the food and fiber industry? Review the changing complexion of farming Discuss the role of other sectors in the food and fiber industry Output and Price Indices Apple Production Appple Price Year Million Lbs. Output Index $/lb Price Index 1985 4,162 0.86 $0.66 0.91 1990 4,828 1.00 0.72 1.00 1995 5,289 1.10 0.84 1.16 2002 4,278 0.89 0.95 1.32 1990 is the base year as index set to 1.0 1.10 = 4,278÷4,828 Output 11% lower in 2002 than it was in 1990…. 1.16 = 0.84÷0.72 Price 16% higher in 1995 that it was in 1990…. Page 14 Nominal and Real Expenditures Year Nominal Expenditures (Mil. $) CPI (1982-84 =1.0) Real Expenditures (Mil. $) 1980 120.3 0.824 145.99 1985 168.8 1.076 156.91 1990 248.5 1.307 190.10 1995 302.4 1.524 198.44 2002 385.8 1.722 224.03 1982-84 avg is the base year for the CPI CPI was 52.4% higher in 1995 than it was in 1982-84 period 198.44 = 302.4÷1.524 The increasing CPI eroded the purchasing power of the dollar…. Characteristics of the Food and Fiber System The Agricultural Sector The agricultural (food) industry can be divided into four major sectors: Farm service Agricultural Producers Processors Wholesale/Retail distributors and marketers The final marketing chain component is represented by consumers Pages 17-26 The Agricultural Sector Farm Service Sector (Implement dealers, chemical sales, fertilizer sales etc.) Producers (Farmers, ranchers, etc.) Processors (Manufacturers, bottlers, etc.) Marketers Consumers (Distributors, retailers, etc.) Pages 17-26 Agricultural Sector Importance An estimated one-fifth of all jobs in the U.S. are related to some aspect of the food industry In many developing countries, more than half of the labor force engaged in agriculture On a global basis the food industry is the largest industry in terms of people employed and value of product Pages 17-26 The Agricultural Sector Farm Service Sector (Implement dealers, chemical sales, fertilizer sales etc.) Consumers Pages 17-26 The Agricultural Sector The farm service sector provides producers with inputs such as feed, fertilizer, fuel, equipment and chemicals. Many firms are multinational corporations: John Deere, DuPont, and Monsanto There are also a variety of small, local service companies that serve diverse needs of local farmers for irrigation equipment, farm structures, etc. Pages 17-26 The Agricultural Sector Also numerous firms that provide farmers with financial services i.e., Banking, accounting, insurance, legal advice, risk management and agronomic consulting As farming becomes increasingly complex, farmers are pressed to rely heavily on providers of farm services A fast-growing, highly localized sector of the food industry Pages 17-26 Relative Importance of Farm Input Expenditures Agriculture sector as a whole Relative values depend on farm type Page 27 Relative Importance of Dairy Farm Input Expenditures Compared to 24% for all of agriculture Source: Economic Research Service, USDA Data is for 2009 The Agricultural Sector Farm Service Sector (Implement dealers, chemical, sales, etc.) Producers (Farmers, ranchers, etc.) Consumers Pages 17-26 The Agricultural Sector The producer sector includes those engaged in the biological processes associated with production of food/fiber i.e., Farmers, ranchers, fruit growers, nurserymen, etc. Producers purchase from farm service sector and sell to the processor sector There is an increasing movement for producers selling directly to consumers Pages 17-26 The Agricultural Sector Farm Service Sector (Implement dealers, chemical, sales, etc.) Producers (Farmers, ranchers, etc.) Consumers Processors (Manufacturers, bottlers, etc.) Pages 17-26 The Agricultural Sector The processor sector creates value by converting agricultural commodities into products that consumers want Processors change form of primary product Processors can provide a storage function (i.e., Hook’s 15 year old aged cheddar) Processors can provide transportation services Value added to raw agricultural commoditys via above activities $80/ lb Pages 17-26 The Agricultural Sector Processors can be divided into two types: Commodities processors – (i.e., milling wheat into flour for use as an input) Flour is an intermediate input for more processing Food products processors - (i.e., cheese plant that transform milk into cheese for direct consumption) Processors (Manufacturers, bottlers, etc.) Commodities Food Products Pages 17-26 The Agricultural Sector Sometimes a company engages in both types of processing activities Hershey Processes cocoa beans into powder (a commodity) Makes candy for direct sale (a food product) ConAgra Foods Processes soybeans into oil to make Blue Bonnet®, Fleischmann’s®, and Parkay® margarines (a commodity) Sells soybean oil directly to consumers (a food product) Pages 17-26 The Agricultural Sector Food product processors can be further divided into two categories Processors that produce for retail food consumers Those that produce for food service (via distributors) Pages 17-26 The Agricultural Sector Processors (Manufacturers, bottlers, etc.) Commodities Food Products At-Home Away from Home Pages 17-26 The Agricultural Sector % of Food E xpe nditure s A w a y From H om e 51.5 48.0 44.5 41.0 37.5 Today, approximately 50% of food expenditures is spent on food eaten away-from-home 34.0 30.5 27.0 08 20 04 20 00 20 96 19 92 19 88 19 84 19 80 19 76 19 72 19 68 19 64 19 19 60 23.5 Pages 17-26 The Agricultural Sector A good example of a food product processor is the Coca-Cola Company Purchases high-fructose corn sweetener (HFCS) from a commodity processor such as ADM or Cargill Combines HFCS with other ingredients using their secret formula to produce Coke® In cans and bottles for the retail market In bulk for the food service industry Pages 17-26 The Agricultural Sector Farm Service Sector (Implement dealers, chemical, sales, etc.) Producers (Farmers, ranchers, etc.) Consumers Processors (Manufacturers, bottlers, etc.) Marketers (Distributors, retailers, etc.) Pages 17-26 The Agricultural Sector Processors (Manufacturers, bottlers, etc.) Commodities Food Products At-Home Away from Home Wholesalers Distributors Marketers Pages 17-26 The Agricultural Sector The marketing sector creates value in the food industry by changing the time and place of food Ties the producer and consumer sectors together Coca-Cola plays the role of wholesaler and distributor in the marketing sector Pages 17-26 The Agricultural Sector Processors (Manufacturers, bottlers, etc.) Commodities Sells to Final Consumer Food Products At-Home Away from Home Wholesalers Distributors Retailers Restaurants, Institutions, etc The Agricultural Sector Farm Service Sector (Implement dealers, chemical sales, fertilizer sales etc.) Producers (Farmers, ranchers, etc.) Processors (Manufacturers, bottlers, etc.) Marketers Consumers (Distributors, retailers, etc.) Pages 17-26 Coordination in Agriculture Coordination: The communication system that conveys consumer wants to the producer Marketers are companies that tie the final food consumer to the processor Their job is to make certain that whatever the consumer wants is available when and where the consumer wants it Pages 17-26 Coordination in Agriculture Traditionally, coordination has been accomplished by prices sending signals from one link in the marketing chain to the next This is changing with management/strategic alliances replacing markets Dairy Farmers of America (DFA): Major dairy farm cooperative controlling large amounts of raw milk Dean Foods: Very large bottler of fluid milk DFA and Dean Foods have entered into an exclusive supply arrangement in New England Pages 17-26 Coordination in Agriculture At the fluid processing level, large consolidated processors dominate the fluid milk industry. These include: (1) Dean Foods, which has a long term strategic alliance (full supply contracts) with DFA, and operates 12 plants in the Mideast and processes an estimated 250-300 million pounds of milk per month at these plants…... Prof. Ron Cotterill, Univ. of CT, 2005 Pages 17-26 Coordination in Agriculture Historically most retail stores Purchase products from wholesalers Wholesalers Purchased in bulk from processors Sell in smaller batches to retailers Many smaller retailers still use this system Many larger retail chains combine wholesale and retail functions Reduces transaction costs Reduced costs can be Passed on to consumers as lower prices or Captured by the producer as higher profits Pages 17-26 Coordination in Agriculture One of the the largest U.S. food retailer (by sales volume) is Kroger $66 billion of food & other items/ year Nearly 2,500 retail outlets. Kroger does both wholesaling & food product processing 42 plants making 3,000 products sold by the chain This illustrates a significant trend in the food system know as vertical integration Several steps in the food system chain are placed under single management control Coordination in Agriculture Vertical integration allows a firm to coordinate the food system stages via internal management Without integration: Coordination is accomplished by price signals sent to and received from various markets With increased vertical integration → An increase in the role of management in coordination →A decline in the role of markets in the coordination of the food system The Agricultural Sector Farm Service Sector Example of Vertical Integration (Implement dealers, chemical sales, fertilizer sales etc.) Producers (Farmers, ranchers, etc.) Processors (Manufacturers, bottlers, etc.) Marketers Consumers (Distributors, retailers, etc.) Pages 17-26 Coordination in Agriculture What are the pros and cons of nonmarket coordination? Markets and prices are highly visible and the consumer has many choices Non-market coordination can be more efficient (particularly in large volumes) than market price coordination →lower prices to the consumer Coordination in Agriculture What does the consumer want—more choice or lower prices? The answer is clear when one compares the successes of Sears (“Good, better, and best”) vs. Wal-Mart (“Everyday low prices”) over the past 20 years Wal-Mart has outpaced other competitors over this time period Sears is searching for survival strategies (e.g. acquisition of Lands End) Structure of Agriculture Physical structure of agricultural industry Fewer number of farms but larger-sized Increasing use of capital relative to labor Increasing productivity per unit of input Financial structure and performance Volatility of net farm income reduced by subsidies although dairy is an exception Declining debt use strengthens equity position Recovering real estate values after sharp declines during financial crises of mid-1980s Pages 17-26 Structure of Agriculture Millions Number of U.S. Farms 4.0 3.8 3.5 3.3 3.0 2.8 2.5 2.3 2.0 Pages 17-26 Structure of Agriculture Agricultural Production Index 30% ↑ Note: This expansion has occurred with significant decrease in farm numbers Page 22 Structure of Agriculture Proportion of U.S. Milk Production by Herd Size 35 < 100 HD 500-999 100-199 HD 1000-2000 HD 200-499 HD 2000+ HD 30 25 20 15 10 5 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Pages 17-26 Structure of Agriculture Structure also concerned with use of various inputs Note decline in role of labor Declining Role of Hired Farm Labor Labor Note: There is an error in the text Capital Materials Page 21 Structure of Agriculture There is public concern that the family farm is giving way to large, impersonal, factory farms. Farm operators are about 1.6% of the U.S. population Characterizing attributes of the American farms and farmers → Study of farm structure. What do farms in the U.S. look like today? Pages 17-26 Structure of Agriculture In 1915: 6.5 million U.S. farms Approximately 2 million farms today The U.S. Department of Agriculture (USDA) defines a farm as: Any establishment that produces (or should produce) at least $1,000 of farm products each year Pages 17-26 Structure of Agriculture With roughly 305 million Americans, the average American farmer feeds himself and 152 others Exports account for an additional 50 persons fed by U.S. agriculture The U.S. food chain can viewed as an Consumers inverted pyramid from producer to consumer A very narrow base made up by farm Farm Operators operators Pages 17-26 Structure of Agriculture Popular press often asserts that farming is being taken over by large, corporate farms 2 million U.S. farms, 98% are family farms Family farms produce about 85% of the total agricultural production value 90% are owned by sole proprietors, rest owned by partnerships or multifamily corp. Non-family farms 2.2% of all farm units Produce 15% of total farm output Pages 17-26 Structure of Agriculture Using the USDA U.S. farm typology 14% or 300,000 are retired 40% of farm operators listed primary occupation as a non-farm occupation i.e. Hobby farm where operator works primarily off-farm & maintains farm as part of lifestyle 38% listed occupation as farm with gross sales less then $250,000 Profit rate of 3% →$7,500 profit → 8% or 160,000 farms are large, economically viable enterprises Account for about 2/3 of farm sales Pages 17-26 Structure of Agriculture What is the typical American farm like? Farm numbers: Most are either retirement homes or hobby farms. Almost all of the remaining are family farms: Only about 20,000 large, non-family farms Clear trend among these food producers is toward fewer, larger farm units Increasingly specialized in what they produce Pages 17-26 Structure of Agriculture Lessons to be learned from the study of the structure of U.S. farms There is no such thing as an average farm Good example are Wisconsin dairy farms: Grazers (i.e., low input technology)→Feedlot (purchase all feed) Averages may cover up more than they reveal When asked as to the average cost of production my response is that “it depends” • Type of technology used • Farm size Pages 17-26 Structure of Agriculture Increasing public policy concerns as to the degree of concentration in food processing Concentration: The degree to which a small number of firms account for a large market share Example of 2010 USDA/U.S. Department of Justice hearings as to competitiveness in the U.S. food sector Pages 17-26 Structure of Agriculture http://www.justice.gov/atr/public/workshops/ag2010/index.htm Pages 17-26 Structure of Agriculture First time there has been a set of joint DOJ/USDA workshops to discuss competition and regulatory issues in the agriculture industry Workshop goals: Promote dialogue among interested parties Foster learning with respect to appropriate legal and economic analyses of these issues Listen to and learn from parties with realworld experience in the agric. sector Pages 17-26 Structure of Agriculture A measure of concentration is the % of the total market accounted for by the four (or any other number) largest producers (CR4). U.S. breakfast cereal industry has a CR4 of 87% Virtually all baby food is produced by the 3 largest firms Pages 17-26 Structure of Agriculture Significant concentration in meat packing Beef processing has a CR4 of 85% 1 of these being foreign owned Smaller competitors bought out via consolidation Large poultry producer, Tyson Foods, recently bought the second-largest beef processor Some beef cattle producers have called for Federal legislation to prevent any further consolidation Pages 17-26 Structure of Agriculture Is concentration in the food industry bad? Processors say consolidating into fewer, larger firms allows them to cut costs They assert it benefits consumers Processors assert that they need to consolidate due to retail consolidation Opponents argue that it provides the processors with unusual market power Allows them to buy from farmers who have little market power that border on exploitation Unequal bargaining power Why dairy cooperatives formed and today market more than 75% of raw milk in the U.S. Pages 17-26 Price Volatility in U.S. Agriculture Average WI Price Recieved for Corn Grain ($/bu) $8.00 $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $1.00 Page 21 Price Volatility in U.S. Agriculture MW/BFP/Class III Prices ($/cwt) $21.75 $20.00 $18.25 $16.50 $14.75 $13.00 $11.25 $9.50 $7.75 $6.00 $4.25 This is the price of milk used for cheese manufacturing Globalization of Agriculture Commodity processors tend to be on the forefront of globalization Because demand for processing technologies is truly global as we all need food to survive. The most successful commodity processors are very internationalized with processing facilities world-wide Pages 17-26 Globalization of Agriculture Globalization in food product processing has not been as strong Consumers have different tastes and preferences across countries i.e., final food product soybeans may be soy protein meal in country A, tofu in country B, and a steak in country C Food product processors are making a push to globalize Processed food market growth dramatically increasing in many developing countries Contrast this with stagnant growth in the U.S. Pages 17-26 Globalization of Agriculture Criticism of Globalization Food security—every country wants to be certain its nutritional needs will be met. As an industry becomes globalized, individual countries lose control to multinational companies that may have different objectives Global concentration: similar to the issue of industrial concentration A Brazilian firm, the world’s largest beef processor has acquired one of the largest U.S. beef processors Pages 17-26 Farm Profitability What do we mean by farm profitability? Cash receipts from farm marketings (Price x Quantity) + Government payments + Other income from farm sources = Gross farm income – Production expenses = Nominal net farm income ÷ Broadly-based price deflator = Real net farm income Page 24 Instability of Net Farm Income Real net farm income in 1983 had the same purchasing power as 1933 Page 24 Financial Structure What do we mean by farm profitability? Value of real estate assets (i.e., owned land, buildings, etc.) + Value of non-real estate assets (i.e., tractor, combines, stored grain, etc. + Value of financial assets (i.e., savings accounts, IRA’s) = Total assets – Total liabilities or debt = Equity or Net Worth Page 25 Start of Farm Financial crisis Low commodity prices High interest rates Assets Equity or net worth Liabilities or debt Page 25 Duration of Farm Financial crisis Assets Equity or net worth Liabilities or debt Page 25 Marketing Bill Marketing Bill: The portion of food expenditures associated with activities of firms beyond the farm gate More than 80% of every dollar spend on food is represented by the marketing bill For every $100 spent at the supermarket… The farm service sector accounts for about $12 The production sector (i.e., farmers), about $7 The remaining $81 goes to processors of agricultural commodities, and the marketing system that brings food to your table Pages 27-29 Where a food dollar goes Only 19 percent of each dollar spent on food products goes to farmers and ranchers… Page 32 % of Food Purchase Dollar Returned to the Farm Farm Value % Trend Line: Explains 92% of variability The % allocation across categories has remained relatively constant % of Food Purchase Dollar Returned to the Farm Often referred to as Farm-Retail Margin 60 55 50 45 40 35 30 25 20 15 10 5 0 Cereals Fruit Cheese Beef Fresh Veg Whole Milk In Summary Increasing role of capital Productivity Weak real profitability Interrelationship among sectors in the food and fiber industry Farmers/ranchers share of food dollar Chapter 3 starts a series of three chapters that focus on the demand curve for food and fiber products….