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 1990 is the base year as index set to 1.0 Page = 0.84÷0.72 Price 16% higher in 1995 that it was in 1990…. Apple ProductionAppple Price Year Million Lbs. Output Index $/lb Price Index 19854, $ , , , = 4,278÷4,828 Output 11% lower in 2002 than it was in 1990… = 4,278÷4,828 Output 11% lower in 2002 than it was in 1990….

Nominal and Real Expenditures CPI was 52.4% higher in 1995 than it was in period CPI was 52.4% higher in 1995 than it was in period avg is the base year for the CPI Year Nominal Expenditures (Mil. $) CPI ( =1.0) Real Expenditures (Mil. $) = 302.4÷1.524 The increasing CPI eroded the purchasing power of the dollar….

Characteristics of the Food and Fiber System

The Agricultural Sector Pages 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

The Agricultural Sector Pages Farm Service Sector (Implement dealers, chemical sales, fertilizer sales etc.) Processors (Manufacturers, bottlers, etc.) Producers (Farmers, ranchers, etc.) Consumers Marketers (Distributors, retailers, etc.)

Agricultural Sector Importance Pages 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

The Agricultural Sector Pages Consumers Farm Service Sector (Implement dealers, chemical sales, fertilizer sales etc.)

The Agricultural Sector Pages 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.

The Agricultural Sector Pages 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

Relative Importance of Farm Input Expenditures Page 27 Agriculture sector as a whole  Relative values depend on farm type Agriculture sector as a whole  Relative values depend on farm type

Relative Importance of Dairy Farm Input Expenditures Source: Economic Research Service, USDA Data is for 2009 Compared to 24% for all of agriculture

The Agricultural Sector Pages Farm Service Sector (Implement dealers, chemical, sales, etc.) Producers (Farmers, ranchers, etc.) Consumers

The Agricultural Sector Pages 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

The Agricultural Sector Pages Farm Service Sector (Implement dealers, chemical, sales, etc.) Processors (Manufacturers, bottlers, etc.) Producers (Farmers, ranchers, etc.) Consumers

The Agricultural Sector Pages 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 agricul- tural commoditys via above activities $80/ lb

The Agricultural Sector Pages Commodities Processors (Manufacturers, bottlers, etc.) Food Products 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)

The Agricultural Sector Pages 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)

The Agricultural Sector Pages 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)

The Agricultural Sector Pages Commodities Processors (Manufacturers, bottlers, etc.) At-HomeAway from Home Food Products

The Agricultural Sector Pages Today, approximately 50% of food expenditures is spent on food eaten away-from-home

The Agricultural Sector Pages 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

The Agricultural Sector Pages Farm Service Sector (Implement dealers, chemical, sales, etc.) Processors (Manufacturers, bottlers, etc.) Producers (Farmers, ranchers, etc.) Consumers Marketers (Distributors, retailers, etc.)

The Agricultural Sector Pages Commodities At-HomeAway from Home Food Products Processors (Manufacturers, bottlers, etc.) WholesalersDistributors Marketers

The Agricultural Sector Pages 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

The Agricultural Sector Commodities At-HomeAway from Home Food Products Processors (Manufacturers, bottlers, etc.) WholesalersDistributors Retailers Restaurants, Institutions, etc Sells to Final Consumer

The Agricultural Sector Pages Farm Service Sector (Implement dealers, chemical sales, fertilizer sales etc.) Processors (Manufacturers, bottlers, etc.) Producers (Farmers, ranchers, etc.) Consumers Marketers (Distributors, retailers, etc.)

Coordination in Agriculture Pages 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

Coordination in Agriculture Pages 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

Coordination in Agriculture Pages 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 million pounds of milk per month at these plants…... Prof. Ron Cotterill, Univ. of CT, 2005 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 million pounds of milk per month at these plants…... Prof. Ron Cotterill, Univ. of CT, 2005

Coordination in Agriculture Pages 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

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 Pages Farm Service Sector (Implement dealers, chemical sales, fertilizer sales etc.) Processors (Manufacturers, bottlers, etc.) Producers (Farmers, ranchers, etc.) Consumers Marketers (Distributors, retailers, etc.) Example of Vertical Integration

Coordination in Agriculture What are the pros and cons of non- market 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)

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 Structure of Agriculture

Pages Structure of Agriculture Number of U.S. Farms

Page 22 30% ↑ Structure of Agriculture Note: This expansion has occurred with significant decrease in farm numbers Agricultural Production Index

Pages Structure of Agriculture Proportion of U.S. Milk Production by Herd Size

Page 21 Declining Role of Hired Farm Labor Labor Capital Materials Note: There is an error in the text Structure of Agriculture Structure also concerned with use of various inputs  Note decline in role of labor Structure also concerned with use of various inputs  Note decline in role of labor

Structure of Agriculture Pages 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?

Structure of Agriculture Pages 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

Structure of Agriculture Pages 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 inverted pyramid from producer to consumer  A very narrow base made up by farm operators Farm Operators Consumers

Structure of Agriculture Pages 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

Structure of Agriculture Pages 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

Structure of Agriculture Pages 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

Structure of Agriculture Pages 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

Structure of Agriculture Pages 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

Structure of Agriculture Pages

Structure of Agriculture Pages 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 real- world experience in the agric. sector

Structure of Agriculture Pages 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

Structure of Agriculture Pages 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

Structure of Agriculture Pages 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.

Price Volatility in U.S. Agriculture Page 21

This is the price of milk used for cheese manufacturing Price Volatility in U.S. Agriculture

Globalization of Agriculture Pages 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

Globalization of Agriculture Pages 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.

Globalization of Agriculture Pages 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

Farm Profitability What do we mean by farm profitability? Page 24 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

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

Liabilities or debt Liabilities or debt Assets Equity or net worth Start of Farm Financial crisis Start of Farm Financial crisis Low commodity prices High interest rates

Page 25 Duration of Farm Financial crisis Duration of Farm Financial crisis Liabilities or debt Liabilities or debt Assets Equity or net worth

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

Only 19 percent of each dollar spent on food products goes to farmers and ranchers… Only 19 percent of each dollar spent on food products goes to farmers and ranchers… Page 32 Where a food dollar goes

% of Food Purchase Dollar Returned to the Farm Trend Line: Explains 92% of variability Farm Value % The % allocation across categories has remained relatively constant

% of Food Purchase Dollar Returned to the Farm Often referred to as Farm-Retail Margin

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….