Farmers have long argued that they are vulnerable to price exploitation due to the atomistic structure of primary production and the concentrated buying power of processors. More recently, with the growth in the market power of retailers, processors have begun to complain that they too are increasingly squeezed. Price changes (decreases) at farm level are often not followed by subsequent decreases at wholesale and retail levels. This failure to transmit price changes at one level of the food chain to other levels lead farmers and consumer group to accuse food processors and retailers of abusing their market power to increase profit margins. Farmers consequently receive too little and consumers pay too much. But is there evidence that this is the case?
Agribusiness consolidation will decrease marketing margins if the impact of size economies prevails and will increase marketing margins if the impact of market power prevails. Whether the economies of size dimension benefiting society or the market power dimension hurting society predominates cannot be answered on theoretical grounds. It is necessary to turn to empirical studies to answer this question.
Can be measured in various ways:
The marketing bill: the difference between consumer expenditure on food (excluding imports, beverages and seafood) and the farm value. Reflects changes in price, product quantity, product mix and the quantity of marketing services.
The market basket approach: measures the changing cost of a fixed basket of groceries. Cost changes solely the result of changes in prices.
Farm-retail price spread: Used for measuring farm share of individual products. Must be measured in equivalent units
Example:
However measured, evidence that farmers' share is falling over time. Is a declining producer share reflected in declining producer welfare?
So a widening farm-retail price spread, particularly over a short time period, can be grounds at least for investigation of suspected abuse of market power. For example, the UK Competition Commission, referring in its preliminary report on market power in the UK retail sector to recent movements in retail milk prices, says 'The benefit of increases in the retail price of milk since 1999 have generally been retained by grocery retailers, increasing their share of milk revenues compared with dairy farmers and processors, and we are concerned to understand why this has been the case.'
See the campaign website Tescopoly or the Friends of the Earth Tesco Takeover pamphlet for examples of allegations of the abuse of market power by Tesco in the UK
Buyer power is a shorthand term for the extent of grocery retailers' market power in relation to their suppliers. It refers to the ability of leading retail firms to obtain from suppliers more favourable terms than those available to other buyers, or which would otherwise be expected under normal competitive conditions. Buyer power is manifested not only in the abilitiy to extract discounts and obtain low prices from suppliers, but also in the contractual obligations that retailers may be able to place on suppliers ('supply chain practices'), and in the shifting of the burden of financial risk on to suppliers.
Buyer power emerges from differences in relative economic dependency, and is determined in the first instance by relative sizes of contracts and relative switching costs. If a supermarket delists a product, it may suffer a profit loss of 0.1% but its supplier could lose 30-40% of its business. With high fixed costs and little chance to find an alternative outlet for its production, there is a huge pressure on the supplier to accept disadvantageous terms.
See Irish Times story on treatment by Dunnes Stores of Whelan's distributors (19 February 2007)
Dobson (2005) argues that a further contributing factor is the multi-faceted roles of retailers as they appear to suppliers. The are at the one and the same time customers, competitors (selling own label products) and suppliers (selling shelf space). Retailers can exercise these three roles individually and jointly to extract economic rents from suppliers.
The UK Competition Commission characterise grocery retailers' relationships with their suppliers in two main ways: first, those situations where there are numerous suppliers and a single 'market price' is paid by all grocery retailers to their suppliers for the product in question (referred to as a 'market framework'); and second, those situations where suppliers are relatively concentrated and prices and other terms are negotiated bilaterally (referred to as a 'bargaining framework'). Within a market framework, the factors affecting buyer power include the size of the grocery retailer's sales of a product relative to the supplying industry's total sales of that product and the degree of concentration of grocery retailers in relation to the sales of a product. Within a bargaining framework, the factors which confer buyer power are those which affect the retailer's reliance on its supplier (sometimes referred to as its 'outside options'). These factors include, for example, the size of the grocery retailer relative to the size of its supplier, the absolute size of the grocery retailer and the supplier, and the supply of own-label products that compete with the supplier's products.
The UK Competition Commission in its 2007 enquiry into the UK grocery trade has identified three ways in which grocery retailers' buying power might adversely affect competition and harm consumers:
But it also points out that buyer power may not be disadvantageous to consumers. It could lead to lower prices or better quality, increase innovation or act as a countervailing force to market power held by suppliers. It is the net effect on consumer welfare which is important. Its preliminary view is that there is little evidence in the UK to support any of three buyer power mechanisms which potentially could make consumers worse off.
It also considers a fourth set of issues under the heading of supply chain practices. Supermarkets may unilaterally and retrospectively change contract terms; suppliers may be required to pay for shelf space for new or existing products (known as 'slotting allowances'); suppliers may provide category management and marketing support services to retailers; exclusive purchasing and dealing arrangements; stocking of own label products, and recommended retail prices. While acknowledging the potential for these practices to adversely affect consumers, its preliminary view was that evidence for adverse effects was currently lacking. In its 2000 enquiry, it identified 27 practices found to operate against the public interest. However, it did not recommend that these anti-competitive practices should be prohibited outright but rather constrained by a Supermarket Code of Practice.
Seller power at the retail level and legislation to prohibit below cost selling as a way of controlling seller power in considered in Lecture 34.
The abuse of market power requires the existence of dominant firms and a high level of industry concentration. But not all dominant firms abuse the power they possess. Raw concentration measures are useful to identify markets which contain dominant firms. But highly concentrated markets, while necessary for market power abuse, are not sufficient. How do competition authorities or researchers prove that market power exists?
Many studies have found significant relationship between measures of market concentration (such as Cn measures or HHI index) and indicators of market power (price-cost markup (Lerner index), prices, margins, or profitability) (Connor, 2003). From a policy perspective, though, the dilemma is that market power generates consumer welfare losses: but concentration may also have positive effects on firm efficiency. Evidence of market power-efficiency tradeoffs has been found in several studies.
The corresponding studies for food retailing examine the geographic variation in retail grocery-price indexes, controlling for local market cost variations. US studies find that high metropolitan-area concentration is associated with high food prices and higher profits. Again, it is important that studies try to disentangle whether higher profits are due to greater efficiency or greater market power.
Focus of this literature is on the conduct of firms within a particular industry.
Based on structural oligopoly models by specifying the first-order conditions for the profit maximising behaviour of a single oligopolist.
The key behavioural parameter in this approach is the conjectural variation of the oligopolist (usually designated as θ), which measures the degree to which a firm takes into account its rival's reactions to its own output choice.
The expectation of a limited market response to a change in firm output (low θ) suggests market is competitive.
Expectation of an extensive market response suggests presence of market power (high θ).
Estimating the structural model allows the empirical data to provide information on the value of θ
Given the value of θ, the size of the market power mark up can be calculated.
The estimate of market power relies crucially on accurate estimates of the underlying market and cost conditions
Theoretically highly appealing, but complex to apply empirically and often requires simplifying assumptions.
Concern is that reductions in farm prices are not passed on to consumers in form of lower retail prices.
Three types of imperfect price transmission:
Imperfections in price transmission may be due to market power but can also be due to adjustment costs (relabelling prices, advertising, goodwill).
Price transmission studies: Traditional regression methods (regressing retail price on farm price) ignore time series properties and give biased results. Co-integration methods are now preferred, which also allow for speed of adjustment and direction of causality to be inferred, as well as testing for asymmetric price responses.
Democratic Staff of the Committee on Agriculture, Nutrition and Forestry, United States Senate, 2004. Economic Concentration and Structural Change
In the Food and Agriculture Sector:
Trends, Consequences and Policy Options, Washington, D.C.
(although written from a US perspective, provides a succinct summary of the issues in the debate on market power in the food chain).
Tweeten, L., 2000, Agribusiness concentration: implications for farmers and consumers, Presentation to the Visions for the Millennium Conference, organised by the USDA Grain Inspection, Packers and Stockyards Administration, May 2000.
(short, sharp attack on 'populist' criticisms of agribusiness by a leading US agricultural economist).
Dobson, P., 2005. Exploiting buyer power: Lessons from the British grocery trade, The Anti-Trust Journal 72, 2, 2005, pp. 529-562.
Dobson, P., 2002, Retailer Buyer Power in European Markets: Lessons from Grocery Supply, Business School Research Series Paper 2002:1, Loughborough University.
[Much the same ground is covered in Buyer power in food retailing: the European experience, Paper presented at the Conference on Changing Dimensions of the Food Economy: Exploring the Policy Issues, The Hague, Netherlands, 2003.]
The UK Competition Commission (ongoing in early 2007) Groceries Market Inquiry is an important source of information on supermarket behaviour towards suppliers, towards shoppers and towards each other. In January 2007 it published its emerging thinking report on the issues it had been asked to investigate. It has also published a series of working papers setting out the issues involved in market definition, as well as in evaluating buyer power, supply chain practices and pricing practices.
UK Competition Commission, Buyer Power and the Supply Chain Discussion Paper, 2006.
Checkout Magazine, 'Will it happen here? UK report paints bleak picture for independents' survival', March 2006.
Bunte, F., 2006. Pricing and performance in agri-food supply chains, Chapter 4 in C.J.M. Ondersteijn, J.H.M. Wijnands, R.B.M. Huirne and O. van Kooten (eds.), Quantifying the Agri-food Supply Chain, Springer, pp.37-45.
(useful short overview focusing on interpreting changes in farmers' share of supply chain income and price transmission studies).
London Economics, Executive Summary of Investigation of the determinants of farm-retail price spreads, Final Report to DEFRA, 2004 (Annex 5 Empirical investigations into buying power and farm gate-retail price spreads is also useful).
Marion, B., Geithman, F. and Quail, G., 1990, Monopsony power in an industry in disequilibrium: beef packing, 1971-1986, Working Paper-96 University of Wisconsin-Madison, Department of Agricultural and Applied Economics.
UK Office of Fair Trading, 1998. The Welfare Consequences of the Exercise of Buyer Power, Research Paper 16, Prepared by Dobson, P, Waterson, M. and Chu, A., London, Office of Fair Trading.
Clarke, R., S. Davies, P. Dobson and M. Waterson, Buyer Power and Competition in European Retailing, Cheltenham: Edward Elgar, 2002.
Cotteril, R., 2005. Antitrust Analysis of Supermarket Retailing:
Common Global Concerns that Play Out in Local Markets, Food Marketing Policy Center Research Report No. 88, July, University of Connecticut Department of Agricultural and Resource Economics.
(a more difficult article which requires some background in industrial economics - may be of interest to students taking Industrial Organisation this year)
Department of Enterprise, Trade and Employment, 2001, Report of the Independent Group into Anti-Competitive Practice in the Irish Beef Industry (the Sheehy Report).
(Ch. 3 deals with retail price margins, Chs 4 and 5 with the purchasing power of meat factors vis a vis farmers. While the report looks long, ignore the many appendices)
Collins A. et al, 2006. Food Prices in Ireland - Report for the Consumer Liaison Panel, Dublin, Department of Agriculture and Food.
(a lengthy report which shows the difficulty in constructing farm-retail price spreads using available Irish data).