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When food buyers restrict farmingWhen food buyers restrict farming

Krissa Welshans 1

September 11, 2015

5 Min Read
When food buyers restrict farming

CONSUMER preferences continue to evolve as products such as "organic," "free-range," "cage-free," "GMO-free," "natural" or "antibiotic-free" (AF) become increasingly popular.

While food marketers have done their best to respond to the new wave of demand by expanding consumer choices, a newly released University of California-Davis agricultural economics study suggests that this may actually reduce consumer choice and increase food costs.

Report authors Tina Saitone, Richard Sexton and Daniel Sumner pointed out that providing these choices to consumers often places restrictions on the production process (e.g., the use of chemicals, the geographic location of the farm, animal welfare, fair labor and environmental impact). This, in turn, affects the economics of the supply chain.

Additionally, they found that a common result of the increased options may be that restaurant chains, foodservice operators and/or grocers offer only a limited number of food items produced using tightly specified processes instead of offering a selection of products with alternative bundles of characteristics.

"Intermediary buyers have long specified the observable attributes of the products they seek to acquire, but now some are seeking deeper involvement in the production chain by specifying production and marketing practices such as traceability, environmental standards, animal welfare requirements, labor standards and other means to meet 'sustainability' criteria," the authors noted.

These actions may be motivated by the demands of consumers of the final product, but they also seem to be inspired by external pressures from special interest groups and notions of corporate responsibility, the authors explained.

According to the report, examples of this include Burger King, Hyatt and Sodexo, which all have announced plans to sell products made from only cage-free eggs.

Chipotle touts "all-natural" and AF pork but also recently launched an advertising campaign that claims that its food is free of genetically modified organisms (GMOs).

McDonald's, too, has contemplated requiring certain standards for its suppliers, and restaurant chains such as Applebee's and Denny's and grocery retailer Safeway are among key buyers embarking on a program to eliminate gestation crates from their pork supply chains.

The food animal sector isn't alone, however. The report also points out examples of restrictions on products made from plant materials, including General Mills requiring non-GMO inputs for its Cheerios cereal, Post doing the same for its Grape-Nuts cereal and Walmart announcing recently that it has joined the "fair food program" intended to guarantee better conditions for workers in Florida's tomato fields and possibly other crops.

In the study, the researchers examined a case when intermediary buyers imposed restrictive farming production practices on their suppliers and traced the economic impacts on producers and consumers. For this study, they focused on restrictions on pork production practices, specifically on AF pork.

"Our analysis suggests that either willingness to pay for enhanced meat products reported in the experimental and survey literature is far too high, or the pork industry is missing a huge opportunity to increase sales and profits through aggressive adoption of AF pork," the authors stated.

Even with a relatively small (5-15%) share of consumers who view AF pork as a superior product to conventional pork, the authors said substantial growth in pork sales and revenue is possible if the reported estimates of incremental willingness to pay are accurate.

However, if the estimates of willingness to pay are not accurate, i.e., too high, the authors said both hog farmers and consumers of pork products are likely to lose from intermediaries imposing restrictive practices, because higher production and processing costs will be passed on to final consumers and will reduce sales of pork products.

"Restrictions on production practices increase farm costs," the authors noted. "They also increase processor costs because they either require segregation in facilities that handle both restricted and unrestricted product or dedicated facilities for each type of product. The latter alternative increases procurement costs such as for shipment of raw and processed products and reduces opportunities for scale economies."

What's somewhat less obvious but very important, the authors said, is that the associated higher production and processing costs apply to the entire animal, even though the share of the edible product utilized by buyers requiring the practice may be quite small.

For example, the report explains that a fast-food restaurant chain requiring gestation crate-free pork or pork from animals with restricted antibiotic use may seek only that portion of the hog used to produce bacon and breakfast sausage — normally about 18% of the carcass weight of a hog.

"The smaller the share of the live hog used by these buyers, the larger the share of farm production that must be converted to the restrictive practice to meet a given share of overall demand," the authors explained.

Additionally, to promote supply of the product with the desired characteristics, the authors said the additional cost must be compensated for entirely on the portion of the product the restrictive buyers purchase, because the rest of the product will have to be sold in the undifferentiated market, where it receives no premium.

"Costs cannot be shifted to segments of the market that do not require the restrictive practices because the higher prices would be undercut by competing sellers who did not participate in the restricted segment of the market and, thus, had lower unit costs," the authors noted. "Thus, cost increases incurred by these intermediary buyers will be magnified on a percentage basis relative to the percent increase in production and processing costs on a whole-animal basis."

According to the report, the restricted and unrestricted segments of the market are integrated on the supply side, because producers and processors can switch between the two production methods.

Because of this, the impact on price and profits will be the same for all producers of the commodity, regardless of whether they produce for the restricted segment of the market or the conventional segment, the authors noted.

"Linkages between the two market segments ensure that impacts of requiring restrictive production practices will extend beyond simply those producers, processors and consumers engaged in the supply chain of the restrictive practice," they said.

Volume:87 Issue:34

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