Concentration, Competition, and Industry Structure in Agriculture

Stephen R. Koontz

Department of Agricultural and Resource Economics

Colorado State University

It is a pleasure to be asked to offer testimony on concentration, competition and the changing structure of agriculture and agricultural markets, and to participate in this panel. Concentration and competition are the area within which I have focused most of my thoughts and research program for much of my professional life. I have done this because I believe it is the most important economic and public policy issue that faces U.S. agriculture.

However, it has been intriguing to me to observe the interest with which agricultural producer groups, industry associations, and government bodies place on the issue of concentration and industry structure over time. Public interest in this topic waxes and wanes with profitability in the various industry sectors. It is my perception though that the underlying economic forces at work determining this change have remained largely constant. This illustrates to me the need for the impartial academic university perspective. Further, these economic forces have been with us for many years - since the 1840s with the emergence of international trade and industrialization of agricultural production and marketing. The process of industrialization has ebbed and flowed with scientific technological advancement, but the course of change has been steady. It appears to me that the issue of industry structure always seems to become The Issue of Industry Structure following time periods of increased production, low prices, and low profitability. It is my perception that this is what we have today.

It is not my intent to make light of the issue or the recent income problems the farm sector has faced. Price and profitability declines have been substantial for a number of commodities and sectors since the peaks of 1996. Further, the declines have been widespread through a large number of high-volume commodities. But it is clear to me that the cause of this problem is supply and demand related, and is not due to industry structure. On the supply-side, there has been exceptional weather, increased crop production, and increased livestock production. On the demand-side, the relief-value that exports provide for the domestic markets has been limited because of the strong U.S. dollar, the sluggish world economy and the weak Asian country economies in particular. Industry structure is not the devil it is often portrayed. I think that it has had little impact on markets in the recent years. For example, there has been little increase in concentration within livestock processing - the markets I follow most closely - since the late-1980s.

Concentration is not the cause of low prices and profitability in agriculture. However, there are a number of specific issues which have arisen out the continued consolidation. There are serious questions about market access for independent producers, market entry for firms with innovative ideas, service of the general public interest by large businesses, and policy inconsistencies which have contributed to increased consolidation and concentration.

The issue of industry structure is important. Study of this area is the one constant in my career. It is important to outline the economic concepts at play and it is important to take a comprehensive look at what the published research has to say about this issue.

Long-Term Perspective

Competitive markets require many buyers and sellers combined with an open exchange of market information. Lawmaking government bodies and regulatory agencies face a dilemma referred to by economists as the Williamson tradeoff. Growth and consolidation among firms happen for a reason. It is due to enhanced technical efficiency and reduced costs associated with production, processing, and distribution of products within an industry consisting of large firms. However, the resulting concentrated structure may facilitate noncompetitive behavior among the few remaining firms, leading to net social costs in terms of higher consumer prices and lower prices for producers. The issue of this tradeoff is particularly relevant in U.S. agricultural processing industries - and specifically livestock and meat industries.

However, this question could also be asked of about any sector in production agriculture - this includes livestock, poultry, grain crops, and fruits and vegetables. One of the more important pieces of information that can be gleaned from the 1997 Census of Agriculture is the degree of concentration in agricultural production. It is common that more than 80% of the value of production within an industry is produced and marketed by less than 20% of the producers.

The research community has recognized the need to evaluate the potential tradeoffs between economic efficiency and abusive market power. However, it has been almost exclusively focused on agricultural marketing and food processing industries. Research has been motivated by the desire to protect farming and rural community interests. There is a large body of academic literature devoted to this topic. There are a number of research programs, academic programs, and academic professional organizations that are devoted to discovery and communication on this issue. (These groups include NE-165 and The Food and Agricultural Marketing Consortium.)

The interest in market structure has not always been substantial - especially in the policy arena. In the economic and political climate of the early-1990s, where the national emphasis is on economic development and job creation, research on market structure topics was difficult to fund and difficult to publish.

We should not lose sight of the long-term economic goal of maintaining competitive markets. Research and policies need to facilitate economic growth, but also need to identify and encourage the right kinds of economic conduct. We should be cautious of changes which may lead to larger economic problems in the future. However, we should not limit change because it is unpopular or painful. Economic growth and change are often painful for a few but beneficial to the nation and economy as a whole.

What Does the Research Say?

Much popular press hay is made from the increasing nominal and real value of the marketing bill, or the widening gap between retail-level and farm-level prices. The widening of this gap is almost entirely due to the increasing cost of marketing services. Consumers are purchasing more and more service, demanding increases in quality and variety, and desiring more and more convenience. All declines in the farm share of the consumer's dollar is due to the farm and ranch providing less and less of the final product with which the consumer is interested.

Profitability of farm product processors and marketers are remarkable in size - remarkable in how small they are and how consistently small they are. The profits of firms which provide food-related goods for at home consumption are 4-4½ % of consumer expenditures, or business income, net of the value of the farm input. Profits are 4-4½ cents on a dollar of net margins with the remaining 96-95½ cents going to cover costs.

The real proof-in-the-pudding emerges if you look at the stock prices for these firms. Financial markets absolutely recognize the profit limitations of agricultural marketing and food processing companies. The stocks of these companies are clearly priced as slow-growth low-profit businesses.

Much popular press hay is also made from the high levels of concentration in agricultural marketing and food processing industries. The causes of the concentration are economies of size, scale, and scope. Large facilities, large firms, and concentrated industries have lower costs. Low costs translate into larger sectors - aggregate supply is larger - lower prices for consumers and higher prices for producers which supply the farm-level inputs. The tradeoff is clearly that concentrated industries have a greater potential for exercise of market power.

Livestock and grain processing and marketing has become dominated by large plants and firms. A series of mergers and acquisitions in 1987 involving some of the nation's largest meatpackers, combined with internal growth by the largest meatpacker, resulted in what has since been called the "Big Three" packers. As a result, concentration or market dominance by a few firms has increased to unprecedented levels. Fewer and larger meatpackers have resulted in increased plant and industry efficiency. However, several studies suggest larger meatpackers have exercised market power in livestock procurement. Fewer buyers and increased concentration and consolidation lead to lower prices for livestock. There is little evidence about the effects of concentration on consumer prices. While research points toward the conclusion that larger meatpackers have exercised market power, many researchers interpret the results as inconclusive. This was also a conclusion of the 1990 U.S. GAO review of available research. This report was instrumental in initiating the P&SA Concentration Study mandated by Congress.

At the same time, studies of livestock processing industry costs clearly show these costs are substantially lower for large firms and that these benefits result in higher livestock prices. The bottom-line of published research is that the gains to efficiency of large firms are greater than losses attributable to the exercise of market power. In the case of beef slaughter and processing, the cost savings are approximately 4-6% of price levels while the losses due to market power are approximately 1-2% of price levels. Efficiency gains are in most cases orders of magnitude greater than market power losses.

What Does the Research Not Say?

Industries continue to innovate and change. There are always new but-what-ifs. Likewise, the economics profession develops new models to study conduct and measure the impact on economic performance. We need to look ahead and continue to be vigilant, but we also need to be scientific and discuss what we know as the truth no matter how unpopular it is.

Livestock slaughtering and grain processing industries have become dominated by large plants and firms. Specifically, meatpackers have changed the manner in which they purchase livestock, increasingly using contracting procurement methods: (1) packer feeding of livestock in packer-owned facilities or on a custom basis; (2) forward contracting or production contracting; and (3) purchasing livestock under exclusive marketing/purchasing agreements. Such structural and behavioral changes affect the economic performance of firms and industries. Economic performance measures include efficiency, profitability, productivity, and investment in research and development, among others. Much is not known yet about behavioral change impacts on competition and pricing and further research is necessary. There has also been little study on long-term productivity, investment in research, and product development.

Policy Inconsistencies and Opportunities

I see a number of inconsistencies in farm and economic policy that have, in part, lead us to where we are today. U.S. government bodies have spent considerable time addressing what to do about the economic viability of the family farm and ranch. Many farm-related government programs have this in mind. The legislation under consideration currently addresses this issue by cracking down on concentrated industries and the exercise of market power. But there is little evidence of market power. This legislation also attempts to limit unfair practices. But what are unfair practices? Defining unfair is the precise problem with the P&S Act. Limiting unfair trade practices is an almost hopeless and certainly expensive path. The proposed legislation will not change the margins, marketing bill, or the farmer's share of the consumer's dollar.

What can be done? What are the opportunities? First, legislation should focus on the limitation of market access and protection of market entry. Contract production is mainly motivated by quality and cost management problems. Legislation needs to look at limits to access of participation in contract and other integrated systems.

I can also envision an economy which is better served by 12 firms in a particular processing industry than it is by four. Beef demand has declined substantially since the early-1980s and the cause is linked to quality, consistency, and convenience of consumer products. This structural change is well known. Yet it is only recently that the processing industries have made any significant efforts to address this problem. Until now, the existing firms have focused on doing the same things that they had been doing for years only at larger volumes and lower costs. New industry entrants have been driven out and innovation is difficult. I wonder how much larger the beef production industry would be - with its base in rural America - and how much better consumers would be served if the beef processing industry consisted of a larger number of smaller and more innovative firms.

Second, legislation should provide for public goods. Public goods are those things that the marketplace does not provide enough of for various reasons. I am a strong believer that well-reported and open marketplaces are public goods. There is currently significant support for mandatory price reporting and yet in the late-1980s and early-1990s the funding of Livestock and Grain Market News within the USDA Agricultural Marketing Service was reduced. The justification was that private news reporting services would provide this function. That has not happened because of the public good component. I do not think mandatory price reporting will do as much for agricultural markets as simply increasing the funding to AMS would.

Further, the government should support development electronic trading mediums. This was done in the late-1970s and early-1980s and the competitive properties of those institutions were well documented. However, most of the systems failed commercially because of their costs. Since then, there have been quantum improvements in that technology and reductions in costs. But there are few systems currently under development because of the public good component.

Third, legislation should support the public institutions that are difficult to change but that are essential to the operation of markets. Advancements need to be made in agricultural commodity grades and standards and supporting technologies. These technologies then need to be implemented. A large portion of the increase in contract production is because quality control is impossible without it. I would argue that little contract production has emerged because of power. It has emerged to produce a product more consistent with low-cost processing systems and consumer wants. The beef industry has needed a scientific method of measuring tenderness of a carcass and a system to implement that measurement at commercial processing plant speeds. Investment in this technology would help the independent beef producer.

I believe that we are currently in the throes of a large market failure - that being increased consolidation, contracting, and vertical integration - not because returns to power are so great but because of our collective failure to protect innovation and invest in public goods and the market institutions that are necessary for a competitive marketplace populated by independent producers.

Thank you again for the opportunity to speak.