Farm-To-Retail Price Spread and Farm Sharein Food Supply Chains

Farm-to-retail price spread and farm sharein food supply chains

Background paper

Nga Nguyen, David Mobsbyand Tim Goesch

Research by the Australian Bureau of Agricultural
and Resource Economics and Sciences

Research report 16.5

December2016

© Commonwealth of Australia 2016

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Cataloguing data

Nguyen, N, Mobsby, D Goesch, T 2016, Farm-to-retail price spread and farm share in food supply chains: background paper, ABARES research report 16.5, Canberra, December. CC BY 3.0.

ISSN 1447-8358
ISBN 978-1-74323-294-1
ABARES project 43434

Internet

Farm-to-retail price spread and farm share in food supply chains: background paperis available at agriculture.gov.au/abares/publications.

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The Australian Government acting through the Department of Agriculture and Water Resources, represented by the Australian Bureau of Agricultural and Resource Economics and Sciences, has exercised due care and skill in preparing and compiling the information and data in this publication. Notwithstanding, the Department of Agriculture and Water Resources, ABARES, its employees and advisers disclaim all liability, including for negligence and for any loss, damage, injury, expense or cost incurred by any person as a result of accessing, using or relying upon information or data in this publication to the maximum extent permitted by law.

Acknowledgements

The authors thank USDA ERS Senior Economist Patrick Canning and Agriculture and Agri-Food Canada Senior Economist Ken Nakagawa for generously sharing information on the food dollar series research in their respective countries. The authors also appreciate the helpful comments on the report from ABARES acting Executive Director Peter Gooday.

Farm-to-retail price spread and farm share in food supply chainsABARES

Contents

Summary

1Introduction

2Economic linkages in the food supply chain

2.1 Food supply chain

2.2 Price transmission in the food supply chain

2.3 Farm value, farm share and price spread

2.4 Price spread and price transmission

2.4 Costs and margins in the food value chain

3International studies on price spread and farm share

3.1 United States

3.2 France

3.2 Netherlands

3.3 Finland

3.4 Canada

3.5 South Africa

4Price spread and farm share in Australia

4.1 Previous studies

4.2 Australian data availability and issues

5Further research

6Conclusion

Appendix A: Methodology of USDA ERS price spread series

A.1 Formulas

A.2 Conversion factors

A.3 Limitations

References

Tables

Table 1 Farm share of food expenditure for select foods, United States, 2000 to 2013

Table 2 Farm share for market baskets, United States, 2000 to 2013

Table 3 Food dollar value added by industry group and primary factor, United States, 2013

Table 4 Farm share for select foods, France, 2001 to 2014

Table 5 Farm share, South Africa, 2009 to 2013

Table 6 Data sources and limitations

Figures

Figure 1 Australia’s food supply chain

Figure 2 Price spread and price transmission along the food chain

Figure 3 Effects of increased consumer demand on the marketing margin (elastic supply)

Figure 4 Effects of increased consumer demand on the marketing margin (inelastic supply)

Figure 5 Marketing bill series (in 2014 dollars), United States, 1953 to 1997

Figure 6 Farm share for milk, cheese and ice cream, United States, 2001 to 2013

Figure 7 Food dollar series, United States, 1993 to 2013

Figure 8 Food euro, France, 1999 to 2011

Figure 9 Food price indexes, Netherlands, 2005 to 2015

Figure 10 Bread supply chain margins, Netherlands, 2005 to 2008

Figure 11 Farm share for select foods, Finland

Figure 12 Farm share for select commodities, Canada, 1981 and 2003

Figure 13 Farm share, all food, Canada, 1997 and 2010

Figure 14 Australian farmers’ terms of trade, 1974–75 to 2014–15

Figure 15 Shares of retail milk prices, 1997, 2000 and 2003

Figure 16 Shares of retail beef prices, 2003

Figure 17 Farm share of retail value

Figure 18 Producer shares of the retail dollar, March quarter 1998 to Sep quarter 2016

Boxes

Box 1 Definitions of farm share pricing concepts

Box 2 Perfect vertical price transmission and price spread

1

Farm-to-retail price spread and farm share in food supply chainsABARES

Summary

Similar to some other countries, farmers and consumers in Australia are concerned about diverging trends between farmgate and retail prices for food, and the potential for market concentration in the processing and retailing sectors to lead to higher retail prices and lower farmgate prices. Theseconcernswererecently reflected in the terms of reference for the Senate Committee on Ruraland Regional Affairs and Transport’s inquiry into the effect of market consolidation in the red meat processing sector on market competition and farm returns. Similar concerns have been raised in other countries.

The main objectives of this paper are to:

• review local and international experience in monitoring and analysing movements in farm and retail prices for food products
• outline a relatively simple methodology used by the United States Department of Agriculture Economic Research Service(USDA ERS) to monitor changes in farm shares and farm-to-retail price spreads for food products
• review the availability of price data within Australia’s food supply chains
• identify options for ongoing monitoring and analysis.

The review of international research found significant variation across countries in the importance they place on food price monitoring and analysis. Research has consistently found that the more processed food products are at the point of retail sale, the lower the farm share, and that farm shares have generally been declining over time.

The review also found that the USDA ERS is a world leader in analysing prices in food supply chains. In 1946 the US Government introduced legislation mandating that the United States Department of Agriculture (USDA) measure the cost of marketing US agricultural commodities following concerns over movements in food prices. The methodology developed by the USDA ERS to calculate farm share and farm-to-retail price spread is considered to be the benchmark for this type of analysis.

Farm-to-retail price spread and farm share of the retail price are high-level indicators of the cost structure of a food supply chain. Farm share is the proportion of farm value in the retail price of a food item purchased at a retail store. The farm-to-retail price spread is the difference between the retail price and farm value at a given point in time. The farm-to-retail price spread includes payments for value-added services beyond the farmgate that are needed to transform a raw product into a retail product. They include transport, processing and retailing costs. Movements in farm share and price spread are analysed because a decline in farm share or an increase in price spread could signify a change in the level of competition in one or more sectors of a food supply chain.

Few studies systematically analyse movements in farm share or price spread in Australia over the longterm. Despite this, some price data are available in Australia that could be used to estimate long-term trends in farm share and price spread. Although these data have some limitations, ABARES is currently investigating the potential to estimate farm share and price spread over longer periods by applying the USDA ERS methodology to Australian data, using the sugar and beef industries as examples.

One limitation of the high-level analysis undertaken in these type of studies is that many factors can lead to an increase in price spread (or a decline in farm share). For example, in addition to changes in relative market power along a food supply chain, an increase in farm-to-retail price spread could reflect productivity in the farm sector increasing at a faster rate than in the processing or retailing sectors, an increase in the price of inputs in the processing or retailing sectors or a change in consumer preferences that require more value-adding by processors or retailers.

Although monitoring changes in farm-to-retail price spreads may be useful, because a widening in spread could be an early indicator that competition issues are emerging within a supply chain, further research will always be needed to confirm whether this is the case.

Another option that could help identify whether market power is a problem is to collect data on costs and prices beyond the farmgate. This approach could allow an analysis that differentiates between sectors (for example, the processing and retail sectors), and identifies the range of factors influencing costs and prices within these sectors. It could also facilitate the estimation of profit margins in different sectors. However, the data required for this type of analysis arecommercially sensitive, likely to be difficult to obtain and expensive to collect and validate. Collecting this type of data may be possible and worthwhile following identification of a potential problem, but it is unlikely to be feasible for general ongoing monitoring and analysis.

A more realistic option may be to replicate another methodology developed by the USDA ERS, which uses input–output data to decompose costs and profits between different sectors within a supply chain and to estimate returns to primary factors, including capital and labour. This type of analysis would be more expensive than the high-level analysis described in this paper but it would also be more informative than the farm share/price spread analysis in identifying the range of factors influencing prices, and lead to a more informed debate about the various factors influencing prices, including market power. It would also allow a more detailed analysis of the cost factors influencing the competitiveness of Australia’s food exports. If the methodology implemented was consistent with that used by the USDA ERS, it would allow comparisons with the United States and other countries adopting this methodology, including France and Canada.

1Introduction

Concerns about diverging trends in prices received by farmers and retailers in Australia’s food supply chains have generated interest in the connection between farm commodity prices and retail food prices. Prices are a common factor linking raw farm commodities through the various stages of the supply chain to the retail food product.

Price transmission is a major indicator of efficiency, effectiveness and degree of competition within supply chains. If all markets along the supply chain are perfectly competitive, a price change in one sector of the supply chain should be transmitted to other sectors in the supply chain. Although there may be short-term deviations, because of price levelling practices or use of inventory, sustained changes would be expected to be fully reflected in other sectors.

The main reason policymakers are interested in farm commodity and retail price trends is because a change in trend could signify a change in degree of competition in one or more sectors in the food chain. An important role for government is to implement institutional arrangements that lead to efficient markets. Markets can fail when businesses dominating a market inflate output prices or suppress input prices. Given that most farmers are price-takers, an increase in market concentration in the retail or processing sectors could result in farmers receiving lower prices than would occur in a perfectly competitive market. It could also lead to higher retail prices.In Australia, there is significant interest in whether consolidation in the food processing sector could lead to farmers receiving lower prices.

One of the objectives of this background paper is to review local and international experience in monitoring food prices and analysing movements in farm and retail prices for food products. Specifically, movements in farm-to-retail price spread and the farm share of the retail price are discussed. Price spread and farm share are high-level indicators of the cost structure of the food supply chain. The retail price is divided into the value of farm inputs used to produce the retail food item and the marketing bills. For farm inputs, if it takes two units of a raw commodity to produce one unit of a retail food product, the price analysis takes this into account. Marketing bills are payments for value-added services beyond the farm gate that are needed to transform the raw product into a retail product. They include transport, processing and retailing costs.

Identifying inefficiency within food supply chains as a result of an increase in market power in one or more sectors is more complex than identifying an increase in price spread or a reduction in farm share. These changes can occur for a number of reasons. For example, an increase in the price spread could occur because of changes in consumer preferences, requiring retail products to be more highly processed. They could also be the result of an increase in off-farm input costs, such as energy or labour costs, or an increase in productivity in the farming sector relative to the processing or retail sectors.

The methodology used by the United States Department of Agriculture Economic Research Service (USDA ERS) to monitor changes in price spread and farm share is outlined in this paper. The discussionpresented in this paper and the analysis in subsequent industry reportsis based largely on the USDA ERS methodology. Applying this methodology to Australian datacould alert policymakers to competition issues in one or more sectors within Australia’s food supply chains. However, the nature and complexity of markets within supply chains suggest that additional analysis would be needed to confirm whether any participant in the supply chain is exerting market power.

Issues relating to price data within Australia’s food supply chains are also discussed. Calculating farm-to-retail price spread and farm sharestatistics requires access to a range of data. The main publicly available sources of data are the Australian Bureau of Statistics (ABS) and the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES). The ABS collects data on retail food prices and local value and volume of production for agricultural commoditieswhileABARES collects farm-level data for some commoditiesvia farm surveys.Scanner data and shoppers’ panel data can also be used to estimateretail prices but these datacan be costly and access and use can be restricted.

Unfortunately, there is generally a lack of data that will allow a breakdown in marketing costs and facilitate analyses of farm to processing or processing to retailing price spreads. Access to this type of data would help identify the use of market power. However, confidentiality agreements between processors and major retailers are likely to preclude collection of this type of data.

Another potentially rich source of data is input–output data. The USDA ERS has developed a methodology that uses input–output data to decompose costs and profits between different sectors within a supply chain, and to estimate returns to primary factors, including capital and labour. The ABS releases input–output tables every few years detailing the supply and use of products in the Australian economy. This type of analysis would be more expensive than the high-level analysis described in this paper but it would also be more informative in helping identify market power in food supply chains. It would also have the additional benefit of identifying factors influencing the competitiveness of Australia’s food exports.

Chapter 2 of this paper containssome background information on the economic linkages in the food supply chain and the relevance of farm-to-retail price spread and farm share. In Chapter 3, a review of international studies on price spread and farm share is provided. In particular, the findings on price spread and farm share of food products in the United States, France, the Netherlands, Canada, Finland and South Africa are discussed. Chapter 4 includes a review of previous studies in Australia on food prices,discusses data availability and identifies issues associated with using existing data for analysing long-term price spread and farm share for food. Some options for further research are identified in Chapter5 and Chapter 6 contains some concluding comments.

2Economic linkages in the food supply chain

2.1 Food supply chain

Food supply chainscan be highly complex. Figure 1 represents an indicative supply chain within the food system (DAFF 2012). It starts at the farm, which produces agricultural commodities that are used by processors to manufacture retail fooditems that arethen distributed to consumers via retailers or exporters.

Figure 1 Australia’s food supply chain

Source: Adapted from DAFF 2012

The supply chainillustrated in Figure 1covers the main components of supply chains for retail food items found in grocery outlets. Depending on the food item, some or all of the processes are required. Some food items bound for export (such as wheat) are only lightly processed in Australia, undergoing further processing overseas. Others targeted for domestic consumption (such as fresh bread) involve a high level of processing within Australia. Transport is an important component ofsome food supply chains.