List of Research Reports, Papers and Articles

Annotated Bibliography on Marketing Margins for Agricultural and Food Products with Emphasis on Specialty Crops

June 2012

Prepared by John Bovay

This research was funded by California Department of Food and Agriculture, Specialty Crop Block Grant Program (SCBGP) Grant CFDA# 10.170: “Measuring and Understanding the Pattern of Margins between Farm and Retail Prices for California Specialty Crops to Increase Growers Returns”

List of research Reports, Papers and Articles

Frederick V. Waugh, 1934. “Margins in Marketing.” Journal of Farm Economics, Vol. 16, No. 2, pp. 233-245.

In one of the first papers on the topic, Waugh discussed the measurement of marketing margins and the changes in margins over time. He suggested that the study of efficiency in marketing may be even more important than the study of production efficiency, and that the problem might require a dynamic explanation, a precedent for Wohlgenant (1985). He noted problems in gathering data, e.g., that the heterogeneity in cuts of beef and in dairy products makes determination of the farm-retail spread for beef and milk difficult. He also dealt with the regulation of marketing, writing that any regulatory limitation of competition should result in lower consumer prices, higher producer prices, or both.

Bruce L. Gardner, 1975. “The Farm-Retail Price Spread in a Competitive Food Industry.” American Journal of Agricultural Economics, Vol. 57, No. 3, pp. 399-409.

In his paper on the farm-retail price spread in a competitive industry, Bruce Gardner developed a model to explain equilibria observed in the retail food, farm output, and marketing sectors. The primary focus of the paper is how the price spread responds to shifts in demand, farm supply, or the demand or supply of marketing inputs. He noted the importance of substitution within the marketing sector, which implies in a change of prices for both farm inputs and non-farm inputs when demand for food increases or supply of farm inputs increases. His conclusions are broad: no simple markup pricing rule can accurately represent the farm-retail price spread, because shifts may occur in any of the three sectors. He showed that (a) the effect of demand shifts on the retail-farm price ratio depends on the relative elasticity of supply of farm products and marketing inputs; (b) increased supply of farm products increases the ratio; (c) increased supply of marketing inputs decreases the ratio. He also derived results regarding the response of the price ratio to price ceilings and floors, and results that depend on the value of the elasticities of farm and retail demand and on the elasticity of substitution.

Dale M. Heien, 1980. “Markup Pricing in a Dynamic Model of the Food Industry.”American Journal of Agricultural Economics, Vol. 62, No. 1, pp. 10-18.

Developed a dynamic model of farm and retail pricing.Tested the hypothesis that price changes are transmitted from wholesale-to-retail using 24 commodities. Among produce commodities, the results supported the hypothesis for oranges, frozen orange juice, potatoes, and frozen French fries; the results suggested bidirectional causality for fresh orange juice and canned tomatoes; and they suggested independence between wholesale and retail prices for eggs, apples, tomatoes, and lettuce.

Ronald W. Ward, 1982. “Asymmetry in Retail, Wholesale, and Shipping Point Pricing for Fresh Vegetables.”American Journal of Agricultural Economics, Vol. 64, No. 2, pp. 205-212.

Analyzed price linkages in fresh vegetables between retail, wholesale, and shipping point.Tested the hypothesis that there should be strong linkages between the three points, because fresh vegetables require minimal processing. He found that both retail and shipping point prices generally lagged wholesale prices, and offered the hypothesis that wholesale markets were more concentrated as the explanation. Further, he tested for asymmetry in price transmission from wholesale to retail and shipping point and found that retail prices tended to respond more quickly to wholesale price increases than to decreases. (The asymmetry was observed in celery, cabbage, corn, green peppers, potatoes, and tomatoes, while symmetry was observed only in carrots and cucumbers.) Finally, he found that the farm-retail price spread had widened over time.

Michael K. Wohlgenant, 1985. “Competitive Storage, Rational Expectations, and Short- Run Food Price Determination.” American Journal of Agricultural Economics, Vol. 67, No.4, pp. 739-748.

To explain farm-retail price spreads and price stickiness for food commodities, Wohlgenantdeveloped a dynamic model in which producers derive price expectations according to the rational expectations hypothesis, and applied the model to estimate the implications of inventories on price spreads. In this model, the short-run market rental rate depends on anticipated gains or losses from holding inventories; that is, on the next period’s expected retail prices. Inventory costs consist of both (1) the physical costs of holding inventory, which increase with inventory; and (2) the costs of set-up and stocking out, which decline as inventory rises, for a given sales rate. Producers maximize the expected present discounted value of net revenue. He concluded that the estimating equation for retail price depends on the nature of the stochastic process by which next period’s wholesale price is determined. He also noted that by including overidentifying restrictions in his model, he could test the rational expectations hypothesis, and disentangle the effects of realized price from the effects of realized price on farm-retail price spreads.

Michael K. Wohlgenant and John D. Mullen, 1987. “Modeling the Farm-Retail Price Spread for Beef.” Western Journal of Agricultural Economics, Vol. 12, No. 2, pp. 119-125.

The authors used a relative price spread model, in which the price spread is calculated only relative to the industry output price and marketing input price, both deflated by the retail price. As Gardner (1975) noted, the common approach is to assume that price spread is determined as a combination of proportional and absolute markups, but this only works if shocks affect either supply or demand, and not both simultaneously. Wohlgenant andMullen tested the relative price spread model using an application to beef, and showed that it performed better, empirically, than the common markup approach.

J.S. Shonkwiler and T.G. Taylor, 1988. “Food Processor Price Behavior: Firm-Level Evidence of Sticky Prices.” American Journal of Agricultural Economics, Vol. 70, No. 2, pp. 239-244.

Used an empirical friction model to show that the indirect costs of changing prices, for a major processor of frozen, concentrated orange juice, caused price rigidity. Found that prices are equally rigid in response to increases and decreases in indirect costs.

Michael K. Wohlgenant, 1989. “Demand for Farm Output in a Complete System of Demand Functions.” American Journal of Agricultural Economics, Vol. 71, No. 2, pp. 241-252.

Developed a new conceptual and empirical framework on retail-to-farm demand linkages. He showed that, except for fresh fruit, increases in retail demand are positively related to both retail and farm prices. These results are consistent with constant-returns-to-scale production technology. For two categories, (1) fresh fruits and (2) processed fruits and vegetables, he argued that the empirical results likely do not match the model prediction because of problems in aggregating such heterogeneous products into a single commodity. Even if Wohlgenant had obtained reliable results for fruits and vegetables, we would want disaggregated results for fruit and vegetables to use in any study focused on the price-retail spread of fruits and vegetables.

Daniel H. Pick, Jeffrey Karrenbrock, and Hoy F. Carman, 1990.“Price Asymmetry and Marketing Margin Behavior: An Example for California—Arizona Citrus.”Agribusiness, Vol. 6, No. 1, pp. 75-84.

Estimated the extent and timing of retail price changes for lemons and Navel oranges in response to changes in FOB price.Also estimated changes in marketing margins, which the authors expected to increase in response to increases in FOB price.Employed a method similar to Heien (1980) and Ward (1982). First, they determined that for lemons, the retail price was more volatile than the FOB price; however, there was no similar relationship that held for oranges across all four markets studied. For lemons, the authors found that retail markets responded more to FOB increases than decreases in two of the four markets, and could not reject symmetric response in the other two markets. For oranges, three markets showed asymmetric responses to FOB price increases and one showed a symmetric response. About one of the four markets (depending on the test) showed the expected response of marketing margins to FOB price changes. Finally, they conclude that there was a direct relationship between responsiveness of retail price to FOB price changes and responsiveness of marketing margins to FOB price changes.

Garth J. Holloway, 1991. “The Farm-Retail Price Spread in an Imperfectly Competitive Food Industry.” American Journal of Agricultural Economics, Vol. 73, No. 4, pp. 979-989.

Used the model of Gardner (1975) to test for perfect competition in food industries. He failed to reject the hypothesis that food marketing sectors, including eggs, fresh fruits, fresh vegetables, and processed fruits and vegetables, are perfectly competitive on the basis of the price spreads in those industries.

Henry W. Kinnucan and Robert G. Nelson, 1993. “Vertical Control and the Farm-Retail Price Spread for Eggs.” Review of Agricultural Economics, Vol. 15, No. 3, pp. 473-482.

Examined whether increased vertical control in the egg industry hurts welfare, because market power enables price markups, or helps welfare through increased farm-to-retail co- ordination (i.e., efficiency in the marketing sector). Over the period 1973-1983,the farm-retail price spread decreased by 42% as vertical control—contracts and vertical integration—increased. Using OLS and modeling production technology as constant-returns-to-scale, the authors found a highly significant negative relationship between price spread and vertical control, and concluded that vertical control improves welfare because of improved coordination. This is in the context of a product with fixed-proportions technology, with very little processing between farmgate and retail. They estimated that 58% of the decrease in price spread is attributable to increased vertical control. Thus, their result is consistent with the results of Holloway (1991): vertical control is not anti-competitive. They do not use any variation in quality (considering only large Grade A eggs); but they do use variation in seasonality on a quarterly basis.

Oral Capps, Jr., Patrick J. Byrne, and Gary W. Williams, 1995. “Analysis of Marketing Margins in the U.S. Lamb Industry.” Agricultural and Resource Economics Review, Vol. 24, Issue 2, pp. 232-240.

Showed that in the lamb industry, increases in packer market power (as measured by the four-firm concentration index) had a positive effect on farm-retail price spreads. Augmented the relative price spread method of Wohlgenantand Mullen (1987).

Nicholas J. Powers, 1995. “Sticky Short-Run Prices and Vertical Pricing: Evidence from the Market for Iceberg Lettuce.” Agribusiness, Vol. 11, No. 1, pp. 57-75.

Used the approach of Heien (1980) to examine the transmission of price changes in California iceberg lettuce, from farmgate to wholesale to retail. Found that the response of wholesale prices to FOB prices was symmetric (to increases and decreases), that the price changes fully passed through, and responses were also symmetric to trucking cost changes. Found that retail prices responded more slowly to wholesale price changes than wholesale prices responded to FOB price changes. Retail prices responded at least as fast, and with greater magnitude, to increases in wholesale prices than to decreases, but the price changes exhibited only partial pass-through. Finally, the author simulated the effects of offering constant FOB price for a month, and found that the consumer price should be lower under such a buyer policy.

Richard J. Sexton and Mingxia Zhang, 1996. “A Model of Price Determination for Fresh Produce with Application to California Iceberg Lettuce.” American Journal of Agricultural Economics, Vol. 78, No. 4, pp. 924-934.

Modeled the short-run determination of farm prices for fresh produce that has in- elastic short-run supply, with an empirical application to the iceberg lettuce industry in California. They characterize the industry as one in which there is imperfect competition in procurement, meaning that supply and demand do not determine a unique price and that monopsonistic buyers may extract surplus. They employed a switching regression frame- work, in which wholesale price is set equal to harvest cost at some times, and set above harvest cost at some value depending on the bargaining power of buyers. Under perfect competition, farmers would receive all existing rents, and Sexton and Zhang tested the null hypothesis that farmers’ bargaining power was inversely related to the volume of lettuce on the market. They rejected both the hypotheses that the wholesale market was perfectly competitive and that it is collusive; they found that, 30% of the time, the crop was sold at the harvest cost, and that the remainder of the time, the crop was sold at a marked-up price.

Michael K. Wohlgenant, 2001. “Marketing Margins: Empirical Analysis.” Chapter 16 in Handbook of Agricultural Economics, Volume 1. B. Gardner and G. Rausser, eds. Elsevier Science B.V.

In this Handbook chapter, Wohlgenant wrote that marketing margins have attracted much public scrutiny, but little consensus. Among the questions commonly asked are: Are they too large? How have they changed? What variation is systematically explicable? How do they relate to market power? What is the incidence of marketing costs on retail and farm prices? What is the transmission for shocks to marketing costs to reach retail and farm prices? Does the concentration of middlemen help or hurt farmers? In the chapter, Wohlgenant addressed determinants of marketing margins, and modeling them in the context of fixed and variable proportions and markup pricing, concluding that none of these modeling approaches works perfectly. He also discussed lags in food price determination, with particular attention to the model of Wohlgenant (1985) in which any direction of changes in price spreads is theoretically possible.

Timothy J. Richards and Paul M. Patterson, 2003. “Competition in Fresh Produce Markets: An Empirical Analysis of Marketing Channel Performance.” USDA-ERS Contractor and Cooperator Report No. 1.

This paper analyzed retailers’ ability to set noncompetitive prices in fresh apples, table grapes, fresh California oranges, and Florida grapefruits. Similar to Sexton and Zhang (1996), this analysis employed a switching regression framework. They showed that retail prices for semi-perishable fresh produce are mostly determined at the shipping point; that retail prices respond more rapidly to wholesale price increases than to decreases; and that retail prices are fixed relative to shipper prices, indicating that retailers possess bargaining power and control over prices. They also found evidence of tacit collusion, using an econometric specification developed by Green and Porter (1984). Their tests showed that retailers exhibit market power in both buying and selling of fresh apples and grapefruit, and market power in the sale of fresh oranges. Finally, they showed that retailer power falls as the quantity of commodity sold increases.

Richard Sexton, Mingxia Zhang, and James Chalfant, 2003. “Grocery Retailer Behavior in the Procurement and Sale of Perishable Fresh Produce.” USDA-ERS Contractor and Cooperator Report No. 2.

In this publication, the authors applied the model of Sexton and Zhang (1996) to new industries, tested for changes in farm-retail spread as a function of production volume and shipping costs, and tested for any overall trends in farm-retail spread in these industries. Under perfect competition, the variations in the spread would be fully explained by variations in sellers’ marginal cost. Under competition, an increase in volume should decrease the farm-retail spread, if an increased volume gives sellers more bargaining power. On the other hand, if the spread increases as a function of volume, then buyers are acting as oligopsonists. They conclude that, in the California and Arizona iceberg lettuce and fresh tomato industries, there is strong evidence that increases in marketed volume increase the farm-retail price spread, and that, in Florida, a high degree of industry coordination helps protect mature-green tomato growers from price fluctuations. Further, they found that retail chains tended to stabilize retail prices, a strategy that reduces total surplusand therefore farm-sector income. Inelastic demands for produce, driven partly because consumers are unwilling to shop at multiple grocery stores, enables retail markups over marginal cost, and harms upstream producer welfare. Finally, they find that there is no consistent relationship between the prices of bagged iceberg salads and the farmgate price of iceberg lettuce.

Julian M. Alston, Daniel A. Sumner, and Stephen A. Vosti, 2006. “Are Agricultural Policies Making Us Fat? Likely Links between Agricultural Policies and Human Nutrition and Obesity, and Their Policy Implications.” Review of Agricultural Economics Vol. 28, No. 3, pp. 313–322.