Cal-Med Sonoma Workshop

October 25, 2007

Richard J. Sexton

Producer Collective Action inCalifornia Agriculture

What are the key trends affecting Agricultural markets? What are the key trends affecting Agricultural markets?

Consolidation across the market chain in most industries

Emergence of a few major retailers as the dominant power players in the food chain

Increasing vertical coordination across market stages

A mature domestic food industry and slow population growth mean that the potential for sales and revenue growth is through the provision of quality and variety to U.S. consumers

Decreasing trade barriers; international markets for many commodities

Consolidation across the market chain in most industries

Emergence of a few major retailers as the dominant power players in the food chain

Increasing vertical coordination across market stages

A mature domestic food industry and slow population growth mean that the potential for sales and revenue growth is through the provision of quality and variety to U.S. consumers

Decreasing trade barriers; international markets for many commodities

What are the key attributes of food that U.S. consumers demand?What are the key attributes of food that U.S. consumers demand?

Quality—in terms of physical product attributes

Quality—in terms of environmental and related attributes of food: sustainability of production practices, treatment of animals, locally grown.

Variety

Consistency, both in terms of availability year around and quality

Convenience—one stop shopping, easy-to-use foods

Quality—in terms of physical product attributes

Quality—in terms of environmental and related attributes of food: sustainability of production practices, treatment of animals, locally grown.

Variety

Consistency, both in terms of availability year around and quality

Convenience—one stop shopping, easy-to-use foods

What are the key attributes that U.S. food retailers demand from suppliers?What are the key attributes that U.S. food retailers demand from suppliers?

Provide products on a consistent basis and provide consistent quality.

Provide services to the retailer such as category management.

Provide products across an entire product category

Source products year around

Provide products on a consistent basis and provide consistent quality.

Provide services to the retailer such as category management.

Provide products across an entire product category

Source products year around

Issues emerging from these key trends

Market power is important throughout the food chain. Vertical control can enhance market efficiency, but it

might also exacerbate market power imbalances. Producers and marketers seek to differentiate

products to benefit from market’s demand for quality and variety.

How to deal with international competitors in the absence of explicit trade barriers?

Successful producers and food marketers will be those who can:Successful producers and food marketers will be those who can:

Satisfy consumers’ demands for quality, variety, consistency, convenience, etc.

Meet the demands retailers’ impose upon their suppliers.

Acquire sufficient power to at least countervail the power of downstream buyers

Satisfy consumers’ demands for quality, variety, consistency, convenience, etc.

Meet the demands retailers’ impose upon their suppliers.

Acquire sufficient power to at least countervail the power of downstream buyers

Implications of key market trends for producer collective action

Are traditional methods for producers to exercise collective action in the U.S. becoming more or less important in modern agricultural markets?

Do the tools of collective action—mostly set in place in the Depression era or before—need to be revised and updated to fit modern agricultural markets?

Foundations for collective action in U.S. agriculture

Capper-Volstead Act (1922) enables farmers to undertake joint marketing activities through cooperatives without violating antitrust laws.

Ag Marketing Agreement Act (AMAA 1937) enables industries to act jointly in several dimensions of marketing.

Similar legislation to AMAA was enacted by most states around this same time.

AMAA Amendment (1954): Section 8e requires imports to comply with the same standards and regulations that domestic producers face.

Role of cooperatives in a market-oriented economyRole of cooperatives in a market-oriented economy

A cooperative represents horizontal coordination to achieve mutual vertical integration, upstream (supply or purchasing cooperatives) or downstream (marketing cooperatives).

To understand the circumstances when cooperatives can benefit producers in agriculture, we must understand

– situations when producers have an incentive to undertake upstream or downstream vertical integration, and

– when they have incentive to undertake such integration jointly rather than unilaterally.

A cooperative represents horizontal coordination to achieve mutual vertical integration, upstream (supply or purchasing cooperatives) or downstream (marketing cooperatives).

To understand the circumstances when cooperatives can benefit producers in agriculture, we must understand

– situations when producers have an incentive to undertake upstream or downstream vertical integration, and

– when they have incentive to undertake such integration jointly rather than unilaterally.

How does this economic rationale fit into today’s markets?

The coordination advantages of vertical integration are increasingly important, but can be accomplished through other means of vertical control, such as contracts.

Producers are large enough in many CA industries to integrate downstream unilaterally—e.g., grower-shippers of fresh produce, large nut growers who perform hulling and export operations.

However, harmonization of interests obtained in a vertically integrated chain may be increasingly important, given the power of downstream buyers.

But cooperatives face disadvantages in today’s agricultural marketsBut cooperatives face disadvantages in today’s agricultural markets

Traditional cooperatives that provide a ‘home’ to member production lose the power to control supply and influence price.

Cooperatives that market a single product face disadvantages relative to suppliers who can fill an entire product category.

Traditional cooperatives that provide a ‘home’ to member production lose the power to control supply and influence price.

Cooperatives that market a single product face disadvantages relative to suppliers who can fill an entire product category.

Co-ops also face disadvantages in the quality and value-added dimensions Co-ops also face disadvantages in the quality and value-added dimensions

Investments in advertising, R&D, branding, product innovation, etc. are all long-term capital investments.

The horizon problem limits cooperatives’ ability to generate capital to undertake this type of investment.

– Members typically push the cooperative to maximize the current payout, thus limiting the funds held back for capital investments.

Cooperatives may be unwilling to terminate “marginal” members.

Investments in advertising, R&D, branding, product innovation, etc. are all long-term capital investments.

The horizon problem limits cooperatives’ ability to generate capital to undertake this type of investment.

– Members typically push the cooperative to maximize the current payout, thus limiting the funds held back for capital investments.

Cooperatives may be unwilling to terminate “marginal” members.

More co-op disadvantagesMore co-op disadvantages

Producers want the opportunity to capture the benefits from successful investments, which in a traditional cooperative can be accomplished only indirectly through patronage.

– Conversion to IOF may be the only way to “unlock” equity.

Cooperatives’ pooling methods commonly fail to adequately reward quality and value and consequently cause an adverse selection problem that investor-owned firms normally won’t face.

In many industries producers want to compete, not cooperate, with each other—cooperatives encourage homogeneity when heterogeneity is demanded in the market.

Producers want the opportunity to capture the benefits from successful investments, which in a traditional cooperative can be accomplished only indirectly through patronage.

– Conversion to IOF may be the only way to “unlock” equity.

Cooperatives’ pooling methods commonly fail to adequately reward quality and value and consequently cause an adverse selection problem that investor-owned firms normally won’t face.

In many industries producers want to compete, not cooperate, with each other—cooperatives encourage homogeneity when heterogeneity is demanded in the market.

Tri Valley Growers Member Equity, FY1969/70-1999/2000

(200,000,000)

(150,000,000)

(100,000,000)

(50,000,000)

0

50,000,000

100,000,000

150,000,000

200,000,000

250,000,000

69/70 71/72 73/74 75/76 77/78 79/80 81/82 83/84 85/86 87/88 89/90 91/92 93/94 95/96 97/98 99/00

Fiscal Year

Va

lue

($

)

Equity Pool Fund Credits Capital Stock Allocated Pool Loss Retained Earnings

Tri Valley Growers' Peach Pool Performance: Returns to Members As a Percentage of Established Price, 1983-1996

80.0

90.0

100.0

110.0

120.0

130.0

140.0

150.0

160.0

170.0

83 84 85 86 87 88 89 90 91 92 93 94 95 96

Pool Year

Pool Return (% of Established Price)

Independent Pool 50/50 Pool Established Price

“Innovations” in cooperative structure“Innovations” in cooperative structure

New generation cooperatives

– Closed membership

– Delivery rights are tied to stock equity contributions

– Equity shares (delivery rights) are tradable

– Members are contractually obligated to deliver to the cooperative

New generation cooperatives

– Closed membership

– Delivery rights are tied to stock equity contributions

– Equity shares (delivery rights) are tradable

– Members are contractually obligated to deliver to the cooperative

Potential advantages of new-generation structurePotential advantages of new-generation structure

An incentive is provided to contribute equity by tying delivery rights to equity—overcome free rider problem.

Members can benefit from appreciation in the value of the cooperative—overcome horizon problem, but

– rights have no value unless the co-op outperforms the rest of the market, and

– equity markets will always be thin because buyers of equity must also be producers.

Delivery obligation insures stable sources of supplies and member loyalty. Prevents defections during “good times”.

An incentive is provided to contribute equity by tying delivery rights to equity—overcome free rider problem.

Members can benefit from appreciation in the value of the cooperative—overcome horizon problem, but

– rights have no value unless the co-op outperforms the rest of the market, and

– equity markets will always be thin because buyers of equity must also be producers.

Delivery obligation insures stable sources of supplies and member loyalty. Prevents defections during “good times”.

Innovations in co-op structure…

“Information-sharing” cooperatives– Legal shells that enable growers and grower-shippers to

collude with Capper-Volstead protection.– Have existed in California since around 1970.

Other “limited liability” corporations try to merge ideas of cooperatives with concepts from partnerships and S corporations

– Enable producers to capture appreciation in value of collective enterprise.

What has happened to major co-ops in California?

Co-op Product(s) What has happened?

Blue Anchor Fresh fruits Out of business

Calavo Avocados Converted to IOF

Blue Diamond Almonds Going strong, but share has fallen by half

Diamond Walnut Walnuts Converted to IOF

Lindsay Olives Olives Sold out to IOF Bell-Carter

Pacific Coast Producers Pears, tomatoes Going strong

Rice Growers Association Rice Out of business

Sunkist Citrus Going strong but lost largest member in Paramount Farms

SunMaid Raisins Still in business

Sunsweet Prunes Still in business

Tri Valley Growers Peaches, pears, tomatoes Bankrupt in 2000

What is the future of California cooperatives?

Although incumbent marketing cooperatives may carry on, the era of large-scale, capital-intensive processing cooperatives is mostly over.

New co-ops will be low-investment, limited-purpose supply or marketing cooperatives that exploit legal advantages or particular market niches, such as information-sharing, collusion, bargaining, economies of large-scale purchases.

These new co-ops will impinge little on the autonomy of their members.

Self governance through mandatory marketing programs

Over half of CA ag production takes place under the auspices of one or more mandatory marketing programs

CDFA website lists 57 active state programs USDA AMS website lists 12 active federal programs

for CA commodities Total assessments in CA to support marketing

programs were $227 million in 2004-05.

Importance of marketing programs by industry sector

Percent of total value of production with one or more marketing programs:– Field crops 16.1%– Fruits and nuts 96.6%– Vegetables 55.6%– Animal products 81.9%– Nursery and floral products 8.3%

Key features of federal and state mandatory marketing programs

Industry initiative, with approval by supermajority vote Once approved, regulations are mandatory on entire industry. Termination upon industry request (50% of producers with 50%

of volume)—review and re-authorization every 5 years for CA programs.

Nominal supervision by U.S. or CA Ag Departments Finance by assessments on growers and/or handlers—state

orders impose max 2.5% for administration, 4% for advertising and promotion

Decision making by elected industry boards

Major authorized activities

Generic advertising and promotion Minimum quality standards Supply management or volume control Production, processing, and market research

Incidence of authorized activities

State orders– Promotion: 36 active programs, $121 million exp.– Research: 40 active programs--$21 million exp.– Quality standards & inspection: 8 active programs

Federal orders– Size and grade: 11 active programs– Advertising: 6 active programs--$25 million exp.– Research: 10 active programs– Volume control: 4 “active” programs, but only used for

raisins in recent years.

Commodity promotion programs

Arguments in favor– Agricultural commodities are fundamentally undifferentiated

products.– Promotions by individual growers and/or handlers will

benefit the entire industry.– Due to this free-rider problem, advertising will be

underprovided relative to amount that maximizes joint producer profits unless it is conducted jointly through a mandatory program that internalizes all benefits.

– Many economic studies of program effectiveness have found high benefit-cost ratios in the range of 4:1 – 10:1.

Commodity promotion programs

Arguments against– In modern agriculture, growers and handlers can and do

differentiate their products.– Generic advertisements that convey the message that all products

are the same undermine efforts of growers/handlers to differentiate their products.

– Reducing product differentiation enhances price competition and reduces industry profits.

– Mandatory programs unreasonably encroach on individual rights, such as free-speech rights.

– Economic studies have failed to investigate programs’ impacts on product differentiation.

Minimum Quality Standards (MQS)

Minimum size or grade Minimum sugar content Maturity requirements Freshness requirements

Economic arguments regarding MQS

MQS address an adverse selection problem– MQS will raise average quality on the market and cause

higher demand.– MQS can benefit both producers and consumers in this

setting.– MQS could be a valuable tool in responding to market’s

demand for quality.

But many of the MQS regulations would appear not to pertain to information problems.

Economic arguments regarding MQS...

MQS represent a “hidden” form of volume control– Traditional argument is that MQS simply removes

edible product in a less overt form than direct volume control.

– A more nuanced understanding is that a MQS eliminates ability of consumers to substitute between “low-quality” and “high-quality” product, removing a self-selection constraint on pricing.

Economic arguments regarding MQS...

MQS may be used as a nontariff trade barrier because domestic standards can be imposed on imports under section 8e

– Domestic industries choose whether to impose a MQS and which attributes to regulate.

– MQS can perform a raising-rivals-costs role in these settings.

– This type of MQS complies with all trade regulations and may have increasing importance in free-trade environment.

Supply management or volume control

Total volume regulations Spatial allocation to alternative market outlets

—third degree price discrimination Temporal flow to market—intertemporal

discrimination

Issues in supply management/volume control

Although volume controls can raise producer income in the short run when demand is inelastic, domestic industries cannot prevent entry or free riding by outside producers.

Volume regulations tend to become more onerous over time, causing incentives to cheat—citrus and raisin orders are classic examples.

USDA seems to have little interest in approving new volume-control programs.

Research

Economic rationale is also a free-rider argument surrounding research benefits that are non-appropriable.

Supply-expanding production research may diminish producer returns in the short run.

Market-failure argument in favor of production research is weakened in today’s markets—many innovations are patentable.

Innovations are in the area of research into product attributes, especially health-enhancing attributes

– California Walnut, Avocado, and Strawberry Commissions have funded health and nutrition research and built promotion programs to publicize favorable research outcomes.

What is the future for mandatory marketing programs in California?

These programs do not seem to be in decline; existing programs are usually re-authorized; some new programs have been created recently.

– Leafy Green Commission established in 2007 to deal with safety practices and traceability

– Plum and Tree-Fruit orders have added trace back provisions

Promotion programs will continue but with greater sensitivity to not counteract messages individual marketers are sending

– An example is industry advertising of health benefits, which should complement advertising by individual marketers.

Future for California mandatory marketing programs . . .

Research programs will emphasize health and nutrition aspects of the product and de-emphasize production research.

Quality regulations will focus on food safety, traceability, and environmental issues, and will be designed to benefit the domestic industry when imports are important.

Direct volume regulation will be used in only a few industries.

Conclusions

Collective action remains a valuable tool for California producers to utilize in responding to the major forces shaping agricultural markets.

The form of collective action is changing and will continue to change in response to market conditions.

Fewer large-scale, capital-intensive marketing cooperatives

More small-scale, low-investment, single-purpose cooperatives.

Conclusions . . .

Mandatory marketing programs will continue to play a role in industries comprising the majority of California’s agricultural production.

The types of activities undertaken will continue to change.

– Activities that restrict producers’ ability to freely produce and market their products will wane.

– Activities that complement these efforts and address spillovers will flourish.