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MARKETING TODAY AND

YESTERDAY LESSON 2

FOOD PRODUCTS MARKETING

AGRIBUSINESS MANAGEMENT 302

SCOTT COLBY

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Who Cares About Food Marketing?

Because of food’s unique characteristics and importance, more parties are concerned with food

marketing than, say, Blu-Ray player marketing. These parties include

1. Businesses In 2012, U.S. consumers spent more than $1.5 trillion on food and beverage.1

This sum is, in effect, distributed to all firms involved in adding value to food products.

Interested business parties include agricultural input suppliers, farmers, commodity

brokers and agents, processors, wholesalers, distributors, retailers, restaurants, and ad

agencies. All these parties apply food marketing.

2. Policy Makers include both government agencies as well as public health organizations.

Preventable diet-induced chronic health diseases have reached epidemic proportions.

Figure I

Source: Danaei, G., Ding, E. L., Mozaffarian, D., Taylor, B., Rehm, J., Murray, C. J., & Ezzati, M. (2009).

The preventable causes of death in the United States: comparative risk assessment of dietary, lifestyle, and

metabolic risk factors. PLoS medicine, 6(4), 365.

1 “Food Expenditures Table 1—Food and alcoholic beverages: Total Expenditures,” Economic Research Service,

2013.

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A staggering 1 in 3 children will develop diabetes in their lifetime and that number goes

up to 1 in 2 for underprivileged urban youths (CDC, 2010). For the first time in

American history, the life-expectancy of children is less than that of their parents,

primarily due to food choices.

There are some potential early signs that this trend is being reversed. Fourteen percent of

2-5 year olds were obese in 2003-2004, but by 2011-2012 the rate had declined to 8%.2

Obesity rates of this young age group have historically been good predictors of adult

obesity rates and related health outcomes.

While it is difficult to explain why this important obesity rate has declined, surely policy

makers have had a hand. For example, the USDA3 run WIC

4 program strongly

influences the health and well-being of this group by supplying nutritious foods to

pregnant and postpartum women, and children up to age five. 53% of infants born

benefit from WIC5. However, as the adage goes, “You can lead a horse to water, but you

can’t make him drink.” For this reason, food marketing techniques are increasingly being

used to make effective public policy.

From 2007 to 2009, marketing scientist Brian Wansink was the Executive Director of

USDA's Center for Nutrition Policy and Promotion, the Federal agency in charge of

developing the 2010 Dietary Guidelines and promoting the Food Guide Pyramid

(MyPyramid.gov). He and other academic and industry food marketing scientists

continue to play an increasingly large role in crafting the recommendations of public

health institutions such as the National Institute of Health, and improving the

effectiveness of government programs such as the National School Lunch Program.

3. Consumers interact with food marketers every day in a delicate dance with their daily

enjoyment and health on the line. Effectively navigating the modern food landscape

requires being an expert in psychology, labeling regulation, nutrition, food science, and

cuisine; in short having the same expertise as food marketers. With an increasing number

of food options, a constant barrage of information from food marketers and nutritionists,

and elevated concern for diet-based disease, consumers increasingly are interested in

learning the “tricks” of food marketers to help them make their 221 daily food decisions.6

2 Ogden, C. L., Carroll, M. D., Kit, B. K., & Flegal, K. M. (2014). Prevalence of childhood and adult obesity in the

United States, 2011-2012. JAMA, 311(8), 806-814. 3 United States Department of Agriculture

4 Special Supplemental Nutrition Program for Women, Infants and Children

5 Reference http://www.fns.usda.gov/wic/about-wic-wic-glance

6 Wansink, B., & Sobal, J. (2007). Mindless Eating The 200 Daily Food Decisions We Overlook. Environment and

Behavior, 39(1), 106-123.

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Food Marketing Defined

Food Marketing The activities needed at all stages in the food system to facilitate the exchange

of food products and services which satisfy the needs and wants of individual consumers and

organizations.

An important corollary to this definition is that for the value-added food chain to exist, all parties

must be satisfied. For an enterprise to achieve long term success, all upstream and downstream

partners must be satisfied. Thus,

Food marketing then is concerned with the satisfaction of all the links in the food value added

chain.

This seemingly obvious “big idea” has motived the current paradigm in marketing: the

Relationship Era.

At an agricultural economics meeting I had a conversation with an agricultural commodity

broker named Carlos. Affable, charming, and handsome, Carlos’s job as an agricultural broker is

to sell large shipments of fruit for producers in Honduras to wholesalers and retailers in the

Washington D.C. area. Today was not a good day for Carlos. Due to supply and demand factors

and some unusual circumstances with retailers, Carlos was not able to fetch a very good price

from his biggest buyers. However, instead of seeking out other buyers willing to pay more, he

had decided to sell for a lower price to those whom he wished to maintain a long and lasting

profitable relationship. He explained that, “Sometimes you bite the dog, sometimes he bites

you,” and that he needed to “help out the retailers today.” Then he got drunk.

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Needs, Desires, and Demand

Caution: These are technical marketing terms.

A customer has a Need when there is a difference between their actual condition and a preferred

condition.

A Desire on the other hand is the particular choice the customer makes to satisfy one or more

needs.

Demand is the aggregate measure of the desire that potential customers have for a particular

product and their willingness to pay for it.

A key to food marketing is identifying customer needs. A common misconception is that

consumers choose a food product “because they are hungry.” While hunger may certainly play a

role, this does nothing to explain why one brand is chosen over another because just about any

food can take satisfy hunger. Marginal differences in need satisfaction are what makes a

consumer desiring one product most of all. Typically, it is the addition of a satisfied need

category that makes the difference. Needs tend to be very subtle.

The distinction between needs and desires fits the household production model in economics

developed and made famous by Kelvin Lancaster and Nobel laureate Gary Becker. In that

model, consumers purchase goods (cf. desires), but the goods themselves do not create utility.

Rather, attributes of goods generate utility by satisfying the needs of consumers.

A recipe is a classic example. We purchase ingredients for their attributes and these attributes

are combined to create something of value—something that gives us utility. Soy sauce does not

generate utility by itself. Recipes do not only require ingredients, however. They have other

inputs such as time, and capital in the form of cooking equipment. Time can be an especially

costly input, as we will discuss throughout the course.

Successful brands satisfy needs on a deeper level than that of recipes. Land O’Lakes and Private

Label brand butter are perfect substitutes in recipes. Then why do people pay such a high

premium for Land O’Lakes butter?

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Figure II

Name Brand Versus Private Label

Land O’Lakes satisfies deeper needs, such as wholesomeness. Satisfaction of those deeper needs

allows Land O’Lakes to charge $1.20, or 40% more for their product than private labels.

Marketing Myopia

Often times a company or brand managers come to focus on the product as an end in itself as

opposed to the customer needs that it satisfies. When this occurs, the firm becomes shortsighted.

This is called marketing myopia, as managers fail to recognize the scope of their business.

Marketing myopia occurs when a company identifies with their product or past structure

instead of customer needs.

Marketing myopia blinds the firm from opportunities to utilize their hard-earned expertise and

brand equity. Furthermore, their precious product becomes at risk of decline as managers fail to

improve it and competitors better satisfy customer needs. Even in the absence of competitors,

the firm may fail to adjust it to changing consumer tastes, preferences and needs.

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Figure III

Source: 2004 reprinting of Theodore Levitt’s “Market Myopia,” Harvard Business Review

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Marketing Myopia Is a Perspective

Avoiding Myopia – More than Just Lip Service

Defining oneself in terms of customer needs can lead a firm to unexpected territories and

opportunities. Dannon realized that it had strong expertise in nutritional food science, and its

customers strongly associated it with health, consistency, and high degree of expertise with

functional foods.

Functional foods are foods that have been altered to promote health. As a

result of a mountain of emergent medical research that concludes that gut flora

plays a fundamental and dramatic role in human metabolism and immune

function, one of the most explosive categories of functional foods is probiotics.

One of the first genera of flora identified as promoting metabolic and immune

function was Lactobacillus, which is abundant in yogurt. Dannon’s Activia

was one of the first popular brands to be strongly marketed as a functional

through gut flora function. Everyone knows Jamie Lee Curtis would have no

chance of staying regular without Activia.

Realizing this, Dannon launched its Nutrica brands which includes products that target people

with malnutrition, Alzheimer’s, dysphagia, tube fed nutrition, metabolic disorders, allergies, and

pediatric dietary/metabolic problems. Most of their products require a prescription or should be

taken under the supervision of a clinician.

Figure IV

This is how Dannon describes Nutrica:

Price = $139

Lasts 1 week

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“Nutricia is a specialized healthcare division of the food company Danone, focused

exclusively on research-based scientifically-proven nutrition, developed to meet the needs

of patients and individuals for whom a normal diet is not sufficient or possible.”

What factors led/allowed Dannon to take this market on?

Market Myopia: Traditional Grocers

The “traditional grocery store” format that dominated prior to the 1940’s were small, but

numerous, had most of its goods in bulk containers, and had employees fetch desired products

from parts of the store that were inaccessible to the consumer.

Figure V

Traditional Grocer Store

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Starting in the 1930’s, the supermarket format that we are all familiar with began its meteoric

rise. These stores had relatively lower prices, were self-serve, and were large, few, and required

consumers to travel further than to traditional “corner store” grocers.

Most traditional grocers suffered from what today would seem to be severe market myopia.

Traditional grocers identified themselves with their location, size, and folksiness—their

product—instead of with their customers’ needs. They attributed supermarkets’ rapid rise to

novelty and appeal to a presumably very narrow price sensitive segment. An executive of one

big chain announced at the time that he found it “hard to believe that people will drive for miles

to shop for foods and sacrifice the personal service chains we have perfected and to which [the

consumer] is accustomed.” Only those that responded to the newly revealed customer needs

survived (e.g. Safeway, Kroger).

Figure VI

Hindsight is 20/20

Questions:

How did traditional grocers myopically define themselves? What would their market-oriented

definition be?

Supercenters and club stores are rapidly gaining market share at the expense of supermarkets.

Are these new store formats supplanting supermarkets similarly to how supermarkets supplanted

traditional grocers? Why or why not?

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Figure VII

Supermarkets Cater to the Dude’s Needs

What is a Product?

It is natural to think of products—especially food products—in terms of their chemical

composition and physical characteristics. After all, you are what you eat. As the discussion

about needs suggests, however, thinking of food products in this way would ignore some of the

most crucial and decisive aspects of food.

Food Products consist of

1. Ingredients

2. Form

3. Packaging

4. Associated Services

5. Credence Attributes

6. Associated Feelings and Ideas

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We will discuss each of these components later in the course, but here a general description of

each will be provided.

Ingredients are the constituent parts of foods that are eaten. Contrary to non-food products, the

constituents of food products are crucial even in cases when they cannot be directly observed.

For instance, nobody cares what their TV is made out of so long as its image is effective. But

people care about what their food is made out of for nutritional, religious, and sometimes silly

reasons.

Form refers to how the ingredients are combined. Otherwise identical food products can be

dramatically altered simply by differences in form. While close substitutes, frozen raspberries

and fresh raspberries very different products.

Packaging plays a more important role for food products than in any other product category for

three reasons. First, packaging slows food decay and provides a barrier that prevents

contamination. Second, a great deal of unobservable information is communicated on food

packaging, and much of this information is of critical importance. Some information is not

observable at the point of purchase, but eventually is observed after the packaging has been

opened, such as flavor. Packaging provides a platform on which useful information may be

communicated. Third, packaging provides an opportunity for the product to stand out from other

products. With food consumers making 240 food decisions per day and with 50,000 SKUs7 in a

typical grocery store, most products are not even noticed. Packaging provides an opportunity for

marketers to overcome consumers’ bounded rationality, often with unique shapes and designs or

by taking advantage of subtle biological cues to which we as omnivorous mammals respond.

Associated Services are included in the definition of “product.” These may include customer

service, return policies, and so on.

Credence Attributes are aspects that are never observed by the consumer, such as production

processes, social responsibility of producers, nutrition, health effects, and minor ingredients.

Consumers must rely on communications from producers or third parties for information about

credence attributes. Relative to all other product categories, credence attributes play an

unusually central role in food marketing. This is the reason why government agencies such as

the FDA and USDA are charged with the massive job of regulating the flow of information from

food marketers and consumers via labels, while other industries are left alone.

Associated Feelings, Ideas, and Behaviors are a large part of what is meant by brand equity.

Brand equity is as important as the physical aspects of the product itself in food marketing. Take

an inferior product and convince consumers that the product is a familiar brand with an

7 Stock Keeping Unit: a distinct product in a store.

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abundance of equity, and suddenly the product will be perceived to be better and experience a

huge boost in sales. Coca-Cola was one of the first brands to aggressively develop these aspects

of its product instead of trying to persuade consumers to purchase its product based on its

physical attributes. As you watch this commercial, ask yourself: What does its message have to

do with Coke? After years of associating Coke with those feelings and ideas, starting with their

famous 1971 “Hilltop” commercial and following through to the present, the people at Coca-

Cola hope you say, “Everything.”

Do the non-physical aspects of a product add value?

Figure VIII

Argument for: They enhance the experience, even making foods taste better. By resonating with

consumers’ self-identify, they make consumers feel good. Isn’t that the point!

Argument Against: Non-physical aspects are often false-signals that cause harm. When you

consume Coke you are not having a communal experience as their commercials suggest. You

are drinking sugar water that is very bad for you. Coke is worth drinking to many people in

moderation because it tastes good, but the non-physical aspects of Coke as created by its

commercials results in overconsumption and contributes to growing public health problems.

Strategy for Creating Customers

The emphasis thus far has been on identifying customers’ needs and basing marketing decisions

on those needs. The question is, how should a marketer go about focusing on needs and what are

the decisions that marketers make? When successfully marketing a product, you:

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1. Assess your firm’s current product portfolio and capabilities.

2. Identify your customers’ needs.

This is done through intuition and market research.

Different customer segments have different needs. Pick a target market to which

you are especially able and well positioned to provide a high level of value

relative to your price.

3. Base marketing decisions on the needs of the selected target market.

3a. Adjust products and design new products that addresses the needs of the target

market.

3b. Promote products to the target market by communicating information about

attributes, prices, availability, etc., that address those needs.

3c. Distribute products so they are available at the times and places that meet customers’

needs.

3d. Price products to reflect costs, competition, and the target’s willingness to purchase.

4. Provide the necessary service and follow-up to ensure customer satisfaction, and monitor

customer satisfaction.

There is a distinction between customers and consumers. Customers are whom you sell to.

Consumers are the ultimate end-users. Generally,

Customers ≠ Consumers

For example, Cheerios’s customers are retailers; Cheerios’s consumers are the people who eat

Cheerios. Cheerios targets numerous retailer segments with differing marketing plans because

retailers are their customers and they have different needs. Warehouse stores require multipack

packaging, so Cheerios alters their product for that targeted segment. Cheerios’s marketing

plans must consider the needs of all those downstream of them in their distribution network.

The four marketing decisions of Product, Promotion, Place, and Price are the famed Four P’s

of Marketing. Along with goals, they are the decisions that are the substance of a Marketing

Plan.

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Introducing the Four P’s

The marketing decisions that together provide customer satisfaction are called the Marketing

Mix, and are easily remembered as the 4 P’s:

1. Product – goods and services, package design, the idea of the goods, customer

service, brand names, product lifecycle, warranties, etc.

2. Price – set to maximize long-term profit (typically). Other considerations:

production capacity, competition, relationships with suppliers and buyers, ethical

considerations.

3. Promotion – ads, sales, coupons, flyers, tweets, give-a-ways, product bundles,

trade allowances, slotting fees, etc.

4. Distribution (Place) – The time and place customers find products. Importantly

includes the choice of distribution channels and retail outlets. Involves transport,

inventory management, marketing channel choices, order processing,

warehousing, etc.

Creating customers that want to stay with you is all about identifying and tailoring your

marketing mix to the needs of your customers, providing goods and services that meet those

needs, pricing, and follow-up service.

[perhaps include a product here for students to quickly practice making these decisions]

Target Markets

A Target Market is a group of people toward whom the firm chooses to direct its marketing

efforts.

All marketing efforts should have a target market in mind. Once a target market is selected, all

of the 4 P’s should be tailored to the needs of the target. Ignoring those outside of your target is

a virtue that allows for uncompromised, effective marketing plans.

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Figure XI

The Four P’s

One of the most common mistakes made in food marketing is not selecting a target market.

Food entrepreneurs tend to be overly optimistic about the value of their product. Their naïve

mantra often is, “If only the customer will just try it…” In reality, 90% of new food product

introductions fail. A sizeable portion of these failures is due to not targeting a segment of the

market.

I recommend a different mantra for you:

There is no prize for second place

Let me explain. Suppose there are 10 customers in your market, each representing a distinct

segment, and instead of targeting one or two of them, you try to appeal to everyone. If you are

the second most appealing product to each of the consumers, you make zero sales. Hence, There

is no prize for second place.

Product Distribution

Promotion Price

Target Market

A Target Market Thought Experiment: Exceptions Don’t Last for Long

Suppose there is a firm that creates a completely novel and widely appealing food product. They

choose not to target a specific market, instead relying on a, “This is what it is, just try it” message,

that is successful because the product truly uniquely satisfies a consumer need. After a year,

imitators enter the market. Instead of mass marketing their products like the initial firm did, they

focus on specific targets and are, therefore, better able to satisfy the needs of those segments. In a

short amount of time, despite being the best product overall (e.g. on average), the initial firm ends

up being the second best to everyone, and sales dwindle to zero.

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It is tempting to dismiss generation and use of non-chemical attributes as chicanery.1

However, this argument falls apart very quickly, especially with respect to food. Ultimately

people purchase what they like, and people—not being mere chemical analyzers—have

preferences for more than just what the physical application of goods provide.

In blind taste tests people prefer the taste of Pepsi to Coca-Cola (55% to 45%). But Coca-

Cola drinkers like to drink Coke for more than its taste, which explains why Coke accounts for

20% of the carbonated beverage market, while Pepsi accounts for only 10%. In fact, in non-

blind taste tests, taste preferences are reversed!

This was starkly illustrated in 1985 when Coca-Cola launched what would come to be known

as “New Coke.” After conducting the largest marketing research study ever, Coca-Cola

concluded that their lab had created a superior tasting Coke. With great fanfare, they

changed Coke’s formula. The public reaction was extreme. After reading letters written to

Coca-Cola, psychologists determined that the feelings expressed in the letters were those of

someone mourning the death of their child. Clearly, Coke fulfills deep psychological and

lifestyle needs. What do you think they are?

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Four Eras of Marketing

The history of marketing illustrates how focusing on consumer needs is essential to successful

marketing. Studying the shortcomings of past marketing practices helps avoid making the same

mistakes. The world of business and marketing is very much a Darwinian one, with inferior old

ways being supplanted by superior new ones. Keep this in mind while contemplating the history

of marketing.

Era Approximate

Time Period

Prevailing

Attitude

Production Prior to 1920s “A good product will sell itself.”

Sales Prior to 1950/60s “Simple marketing (advertising)

and selling will overcome

consumers’ resistance and

convince them to buy.”

Marketing Since 1950/60s “The consumer is king! Find a

need and fill it.”

Relationship Began in 1990s “Long-term relationship with

customers and other partners lead

to success.”

Table I

Marketing Eras

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Production Era

Prior to the 1920’s, the prevailing attitude in business and marketing was that if you created a

“good” product, it would sell itself as consumers inevitably became aware of it and how it would

benefit them. The underlying model of consumer behavior was one of homogeneity and

omniscience. The homogeneity assumption implied that products should aspire to single

Platonic ideal as opposed to a diversity of differentiated goods tailored to the different needs of

consumer segments.

As a result of the omniscience assumption, only advertising that communicated a product’s

existence and price were favorably viewed. Advertising beyond that was viewed as a waste of

money, or as an undignified practice used only by snake oil salesman trying to trick consumers.8

To a certain degree, this view was correct insofar as patent medicine firms, such as snake oil,

were the first to use extensive advertising. Products such as Pale Pink Pills and Coca-Cola made

outrageous claims as cures of cancer, tuberculosis, yellow fever, arthritis, and anything else

imaginable. These brands guarded against the accusation that their success was unfairly

accomplished through advertising. Asa Chandler, an early owner of Coca-Cola, defended

against this charge by saying, “I challenge the world to show me an article of its kind as popular

as Coca-Cola, for which so little advertising has been done,” and ran an ad saying that, “Merit

sells itself.” Ironically, besides containing substantial amounts of addictive drugs, Coca-Cola’s

early success was due to marketing practices that would be better placed in later marketing eras.

During this era, consumer needs were only rudimentarily embraced, and unified marketing plans

centered on a target market were not common.

8 Pendergrast, M. (2013). For God, country and Coca-Cola: the definitive history of the great American

soft drink and the company that makes it. Third edition. Basic Books.

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Sales Era

Between the two World Wars, greater emphasis was put on “pushing product.” The prevailing

model of consumer behavior depicted consumer preferences as malleable. If the consumer was

not interested in the product, they simply needed to be “worked over” until they were. Customer

of the product needed to be persuaded to buy more. Firms aggressively promoted their products,

and sent out armies of “traveling salesmen” to heroically “win” sales. Transactions with both

consumers and business partners were seen as adversarial rather than mutually beneficial actions

contributing to long-term relationships.

During this era, emphasis remained on the product as opposed to customer needs. The notion of

“products selling themselves” was replaced with the equally naïve notion of the “salesman who

could sell anything.” Of course, it helped to have a “good” product, because “good” products

were easier to sell!

Marketing in this era had two major flaws. First, marketing efforts were not centered on

customer needs. Salesman would relentless try to pound their square products into the round

needs of customers. Second, there were no unified marketing plans. Marketing and sales were

Coca-Cola in the Product Era

Coca-Cola started in 1987 as a patent medicine with the promise to cure an assortment of bodily ills. Quickly the

beverage’s marketers settled on the specific ills of “brain workers;” the newly created white color class. Emphasis

was on the product itself. One of the first Coca-Cola Advertisements stated: “COCA-COLA SYRUP AND EXTRACT For

Soda Water and other Carbonated Beverages. This Intellectual Beverage and Temperance Drink contains the

valuable Tonic and Nerve Stimulant properties of the Coca plant and Cola (or Kola) nuts, and makes not only a

delicious, exhilarating, refreshing and invigorating Beverage (dispensed from the soda water fountain or in other

carbonated beverages), but a valuable Brain Tonic and a cure for all nervous affections—Sick Head-Ache,

Neuralgia, Hysteria, Melancholy, etc. The peculiar flavor of COCA-COLA delights every palate.” In short, Coca-Cola

marketed itself to bored office workers who needed a jolt. Containing cocaine, alcohol, and caffeine, no wonder it

worked to fend off the 9-to-5 blues! In the advertisement above, note the emphasis on the product itself and

absence of any sort of brand image. During this era, brand image was accidental, not something developed. A

large part of Coca-Cola’s subsequent success can be attributed to being one of the first firms to deliberately

develop and sell on image.

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synonymous. Each salesman9 made marketing decisions that suited their specific area, clientele,

and vision for the brand. This led to inconsistencies in products, pricing, promotional activities,

and fragmented distribution systems. With differences in pricing, salesmen often found

themselves competing amongst themselves.

Figure X

Product-Oriented Ad Common before the Marketing Era

9 Rarely women.

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Marketing Era

Starting in the 1940’s and 50’s, firms began to gear all aspects of their business toward

customer-focused marketing concepts. A marketing concept is a company-wide (not just

product) orientation with the objective of achieving long-term success.

Firms became focused on customer needs and tailored their business practices to those needs.

Having identified its customers’ needs, firms created market-oriented descriptions of themselves,

thereby avoiding market myopia. They used those descriptions to suggest the development of

new product development and spot-on promotional activities.

During this era, firms began to strategically develop effective brand images: a slow process that

requires long-term planning, an appreciation of customer needs, and a unified marketing plan.

Instead of emphasizing the product itself and its functionality, firms emphasized the ideas and

personality of the brand and the company.

A key development during this era was the realization that a marketing concept can be better

executed with a unified marketing plan that incorporates all 4 P’s of the marketing mix. Sales

and marketing departments were separated, with marketing personnel participating in higher

level decision making. “Marketing” became strongly associated with “strategy” and the

marketing department became a common proving ground for ascent to leadership positions.

Since the entire company centered around a marketing concept, marketers become involved in all

aspects of the business, including product development. With greater awareness of consumer

needs, companies are better able to anticipate future needs by interpolating from current

customer trends.

The following clip from “Mad Men” illustrates the profound difference between the marketing

philosophies underlying the product-oriented marketing eras (Product and Sales), and the

consumer-oriented marketing eras (Marketing and Relationship).

https://www.youtube.com/watch?v=cT0d-ISXH5Q

Relationship Era

Today marketing concepts play an increasingly larger role. Based on the implications of their

consumer-oriented descriptions, firms are willing to go even further afield from their original

products to fulfill their customers’ needs. This is possible because clear and consistent brand

development has resulted in brand equity and image that lends credibility to the quality of goods

that companies would seemingly not have expertise producing.

The most distinctive characteristic of the Relationship Era is a shift from transaction-based

marketing that views markets as a place of conflict. Instead, firms increasingly think of market

exchanges as cooperative arrangements that benefit a long-term broad marketing concept.

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In contrast to the Marketing Era, in the Relationship Era many firms place higher value on

connections with business partners. Firms attempt to foster relationships with longer termed

horizons in mind. It has been realized that intimate business relationships can provide interesting

business opportunities that would not exist otherwise to any of the individual firms. An example

of this is cobranding and comarketing. In such arrangements firms market their goods together

thereby piggybacking off of each other’s brand equity and possibly benefitting from economies

of scale and other cost saving advantages.

Figure XI

Cobranding

Figure XII

Comarketing. Why do they do this?

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More intricate relationships exist vertically within supply chains as well, with buyers placing

higher values on their relationships with suppliers. Closer and longer relationships with

suppliers results in greater influence and ultimately supplies, inputs, services and products that

are customized to the buyer’s wishes. Closer relationships also result in favors in both directions

when needed. With the long-term profitability of each firm depending on the other, it becomes

in the best interest of each of the firms to consider the interests of the other, and to communicate

long-term intentions

Firms also view exchanges with customers as relationships that require mutual benefit and need

to be nurtured. This viewpoint is rationalized when considering the relative difficulty (i.e. cost)

of acquiring new customers versus maintaining existing ones. Typically firms find that

maintaining existing customers is much less expensive. In retailer and consumer food markets

this is especially the case since grocers are reluctant to change vendors and

consumer choice is mostly determined by habit. Thus, food producers and

retailers strive for deeper relationships with their customers.

To acquire deeper relationships with consumers, firms require more

detailed information about their consumers and their consumers’ needs.

They do this through traditional marketing research techniques, and in food

marketing, often through analysis of “big data” supplied by large marketing

firms, such as Nielsen or IRI, and loyalty cards. Firms increasingly use

promotions customized to individuals, such as customized coupons printed

at check-out that are based on the consumers recorded shopping habits.

Firms also engineer opportunities for greater consumer interaction in hope

of keeping tabs on consumer satisfaction and turning consumers into loyal

supporters or even advocates of the company. This is especially the case

with firms with particularly strong identities that are likely to be favored by

consumers. Chipotle, for instance, has created a video game and

stimulating animated story that laments typical production practices by

highlight poor animal welfare. Of course, the protagonist is the exception.10

In short, today’s Relationship Era of marketing is based on mutually beneficial connections to

others. The realization that long-term profitability is serviced by such relationships has resulted

in deeper relationships with customers, consumers, business partners, suppliers, and even

employees.

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Chipotle truly is exceptional. See Bloomberg News’s “Behind the Counter: Inside Chipotle,” http://www.bloomberg.com/video/behind-the-counter-inside-chipotle-5AnJ9NB~SOG8VvhkjU8QKw.html

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Characteristic (Generally) Level 1 Level 2 Level 3

Primary Bond Financial – Focused on Price Social Structural – Interdependent

Interaction

Degree of Customization Low Medium Medium to High

Potential for Sustained

Competitive Advantage

Low Medium High

Interactions Purchases, Temporary Sales Chats with customers, follow-

ups, Tweets, Facebook, emails

High levels of customer

service, partnership-like

relationships, customer

dependence

Awareness of Customer

Characteristics and Needs

Low Medium High

Example McDonalds Farmer’s Markets

Local diner

Consumer Supported

Agricultural (CSA) groups,

Soda Stream

Table II

Three Levels of Marketing Relationships

Note: Marketers want to move up levels. Source: From Boone and Kurtz’s “Contemporary Marketing,” adapted from Leonard Berry, “Relationship Marketing

of Services—Growing Internet, Emerging Perspectives” Journal of Marketing Science, 1995 p.240.

26

Question: Is relationship building with consumers or business partners feasible in food

industries?

Answer: Consumer relationships are not typically built in the same way as in other industries.

Food purchases are made with unusually high frequency allowing for rapid relationship building

and home food processing generally does not require specialized equipment. Instead,

relationships are built on psychological levels through branding. McDonalds is placed in lowly

Level 1 in the table, but McDonalds has built Level 3 relationships with millions of consumers.

High level business relationships are cultivated in traditional ways.

Marketing Environment

The Marketing Environment is a series of exogenous

11 factors and elements impacting how a

business designs its marketing strategy. These factors affect how a business reaches its target

market.

These factors include the

1. Competitive Environment

2. Social-Cultural Environment

3. Technological Environment

4. Economic Environment

5. Political-Legal Environment

In food marketing, the biological environment plays an important role, and is included in the

Technological Environment.

11

“Exogenous” means these are factors that are outside the control of the firm.

Includes the biological environment

27

Elasticities

Before discussing the Competitive Environment, you must first understand and become

comfortable with the concept of elasticities.

Apologize: for the historical accident that the language describing these ideas being is

cumbersome. Second, the virtue of elasticities is that they do not depend on units.

You have probably been taught this concept in the past through algebraic formulae and been

asked to do practice calculations. The main purpose, here, is to gain an intuitive understanding

of elasticities that will allow you to use “elastic” and “inelastic” in conversation. With marketing

and economic analysis typically measuring elasticities, it is important for you to not be the only

one in the marketing meeting who does not understand reports.

Elasticities measure how sensitive one thing is to another thing. When someone describes the

“____X_____ elasticity of _____Y______,” they are describing how sensitive Y is to X. Is

someone says, “The X elasticity of Y is 2,” that means that if X goes up 1%, Y goes up 2%.12

In

meaningful applications, changes in X are thought to cause changes in Y.

The virtue of elasticities is that it gets around the problem of worrying about unit. It does not

matter if you measure X in Yen or Dollars, and Y in ounces or grams: if X goes up 1%, Y goes

up 2%.

Elasticity Formula

X0 = the value of X at first

X1 = the value of X after a change

Y0 = the value of Y before X changed

Y1 = the value after X changed

12

Since they move in the same direction, they are complements.

1 0

0 0

1 0

0 0

percent change in Y %

percent change in X %YX

Y Y Y

Y YY

X X X X

X X

28

Elasticity Examples

Own-Price Elasticity of Demand

In marketing the most useful elasticity is the price elasticity of demand. This quantity describes

how sensitive demand is for good X to the price of X. Usually people say own-price elasticity

when referring to the own-price elasticity of demand.

Suppose you change the price from $3 to $5 and as a result demand decreases from 1000 to 800.

Denote demand by Y and price by p. Plugging these numbers into the general elasticity formula,

Thus the own-price elasticity is -1.25. The fact that it is negative indicates that as price goes up,

demand goes down, which is the normal situation. What this tells you is that if you increase the

price by 1%, demand will drop by 1.25%. This simple number tells encapsulates all of the

relevant consumer behavior needed to make short-term pricing decisions.13

Cross-Price Elasticity of Demand

The cross-price elasticity of demand is similar to the own-price elasticity of demand, only now

the sensitivity of demand to another good’s price is of interest.

For example, if the price of bacon going up by 10% causes the demand for sausage to go up by

5%, then the cross-price elasticity for sausage with respect to bacon is 5%/10% = 0.5. Because

this is a positive value, we say that sausage and bacon are substitutes.

If the demand for eggs goes down by 1% as a result of the price change, then the cross-price

elasticity for eggs with respect to bacon is -1%/10% = -0.1. Because this is negative, we say

that eggs and bacon are compliments.

This tells quite a bit about how people use these items: people replace bacon with sausage in

their diet, but like to eat eggs with their bacon.

13

Caution: this elasticity calculation only applies “close” to the prices observed in the data; namely around $3 or $5. At other price points the elasticity might be different. In fact, even with linear (i.e. straight) demand curves, the own-price elasticity is different for different prices.

500 1000.6

.510001.25

$5 $3 .4.4

$5

Yp

Y

Y

p

p

29

Income Elasticity of Demand

Often food marketers are interested in how people’s food choices change as their income rise.

Suppose as the U.S. comes out of the Great Recession, incomes rise by 15%. Knowledge of

income elasticities would tell food marketers the goods for which demand will increase and

decrease.

Examples:

If demand for Ramen Noodles decreases by 30%, then the income elasticity of demand

for Ramen Noodles is -2, and Ramen Noodles is an inferior good because demand for

them goes down as incomes go up.

If the demand for skinless boneless chicken goes up by 12%, then the income elasticity of

demand for skinless boneless chicken is 0.8, and skinless boneless chicken is a necessary

good because demand for it increases as incomes go up, but not as fast as incomes on a

percentage basis.14

If demand for sushi goes up by 25%, then the income elasticity of demand for sushi is

1.67, and sushi is a luxury good because demand increases proportionately faster than

income. As a result, sushi’s share of income increases as people get “richer.”

Elasticities - What You Need to Know Cold

If you ever need to calculate an elasticity, you will do what everyone else does: refer to a

reference for the formula. But you need to know and understand the following terms good

enough to use in conversational language.

Elastic — when the (absolute) value of an elasticity is > 1.

With own-price elasticities, this would mean that consumers are very responsive to price

changes.

“With so many options to choose from, demand for Barilla pasta is elastic.”

Perfectly Elastic—a special case occurs when an elasticity is positive or negative

infinity. This occurs when demand curves are vertical.

14

This terminology is clearer in examples where incomes decline. In that case, demand does not decrease as rapidly as incomes, meaning that a higher share of income goes towards the necessary good, suggesting that proportionately, other goods are reduced or eliminated before the necessary good.

30

Inelastic— when the (absolute) value of an elasticity is < 1.

With own-price elasticities, this would mean that consumer are not very responsive to price

changes.

Example: “Because rice is so essential to cuisine, it has inelastic demand.”

Perfectly Inelastic—a special case occurs when an elasticity is zero. This occurs when

demand curves are flat.

Big Take Away

“Elastic demand” means people ARE sensitive to price changes

— Can’t jack the price up on them

“Inelastic demand” means people are NOT sensitive to price changes

— Bleed ‘em through the nose!

31

Competitive Environment

The Competitive Environment is interactive process that occurs in the marketplace among

marketers of directly competitive products, marketers of products that can be substituted for one

another, and marketers competing for the consumer’s purchasing power. Food industries tend to

be hyper competitive due to low barriers to entry. In fact, agricultural food commodity markets

are the canonical application for “perfectly competitive” economic theory.

Compounding the competitive nature of food markets is the physiological limitations of food

consumption. In light of this limitation, food marketers quip that they are vying for “stomach

share.” While this may be true to a certain extent, there is no limit to food markets in terms of

expenditures. In other words, qualities such as taste, image, form, nutrition, and consumer

desired production practices allow expenditures to grow unboundedly even if the “stomach pie”

remains the same size. Thus food producers strive to add value and differentiate themselves

from competitors in order to carve out unique positions that provide market power.

Monopolies, firms that have no direct competitors, have the most market power. For a

monopoly to exist, there must be sufficiently high barriers to entry, and follow the simple pricing

rule

1p c

p

(1)

where p = price, c = unit cost, ε = own-price elasticity of demand. The left hand

side (LHS) of (1) is the profit margin—the percentage of the price that goes

towards profit. The right hand side (RHS) of (2) reflects consumer behavior.

Own-price elasticities are negative15

, so that the RHS of (1) is positive. If

consumers become more price sensitive, the RHS decreases, so that the profit

maximizing firm must lower the LHS by decreasing their profit margin. They

do this by lowering their price. In summary, a monopolist chooses a price that

balances their profit margin with consumer price sensitivity.

An Oligopoly occurs when there is more than one to a moderate number of

firms competing directly against each other with undifferentiated goods. When

this is the case, profit maximizing firm i sets its price approximately to that which satisfies

15

Except for theoretically permissible, but practically non-existent, Giffin goods.

Market Po

wer

32

i i

i

p c s

p

(2)

where is = market share (between zero and one). Now the firm is able to set its profit margin

equal to that of a monopolist times its market share. In the extreme case where one firm has

captured the entire market, 1is and the (2) is identically equal to (1), as it should be since that is

the case of a monopolist. In a true oligopoly setting, however, each firm’s profit margin is non-

zero, but lower than that of a monopolist’s.

In Perfect Competition, there are virtually no barriers to entry and each firm has essentially zero

market share. Thus 0is so that the RHS of (2) is zero. Therefore, the firm must make the

LHS of (2) zero by setting ip c . In other words, in perfect competition there are zero profit

margins.16

0

ii

i

p cp c

p

(3)

For perfect competition to occur, products must be undifferentiated and there must be low

barriers to entry. This is roughly the case in food commodity markets where an apple is an apple

and anyone interested in growing them can. For these reasons, successful food product

marketers avoid products in such low margin markets, instead looking to enter early into product

spaces with high barriers to entry, and where monopolistic power provides opportunities for high

profit margins.

16

Zero profit does not mean the firm goes out of business. Profit is revenue in excess of the cost of all inputs such as capital and labor. The bills and workers still get paid, but the owners do not get rich.

Perfect Competition Thought Experiment

Suppose you want to start a business and find a market in which firms are making a profit. You start a

business identical to successful existing ones, enter the market, and capture market share. Because you

make the market more competitive and lower their market share, firms lower their price thereby reducing

their profit margin. You do the same in order to stay competitive. More firms follow your lead, and this

occurs repeatedly until there are so many firms in the market that everyone’s market share shrinks

practically to zero and, consequently, prices are set so that profit margins are essentially zero. This is the

story economists use to explain the tendency towards perfect competition and justify it as an assumption in

economic models.

33

High barriers to entry are a rarity in food marketing, so that true monopolies are rare across a

wide geographic area or over a long time period. Nevertheless, firms strive for monopoly power

by differentiating their brands and developing deep relationships with their consumers to such an

extent, that consumers do not view potential alternatives as substitutes. When this is the case,

Monopolistic Competition arises, and firms compete not with prices, but rather with their

differentiating attributes. With low barriers to entry, however, imitators are free to enter so that

products must constantly be improved. One of the most effective ways to improve a product is

by developing its image. This is exactly what has characterized the Cola Wars between Coke

and Pepsi, as the two brands compete not with respect to price or recipes, but rather through the

meaning, image, and ubiquity of their products. Similar examples of monopolistic competition

can be found wherever brands are well developed and highly differentiated, such as in the

breakfast cereal aisle.

Thoroughly developed food markets with powerful brands that promote heavily create surprising

barriers to entry. Instead of needing technological or capital investments to break into these

markets, new products must overcome the seemingly insurmountable lead that established

popular brands have in consumer psyches. In such cases, there is little room for a newcomer in

the consumer mindscape. The high promotional cost needed to get a new product on consumers’

radar and try the product instead of opting for familiar, satisfying brands that consumers identify

with and purchase with little thought, is prohibitive. Cheerios becomes not “a cereal,” but rather,

“Cheerios.” Therein lies the market power in branding.

Competitive Environment – Concentration of Food Producers

Competitive Environment and Regulation

With food security17

being a matter of national security and essential to human welfare, the

federal government sagely regulates the competitive environment of food industries. As we saw,

if a firm ascends to high market share they will optimally set their price high above their

marginal costs. When this occurs, less is demanded and produced. This decrease relative to

competitive markets is called “dead weight loss.” In food markets, it could aptly be called

“weight loss.”

17

Food security is the term used by policy makers to refer to the availability of food.

34

Figure XIII

Ownership Map of Food the Food Industry

35

When monopoly or oligopoly power exists, the federal government may invoke the Sherman

Antitrust Act if firms’ behavior discourages competition by, for instance, using predatory

pricing or preemptive product introductions to deter entry into the market. Because of the

importance of food to the nation and individuals, regulators are especially vigilant of the

competitive behaviors of food companies. From the late 1970s through the mid-1990s, the

anticompetitive practices of food industries received much attention as industries reached high

degrees of concentration. As deregulation became the norm, attention waned thereafter.

However, with the collapse of the highly deregulated financial and housing markets in 2007,

regulation and consumer protection is on a steep upswing; increased scrutiny of the industrial

organization of the food industries is sure to come.

Two Examples

Ready-To-Eat Cereal

Since the 1970’s, the Federal Trade Commission

(FTC) has brought a number of anti-trust suits

against the big the ready-to-eat (RTE) cereal

companies (Post18

, Kellogg, and General Mills). In

the 1970’s, the four biggest companies accounted for

90% of the RTE cereal market. The RTE cereal

industry has remained one of the most concentrated industries with recent mergers and

acquisitions (see the note in the table), although the emergence of popular private label brands

have cut into the oligopoly’s stranglehold.

18

Acquired by Ralcorp holdings in 2008, but operates autonomously.

36

Table III

Market Shares of Ready-to-Eat Cereal manufacturers

Note: Since this time, Nabisco and Post have merged, Post was bought by the same parent company as Ralston, and

Quaker Oats has been purchased by Pepsico.

Source: Nevo, A. (2001). Measuring market power in the ready‐to‐eat cereal industry. Econometrica, 69(2), 307-

342.

The FTC contends that the three largest companies have operated as a “shared monopoly,” i.e.

cartel, by cooperatively setting prices artificially high, as evidenced by their high profit margins

of 13.3%

After decades of high profile lawsuits, the courts have determined that no illegal anticompetitive

activity has occurred (at least to the extent that would require these companies to divest). As a

result, mergers of RTE cereals have ensued. Most notably was that between Nabisco and Post; a

merger that was delayed as a result of regulatory jawboning19

until after key court cases and a

change in regulatory climate. Further exonerating the RTE cereal industry was an influential

2001 academic paper20

that concluded that cereals high profit margins are the result of other

factors.

Q: Why do you think cereal prices are so high?

A: While the oligopolistic structure of the RTE cereal plays a primary role, Nevo concludes that

most of the seemingly excessive markup can be attributed to the (i) high degree of product

19

Unofficial political and regulatory threats. 20

If you are intellectually curious, I encourage you to take a look at Nevo’s paper. While the technical details are extremely advanced, section 2 gives clear and concise description of the RTE cereal market. The rest of the paper illustrates the level sophistication needed to answer basic marketing and economic questions.

37

differentiation, and (ii) multi-product pricing. With RTE cereals being eaten daily by consumers,

consumers develop highly particular tastes for their favorite cereals resulting in inelastic

demand at the brand level. Contributing to this low elasticity is the fact that cereal is in fact

exceptionally cheap on a per-meal basis, which contributes to low price sensitivities.

Multiproduct (or “line”) pricing contributes to high margins in the same way collusion would,

but is not illegal.

Supermarket Chains

Read: FTC Requires Bi-Lo to Sell 12 Supermarkets in Florida, Georgia, and South Carolina as a

Condition of Acquiring Stores from Delhaize America

In a town with only one grocery store, that grocer is, in effect, a monopoly, and can extract

monopolistic profits via high margins permitted by the monopoly pricing formula. With food

being a necessity, and even essential to life, demand for food in general is practically perfectly

inelastic. This underscores the critical need for competitive grocery retail markets.

Since the emergence of traditional grocery stores circa 1900, the FTC has been keen on the

deleterious effects of highly concentrated grocery retail markets. The FTC regularly forces

grocery chains to sell stores to ensure competitive markets.

Social welfare is the FTC’s main criterion for evaluating whether or not to force the sale of

grocery stores. In other words, the FTC uses the economists’ method for determining whether

the world will or will not be a better place after the merger. This is a very difficult thing to do.

The first difficulty is in determining what a “market” is, both in terms of goods and services, and

geography. This is done by looking at cross-price elasticities. The second difficulty is

calculating how the consumer will fair with the change. This requires calculating at the own-

price elasticities. The third difficulty is in predicting the cost saving advantages that the merger

will provide to the retailer. Only with those three pieces can the oligopoly pricing formula be

used to calculate the price from, and the change in social welfare after, the merger.

Welfare

Recall that economists and politicians use the term “welfare” differently. To economists,

welfare is the net benefit to producers and consumers. The most basic representation of this is

given by

38

Welfare is a technical

economics term that refers

to the total benefit to

society. Welfare is

decomposed into two

components: producer and

consumer surplus.

Consumer surplus is the

difference between the

value consumers put on a

product and the amount

they pay for it. For

instance, if you are willing

to pay up to $18 for a salad

at a baseball game, but you

pay $13, then your

consumer surplus is $5.

WELFARE

welfare profit + consumer surplus .

Consumer surplus is the total value of the goods sold to

consumers, net what they paid.

Q: It has been found that grocery store mergers in highly

concentrated markets result in higher prices, but mergers in low

concentration markets result in lower prices.21

Why do you

think that is?

A: In high concentration markets, mergers result in very few

competitors so that consumers have little choice but to shop at a

store with high margins. In low concentration markets, mergers

allow grocers to benefit from more efficient distribution,

promotion, procurement, and so on: economies of scale. Thus

the drop in the marginal cost, c, in the LHS of the price formula

for oligopoly pricing (equation (2) more than offsets the gain in

market share in the RHS.

Food Prices and Consumer Welfare

Policies that result in avoidable high food prices are regressive

in that they disproportionately affect the poor. This is the result of food (in its entirety) being a

necessary good with an own-price elasticity between -1 and 0. Thus, as income decreases, the

budget share of food increases. This relationship was discovered over 100 years ago and is

called Engel’s Law and is the justification for food’s tax exemption. A percentage tax on food

would cost a poor consumer a greater percentage of their income than that of a wealthier one.

Types of Competition

Time Based Competition

Time-Based Competition is a strategy of developing and distributing goods and services more

quickly than competitors.

21

Hosken, D. S., Olson, L., & Smith, L. (2012). Do Retail Mergers Affect Competition? Evidence from

Grocery Retailing. Federal Trade Commission, Bureau of Economics, Working Paper, (313).

39

Owing to the vast number of food-related decisions consumers make on a daily basis, careful

considerations of the virtues of each decisions’ option is not feasible. Instead consumers use

simple heuristics to make purchasing decisions, the most common of which is simply choosing

the same product as last time. “Sticky” or “habitual” purchasing behavior is appealing also

because consumers do not know how a product tastes and works in recipes until after they

purchase it. Therefore, purchasing new products constitutes a fair amount of risk to consumers.

Retailers, distributors, and restaurants are reluctant to try new products as well. With 50,000 or

so products in a typical supermarket, supermarkets avoid making procurement complicated. It is

much simpler and cost effective to re-order the same products over and over again to avoid

switching costs. In fact, retailers charge producers expensive slotting fees for shelf space in the

first year of carrying a product. Additionally, retailers are reluctant to switch brands for fear of

upsetting consumers that have come to expect the availability of products.

For these reasons, being the first product within a category and on retailers’ shelves provides a

considerable advantage over competitors. Doing so provides an opportunity to erect barriers to

entry, ensuring long lasting dominance within a category.

First Mover Advantage – The often large advantage that the first firm to market a product,

service, or address a customer need has over subsequent entrants.

Stonyfield Farm: A First Mover

Stonyfield makes organic dairy products, but they

didn’t always. For a while they didn’t make

anything. Previous to 1983 Stonyfield was only an

idealistic nonprofit farming school in New

Hampshire that taught environmentally friendly

practices. But that didn’t pay the bills, so to support

their school, they began to make and sell yogurt

produced from their seven instructional cows.

In their first years of operation, retailers in the northeast were willing to carry only one local

dairy product. Stonyfield’s yogurt immediately found success with local retailers because they

were the only available dairy product, and one of the only food products period, that satisfied

consumers’ unmet need for genuine environmental activism. Today Stonyfield yogurt is a

cornerstone of the yogurt aisle throughout the country with $360 million in sales in 2011 making

40

it the number three yogurt brand in the U.S. Much of Stoneyfield’s success can be attributed to it

being the first mover in the organic yogurt market.

For Stonyfield’s truly inspirational and engrossing story, read the case study “Gary Hirshberg

and Stonyfield Farm.”

At this point you may be convinced that it is always best to be the first mover. While this is

frequently the case, just as often, it is better to let the fools rush in, fall on their faces, learn from

their mistakes, and begin where they left off. Often it is much better to be a “fast follower.”

Second Mover Advantage – The advantage gained when another firm enters a market first.

In addition to learning from the first mover’s mistakes, the second mover has the advantage of

inexpensively mimicking successful innovations. For highly novel products, second movers

benefit from the first mover’s progress with regard to informing consumers of the product. With

the vast majority of food product launches being unsuccessful, it often pays to have other go

first.

Horizon and Wallaby: The Smooth Road of Second Movers

Stonyfield Farm should have failed. It took unbelievable perseverance, passion, and technical

and business acumen for Stonyfield to survive to profitability. Only after nine years of

desperately borrowing exorbitant amounts of money from friends, families, banks and

investors—and more obstacles and disasters than can be listed

in this box—did Stonyfield have its first profitable quarter.

That was exactly one year after second mover Horizon

Organic and the same year Wallaby Organic yogurt entered

the organic dairy market. Stonyfield had proven to retailers

that organic dairy products were valuable additions to their

dairy selection and could drive traffic to stores. By

familiarizing consumers with the virtues of organic dairy

products, consumers had become much more willing to try

other organic dairy products. Stonyfield had solved many

of the technical problems associated with producing

organic yogurt, and had provided the incentives for a

sufficient number of suppliers to go organic to support

41

other producers. By the time Horizon and Wallaby Organic entered the market, Stonyfield had

solved most of the major problems, and had stimulated consumer and retailer demand for organic

dairy products. At the time of their founding, was Stonyfield (1983) or Horizon (1991) a better

investment?

Obvious and Not-So-Obvious Competitors

“Competition” likely evokes images of brand wars and other fierce forms of business

competition. Such competition is called Direct Competition: competition between firms or

brands that customers directly compare when they make a purchase.

A less obvious form of competition is Indirect Competition: competition that occurs between

firms and brands for which customers substitute but do not directly compare. For example, a

frozen Italian entrée brand indirectly competes with pizza delivery firms.

Often firms are unaware of the identity of their indirect competitors. Thoughtful behavioral

insights or data analyses are needed to identify indirect competitors. Of the latter, customer

cross price elasticities are particularly useful. If customers jump from your product to another’s

in response to you increasing your price, you’ve identified a competitor.

Food marketers also particulate in Competition for All Consumer Food Purchases. Because

consumers have a limited amount of food that they can consumer, food marketers often

conceptualize their success in terms of “stomach share.” For example, Coca Cola internal

documents state the goal of 100% of the world competition using Coca Cola products for 100%

of their beverage consumption. While this is a quixotic goal, it illustrates the natural bounds that

exist in food competition. The implication is consumers do not simply consume more food just

because there are more good food products. Nobody decides to stop off for a second dinner after

having a first.

Social-Cultural Environment

You probably have national clichés before your mind, such as a waving American flag,

the Eiffel Tower, a painting by Salvador Dali, a mariachi band, and so on. These indeed have

deep ties to their associated social-cultural environments, but are unlikely to be of much use to a

food marketer. Useful social and cultural elements tend to be subtle and ephemeral.

42

Unless you are well traveled, it is likely you take much of your social and cultural environment

for granted, and are blind to many of the elements that are particular to it. I remember a long

time ago getting into a debate with a close friend. He was arguing that there was no culture

where we grew up. I argued that that is an illusion: without an alternative culture for contrast,

much of what we considered “normal” human behavior and environmental elements were in fact

idiosyncratic to our culture. After traveling the world extensively, he now likes to joke about the

subtle “culture of western New York” with his Peruvian wife and friends who grew up in other

areas in the U.S.

What are some subtle social and cultural characteristics that are important to food marketers?

Japanese consumers place high value on novelty and newness. In the U.S. consumers

are often willing to try a new product, but eventually revert back to consuming the

products they have had extensive experience with. Hershey has discovered that newly

introduced items in the U.S. are either hit or miss with even moderately successful

product launches. With the latter, consumers revert back to purchasing traditional

successful brands. In Japan, on the other hand, newly launched products are more likely

to be successful, and once a critical level of success is achieved, consumers do not revert

back to the previous popular brand. Instead, the stick with the novel product until the

next best thing comes along.

Coca-Cola has observed a similar phenomenon with Japanese consumers.

French consumer view cheese as living. The marketer Clotaire Rapaille: “In France, the

cheese is alive. You never put the cheese in the refrigerator because you don't put your

cat in the refrigerator. It's the same. It's alive. If I know that in America the cheese is dead

– and I have been studying cheese in almost 50 states in America I can tell you, the

cheese is dead everywhere – then I have to put that up front. I have to say, "This cheese is

safe, is pasteurized, is wrapped up in plastic." I know the plastic is a body bag. "You can

put it in the fridge." I know the fridge is the morgue. That's where you put the dead

bodies, eh? And so once you know that, this is the way you market cheese in America.”

(The Persuaders, Frontline).

U.S. millennials and the authentic. Young and middle aged U.S. consumers

increasingly want (to believe they are getting) products that are produced by traditional

means and has heritage. Some of this desire may come from distrust of modern food

systems, but that cannot explain all of this cultural shift since demand for authentic

products has increased across all product markets (e.g. vinyl house siding seems “fake” to

millennials). In food markets there is greater emphasis on authentic cuisine even as

fusion cuisine simultaneously rises. From the consumer’s perspective, fusion cuisine is

43

authentic, provided it has been creatively invented by a real chef and not a major

corporation. But even major food producers strive to convince consumers that their

products are authentic. According to a Bloomberg Businessweek article, “Food

Marketing in 2014 Will be Ugly,” after two years of research and product development,

Oscar Mayer now has the technology to cut purposely meat unevenly so that it looks like

authentic home cooked leftovers. According the same article, 60% of Americans report

they “like goods that are a little flawed or imperfect.”

Many large marketing firms and food corporations employ or contract cultural anthropologists to

find the cultural and psychological meanings of goods and how they fit, or could fit, into

consumers’ lives.

Technological Environment

The technological environment represents the application and state of knowledge in science,

inventions, and innovations to marketing. Technology defines the frontier of what is possible.

There is a tendency to equate technology with electronic equipment at the exclusion of all other

technology. Do not make that mistake.

Some food products are marketed with a strong emphasis on their nutritional and health

properties. The frontier of these sciences may be considered part of the tech. environment. (Be

careful not to equate the knowledge produced at the frontier of these sciences with what

consumers believe!)

The tech. environment section of a marketing plan should include a discussion of the relevant

technology available for production and marketing. This technology may be very specific to the

product or service, and seemingly low tech. The essential characteristic of cake making

technology has remained the same for centuries, but baking is a technology.

Despite most technological advances in food industries being applicable only to a small number

of food products, some have transformed food industries and marketing much more generally.

Can you name some transformative technological advances?

– Universal Product Code (UPC) allowed for

grocers to order products just as they were needed

thereby improving inventory management.

– Hurdle technologies and other technologies have

improved shelf lives. These work by combining

methods of preventing bacterial growth. The

44

probability of any bacterium jumping multiple hurdles rapidly approaches zero.

– Genetically Modified Organism (GMO) technologies have allowed for lesser use

of pesticides and herbicides and increased yields. Also promise for solving a lot

of 3rd

world nutritional problems. Despite being highly controversial and banned

in Europe, there is very little to no evidence of dangers associated with GMOs. I

highly recommend the entertaining and informative “Intelligence Squared”

debate available through Podcast or web on this topic.

– Data collection and statistical analysis know-how

– Food science (artificial sweeteners,…)

– Shipping containers

– Radio Frequency Identification (RFID) are becoming ubiquitous being used even

in livestock industries. RFID uses small electronic tags that allow for more

efficient inventory tracking and management.

Marketing Technology in the Relationship Marketing Era

Marketers increasingly strive to be in greater contact with customers in an effort to build

relationships. The internet and social media are two frontiers that are being rapidly utilized by

food marketers. Online and TV ad expenditures are now equal.

Personal emails are common ways to contact consumers in an effort to form closer relationships,

but be careful! You do not want to burden consumers with spam. Consumers are already

overloaded with marketing efforts.

Do increase consumer reception, many marketers are now using social media to indirectly

connect to consumers. Having consumers make the initial contact through a Facebook page

ensures that only those wanting the interaction get it, and reinforces their behavior. Many

marketers now pay social leaders in social networks to casually endorse a product as a way to tap

into the power of word of mouth advertising.

Two Cool Apps

There are a few cell phone apps that you might be interested in, not just

as food marketers, but also as consumers.

• PriceSpotting –lists prices at nearby store

• Fooducate – consumers get a health score for foods

45

Economic Environment

Many economic factors have an impact on food marketing decisions. When evaluating the

economic environment of a market for a food product, it is important to consider only the market

that is being targeted. If you are selling your product only in Pennsylvania, use Pennsylvania

data, not national data. If your product is a conveniently packaged food directed towards kids in

dual household families, then data describing the economic environment of those households

should be sought.

Income

Changes in income levels have a predictable impact on the demand for goods that are

known to be normal, luxury, and inferior goods.

As incomes rise food demand does too making it a Normal Good. However, the food’s

share of expenditures decreases as incomes rise. This is called Engel’s Law. Engel’s

Law applies to total food expenditures, not the demand for any one food product.

Exercise: Name food products that are normal, luxury, and inferior goods.

Discretionary income—income available to the consumer after essential goods and

services (such as housing and minimal amounts of food) have been purchased—is an

important determinant of consumer market behavior. While much of food expenditures

are subsumed in non-discretionary income, households may choose to spend their “extra”

discretionary income on eating out or more expensive food items.

46

Stagnant income levels for the non-rich have become a contentious issue. Indeed, the

90th

percentile has seen substantial income growth over the last half century, while the

median income household has seen modest income growth. While this phenomenon has

many causes such as differences in non-wage income across quantiles (e.g. investment

income) and the dissolution of blue collar unions, the biggest driver of household income

disparities comes from changes in whom people date! In the 1950’s men and women

divided life’s obligations with the husband working in wage earning activities while the

wife worked in non-market (non-wage earning) labor. If the wife did work in a wage

earning occupation, it was typically at low wage rate. With women increasingly joining

wage earning labor markets, dual wage earning households have become more typical.

Who do high wage earning women usually marry? High wage earning men, resulting in

a strong positive correlation between the incomes of husbands and wives. This is a

departure from the past in which that correlation was non-existent or even negative.

Prices

Input Prices, such as

those for raw

agricultural

commodities, affect the

costs of manufactured

products.

Consumer Prices reflect

what the consumer pays

retailers for goods and

services.

The Bureau of Labor Statistics (BLS) is an excellent source for price and expenditure

data (http://www.bls.gov/data).

Employment

Unemployment level is an important indicator of the economic environment. However,

be careful when using this measure because unemployment numbers only count persons

without a job that are actively seeking employment. For example, a 28 year old computer

programmer living in his parents’ basement who has been unemployed for three years

and has given up looking for a job is not unemployed. This is exactly the sort of thing

that has happened as a result of sustained depressed labor markets during the Great

Recession, thereby leaving unemployment numbers underestimates of true labor market

In the late 1970s cocoa oil prices spiked leading chocolate

manufacturers such as Mars and Hershey to substitute

relatively less expensive oils instead. The substitute oils

were not being used for good reasons. First, their use

resulted in chocolate that scored lower in consumer taste

evaluations. Second, their melting point is not as desirable

for chocolate. Interestingly, Hershey chose not to

substitute out cocoa oil in Almond Joy and Mounds. As a

result Mounds became the best selling candy bar in the US.

It is tempting to call that decision an unambiguous success,

but why might that have been a poor decision by Hershey?

47

deficiencies. For this reason it is advisable to consider the Labor Participation Rate

which is the ratio of the number of people with a wage earning job to the total population.

Business Cycle

The pattern of spikes and troughs in the unemployment graph is known as the Business

Cycle. For reasons that are poorly understood, the economy has historically swung back and

forth between good times and bad times approximately every thirteen years. The phases of

these fluctuation have names.

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Jan-48 Jul-57 Jan-67 Jul-76 Jan-86 Jul-95 Jan-05 Jul-14

Per

cen

t

Source: U.S. Department of Labor: Bureau of Labor Statistics/FRED

Civilian Unemployment Rate

52.0

54.0

56.0

58.0

60.0

62.0

64.0

66.0

68.0

Jan-48 Jul-57 Jan-67 Jul-76 Jan-86 Jul-95 Jan-05 Jul-14

Per

cen

t

Source: U.S. Department of Labor: Bureau of Labor Statistics/FRED

Civilian Labor Force Participation Rate

48

1. Prosperity: period of rising output, rising employment, and decrease of unemployment.

Usually, a period of prosperity is accompanied by an increase of prices level or inflation.

Consumers’ purchasing power is high.

2. Recession: output falls, and so does employment, construction activity, etc. During a

recession, price level may decrease (deflation) or keep increasing (stagflation: inflation in

a stagnating economy). Consumers focus on more basic items.

3. Depression: a recession that continues for a long period (years); consumers’ spending +

firms investments sink; wage income decreases as well. During the Great Depression of

the 1930s, the unemployment rate reached 25% and real wages fell by 40%. Consumers

spending sinks to its lowest level.

4. Recovery: output levels slowly increase; employment slowly raises and unemployment

rate decreases. Lack of confidence is at the base of recovery. Consumers’ purchasing

power increases but caution restraints their willingness to buy.

It is important to be cognizant of this pattern. A firm that anticipates continued prosperity will

unwisely expand its production capacity beyond what can be supported in other phases of the

business cycle. This may result in unused equipment and an overgrown workforce that will need

to be painfully trimmed in leaner times.

Gross Domestic Product

GDP is a measure of the overall output (in $) of an economy, and is used a measure of the

size of an economy.

GDP Per Capita: When interest is in how prosperous the members of an economy are,

GDP can be misleading since a large economy can be the result of a many members

producing and consuming very little. For instance, India has a higher GDP than Canada

despite 24% of India’s population living on less than $1.25/day.

GDP Growth is used as an indicator of the health of an economy. A growth rate is

associated with innovation, high levels of employment, high levels of discretionary

income, and improved qualities of life. When the economy grows, consumers are more

willing to try new food products, spend more on high quality foods, and eat out more.

Furthermore, growth indicates market expansion indicating that the market can sustain

more firms.

49

What is a high GDP per capita growth rate in the US? The US economy has

demonstrated a surprising persistent 2% GDP per capita growth rate. Any annualized

growth rates in the US above 2% should be viewed as higher than normal.

Other Economic Environmental Factors

There are countless of other factors that should be considered when evaluating the economic

environment for a food product. Many factors will be very specific to the product. For example,

if your food product is sensitive to international factors, currency exchange rates and import

tariffs may be prominent factors that determine the decisions you make in your marketing plans.

If you are interested in launching a restaurant in State College, PA, specific factors relevant to

State College should be considered.

What specific economic environmental factors are paramount for making marketing decisions

for a new restaurant in State College, PA?

Possible Answers:

1. Due to the academic calendar, demand will follow a seasonal pattern.

2. The stability of the University provides year-over-year economic stability that insulates

State College from typical business cycles.

50

Food Marketing Decisions and the Economic Environment: The Case of the Shrinking

Containers

Starting in mid-2010, food producer input prices rapidly began to rise. Food

manufacturers anticipated production costs to continue to rise and remain at high levels. Riding

out the cost increase was not an option as operating margins shrank and per unit profit dwindled.

According to the pricing formula for an oligopolist, the profit maximizing response to a

production cost increase is to raise prices.

Source: Data retrieved from BLS

After all, that’s what food manufacturers did in response to the 2006-2008 upswing in production

prices with some minimal consumer pushback. But this time was different.

1. The previous price hike had the effect of making consumers more aware of price

changes. While many consumers did not notice the price increase of their favorite

brands, a second price increase would result in a price far above consumers’

expectations thereby making future increases in the shelf price highly salient.

Food Manufacturers’ Producer Price Index

51

2. When food manufacturers increase prices, they try to avoid increasing past critical

price points. For instance, the $1.00 retail price for candy bars is a critical one

because consumers are more likely to notice the addition of another digit to the

price and consumer psychology is such that crossing that price point will be

perceived as a large change. Thus a candy bar manufacturer might increase their

price from 79₵ to 99₵, but would be reluctant to increase any further.

Unfortunately, many food manufacturers had used up their pricing slack and

would have no choice but to increase their product prices across critical pricing

points.

3. High unemployment and low labor force participation during the Great Recession

left many consumers acutely price conscious. Many brand loyals switched to

being deal seekers.

4. Wages were not keeping up with consumer prices thereby making consumer

products, such as food, relatively more expensive. With the economic recovery

expected to be slow, this was not expected to change any time soon.

5. Increased media attention of the plights of the Great Recession encouraged

consumers not directly affected by the recession to be frugal.

Costs were not the only variable changing in the oligopolist’s pricing formula: 1-5 contributed to

unusually high consumer price elasticities. This was especially the case at the brand level where

competition is the fiercest. All manufacturers were experience a profit crunch and pressure to

increase their prices. But being the first in a product category could be devastating as consumers

switch to competing brands and don’t return.

What did manufacturers do? They increased their prices but in a clever way that consumers did

not notice. Instead of increasing the sticker price across critical salient price points, they

exploited they scalability of food products by reducing package sizes. To give this price increase

a positive spin, many marketed the change as “New Green Packaging.”

52

Size Before Recession Size After Recession

Canned Veggies 16 oz 14.5 oz

Pasta 16 oz 13.25 oz

Tuna Fish 6 oz 5 oz

Tostitos/Fritos X .8 X

Saltines/Graham

Crackers

X .85 X

Edy’s Ice Cream 2 L 1.5 L

Tropicana OJ 64 oz 59 oz

Source: Cite “Food Inflation Kept Hidden in Tinier Bags”

http://www.nytimes.com/2011/03/29/business/29shrink.html?pagewanted=all

Political-Legal Environment

The Political-Legal Environment is the component of the marketing environment consisting of

laws and interpretations of laws that require firms to operate under competitive conditions and to

protect consumer rights. This includes the extensive regulation that plays a central role in food

markets, and direct participation of government redistribution programs.

Maintaining Competitive Balance

Three federal laws restrict the power a food manufacturer can gain. The government is

especially vigilant of competitive practices in food markets because food is a necessity with

national security implications. Nevertheless, since 1980 the Federal Trade Commission (FTC)

has not aggressively enforced the major laws enacted to ensure competitive markets. It is fair to

say that the regulatory climate in this part of the political-legal environment is friendly to big

business.

53

1. Sherman Antitrust Act

“This Act outlaws all contracts, combinations, and conspiracies that unreasonably

restrain interstate and foreign trade. This includes agreements among competitors to fix

prices, rig bids, and allocate customers, which are punishable as criminal felonies.

“The Sherman Act also makes it a crime to monopolize any part of interstate commerce.

An unlawful monopoly exists when one firm controls the market for a product or service,

and it has obtained that market power, not because its product or service is superior to

others, but by suppressing competition with anticompetitive conduct.

“The Act, however, is not violated simply when one firm's vigorous competition and

lower prices take sales from its less efficient competitors; in that case, competition is

working properly.”

- Department of Justice, http://www.justice.gov/atr/about/antitrust-laws.html

The Sherman Antitrust Act is concerned with fairness in competitive markets. With food

being essential, the social welfare loss from unfair competitive practices in food

industries can be very high with the poor, according to Engel’s Law, being the biggest

losers. For this reason the Federal Trade Commission (FTC) keeps a close eye on the

competitive environment of food markets.

The FTC is particularly litigious towards marketing practices that strategically impose

barriers to entry to protect market positions. Nevertheless, this practice is common

because it is difficult and costly to prove that such behavior has occurred. Later in the

course we will read a case study of a familiar brand that deters another brand from

entering their market. That the brand is comfortable revealing this behavior in a case

study is indicative of the level of concern they have of the FTC pursuing legal action!

54

2. Clayton Act

“This Act is a civil statute (carrying no criminal

penalties) that prohibits mergers or acquisitions

that are likely to lessen competition. Under this

Act, the Government challenges those mergers that

are likely to increase prices to consumers. All

persons considering a merger or acquisition above

a certain size must notify both the Antitrust

Division and the Federal Trade Commission. The

Act also prohibits other business practices that may

harm competition under certain circumstances.”

- Department of Justice,

http://www.justice.gov/atr/about/antitrust-

laws.html.

The Clayton Act is a pragmatic law with the purpose of

deciding whether or not greater market concentration will

result in a better or worse world: i.e. increased or

decreased social welfare. Typically the merging entities

argue that the newly formed firm will benefit from

economies of scale that will reduce production costs.

Such cost reduction reflect greater technical efficiency and

is an unambiguous good thing for society with some of the

cost savings contributing to increased profit and the rest

contributing to greater consumer surplus in the form of

lower prices.

The potential negative social welfare consequences of

mergers comes from a loss of consumer surplus and

reduced amounts of produced goods and services.

Consider a duopoly market with two identical competing

brands with equal market share who want to merge. What

will happen when the firms merge if the merged firm’s

marginal production costs are unaltered? According to the

oligopolist’s pricing formula, the new firm will raise their

price so that their markup is doubled. The new firm will have increased profit, but consumers

will face a higher price and therefore will experience a loss in consumer surplus. Furthermore,

FTC v. Kellogg Company, et al., 1982

The ready-to-eat cereal market is

characterized by high concentration,

high price-cost margins, large

advertising-to-sales ratios, and

numerous introductions of new

products. For these reasons the

industry has been suspected of price

collusion and other anti-competitive

practices. In 1982 the FTC pursued

legal action against the major players

in the industry such as Kellogg and

Post, but did not find any wrong

doing.

Recent state of the art analysis finds

reasonable explanations for the

pricing structure and behavior of

firms in the ready-to-eat cereal

market.

Why do you think the ready-to-eat

cereal industry has such high

margins?

Answers:

(i) Inelastic demand due to

consumer habit

formation and bounded

rationality;

(ii) Line pricing

(manufacturers raise all

prices in unison to avoid

cannibalism);

(iii) High degree of product

differentiation;

(iv) Consumers perceive high

quality variation.

Source: Nevo, A. (2001). Measuring

market power in the ready‐to‐eat

cereal industry. Econometrica, 69(2),

307-342.

55

some consumers will avoid negative consumer surplus by opting not to buy anything at all.

Therefore less will be produced. These two negative effects add up to the “deadweight loss” to

society, and is the economic rationale for the Clayton

Act.

Question: We have assumed away the difficulty of

defining a “market.” In reality determining the

products that constitute a market is messy. Suppose

you are a regulator considering a proposed merger of

Dr. Pepper and Coca Cola. For simplicity, assume

those firms’ product portfolio consists only of soft

drinks. What criteria and measures would you use to

define their market? What products are in their

market? To strengthen their case for the merger, what

products do you think Dr. Pepper and Coca Cola will

argue are part of the market they compete in?

Answer: Markets are best defined by substitution

patterns. This is best captured by common sense and

cross-price elasticities. If a cross-price elasticity is

positive, then as a price of one product goes up the

demand for the other goes up as well suggesting

consumers substitute one for the other. Sweet

beverages that are bottled or distributed as fountain

drinks are a reasonable definition of their market. Dr.

Pepper and Coca Cola will argue for a broader market

definition including milk, water, tea, coffee, etc., as a way to down play the market power they

will gain from a merger.

3. Robinson-Patman Act

The Robinson-Patman Act, an amendment to the

Clayton Act, prohibits different prices for different

buyers that are at the same level of the food chain for the

purpose of harming competition. In other words,

manufacturers cannot choose winners and losers. This

limits the applicability of third degree price

discrimination (different prices for different commercial

segments) to garner greater profits. The Act is designed

to protect small businesses from volume discounts given to large retailers. This federal law,

If Hershey sells candy bars

produced in Pennsylvania to 7-

Elevens and a mom-and-pop gas

station in New York at the same

time, they must be at the same

price.

FTC v. Whole Foods,

In 2007 Whole Foods initiated a

merger with Wild Oats, a competing

natural foods store. The FTC had

determined that (i) “natural food

stores” comprised a well-defined

market, and (ii) the merger would

have substantially reduced

competition in that market. Thus the

FTC was prepared to exercise its

power under the Clayton Act in the

interest in social welfare. After two

years of law suits and hearings, in

2009 the FTC and Whole Foods

reached a settlement to, in effect,

undue the merger. Whole Foods

agreed to sell 31 Wild Oats stores,

divest of one Whole Foods store, and

sell the property rights to the Wild

Oats brand to a potential competitor.

Do you think that the natural foods

market is well-defined today? How

would you define that market?

56

which has seldomly been invoked since 1980 due to the requirement that the products must cross

state lines to be enforced, has become even weaker recently as the burden of proof required for a

successful suit has been raised. See Toth, R.J., “A Powerful Law Has Been Losing a Lot of Its

Punch.” Wall Street Journal May 21, 2012. online.wsj.com. 10/16/2013 for more details.

Taxes

Taxes distort prices. Consumer food products are typically exempt from state and local sales

taxes. Such taxes, where they exist, are regressive in the sense that they disproportionately

burden the poor.

Question: Why do sales taxes disproportionately burden the poor?

Answer: Food is a necessary good. Everyone needs to eat food. Suppose there is only one food

good that each consumer must consume one unit of for the price of $1. Suppose there are two

people, a poor person with an income of $2 and a rich one with an income of $20.

Other taxes besides consumer sales may exist. For instance, state and national governments have

invented a zoo of taxes for the purposes of (i) raising revenue, (ii) protecting local industry, and

(iii) discouraging excessive consumption (“sin tax”).

Price Floors and Ceilings

Some industries are protected by price floors below which retailers are not permitted to price a

product. Governments may also impose price ceilings above which producers are not permitted

to price a product to protect consumers or downstream firms from high prices (e.g. utilities).

For example, to protect Pennsylvania dairy farmers, Pennsylvania’s state government sets a price

floor below which retailers such as grocery stores cannot sell milk. This protective policy was a

response to supermarkets use of milk as a loss leader.

57

58

Government Food Regulatory Agencies

Food and Drug Administration (FDA)

The FDA is the regulatory body that regulates most food. We will discuss some of the specific

functions of the FDA later in this course. Here we will briefly discuss the general functions of

the FDA

1. Food Safety

The FDA does this by approving (or disapproving) the use of new ingredients. The

process for getting approval can be long and tedious as the FDA weighs the scientific

evidence of the ingredient’s safety. Common ingredients that have been around for a

long time are granted Generally Recognized as Safe (GRAS) status and do not need

approval.

2. Food Identity

Contrary to other consumer products, consumers have the right to know what they are

buying. The FDA has often extensive definitions of foods. If your new food product

does not satisfy one of those definitions, you have a new food product. Many argue that

this system discourages innovation since the narrow definitions that the FDA uses results

in classifications that turn consumers off as a result of modifications to existing food

products. Nevertheless, US consumers have the advantage of knowing what their getting

thanks to food identity regulation.

3. Food Labeling

The FDA protects consumers against false or misleading information on packages and in

stores. The rules and regulation of food labeling is so complicated that many large food

producers have personnel dedicated to managing their use. This underscores both the

importance of labels to food producers who find it profitable to push the boundaries of

food label regulation. An important class of food labels includes nutrition and health

claims. This important topic will be covered in depth later in the course.

4. Nutrition Panel

The FDA is in charge of enforcing compliance with regulation regarding the nutrition

panel.

59

United State Department of Agriculture (USDA)

While the FDA regulates most end-user food products, the USDA is the

primary regulator of raw agricultural commodities such as livestock and

poultry products. Some notably regulatory actions performed by the

USDA include meat inspection and the administration of the USDA

Organic label program.

Two very important food assistance programs fall under the purview of the USDA.

Supplemental Nutrition Assistance Program (SNAP)—Formerly known as “Food

Stamps,” SNAP serves 1/6 of the US population for a total distribution of $75

billion per year.

Women, Infants and Children (WIC)—WIC provides financial assistance for

healthcare and food to poor pregnant and breastfeeding women and children less

than 5 yrs. that are below 185% of the poverty line. A staggering 53% of all

newborns are served by WIC. Because WIC purchases more than ½ of all baby

formula, the USDA has the market power to dictate the quality of formula by

awarding WIC contracts only to producers that meet the USDA’s requirements.

Discussion Exercise: WIC and the Market

The US government does not only govern, but is also the largest purchaser in the US economy.

In many markets the US government is the single largest customer. When this is the case food

marketers must consider the policy intentions of government entities and other special aspects of

doing business with the government.

Company Brand Market Share

Abbot Similac 43%

Mead Johnson Emfamil 40%

Gerber Good Start 15%

TOTAL 98%

60

Just as producers gain market

power by gaining market

share, buyers gain market

power by accounting for a

large share of purchased

quantities. This allows buyers

to negotiate for lower prices,

higher quality, and other

favorable conditions. When

there is only one buyer in a

market, that buyer is called a

monopsonist. When there are

a small number of buyers in a

market, they are called

oligopsonists.

The most controversial and

powerful retail buyer today is

Walmart. Walmart regularly

gives suppliers the ultimatum

of reducing their production

costs or take a hike. This

occurred repeatedly with

Vlassic pickles until Vlassic no

longer could meet Walmart’s

cost cutting demands.

Fortunately, a Vlassic

employee had the

breakthrough idea of cutting

the pickles lengthwise which

resulted in fewer pickles being

needed to fill a jar, and lower

production costs.

MONOPSONY AND OLIGOPSONY

Federal WIC funds are distributed states who are then free to

administer WIC in their state. Each state negotiates and

chooses a baby formula supplier. The baby formula market

is exceptionally concentrated with three producers

accounting for nearly the entire market.

Two thirds of all baby formula is sold through retail outlets

such as supermarkets and supercenters. The rest is sold

through smaller stores and hospitals. With WIC supplying

more than half of the baby formula market by unit, state

WIC contracts are highly sought by baby formula

manufacturers. The states have a tremendous amount of

monopsony power that they leverage in negotiating lower

prices.

The winning manufacturer for the California contract agreed

to sell baby formula to the WIC formula below their

production costs. Why would a manufacturer be willing to

take a loss in the WIC segment?

Answer: They are more than compensated by an increase in

the non-WIC segment where customers pay full retail price

with a high markup. This occurs because

– WIC consumers are unlikely to pay a high

price premium anyways (little cannibalism)

– Increased production may reduce per unit

costs (economies of scale)

• captures all of the WIC market (53%

of total market)

• gains in non-WIC market too

– Guarantees the product will be sold in nearly

every store that sells formula

• Increased sales from non-WIC

consumers

• More shelf space, greater visibility,

more promotions

– Hospitals will give WIC samples out so that

babies will not have to change formulas as often

61

Horizontal refers to

competing firms on the

same level of the value

added distribution chain.

Vertical refers to connected

firms at varying levels of the

value added distribution

chain.

For example, Vertical

Integration refers to the

agglomeration of two or

more firms (or functions) at

varying levels of the value

added distribution chain.

When a retailer owns its

warehousing facilities and

services it is vertically

integrated.

Horizontal Integration

refers to the agglomeration

of two or more firms at the

same level of the value

added distribution chain.

When Kraft and H.J. Heinze

Co. merged in 2015, they

horizontally integrated.

HORIZONTAL AND VERTICAL

• post-partum moms will stick with the

brand…why?

• Implicit quality endorsement by an

influential 3rd

party…who?

– WIC consumer may recommend the WIC

brand to non-WIC consumers

– WIC consumers will stick with the brand when

they no longer qualify for WIC

Other Regulatory Forces

Many non-government entities are important players in the

political-legal environment.

Consumer Interest Groups

These groups increase public awareness, organize grass root

campaigns, lobby, petition, and sue firms and governments

when they see foul play. These groups have done a

tremendous amount of good. Recently the Center for Science

in the Public Interest made a very persuasive argument for

revamping the nutrition panel on food packages. Their

report, “Food Labeling Chaos: The Case for Reform,” made

specific recommendations based on scientific evidence. This

effort proven successful as the FDA has decided to revamp

the nutrition panel requirements and has adopted many of the

CSPI’s recommendations.

See Penn Public Interest Research Groups (PIRG) for another

example of a consumer interest group.

Special Interest Groups

These groups can be comprised of citizens or firms and tend to be focused on a single issue or

the interests of a single industry. One way these groups exert influence is by lobbying. For

example, the Sugar Cane and Sugar Beets industry’s special interest group gave $4 million in

Congressional contributions in 2012.

62

Question: Why do you think the Sugar Cane and

Sugar Beets industry’s special interest group was the

only agribusiness group to consistently contribute more

to Democrats than Republicans in 2012?

Answer: Because of diabetes, obesity, etc.

Agribusiness SIGs typically try to influence production

policy issues. But sugar is integral to pressing

consumer policy issues related to health. Democrats

tend to represent places where most consumers live and

are therefore more concerned with consumer welfare,

while Republicans represent where most ag producers

live and are therefore more concerned with ag producer

interests.

Self-Regulating Groups

Industries often forge agreements to self-regulate when

the industry as a whole could benefit from adopting

new practices even though adopting the practices would

put a single firm at a disadvantage. In this way

industries are able to overcome competitive forces that

would otherwise make raising industry standards

impossible.

Industry groups typically have little recourse when a

member violates the terms of the agreement, especially

when the agreements are horizontal. For this reason,

the promises of self-regulating groups are often not

credible—a topic we will return to when we discuss

third party labels.

GLOBAL G.A.P.

Retailers such as Safeway and

Wegmans found their quality control

inspectors “running into each other in

the field” as they traversed the world

to monitor their agricultural

suppliers. The costly inefficiency and

redundancy was obvious. The

solution, however, required the

cooperation of competitors. A little

coordination would eliminate

redundancy as all cooperating firms

would experience the benefits of

economies of scale. Producers who

had to accommodate the standards

of multiple retailers would benefit

from uniform industry standards as

well. Finally, increasingly

knowledgeable, concerned, and fickle

consumers would benefit from a

more transparent and effective

system that ensures food safety,

quality, and highly ethical standards.

All retailers are harmed by food

safety disasters such as Mad Cow

disease. In short, a better production

monitoring system would be a win-

win-win for retailers, producers, and

consumers. The result was GLOBAL

G.A.P., a self-regulating industry

group.

See the optional case study on

GLOBAL G.A.P. in the course packet

for an interesting and enjoyable read.