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Concentrating on food concentration

Continued low commodity prices have turned up the heat on consolidation in the food processing industry

January 1, 2000


Ron Wirtz Editor, fedgazette
Concentrating on food concentration

In the public discussion over who's killing the family farm, the lineup of suspects is long—industrialization on the farm, unfair trade and subsidy practices in other countries, the Freedom to Farm Act and other federal farm policies, to name a few. None of them, however, seems to elicit the same emotion as the issue of consolidation and concentration among agribusinesses, particularly food processors like meatpackers and flour mills that purchase and process the bulk of farm commodities. Unlike mushy demons such as international trade, concentration in agribusiness provides a tangible, well-defined target for farm advocates.

Providing much of the ammunition is a feverish pace of consolidation in agribusiness. Particularly in the food processing industry, if you'll excuse the pun, it's eat or be eaten. International food giant ConAgra acquired 11 different companies or product lines in the last two years, including the likes of Seaboard, a chicken company with annual sales of $480 million. Cargill wrestled with the federal Department of Justice last year to purchase the grain operations of Continental, a century-long competitor.

Meat conglomerate IBP bought five different companies or food lines in 1999, and is starting this year off by finalizing the purchase of Corporate Brand Foods America, which had sales of $800 million last year. In September, Smithfield Foods—the nation's largest hog producer-processor—went shopping and came home with No. 2 producer Murphy Family Farms.

Concentration itself matters only to the extent that it adversely affects competition and, by extension, the prices farmers receive for commodities like corn and cattle. But critics point out that agribusiness concentration has drastically reduced sales outlets for farm commodities, amplifying the potential for these companies to abuse their market power and keep commodity prices artificially low.

"We are concerned about the possible misuse of market power," said Gerald Grinnell, a director with the Grain Inspection, Packers and Stockyards Administration (GIPSA), an inspection and enforcement arm of the U.S. Department of Agriculture (USDA). As concentration increases, Grinnell said, "the opportunity for mischief probably increases."

A backlash—mostly rhetorical—has sprouted against further agribusiness consolidation, including a federal legislative proposal to place a moratorium on agribusiness mergers.

In supporting the legislation, the National Farmers Union (NFU) stated, "Mergers, acquisitions, and alliances are squelching competition and drying up markets for farmers and ranchers. How can producers possibly earn a fair price when they have just one or two buyers for their product?"

While the bill was ultimately voted down, it is likely to be introduced again and pushed by a number of politicians from the Ninth District.

Concentration? Yes ...

The question of whether concentration actually exists in food processing has been settled for some time. The answer is a resounding yes, according to numerous sources.

As of 1995, the four largest firms in flour milling, grain storage capacity, brewing and minor oilseed processing held 70 percent of those markets, according to research at North Dakota State University. Earlier concentration data for each of these markets is not readily available, but in 1973, the four-firm concentration in flour milling was just 34 percent.

In 1985, the four largest beef packers controlled 39 percent of the cattle slaughter market. Last year it hit 70 percent, according to GIPSA. The top four firms in pork packing went from a 32 percent market share in 1985 to 56 percent in 1998.

Given such market concentration, "there's a need to be more diligent to ensure there is no anti-competitive behavior," Grinnell said.

But while farmers might not like it, the trend in consolidation and concentration in agriculture is "irrefutable and irreversible," according to Rod Smith, staff editor of the trade publication Feedstuffs. "It's happening in every other industry in every country."

Consolidation and concentration is the result of what Smith called "matching scale of forward players," or becoming more like the companies you sell to. The concentration in processing is the result of a consolidation trend down the food chain, starting in supermarket retailing, where one source put average four-firm concentration in U.S. metro areas at 74 percent.

Once you reach a certain size, Smith said, "You don't 'buy' something from a processor. You tell him what to bring you" at a price you're willing to pay, Smith said. This forces consolidation down the food chain—from packers and other processors through the family farm—as each level looks for cost efficiencies through scale.

The driver behind concentration is not "a packer wanting to put a farmer out of business," Smith said. It's the packer "trying to keep up with the [next-level] processor, who's trying to keep up with the retailer."

"Family farms can't survive in that kind of setting," Smith said, unless they are willing to act like the rest of this integrated system.

Bill Wilson, a professor of agricultural economics at North Dakota State University, pointed out that agriculture is hardly the only concentrated industry. "Concentration in agribusiness is nothing," Wilson said, adding it "doesn't hold a candle" to concentration in other industries like computers and software.

"You don't need an infinite number of firms to have a pretty intensely competitive environment," Wilson said, estimating that four to six firms can create the same competitive environment as one with many more.

Merger mania

Agribusiness is hardly alone in the merger movement. In 1998, there were a record 4,728 company mergers and business acquisitions—about 1,000 more than the all—time high established a year earlier, and triple the number just six years previous.

lthough exact calculations are difficult to determine, less than 4 percent of all mergers in 1998 appear to be related to agricultural or food sectors, according to the joint annual report of mergers and acquisitions by the Department of Justice and the Federal Trade Commission.

Of those mergers having some reasonably direct connection to farming (not including heavy machinery firms, for which agricultural connections cannot be easily determined), acquisitions in the "food and kindred products" industry numbered just 160, or 3.5 percent of the total. The DOJ and FTC challenged just 84 of all proposed mergers—fewer than two out of 100—with varying results.

The report noted "a merger wave of unprecedented proportions" that easily exceeded $1 trillion in value in 1998—a threefold increase since 1995, and sevenfold increase since 1992.

The merger mania rolling through corporate America got kick-started in the 1980s, but is not without historical precedent. According to The Economist, a brief period in the early 1900s saw the monetary value of mergers peak at 10 percent of gross national product-a height not hit again until the last half of the 1990s.

... But so what?

A larger question in the debate over concentration is one of net impact: Does agribusiness concentration have any effect—particularly negative—on prices paid to farmers?

Research to date says no, with small qualifications.

"To the extent that people are blaming low prices on concentration, they're just looking for a bogeyman," said James MacDonald, a senior economist with the USDA's Economic Research Service, and an expert on concentration.

Most research so far has focused on the meatpacking industry. The USDA has studied concentration in this area twice in the last four years, concluding in its most recent effort that there was "no evidence to support the assertion that increasing slaughter concentration results in lower farm prices."

A 1996 USDA report pointed out that previous studies of the effects of concentration in meatpacking were "inconclusive" due to limitations in both data and research methods. Its own analysis showed that "prices in local areas are affected very little by differences in concentration in those regions ... (and) did not support any conclusions about the exercise of market power by beef packers."

The report pointed out that although 95 percent of cattle were shipped to plants within 270 miles, low transportation costs and availability of plants within regions "likely diminishes" the opportunities for packers to manipulate prices significantly or for long periods of time.

Packers have strong incentives to actively compete on price because today's larger feedlots mean producers are in the marketplace more frequently, according to MacDonald, which gives them the expertise and experience "to react quickly to price differences among cattle buyers."

Were a packer or miller strong-arming a farmer on price, "it's hard to believe that a [different] company couldn't take advantage of the price differential," said Maury Bredahl, an ag specialist at the University of Missouri.

That's not to say there are no black eyes for this new economic order. In 1997, grain giant Archer-Daniels Midland (ADM) was fined $100 million for conspiring to fix prices for lysine (an animal food additive) and citric acid, and three of its executives were sent to prison. Cargill was also implicated in the citric acid case, but was eventually cleared.

It can happen at the sub-market level as well. A case against five Minnesota dairies accused of price fixing was recently settled out of court, with four required to give state food shelves 250,000 gallons of milk for the next five years.

Although mergers and acquisitions seem to be a hit on Wall Street, some question whether they live up to advance billing.

"There's a million good reasons for mergers," said John Connor, a professor of agricultural economics at Purdue University. But oftentimes "companies claim synergies that simply aren't there in six or seven out of eight cases." Predicted benefits often seem logical on paper, Connor said, but "tend to disappear when you get close to them."

MacDonald agreed. "A lot of mergers don't deliver the efficiencies they promise ... especially if you're combining two companies and expect something to happen."

Agribusiness: Making a killing or getting killed?

Examples of corporate wrongdoing have bred a fair number of skeptics to concentration. Too much concentration at the upper level strips the ag economy of any opportunity "to provide for viable alternatives" if existing markets bottom out, said Paul Strandberg, program director with the Minnesota Department of Agriculture.

Agribusiness is also feeling the heat of public suspicion and mistrust. "There is a perception that [companies in the grain industry] are making a killing," said Lori Johnson, a spokesperson for Cargill.

MacDonald disagreed with the characterization. "I don't think evidence is showing they have been all that profitable, at least over time," especially in meatpacking, he said.

Whether agribusiness is "making a killing" probably depends on your definition. For starters, the food processing industry runs on very slim margins. IBP's profit margins have averaged 1.5 percent for the last three years, according to Gary Mickelson, manager of communication for IBP.

The same was true at Cargill. "The grain business is in the tank," Johnson said, adding there were "zero margins on the export side. We're moving grain because we have the facilities." She added that Cargill's average margin is "fractions of a cent per bushel."

A look at financial performance for several major agribusinesses showed times have been better for them as well as farmers. ADM saw total revenue drop by 11 percent last year, and net earnings by 34 percent ($138 million).

Cargill's profits were down also: 62 percent in fiscal year 1999, including a $182 million loss in the fourth quarter, and total revenue was down more than 10 percent. Johnson called it "the worst year we've had in probably a hundred," and added that there has been "retrenchment throughout the industry."

ConAgra, for example, is in the early stages of a reorganization called "Operation Overdrive," thanks in part to plummeting revenue and operating profits in its agricultural products segment. The initiative is expected to close a number of production plants along with dozens of storage, distribution and smaller processing facilities, spin off about 20 small noncore businesses or lines of business, and reduce the company's workforce by 6,700 employees. The company is taking a pretax charge of more than $800 million, spread over three years.

Not everybody is feeling sorry for them. The major agribusinesses still manage to earn a profit—usually in the hundreds of millions—something that has eluded many farmers. ConAgra, despite its reorganization, and IBP both announced record earnings in their most recent quarters. Some critics will tell you that profit comes off farmers' backs.

Alan Kluis, president of Northstar Commodity, a commodity brokerage in Minneapolis, said packers and other processors are making "profits at the expense of farmers."

"They don't ever pay what they can. They pay the minimum amount they can get away with. That's an economic fact of life," Kluis said.

He admitted that agribusiness profits were not likely "as exorbitant" as many farmers believe, but low commodity prices have nonetheless helped out processors' bottom line and contributed to a widening farm-to-retail price spread that was "not fair to the farmer or consumer," Kluis said.

He pointed out that when processors and retailers fail to pass low commodity prices on to consumers, farmers get the double-whammy because artificially high prices "don't stimulate more demand" like lower prices would, which then keeps supplies high and prices low.

Food processors have argued that there are many cost factors involved in moving, say, a pork chop from pen to plate, and prices paid to farmers are a fraction of the total retail cost. Retail pork costs also lag behind hog prices to the farmer, and retailers try to protect consumers from wide price swings, which is why lower commodity prices don't always show up quickly—or at all—at the checkout counter.

If that's the case, Kluis said, "then the flip side should be true"-namely that consumer costs should not rise when commodity prices increase. "It's smoke and mirrors," Kluis argued, because low commodity prices were "definitely helping [processors'] bottom line."

Research on farm-to-retail prices shows three things. First, farm-to-retail price spreads have increased for most farm products, but not dramatically so for many commodities when inflation is considered.

Second, the greatest share of the farm-to-retail price increase has been taken not by packers and others in wholesale (what's referred to as the farm-wholesale margin), but by distributors and retailers (wholesale-retail margin).

For example, the average retail price for choice beef in 1989 was $2.66 per retail pound, according to the USDA. Of that, farmers received $1.58, while the farm-wholesale cut was 19 cents, and wholesale-retail collected the remaining 89 cents.

By 1998, retail beef prices averaged $2.77 a pound, but the price paid to farmers dropped to $1.31—meaning farmers' share of the retail price shrank from almost 60 percent to 47 percent. Packers and others in the wholesale end saw their cut increase to 23 cents, but retailers saw their slice for a pound of beef rise to $1.23—a jump of almost 40 percent.

Third, there have been instances where the margins for wholesalers have increased while those of farmers have fallen. For example, hog prices went into a free fall in the last quarter of 1998 due to a huge glut of hogs and low excess capacity in packing plants, but there was little subsequent price cutting to consumers.

During this time, packers and others in the wholesale chain saw their cut for a pound of pork rise from 28 cents in 1997 to 36 cents in 1998, including a fourth quarter spike to 48 cents, according to USDA data.

In its 1998 annual report, IBP noted that pork was the company's "big achiever." Citing a number of factors, including higher than expected hog supplies, the annual report stated that pork had "its strongest and most profitable full year on record at IBP." In the fourth quarter ending Dec. 26, 1998, the company posted net earnings of $92 million—almost as much as the previous three quarters combined.

GIPSA has been investigating the farm-to-retail price gap in the pork industry, but is still at least a year away from any findings, according to a GIPSA official. The office is also studying the effect of recent pork plant closings on kill capacity, and has not released findings on that study.

A December report on the pork industry by the General Accounting Office—also sparked by the 1998 drop in hog prices-noted that the USDA overestimated retail pork prices that year by 14 cents, which meant the farm-to-retail spread was not as large as USDA figures indicated. However, the report did not identify what level within the pork chain was most affected by the price error, or explain whether retail prices in beef or other commodities tracked by the USDA were similarly miscalculated. It did, however, confirm that the historical widening of the farm-to-retail spread in pork was due to higher prices at the retail end.

Skip the tree, look at the forest

There are some who believe the hand wringing over concentration among food processors is nothing more than rantings from the margins. Any effect concentration might have on prices, they say, pales in comparison to simple economic forces reshaping agriculture.

"I don't think [concentration] is the right issue people are fixating on," said Wilson of NDSU. "We've been evolving like this for 100 years."

Effects of concentration can be real, MacDonald said, but their overall impact on farm prices is likely small compared with macroeconomic factors like supply and demand.

Johnson agreed, "What we have is too much supply chasing too little demand."

Mickelson said it was "discouraging (for agribusiness) to have to take the blame" for troubles in livestock farming when "study after study" shows that concentration has not resulted in lower prices. Complaints about concentration "are not unlike the complaints we've heard in the past," Mickelson said. "The problems are driven by basic economics—supply and demand."

Mickelson and many others at IBP "grew up on the family farm. We understand the changes that have taken place. ... What's often missing (from the discussion) is the facts," Mickelson said, adding that too often emotion "overrides the truth in this issue."

Many Cargill employees come from rural and farming backgrounds, Johnson said, and "find themselves kind of vilified" by the very farm customers they serve. She added that sometimes even farmers feel bad because "it's not that nameless, faceless [corporate] giant. It's Joe Smith," whose been working with them for years.

Given global consolidation trends, "rather than fight it and pointing fingers, it's better to anticipate and capitalize and adapt to it, and seek ways to remain competitive," Mickelson said. Competitive and economic forces at work are "bigger than any one company." "There are no quick fixes," Johnson said. "Those looking for easy answers find the wrong things."

Defining concentration

Just when is an industry considered "concentrated"? Although there are no hard-and-fast thresholds, some sources believe an industry is concentrated when four-firm market share reaches just 25 percent, and highly concentrated at 50 percent. One expert said 70 percent was a useful, if crude, benchmark for when concentration becomes problematic to market competition.

However, concentration, as it concerns antitrust laws and action against mergers and acquisitions, is another matter. By itself, the existence of four-firm concentration is not enough to warrant the blocking of a merger by the Department of Justice (DOJ), which handles antitrust matters.

When a merger is proposed, the DOJ looks at a number of factors, including market structure and concentration. The DOJ determines the significance of concentration through a fairly complicated formula known as the Herfindahl-Hirschman Index, or HHI, which is based roughly on the market share of all companies in an industry.

HHI calculates the change in concentration, which in turn is measured against established benchmarks and indicates whether the merger is likely to "raise significant competitive concerns," according to DOJ guidelines. Even where concentration exists, when evaluating a merger's effect on competition, the DOJ must also consider factors like the availability of market substitutes—eating more chicken or beef when pork prices go up—and ease of entry by potential competitors.

Many farm advocates have been critical of DOJ's unwillingness to aggressively block food- and farm-related acquisitions. Two things make doing so difficult. The first is that many acquisitions are of smaller companies by the major players—60 percent of those businesses being bought had sales under $100 million, and about 60 percent of buyers had sales of more than $500 million in 1998. This tendency means that many acquisitions fail to dramatically shift market share distribution and HHI values.

The second, and probably more overlooked, element is that the Justice Department has no authority to stop mergers or acquisitions. To halt mergers it believes will hurt industry competition, it must sue and win an antitrust suit in court—oftentimes in an all or nothing scenario.

That is why many DOJ antitrust suits are settled out of court, including the recent acquisition of Continental's grain operations by Cargill, which was approved after Cargill agreed to divest a number of grain elevators.

"What Justice has to worry about is the ability to win a case," according to James MacDonald, a senior economist with the USDA and an adviser to DOJ on the Cargill suit. If you lose, he said, "You don't get anything."

Ron Wirtz
Editor, fedgazette

Ron Wirtz is a Minneapolis Fed regional outreach director. Ron tracks current business conditions, with a focus on employment and wages, construction, real estate, consumer spending, and tourism. In this role, he networks with businesses in the Bank’s six-state region and gives frequent speeches on economic conditions. Follow him on Twitter @RonWirtz.