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Summary of full report
Generic Promotion in the Food Marketing Chain by John Freebairn, Ellen Goddard and Garry Griffith
July 2008
RIRDC Publication No 08/047 RIRDC Project No UM-60A
Typically a levy takes the form of so many dollars per unit of farm sales or as a percentage of farm sales and represents an additional variable cost of production. In special cases a levy may be of a lump sum form such as dollars per farm. Most generic advertising programs are directed at increasing domestic sales, but some may be directed at export sales or to both markets. The advertising aims to increase sales by providing information and/or by persuading consumers to change their tastes in favour of the advertised product.
The farm sector is represented as a competitive industry. Individual farmers choose their own output where the market price for the farm product equals the farmer’s marginal cost, inclusive of the levy to fund the generic advertising program.
Farmers gain from a generic advertising program only if the net farm price rises. The higher net price to farmers increases producer surplus, or the returns on farmer-owned land, management, labour and other resources which are in limited supply.
This report seeks to do three things. First, it reviews the literature and develops theoretical models to assess the conditions under which farmers would gain from a generic advertising program funded by a levy on production. Second, it applies a general model to the range of Australian agricultural products to assess the minimum increase in domestic sales from advertising that would be required for the program to increase farmer returns. In particular, the assessment distinguishes products by their exposure to international trade. Third, by way of illustration, the report summarises three detailed case studies of generic advertising programs for the egg, pork and beef industries.
Who is the report targeted
at?
The report is targeted at
policy makers, and industry groups involved in advertising campaigns.
Background
Generic advertising has
been a widely-used marketing tool of many agricultural industries, both
in Australia and overseas. In recent years, the strategy has come under
increasing scrutiny, especially by levy-paying producers who fund the advertising.
Also, for many food products, supermarket chains have developed and advertised
their own “store” or “private label” brands in competition with both processor
brands and generic advertising of those products. In such an environment,
the issue is whether generic promotion will increase producer returns or
could the funds spent on advertising be put to better use elsewhere.
Farmers gain from a generic advertising program only if the net price of produce rises, where the net farm price is inclusive of the levy collected to fund the generic advertising program. The higher net price to farmers increases producer surplus, or the returns on farmer-owned land, management, labour and other resources which are in limited supply.
Aims/Objectives
The aim of this project
was to examine the conditions under which an increase in the net farm price
is likely to occur in response to advertising for produce.
Results
This research found that
the generic advertising program has two sets of effects on farmer returns.
First, the advertising-induced increase in retail sales shifts out the demand for the farm product.
Second, the levy to fund the program shifts up the farm supply curve. These two curve shifts lead to market adjustments and to changes in market prices and quantities, including the net farm price. The focus of the report is on models which can be used to measure the net change in farm returns after the market responds to the shifts in the demand curve and the supply curve.
The basic model assumes competitive behaviour by processors, retailers and others in the post-farm marketing chain; no changes or reactions of existing brand and other advertising programs in response to the generic advertising program; and a constant rate of transformation of the farm product into the retail product.
For farmers to gain from a generic advertising program funded by a levy, the increase in domestic sales due to the program needs to be greater when, under three conditions:
Results/Key findings
Experimental simulations
of the impact of generic advertising were undertaken in three different
types of markets. First, using a formal structural model of the pig meat
industry (a minor trading industry), a 1 per cent exogenous shift in the
domestic demand for pork would generate a larger return to pig producers
($1.82 million) under a non-trading scenario than when Australian pork
is exported and assumed to be homogenous with other pork ($1.62 million).
Thus, when an industry operates in a trading environment, the returns from
generic advertising would always be expected to be less than those if it
were in a non-trading environment. This is because adjustment to the displacement
of the domestic demand curve may occur in export and import markets as
well as in the domestic market, so price rises are curtailed and producer
surplus changes are lower.
Second, using a similar type of structural model of the beef industry (a major trading industry), found that domestic advertising and export advertising would have very different welfare implications for both producers and consumers. Shifting the domestic demand curves for grass-fed and grain-fed beef outward by one per cent returns about $41 million annually (for the whole beef industry), while shifting the export demand curves outward by one per cent returns about $26.5 million annually, even though about twice as much beef is exported as is sold on the domestic market. The export demand curves are quite elastic and the potential for price increases is limited.
Third, rather than simulate a formal model of the shell egg industry (a non-traded industry), an estimated break-even, or minimum, level of extra sales which would need to be achieved if egg farmers were to gain from the current levy funded generic advertising program. For a one cent per dozen levy and domestic demand elasticity of -0.6, advertising would need to increase egg sales by at least 0.26 per cent, or by about half a million dozen eggs a year, for egg farmers to gain from the current levy-funded generic advertising program.
Implications for relevant stakeholders
Model Extension: Market
power
For many agricultural products
the post-farm sector is characterised by a few dominant firms in the processing,
wholesaling and retailing of agricultural products. The potential for these
firms to exercise market power, whether against consumers, against farmers
or both, is at variance with the perfect competition assumption of the
basic model.
In terms of market prices and quantities, the exercise of market power by companies in the post-farm sector will reduce quantity, increase the retail price, reduce the farm price and reduce farmer returns.
However, the results from the formal economic models, and from illustrative simulation studies for likely market circumstances in North America that have been reported in the literature, show that the exercise of market power by companies in the post-farm sector seems likely to have little effect on the net benefits to farmers of a levy-funded generic advertising program. Compared with a competitive model, the exercise of market power does dampen the benefits to farmers from the demand shift due to the advertising, but at the same time, the costs to farmers of the funding levy are similarly dampened by firms exercising market power.
Model Extension: Advertising
reactions
The basic model assumes
that post-farm sector firms do not change their brand advertising levels
in response to a farmer-funded generic advertising program. Further, there
are no available data to refute this assumption. But, if existing brand
advertising programs are increased as a result of a generic advertising
program, the required minimum generic advertising response for farmers
to gain would be reduced, with the converse also being true. The model
was explored to investigate its impact on market power, advertising reactions
and production technology.
Model Extension: Production
technology
The basic model assumes
a constant rate of transformation of the farm product to the retail product
that is invariant to changes in the relative prices of the farm and non-farm
inputs. Where there is some input substitutability, and there is growing
empirical support for this fact, the basic model overestimates the gains
to farmers from an advertising-induced increase in retail demand.
Application to Australian
agricultural products
Estimates of the minimum
increase in domestic sales required from a generic advertising program
if farmers are to gain, are provided for different levels of the levy rate,
the importance of domestic sales in total sales, and for the own-price
elasticities of domestic demand and export demand. Some examples are as
follows.
Recommendations
It has been shown that if
existing brand advertising programs are changed as a result of a generic
advertising program, the required minimum generic advertising response
for farmers to gain would be changed. Whether such changes would occur
and in which direction and by how much depends very much on the form of
the strategic games being played by the processors and retailers in any
particular market. However, to our knowledge, no published study of the
advertising of agricultural products has considered estimating the strategic
reactions of brand advertising to changes in the level of generic advertising.
It is recommended that such a study be conducted, if the required data
were made available, as clearly such a study would place enormous requirements
on the data.
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