IO - The Food Industry

What is happening in the food industry? We are observing considerable consolidation in the grocery store business as well as in other areas of agribusiness, such as food processing. Mergers in grocery stores are in part occurring because of the entry of Walmart and other mass merchandisers into retail food sales. A related issue is that there are possibly some economies of scale. Other factors include changing technologies (scanner data etc. makes central planning easier) and changing American lifestyles (time pressures lead to the desire for on stop shopping).

In food processing mergers have also been occurring recently. A number of interesting questions remain:

What is the impact of consolidation going to be on consumers, small chains and downstream firms, in particular farmers be?

Is there a link between food processing mergers and grocery store mergers?

Are there really economies of scale to be taken advantage of? If so, how big are they? These are important questions, because one can get a better idea of how beneficial these mergers are and how concentrated we can expect the industry to become.

How concentrated is the food industry?

In these articles we saw various definitions of concentration, although none matched the DOJ's definition.

The Fed Reserve article suggests there is no consensus among economists, but that C4s of between 25 to 70% may be considered concentrated.

Breslow suggests the number 40%. What does this convert to in terms of HHI?

In looking at concentration, not only do we need to determine what is considered a high number, we also need to define what we mean by a market - in terms of geography, as well as in terms of products.

At the regional level grocery store concentration was already pretty high, even before the mergers. C4=75

But at the national level it does not look that concentrated compared to other industries. C4 = 30. Still there is a clear trend of increasing concentration.

In looking at the food processing industry, national statistics are relevant. This industry is far more concentrated than the grocery store industry is at the national level. C4 = 70.

The Fed reserve article suggests there is a link btw consolidation in the various segments of the food industry. Basically you have to be big to dictate terms, so if another part of the industry becomes concentrated, your best response is to become concentrated as well.

Some background on the grocery store industry:

This is an industry with very narrow profit margins.

Food sales are not a growth industry. (So total sales do not grow much from year to year.)

Consumers are spending more and more on prepared foods, and as such less of their income is going to grocery stores, although one way grocery stores are reacting to this is by providing more preprepared foods (which are not included in the stats in the ERS article.) Now 87% of supermarkets serve prepared foods.

Another way is to find other niche markets, such as organic food.

Why merge?

Various forms of cost savings may result.

Can take advantage of volume discounts at the wholesale level.

Centralized management.

Exclusive partnerships with suppliers have also resulted. This helps maintain quality and both suppliers and retailers like the stability (although this also means less risk diversifaction.)

There has also been a bit of vertical integration, as larger chains are likely to do their own distribution.

What is the impact of consolidation on consumers:

the evidence is mixed - some possibility of higher prices and less variety.

The Fed Res article suggests that some prices have increased, and that retailers are the big beneficiaries, not farmers or food processors. But this was just the example of one price.

The FTC and the Congress have also expressed some concern over the mergers. For instance, the FTC has required divestiture in some markets, when grocery store mergers have occurred (although Breslow argues that this has simply led to one giant selling off stores to another giant.)

Wholesalers are concerned that they will be squeezed by further consolidation and as we see in the Fed res article, have reacted by merging themselves.

Grocery stores may have considerable power - dictating slotting fees, etc.

Yet, overall, the articles written by government economists do not paint a very gloomy picture.

Breslow has a less optimistic view of mergers.

He points out that mergers can mean store closures, which means reduced convenience for consumers, as well as job loss for local communities. (In another article he quotes economist Shepherd, who argues that less innovation also results.)

He is also concerned about variety and quality.

He points to the demise of family businesses and the rise of corporatism.

This is linked to more concern for profit and less for employees, customers, etc.

He points out there is a whole new area of 'middlemen' and women - those specializing in leverage buyouts, who collect big fees for their 'work.'

In fact, he points out that mergers themselves may be a new form of inefficiency.

Finally, he calls into question the idea that economies of scale, lower prices, higher profits necessarily result from buy-outs or mergers! (So does the Fed reserve article.)

Finally, he suggests out that the real winners are

1. corporate executives, who get bonuses, stock options, etc. and make money whether the merger is successful or not.

2. the oil industry, because mergers lead to fewer retail locations, which means a longer drive for consumers. This is of course does not help with the time crunch which most Americans are feeling.

Why have we seen so many mergers in the 1990s?

1. Strong stock market

2. Weak anti-trust enforcement

While the latter may continue, the former is not, at present.

He goes on to predict that this recent round of mergers could lead to a crash.

Solutions:

Better enforcement of anti-trust legislation (is this possible, given what the Fed res article says?)