Consumer Psychologist Facebook Forum

Lars Perner, Ph.D.
Assistant Professor of Clinical Marketing
Department of Marketing
Marshall School of Business
University of Southern California
Los Angeles, CA 90089-1424, USA
(213) 740-7127


Food Market Structure

Background. Several characteristics of a market determine its structure. Usually, no one firm or individual controls the entire value chain, but some firms may decide to integrate horizontally—by buying up competing firms or increasing capacity—or vertically by buying facilities that tend to come earlier or later in the chain. Some industries provide for large economies of scale, potentially resulting in a limited number of firms controlling a large portion of the total market. Where economies of scale are smaller, or where obstacles such as government regulations limit the size of individual firms, the market may be more fragmented.

Horizontal Integration. Economies of scale can be important in some industries. Sometimes, it may also be useful to have different brands or businesses that serve different segments. For example, a firm that has experience in the retail industry might want to operate both a full-service retail chain that can charge higher prices and a discount chain that serves a more price sensitive segment.

When growth opportunities in existing firms may be limited, there may be significant pressure to find other businesses in which to invest current earnings. Frequently, stockholders do not want to have profits paid back in dividends since this money would be immediatley taxable. Firms may therefore need to find other ways to invest the money to make a satisfactory return, and it may be attractive to buy another firm in an industry the management already understands. In the United States , and to an increasing extent in Europe , governments are concerned about too much market share being controlled by one or a few firms and opportunities to acquire competitors may therefore be limited. There are also some businesses that do not lend themselves well to consolidation. For example, running farms depends a great deal of entrepreneurial drive and willigness to work long hours, so therefore corporate farms tend to be rare—usuallly, they would simply not be cost-effective.

Vertical Integation. Another way for a firm to grow is to integrate vertically. Here, the firm will buy firms that come earlier or later in the value chain. For example, McDonald’s could buy a meat packing plant that would supply much of the beef that its restaurants would need.

There are certain advantages to vertical integration. The most important advantage probably is having an assured supply in case of a “tight” market. Sometimes, it may also be possible to obtain “synergy”—a situation where two assets together may be worth more than the “sum of their parts.” For example, a seed manufacturer might be able to buy a chemical firm that supplies fertilizer used in the process of producing the seed and be able to use some research and development investments in both processes.

In agricultural industries, however, genuine synergy potential does not appear to be frequent. There are also considerable potential downsides to vertical integration:

In practice, therefore, many atttemps at vertical integration have not been very successful.

Specialization. Firms that tend to focus on one process often become more effective. KFC, for example, prides itself on the slogan of doing only “chicken right.” It is possible for firms that specialize to gain considerable economies of scale, including considerable bargaining power because of large quantities purchased. The firm can also spread research and development expenses across large volumes and can afford to invest in technology and research that allow superior quality and performance. Wholesalers spread costs of distribution across numerous product categories and develop extensive knowledge of efficiency in distribution. Farmers may hire agents to negotiate and tend to focus on farming rather than getting into how to make and distribute butter and cartoned milk in small quantities.

Diversification. Agricultural price markets often fluctuate dramatically. Therefore, it may be dangerous for a farmer to put “all [his or her] eggs in one basket.” For this reason, a farmer may produce several different crops or may even produce both produce and meat. On the average, this will probably be a less efficient strategy—the farmer does not get to specialize, does not get the same economies of scale, and does not get as much use of each piece of equipment. However, in return, the farmer is less likely to be driven out of business by a disaster in one crop area. For larger firms, diversification appears to be less useful. Financial theory holds that it is usually not beneficial for stockholders if firms diversity. The stockholders themselves can diversify by buying a portfolio balanced between different stocks. Sometimes, however, it may be difficult for a firm to find an opportunity to invest current earnings in the core industry, and management may be motivated to buy into other industries mostly as a way to avoid paying dividends that would be subject to immediate taxation.

Decentralization. In the old days, it was frequently necessary for buyers and sellers to physically gather to settle market prices. Many commodities would be sold through auctions where the price would be set by supply and demand. Nowadays, much of the negotiation can be done electronically. A farmer may notify an agent of what he or she has to send and one or more buyers can be approached. Buyers and sellers can then accept or reject offers that are being made at various times. This is more efficient, but it also means that less will be known about market prices by at least some participants. Large buyers that can invest in extensive market research often will know much more than small sellers about market conditions and thus have an advantage in negotiations. Since auctions in some markets now account for only a minority of commodities sold, the U.S. government is now unable to supply reliable market price estimates for some categories.

Farmer cooperatives. Farmers may decide to set up organizations that allow them to pool sales and purchases or provide or obtain certain services jointly. Cooperative organizations may be set up to run storage elevators or milling operations rather than contracting with outside firms to provide these services. In many cases, cooperatives appear to come about not so much for economic savings but rather for ideological reasons—farmers feeling in control of the process rather than having to deal with outside firms. Cooperatives may not be cost efficient, especially if they need to handle smaller volumes than commercial operators. They must also be managed—either by volunteers or outside management. With cooperatives also come governance issues and the need to resolve disputes between members. Cooperatives may be set up for marketing purposes—finding buyers for and transportation to potential buyers or establishing a regional brand identity. Purchasing cooperatives may allow for greater bargaining power through larger volume purchases. Cooperatives can also pool buying of such services as medical benefits or insurance for farms with a small number of employees.