**The Many Faces of Power in the Food System**

Comments by

**C. Robert Taylor**

Alfa Eminent Scholar of Agriculture

Auburn University

Alabama Crop Improvement Building

South Donahue Drive

Auburn, AL 36849

taylocr@auburn.edu

Presented at the DoJ/FTC Workshop on Merger Enforcement

February 17, 2004

**The Many Faces of Power in the Food System**[^1]

**C. Robert Taylor**

> *"... it is clear why manufacturers press down the prices of the raw
> products they purchase. Who, then, must make the concessions? The
> answer is those who are least able to resist pressure and who can take
> reductions and still stay in business. There is but one group that
> regularly meets these specifications---farmers." D. Howard Doane,
> 1950*
>
> *"There isn't one grain of anything in the world that is sold in a
> free market. Not one!" Attributed to Dwayne Andreas, CEO of Archer
> Daniels Midland (ADM)*[^2]
>
> *"Agriculture is the most manipulated industry on the planet."
> [Fortune]{.underline}, 1990.*

I am honored to participate in this workshop on merger standards. As an
introduction, I would like to point out that for the first two decades
of my professional career I was essentially a traditional academic,
conducting applied and theoretical research from my office and teaching
graduate courses in microeconomic theory and industrial organization.
However, for the past ten years, particularly the last five years, I
have spent much of my time talking to agricultural groups and listening
to their concerns about market power issues. What one learns in the
field does not always correspond to what one assumes sitting in the
office. Many of my comments reflect what I have learned by getting out
of the office and closer to the food industry.

The workshop organizers have asked me to address the question of whether
the creation of buyer power should be assessed differently from the
creation of seller power. Conceptually and theoretically I do not see
any compelling philosophical reason to treat buyer power differently
from monopoly power for purposes of merger analysis. However, I believe
the elements of theory relevant to empirical analysis and the complexity
of buyer power exertion are often considerably different from similar
considerations of seller power in the food system, particularly when
contrasting potential seller power in the final consumer goods market
from buyer power exerted over raw material suppliers. A unique
characteristic of agricultural markets is that in some markets a single
firm is both buyer and seller. Such a firm can use buyer power or seller
power, depending on market circumstances. This alone adds considerable
complexity to definition of merger standards and to antitrust analysis.

Here are a few general observations: First, monopsony, monopoly and
economic power imbalances are all evident in the global food system.
Second, power can and has been exerted in many, ever-changing and often
complex ways. Third, the central economic issues facing the food system
have little to do with economic efficiency, but a lot to do with
fairness and economic freedom for farmers and ranchers. The food system
is highly efficient, but farmers and ranchers world-wide are
increasingly squeezed by monopoly, monopsony and economic power.
Furthermore, as contracting for supply of raw agricultural products
increases, involvement in production agriculture comes by "invitation
only," which I view as a potential constraint on economic freedom.

Economic models in textbooks and academic literature contain elements of
the ways in which power can be exerted, but none adequately capture the
combined---perhaps multiplicative---effects of the many ways in which
power over farmers and ranchers is exerted globally. Because power is
exerted in many ways that vary considerably from industry to industry,
simple merger or antitrust guidelines are difficult to formulate.
Complexity of issues poses definite challenges not only for merger
analyses but for Judges and Juries adjudicating antitrust.

**The Many Faces of Power**

There are many faces to monopsony, monopoly and economic power in the
food system. The faces of power include traditional power due to size
and dominance in a market resulting in a non-competitive price or
non-competitive contract terms, asymmetric information, price
discrimination, barriers to entry and control of entry/exit, control of
innovation, use of threats, agency capture, association capture,
economic power to control or influence legislation aimed at restoring
competition, and firms simultaneously being buyers and sellers in a
market.

Time and space do not permit me to fully discuss the many ways in which
power may be manifested in the food system, so I will discuss buyer
power issues in two specific cases. One case is the beef industry which
is only partially integrated vertically through many kinds of contracts
between beef packers (slaughter and processing firms) and cattle
feeders. The other case is the poultry industry which has been
vertically integrated through contracting for about 50 years.

**The Beef Industry**

In the field of economics and industrial organization there is the near
universal assumption that the buyer of a particular commodity is
distinct from the seller of that commodity. In a sense, there is a fence
separating buyers from sellers. Market transactions, whether they are
over contract terms or cash transactions, occur over this fence. Merger
standards and antitrust analyses generally reflect the mind set that
there can be buyer power exerted by a firm on one side of the fence, or
there can be monopoly power exerted by a firm on the other side of the
fence, or perhaps there can be a balance of power with bilateral
monopoly. But never the same firm on both sides of the market, routinely
jumping back and forth across the fence.

Historically there was a fence---a barbed wire fence---separating the
buyers of slaughter cattle from the sellers of slaughter cattle. That
barbed wire fence has been torn down with *partial* vertical integration
and consolidation that has occurred primarily in the last two decades.
The major packers---firms that slaughter and process cattle---stand on
both sides of the fence---often jumping back and forth several times
daily. Through ownership, joint ventures, and various
contracts---collectively known as captive supply---the major beef
packers own or control roughly 50% of their slaughter needs. The rest of
their slaughter needs are obtained from the cash market. Captive
supplies may be even higher, depending on the extent of unreported
relationship agreements with feeders. The extent of captive supplies
varies considerably from week to week.

Packers feed cattle, and packers often sell slaughter cattle to other
packers. Roughly 5% of fed cattle are in packer owned or controlled
feedlots and another 5% are known as forward contracts usually tied to
the futures market for slaughter cattle. Most of the captive supply
arrangements, which account for about 40% of slaughter, are called
marketing agreements. In typical marketing agreements, the base price is
tied by a "formula" to an announced cash price or an in-plant average
price (generally cash) for slaughter cattle slaughtered in the same
week. It is also typical for the feeder selling under a marketing
agreement to commit cattle two weeks before actual slaughter.

It is critical to note that the base price in marketing arrangements is
typically tied to an announced market price in which the packer is an
active participant, usually as a buyer but sometimes as a seller. Such
arrangements obviously distort packer's incentives and provide a
"multiplier" advantage to manipulating the cash market.

The distorted incentive was noted in colloquial terms when a cattle
feeder with a pen of high quality cattle was told by the buyer that:

> *"In the old days I would have been able to offer you \$67.50 for
> these cattle (on a \$66 market), but now paying more would screw up
> 20,000 formula cattle."*

In economic jargon, such arrangements increase the marginal cost of
buying on the cash market, which causes cash price to fall below a
competitive level. Use of such contractual arrangements throughout the
industry may result in an aggregate effect that is significant and
non-transitory, even in a market that is not highly concentrated by
traditional standards.

Slaughter cattle should be viewed as a perishable commodity because
there is a narrow window of one to three weeks in which they are optimal
for slaughter. As a practical matter the cattle market is widely
considered to be a weekly market, but the trading window for cash cattle
is much narrower, often less than one hour wide on a day selected by the
buyer. If an offer is rejected, the feeder will not typically see that
packer's buyer until an unknown day the following week. If the packer's
offer is rejected, the feeder may be feeding cattle for another week.

Being on both sides of the weekly cash market for a perishable commodity
provides beef packers with many opportunities that may result in cash
prices below a competitive level. For example, a packer may be able to
satisfy daily slaughter needs or threaten to satisfy needs from their
own cattle, from the cash market, from contracted supplies, or from all
of these sources. If a packer expects price to be going down (or up)
during the week, there is an obvious incentive for the buyer to enter
the cash market late (or early) in the week. This ices down the feeder
and affects the psychology of the market. The longer the packer waits to
enter the cash market, the more worried the feeder gets that he will be
feeding cattle past the optimum time for slaughter, thus being out feed
costs and later receiving a lower price for the cattle due to quality
discounts. Thus the feeder might accept a lower price than he would in a
competitive market with a tightly strung fence between buyers and
sellers. This also tends to reinforce the packer's expectation about
cash price movements during the week because of their actions that tend
to make price move in the expected direction.

A packer with a high commitment of captive supply may elect to sell
cattle when price is high. If enough packer-owned cattle are dumped on
the market, price is expected to go down. In the event that price
actually does go down, the packer could then enter the market as a
buyer. Thus the packer can be both a buyer and a seller in the market,
even the same day or week. Packers can also call for slaughter cattle
they purchased in the cash markets or through captive arrangements to be
delivered to a feedlot and held for a week or so, thereby affecting
supply available to other packers.

Each major beef packer has what is called a head buyer. Buyers assigned
to cover specific feedlots in a region simultaneously call the head
buyer several times a day to find out how much to offer. This gives the
head buyer considerable power, perhaps more than category captains in
retailing.

Price discrimination occurs in the fed beef industry. One effect of the
preferential deals or sweetheart deals for the feeders "chosen" by the
packer is that these feeders will expand production, which has the
effect of lowering cash price below a competitive level. Not only are
the sweetheart deals discriminatory, they allow the packer to subtly
control entry and exit of feeders. Feeders selling on the cash market
may be forced to exit due to the sub-competitive cash price, while the
feeders with the preferential deals may continue to be profitable.

Another entry/exit complication is that even with economies of size for
the most efficient supplier, a packer who can practice price
discrimination and make selective all-or-nothing offers to suppliers may
not want to force the exit of all but one of the suppliers, because it
would be rational for the packer to keep a sufficient number of
suppliers to prevent any single supplier from gaining countervailing
power. Thus, such a buyer can indefinitely maintain their position of
power over suppliers.

Another effect is that exclusive preferential deals---and there are
some---may also reduce competition because they preempt other buyers
from accessing those cattle.

The issue of merger standards or antitrust analysis appropriate to
packers being both buyers and sellers in the cash market is further
complicated by the fact that there is a futures market for cattle. Major
packers routinely buy and sell cattle futures, and some even have seats
on the Merc. As is well known, cash and futures prices tend to move
together; directly manipulating one of these markets will indirectly
manipulate the other market. Thus, there are many opportunities for
large packers, operating as buyers and sellers in both markets, to
engage in practices that would result in a sub-competitive price for
slaughter cattle.

Some of the large beef packers also own or control a significant number
of cattle in other countries, especially Canada, Australia and New
Zealand. These international captive supplies provide additional
opportunity to manipulate cattle and meat markets.

Although many cattlemen express concern about the cattle industry being
"chickenized," I do not think this will happen for two important
reasons. First, ownership of cattle would take a huge capital investment
in animals, land and equipment, unlike the poultry industry. Second, by
continuing to be "partially" integrated vertically through various types
of contracts, packers not only have opportunities to manipulate the cash
market, but they can also transfer demand risk to what remains of the
market. If demand for boxed beef suddenly falls, the packers can
slaughter the cattle they own or control and pull out of the cash
market. This transfers risk largely to independent feeders who sell on
the cash market. Hence, their business practices may not only lower cash
price below competitive levels, but their practices may also increase
market risk above competitive levels.

Asymmetric information may also be an important consideration in merger
analyses. Packers hold a clear information advantage over feeders and
undoubtedly use that information to their advantage. Even under
mandatory livestock price reporting begun in April 2001 and revised in
August 2001, some large transactions might not be reported. A merger of
packers could thus result in even less price and captive supply
information reported due to confidentiality requirements involved more
often. Thus, a merger could strengthen the information advantage packers
already hold over cattle feeders.

The CR4 ratio for domestic slaughter of fed cattle is presently 84%, and
the HHI is over 2460, which are high enough by current merger standards
to warrant considerable concern yet mergers and acquisitions continue.
We do not have extensive data on the extent of international captive
supplies, but my guess is that a HHI computed on the basis of
international trade flows of slaughter cattle and boxed beef would be
much higher than the HHI based on domestic slaughter.

Because of distorted incentives facing packers with captive supply
arrangements and packers operating on both sides of the fence, cash
prices may be depressed even when traditional concentration
indices---CR4 or HHI---do not reach existing standards to block a merger
or acquisition. Current indices are inadequate to reflect the complexity
of power in cattle markets.

**The Poultry Industry**

The poultry industry vertically integrated in only a few years in the
mid 1950s. There has not been a viable cash market for broilers in the
United States since then. Integrators contract with growers to provide
production facilities (houses) and labor for the day-to-day management
and care of the birds. Initially, integration provided higher quality,
more uniform, and lower priced poultry products to consumers. Up until
the last decade or two, the integrator and the growers were "family" and
tried to take care of each other. Now, however, the system can best be
described as feudal, with master (integrator) and servant (contract
producer).

Houses require a huge investment. Four to six houses, which are a
full-time job for one person, cost from \$500,000 to \$1,000,000.
Poultry houses generally have a 20-30 year economic life. Poultry houses
have no practical alternative use; without a contract, the houses have
essentially no salvage value.

The integrator owns the birds and feed, and fully controls the breed,
quality of chicks, feed deliveries and quality of feed, timing of chick
delivery and time at which birds are processed. The pay system for
growers has bonuses for performance, but the integrator determines in
large part the ranking of the grower and fully controls computation of
performance. Economists call this a tournament pay system, but it is
closer to a lottery and, at the whim of the integrator, can be a rigged
lottery.

One becomes a contract producer "by invitation only." Expansion of
production occurs only with approval of the integrator. Thus, the
integrator can force the grower into an all-or-nothing decision. As I
have shown in another paper, a monopsonist who forces competitive
suppliers into all-or-nothing decisions results in a socially efficient
outcome, but with the monopsonist appropriating returns from the input
supply industry[^3].

Growers can be instantly bankrupt if the grower delivers a few batches
of bad chicks, or chooses to not deliver any chicks. Thus, the
integrator largely controls production as well as pay for growers.
Consequently, textbook monopsony models and textbook tournament models
are not appropriate for analysis of the poultry industry.

In the vertically integrated poultry industry, innovation is controlled
and mandated by the integrator. Growers rarely have any input into
mandated changes in the house and equipment specifications.

Historically there has been surprisingly little public information on
the actual returns to production. USDA publicly provides morning and
afternoon cattle prices for many area markets, but provides no
information on price and returns for contract poultry production.
Available farm business records show that contract producers who once
had acceptable income from their poultry operations now put up a few
hundred thousand dollars of equity and borrow several hundred thousand
more to hire themselves at minimum wage with no benefits and no real
rate of return on their equity[^4].

Technically the contracts typically call only for the integrator to
deliver the first batch of chicks, but growers as well as their bankers
expect the arrangement to continue indefinitely. Even though contracts
only provide for one batch of chicks, bankers approve loans because they
will cash flow, because they get their cut off the top, and because the
loans are generally guaranteed by the federal government.

Opportunities for a grower to switch to another integrator are few,
partly because integrators cluster grower houses in specific areas.
Contract terms for a new grower as well as changes in contract terms for
existing growers are determined wholly by the integrator. Growers have
no bargaining power and attempts by growers to organize to develop
countervailing power have been quashed by the integrators, often with
grower organizers bankrupted. The age old threat system appears to be
alive and well in the poultry industry. Efforts by poultry growers to
get state or federal contract reform legislation have been killed by the
more powerful integrators.

Simple merger guidelines, such as those related to the HHI or CR4 do not
adequately reflect the power of integrators over poultry growers. The
CR4 for the broiler industry is now about 50%, suggesting that
concentration is not a problem. However, when viewed from the standpoint
of a cluster of growers in a particular region, a proposed merger could
mean that a grower who had at most one alternative integrator to
contract with now has none. Some might say that this is just a matter of
antitrust market definition, and to some extent this is true. But the
fundamental problem is obtaining information on such issues. Due to the
feudal nature of the system, most growers will not talk to USDA/GIPSA,
DoJ or FTC economists about what is going on in the system; to do so
could mean instant bankruptcy for the grower. The control of information
by monopsonistic buyers poses distinct difficulties for merger and
antitrust analyses.

Merger or antitrust analysis is further complicated by relationships
between firms that may compromise competition. Examples of such
relationships include: (a) genetics for the dominant breed of broiler is
owned by the largest integrator, and the genetics are commonly used by
other integrators, (b) one integrator processing birds for another
integrator, and (c) some integrators cross-test birds and feed. Such
relationships make specification of standards and analyses complex.
Cross-testing of birds and feed by integrators poses an unusual tradeoff
in that it may increase production efficiency of other integrators.
Furthermore, such an increase in efficiency, *ceteris paribus*, may
benefit consumers, but it may also compromise competition eventually
resulting in consumer harm.

**Concluding Remarks**

I see no fundamental philosophical reason for treating buyer power
differently from seller power in merger analysis. However, the faces or
characteristics of buyer power may differ considerably from seller power
in the food system, and buyer power can differ considerably from
industry to industry as the beef and poultry examples illustrate.
Because power can be exerted in so many ways, the tools of merger
analysis\--threshold indicators, elements of economic theory,
quantitative analysis techniques, and data needs\--may be totally
different from industry to industry, or from one market level upstream
or downstream to another market level.

While I realize that this workshop is focused on merger analysis and
that the Department of Justice and the Federal Trade Commission do not
have the power and authority to restructure an industry, I would be
remiss if I did not issue a warning about the rapidly evolving global
food system. Farmers and ranchers world-wide are being squeezed by
monopsony power and to some extent by monopoly power. Through exertion
of market power, large corporations appropriate profits normally earned
by agricultural producers. This not only strains the economic viability
of the global farm community, but also siphons profits out of rural
areas and moves them to international financial centers. It must be
recognized that the emerging vertically integrated system, viewed from
the perspective of farmers and ranchers, has more features of a feudal
system than of a competitive market system. Loss of economic freedom and
other social issues should not be ignored. Giant transnational
agribusiness corporations have used economic power to change the rules
of the competitive market game in their favor, further strengthening
their power in specific markets. We are rapidly nearing realization of
the self-destructive nature of a competitive market economy. Preventing
destruction of a competitive market economy---and along with it loss of
the American Dream and American Democracy---should take legislative and
regulatory precedence over tinkering with existing merger standards.

[^1]: Constructive comments of Mollie M. Taylor are gratefully
    acknowledged.

[^2]: Lieber, James B. [Rats in the Grain: The Dirty Tricks and Trials
    of Archer Daniels Midland The Supermarket to the World]{.underline},
    Four Walls Eight Windows, New York, 2000, p. 306.

[^3]: Taylor, C. R. "Monopsony and the All-or-Nothing Supply Curve,"
    2003. Available at www.auburn.edu/\~taylocr

[^4]: Taylor, C. R. "Restoring Economic Health to Contract Poultry
    Production," [Agricultural and Resource Policy Forum]{.underline},
    Auburn University, College of Agriculture, May, 2002.