September, 2008

Research Perspective and Comments & Analysis

Market Disruption: Challenge Or Opportunity?

Not a day passes now without rising food prices making headlines around the world, and produce is no exception. The latest Consumer Price Index data shows fresh produce prices up 6 percent from this time last year — that’s three percentage points higher than the normal year-to-year increase. Given the current produce marketing climate being anything but normal, historical data has become a poor predictor of what our industry and produce-buying consumers are facing in the months and years ahead. Produce Marketing Association (PMA) recently sought to learn how consumers feel about the rising price of produce.

Most surveyed consumers told us they consider food-cost increases extremely serious. If produce prices jump as much as 26¢ to 50¢ per pound, many say they would migrate away from fresh produce. Most consumers tell us they would move to less expensive produce or canned and frozen options. Nearly one in five — 19 percent — claim they would abandon produce purchases all together if prices reach an extra 51¢ to 75¢ per pound. These survey results underscore consumers’ alarm with rising food prices and reveal their readiness to alter purchase patterns should produce prices climb further. However, to what — and to what extent — they would migrate is another question, as other food categories are also headed up and one can’t look at produce in isolation.

You know and I know that shoppers aren’t the only ones alarmed. There’s no doubt that produce industry members in both retail and foodservice channels also wrangle with the impact of dramatically rising costs on consumer food prices. We must also continue to point out the health and other benefits of eating fresh produce. When our industry struggles not only with rising consumer prices but also with astronomical price increases of our own inputs ranging from fertilizer to fuel, normal business practices get even further pinched — and the produce supply chain cannot be expected to absorb the line on prices indefinitely. Plus, cost is only one item on board a truckload of market disruptors currently being faced by the fresh produce industry.

Market disruption is defined as “situations causing markets to cease functioning in their traditional manner.” Price, the slowing economy, sustainability, the “locavore” movement, food safety — these are all disruptors of our traditional market paradigms that have merged into a perfect storm that I believe is changing our industry forever. Serious market forces we have never seen before at this level — and certainly not all at once — are advancing a brave but scary new world. To survive means finding opportunity amid challenges, and opportunity will come only when we challenge ourselves to question how we have done things in the past and why.

We have grown used to cheap everything, believing that most inputs will always be there for us because we have the dollars to pay for them: cheap water to grow; cheap labor to harvest, pack, and deliver; cheap packaging to protect; cheap fuel to drive. American consumers have benefited, too, by being treated to the lowest percentage of disposable income spent on food on this planet. Consider that in 1950 our grandfathers who farmed received an average of 41¢ for every dollar spent on food. Today, the average return to our growers is less than 17¢. Two generations later, we’re drowning in the realities of modern-day farm economics, trying to deal with costs for some inputs that have tripled in only a few years.

And so we see some members of our supply chain closing their doors or changing their business fundamentals. Producers are moving farms to Mexico or decentralizing production — in part to help tap into consumer interest in locally grown, in part to reduce transportation costs. Retailers are dramatically shifting their formats, such as the current explosion of small-store formats — think Tesco and Bloom, for example. Foodservice is doing everything possible to reduce plate costs (presenting an ever-greater opportunity for produce, by the way). Every link in the supply chain grapples with enhancing food safety and worries about the human and financial costs of an outbreak. Every link is getting its head around sustainability.

Is the lesson we’re starting to learn that the many privileges our businesses and lives have grown dependent upon have been undervalued and are unsustainable — whether for our farmers, for our environment, or for consumers? We’ve done so many things because we could. Isn’t it time to start asking ourselves the question: do we do things the way we do because we should?

I believe we have entered an era of intense questioning for our industry worldwide, perhaps a tipping point that will dictate our future for decades to come. The availability and cost of inputs, of land, of water, of labor, will have as much to say about our successes as anything that has gone before. Whether they present challenges or opportunities will be up to us.

Look Beyond The Industry

When FDA used its authority to institute a de facto ban on the sale of spinach, tomatoes and jalapeños, those were all examples of market disruption. When the prices of agricultural inputs rise, as fertilizer has, for example, that is just an example of markets.

As Bryan points out, everything has to be considered in context. Consumer research is vital but, as is always the case, the answers you get depend on the questions you ask. If you ask consumers what they will do in the event bus fare will go up — they will say ride the bus less frequently. But if you mention that train fare and gas prices are also going up, they may say they have no alternative but to pay it as they have to commute to work.

If chicken prices alone go up, beef sales probably will rise as consumers substitute. If both go up proportionately, there may or may not be a change in consumption. Possibly consumers will try to keep their “meat and poultry budget” to a fixed dollar amount and thus switch to the cheaper item, but maybe not. And much depends on whether that price switch is isolated or part of a general inflation. If it is a broad-based inflation, then wage earners may be getting raises and it will not impact their consumption very much. Some segments of the population — say pensioners on fixed incomes — may have to reduce consumption substantially.

Equally with fresh produce, if prices rise, we have seen no indications in the consumer surveys that indicate consumers will be reducing consumption of food except in the most extreme of economic situations. If consumers are going to eat just as much as ever, then they are unlikely to significantly reduce fresh produce consumption unless fresh produce prices rise disproportionately.

Right now that is not happening, and the reasons it could happen are mostly public policy questions. If immigration is severely restricted, for example, then harvesting labor may go way up in price. If we can’t automate economically, the cost of domestically grown fresh produce may go up disproportionately. This could lead to the substitution of foreign-grown produce for domestically grown.

If food-safety rules are imposed on the growing of produce for sale as fresh, and such rules are expensive to implement, but such rules are not applied to produce that is canned or frozen since all of this product is cooked or blanched, one might see a consumer shift to less expensive frozen or canned product.

Of course, none of this has happened. What has happened is a more generalized inflation, especially of costs such as transportation and fertilizer tied to fuel prices. This has left in the lurch those producers who agreed to fixed-price contracts for a year or two.

Inflation is resurging now, and this means producers need to be cautious about signing fixed-price agreements. They either have to use adjustment clauses or learn to use sophisticated hedging strategies involving petroleum futures and other proxies for their costs.

On the broader issue of sustainability, the core of the matter is actually outside what any company in the industry can actually do. Companies have to operate within the economic environment developed by government policy. Otherwise their competitors will drive them out of business, so company-directed sustainability efforts can only be effective on the margins — better use of energy, etc.

The big questions are social. If immigrants, for example, pose a social cost, say for free medical care, but immigration is not restricted nor costs imposed on their employers, it will be difficult for a competitor to unilaterally spend the money for expensive mechanization. The promoters of sustainability are fundamentally expressing a belief that things we do in society — including food production — impose costs on society that are not being accounted for in the product itself. The most obvious claim is that by expelling carbon into the environment in the course of producing food, we are promoting global warming and that global warming will impose great costs on society.

There are other claims. The industry uses a lot of water and the allocation of that water may have been more influenced by politics than social good. Pesticides may have impacts on people or workers that have not been fully accounted for.

There are many specific issues. The key question is how these issues are resolved by society. If government decides to trump the market by instituting bans and mandating performance — say by mandating the use of ethanol or electric cars — we will indeed have market disruption and will, as a society, be much poorer than we could have been. If the government decides to use market forces to correct what economists call externalities by, say, imposing taxes on carbon output proportionate to the expense such output imposes on society, we will not have market disruption but instead, the market itself will act as it always does to move our consumption from resources that are scarce to those that are plentiful.

Whatever the government does, there is no question that change is a constant. As to whether, as Bryan suggests, such change shall be an opportunity or challenge, we are reminded of the Chinese symbols for crisis pronounced wei ji.

Wei means danger or peril, and ji means opportunity or crucial point — so the Chinese remind us in their very language that a crisis is always a situation combining both danger and opportunity. Sound advice from an ancient civilization.