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Got Produce? The Rent-Dissipation Hypothesis And The Issue Of Cui Bono

Jim Prevor’s Perishable Pundit, May 27, 2009

As we have tried to think through the pros and cons of the industry launching a generic promotion program, we find ourselves continually frustrated by the kind of proposal that has been made and the process by which the industry is being asked to evaluate this matter.

First, we ran a piece titled, Got Produce? Generic Marketing Program Dialog Begins, But Is It Right To Use PBH Donor Funds To Lobby For A Mandatory Assessment? In this piece, we pointed out that donors who gave to the Produce for Better Health Foundation never intended for their money to be used in a lobbying campaign. Yet donor money has been seized to run websites, webinars, buy airplane tickets, hotels, divert staff effort, etc. This is just wrong, and we hope the activity will be stopped and the money refunded.

We also pointed out that the normal process by which ideas get vetted includes the painful but necessary step of reaching out and asking for support. If there are not 25 industry members willing to fund this campaign, then is there really enough support to even go through the process? The decision to simply take money from the Produce for Better Health Foundation may have short-circuited a useful go/no-go test.

Second, we ran a piece that we titled Got Produce? Both Sides Need To Be Heard, which pointed out that the credibility of the industry “dialog” was in question because the same people who were advocating for the program were also controlling the dialog. So in the presentations, webinars, etc., instead of being arranged as even-handed debates between intelligent, studied and articulate advocates for both sides, we have one-sided scripted presentations with a few questions at the end. Further, the advocates make no effort to communicate critiques of the plan, nor would they use their funds to make sure the critiques of the plan get presented and communicated.

Third, we published Got Produce? Is $30 Million Sufficient? We asked what evidence was presented that $30 million a year — the projected resources of this proposal — would actually be sufficient to increase demand. We pointed out that not enough research had been done to answer that question — though the examples the advocates gave all implied much larger amounts of money would be needed. Once again, we found a process problem as it was the advocates for the program that decided how much money is sufficient. We urged taking a step back and arranging for some real research done by neutral parties so that the industry could feel confident that the funds raised would be sufficient to achieve the desired goal.

Today we consider the ancient issue of Cui Bono, which loosely translated means “to whose benefit?”

Although the phrase is often connected to something untoward and is used in criminal investigations to discern who might have had motive to commit a crime, we use the phrase just in its plain meaning and look to think about who could profit from such an enterprise.

One of the reasons it will be hard to have a healthy dialog on this subject is that most industry institutions, the associations, the trade press, etc., will in fact benefit from a larger industry. This is true even if not one existing grower would realize a benefit.

It is also true that companies that have weak brands but compete against more prominent brands might see this in their interest. We have never asked, but it would not surprise us to see Taylor Farms, with its roots in foodservice and barely any consumer branding, to endorse this kind of plan, while we would expect Fresh Express/Chiquita, a much more prominent brand, to decline endorsement of the plan.

Basically, we would expect Fresh Express and its parent company Chiquita to want to spend their money promoting their own brands, while a competitor would prefer to divert that promotional expenditure to industry promotion.

Retailers always love industry-wide generic promotion because it comes with no strings attached. To get marketing dollars from Dole is possible, but Dole would want something in return, an end cap, an ad, a demo, something. Only industrywide generic promotion comes free and clear.

What about produce firms themselves? Would they all benefit? No, not at all.

Let us assume, for argument’s sake, that the generic promotion program is a success and successfully has driven up demand for all produce items. Will this result in higher profits for everyone?

In our first piece on this program, we pointed out that many farmers grow a set number of acres. The industry could double or triple consumption and the growers won’t get any more profit unless they get higher prices.

Now we pointed out that there is something of a contradiction at the heart of this program since it proclaims itself an effort to increase consumption, yet higher prices driven by higher demand would be inimical to that goal of higher consumption.

Another point, though, is that the industry would not experience the benefits of even a successful program in anything approaching an even-handed way. The reason is that higher prices created by more demand create a “supply response” in which the supply rises to take advantage of the higher price.

This is typically called the “rent-dissipation hypothesis,” and Professor Henry W. Kinnucan of the Ag Economics faculty at Auburn University describes the phenomenon clearly in a piece related to the supply response to catfish promotion:

A paradox of industry-sponsored advertising is that the very thing that causes it to be effective — elevation of market price — undermines its effectiveness in the long run. Producers in competitive industries respond to elevated prices by expanding output. Upon reaching the market, the expanded output places a downward pressure on price which, if sufficiently strong, may leave producers no better off with the advertising program than without it. The hypothesis that states profit from generic advertising may prove illusory without effective supply control is sometimes referred to as the “rent-dissipation hypothesis.”

The gist of the research is that everything depends on how quickly and cheaply production can increase. The Professor found that there was a profit to be realized for catfish growers mostly because increasing catfish production in the short term was difficult. In produce, there are many variables as the Professor explains:

With few production alternatives existing for catfish ponds and equipment, asset fixity operates as a natural deterrent to entry or expansion, causing a relatively inelastic supply response at the farm level. Furthermore, demand for catfish at the wholesale level is only slightly elastic and is probably inelastic at the farm level. This combination of elasticities, coupled with the magnitude of the demand shift as represented by the advertising elasticity, results in sufficient rents from increased advertising to more than offset incremental costs over any reasonable time horizon. Thus, the notion that producers are no better off with the promotion program than without it is not supported by our analysis.

Our findings are generalizable only to the extent that other industries have characteristics similar to those of the catfish industry. Asset fixity, which accounts for the sluggish supply response for catfish, may exist in other industries, especially those involving perennials such as almonds, raisins, walnuts, oranges, etc. This may not be the case for vegetables and some row crops, where inputs are less specialized and production lags are shorter. Then, too, farm-raised catfish is a relatively new product; this increases the likelihood that consumers will respond to catfish advertising. Clearly, the rent-dissipation hypothesis needs to be tested over a wider range of commodities before we can be confident that cooperative advertising ventures can indeed generate sustainable benefits for producers in the face of uncontrolled supply response in competitive markets.

What all this means is that if prices rise due to increased demand, we would expect squash production and imports to very quickly depress the market — so the industry might be larger, but not necessarily more profitable. If the supply response is robust, prices could even drop.

On the other hand, growers of certain tree crops, say pears, which have a long growth period, might have many years of higher demand and thus higher prices before additional trees are planted and grow to maturity.

One reason some regional commodity promotion groups, particularly those representing certain tree crops, can be more successful is that if their advertising works, an increase in demand for that commodity will almost certainly result in higher prices and thus a higher return for growers. So for example, if the California Avocado Commission increases the demand for, specifically, California avocados, it is very difficult to dramatically increase production of California avocadoes. The land is not available, the water is not available, the labor is not available. The consequence will be higher prices and higher returns for the California avocado growers.

In contrast, a national campaign that increases demand for avocados can be easily supplied by avocados from Mexico, Peru, Chile and other producers, so the campaign may not raise prices or profits. Producers of row crops tend to respond very quickly to higher prices with higher production so would be expected to experience the benefit of higher prices for a very short period.

In addition the internationalization of the industry has made it more difficult for growers to profit from these types of expenditures. If prices rise in the US so that returns are more attractive for selling in the US market, we can expect product to be diverted to the US rather than foreign markets until the prices equalize.

Now one would think that the proposal presented has a careful study of the rent-dissipation hypothesis on each covered commodity so that everyone can see where they and their commodity would stand. In fact, the whole issue is ignored, just glossed over.

Once again, this speaks to process. The proposal on the table is to spend 150 million industry dollars over the next five years. Yet the research that went into the proposal is less than most companies would accept to justify a new warehouse.

There is a lot of work that needs to be done before the industry can possibly make an informed decision. The advocates of this proposal are making a mistake in trying to ram it through before all the homework is done. They will wind up losing votes they could have gotten if all the ducks were in a row.

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