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Got Produce? …And Spawns Virtual Debate On Generic Promotion

Jim Prevor’s Perishable Pundit, October 2, 2009

Below the good Professor’s comments (in red), we have added some thoughts of our own (in black). (To avoid confusion, we are adopting Professor Kaiser’s style and are using blue type to denote content that the Professor picked up from our original article, Got Produce? Generic-Promotion Expert Enters Debate With Some Shocking Analysis

I) PUNDIT ORIGINAL CONTENT: The shock, though, comes in the first and last point that PBH highlights from the Professor’s findings:

To say that the “median average return” for “these types of programs” is a “10-fold return” and the return will go to the “producer, or whoever pays” sounds very odd.

KAISER RESPONSE: This number is based on the benefit-cost ratios (BCRs) from previous economic evaluations of specific programs for fruits and vegetables, e.g., domestic raisin promotion. For instance, I found that every $1 invested in generic raisin promotion (advertising, public relations, retail programs) returned $9.50 in net (net of the additional production required to meet the increase in demand) revenue to California raisin growers.

All of the studies in this table computed similar BCRs for individual programs, and all found BCRs larger than 1, which clearly indicates that the net benefits of generic promotion are larger than the costs, and hence, they are profitable to the producers in the industry that fund the programs. Hence, there is nothing “odd” about this; they are based on independent research studies.

We should note that the phrases we were critiquing were in the press release PBH published with Professor Kaiser’s statement, not in the statement itself, and we would say that PBH was overreaching and that the Professor’s statement confirms this:

1) That one study showed a $9.50 return for every dollar spent does NOT MEAN that the “median average return” for “these types of programs” is a “10-fold return.”

2) The definition of “these types of programs” is very questionable. Raisins are a semi-perishable product often sold in the grocery aisle. It is one product, from one state, sold, by definition, only as a dried product. In what sense is the sale of raisins from California of the same “type” as the sale of all varieties of fresh, frozen and canned produce sold from every corner of the globe?

3) Benefit-cost ratios (BCRs) are also tricky. Whenever someone creates a term, like BCRs, to use in place of a perfectly acceptable English phrase in common usage — in this case, net profits — beware. Although BCR seems to incorporate the actual cost of goods, it is not clear how or if it incorporates the other expenses that get attributed to a given sale.

4) Finally, the part we found “odd” was that the return, whatever that might be, would go to “Producer, or whoever pays.” We actually see nothing in the Professor’s research to say he claims this. This was PBH’s characterization of the professor’s work. We would say the point makes no sense. Who pays the assessment is a matter of industry vote. We could vote to impose the fee solely on growers or first handlers or at retail and foodservice, or we could vote to have the assessment collected at multiple steps along the supply chain. To believe that the return on investment would magically switch from retailers to wholesalers to growers to importers based on our industry vote of where to allocate assessments is not supported by any research and seems highly unlikely.

II) PUNDIT ORIGINAL CONTENT: First, we are not aware of much research at all on “these types of programs” — that is to say multi-product in a multiplicity of formats such as fresh, frozen, canned and juice — so we wonder where this claim comes from.

KAISER RESPONSE: There are no programs like the broad program being proposed for fruits and vegetables, and hence, there is no research that I know of. I was therefore asked to speculate on the potential impacts of the proposed program.

Based on this, I believe that looking at the results of actual individual fruit and vegetable generic promotion impact evaluations is the best way to estimate the potential impact. Since individual promotion programs for these commodities have been profitable to their funders, I do not think it is a stretch to claim a broad-based program for all fruits and vegetables would also be profitable.

Admittedly, the proposed broad fruit and vegetable program is different from the individual commodity promotion programs in existence, but my best guess is that a $30 million generic promotion program for fruits and vegetables will have a positive impact on overall consumption and profits.

We certainly value the professor’s input, but we do think it is worth noting that even an informed opinion is still just opinion, especially when no research is available.

The problem we confront is that even if the Professor is correct and the overall industry will have some net benefit, this doesn’t mean that all or even most of those that will pay the assessment will make a profit. After all, it is quite possible that if demand increases it won’t increase equally for all items.

It also is quite possible that even if demand did increase equally for all items, some producers would benefit because production of their items has a long lead time or is difficult to accomplish, whereas other growers producing crops that can easily be grown will find other farmer’s production keeps pace or exceeds the new demand, thus delivering no benefit at all to some farmers.

Professor Kaiser’s focus on the overall industry well being is laudable, but most first handlers, who will have to write the check, want to know not that the industry “on average” will benefit but that they, specifically, will benefit.

III) PUNDIT ORIGINAL CONTENT: Second, we don’t see how the decision of where to collect the money, say at grower level or first-handler level, could possibly change who gets the benefit of the program. Third, how is it possible that the world is filled with programs promoting commodities and industries — California Iceberg Lettuce, Washington Apples, California Tree Fruit, PromoFlor, the Western Australian produce industry — and these producers are earning “10-fold return” and yet they keep refusing to fund the programs? Are producers really so dense?

KAISER RESPONSE: The reason estimated BCRs are so large for generic promotion programs is not because benefits are large in an absolute sense, but rather they are large relative to costs. Because the costs of these programs are so tiny in relation to industry revenue (almost always well under 1%; and 0.046% for the proposed fruit and vegetable promotion program), the upshot of this is it does not take much of an increase in demand or in price to produce a high BCR.

Kinnucan and Zheng presented an interesting illustration to highlight this point, using 11 federal programs encompassing over 80% of all checkoff program revenue. In their study, the authors calculated how much of a farm price increase would be necessary to yield a BCR equal to 1.0 (benefits = costs) for the 11 checkoff programs.

The average increase in price to yield a BCR of 1.0 was a mere 0.94%. In other words, if the checkoff program increases price of the commodity by 0.94%, the program is break-even in terms of costs and benefits. To the extent that generic promotion could increase the farm price by more than 1%, the BCRs for the 11 checkoff programs ranged from a low of 2.0 for honey to a high of 15.5 for potatoes.

The fact that, as the Professor says, the programs are very profitable not in absolute dollars but only relative to their small size goes a long way toward explaining why so many of the programs get dumped by the industries that are supposedly benefiting. This is a giant industry. A proposal for a $30 million that will earn a total of $60 million for the industry is probably not worth the trouble.

The Pundit’s own family business on Hunts Point sold much more than that 20 years ago. The issue is whether it is scalable and, as the Professor explains, the programs never seem to get to a significant size. Maybe the reason so many boards get jettisoned is not that they aren’t profitable, but that they are more trouble than they are worth.

Remember that anything we do has an opportunity cost in money and in time. If these funds and the hours spent running and debating this organization could be invested elsewhere — commodity-specific promotion, branded promotion, distressed real estate, etc. — at a higher return, then this program doesn’t make sense.

IV) PUNDIT ORIGINAL CONTENT: This is all certainly problematic but the stunner is the claim that the program will cause only a “small increase in production” and, in fact, will result in a “sustainable price increase.” This is shocking because the whole justification for PBH’s involvement in this matter is that it will increase consumption. Since a substantial increase in consumption is impossible without a substantial increase in production, it seems highly unlikely that consumption will boom at the same time prices are supposed to be rising.

KAISER RESPONSE: I base this claim on published research studies that have looked at this issue. Here are a couple of examples. For instance, one study found that the generic dairy promotion program increased the farmer milk price by 2.9%, which had a mild positive “supply response” of 0.6%. In other words, the price increase was almost 5 times larger than the production increase.

This same study found no rent dissipation at all; even in the long-term, farmer net revenue increases 3.5% because of generic advertising. These estimates are “long-run” estimates, which mean that they are based on a period of time that is long enough so that the full effects of the demand increase are accounted for. The Kinnucan study for catfish you mention later on is another example where the profits of these programs are not eroded by future increases in production.

A substantial increase in consumption IS possible without an increase in production. In this case, the market mechanism is that price will rise enough so that quantity demanded will just equal quantity supplied (this is economics 101). Changes in supply and demand have two effects: price and quantity adjustments.

In the produce industry a sensitive pricing mechanism means that simply dumping loads is rare. So, by definition, in order to increase consumption in produce, we must increase either production or imports. In other words, if we grow 100 million cases of apples, we sell 100 million cases of apples, so the only way to increase consumption is to grow 100 million plus one case of apples (this is math 101). Professor Kaiser’s claim that you can increase consumption without increasing production only makes sense if one is speaking of dollars worth of produce consumed, not volume of produce consumed. PBH’s mission to increase public health depends, however, crucially, on increasing the actual pounds of produce consumed, not increasing the cost of the produce consumed.

When it comes to rent dissipation, we agreed with the researchers of the Kinnucan study who said:

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.”

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.

Put another way, every product has its own rate of increase in production in response to higher prices. Items that take many years to grow or rely on scarce soil and climate ecosystems are going to respond more slowly than row crops that can be grown in numerous climates, soil types, etc.

V) PUNDIT ORIGINAL CONTENT: If this assessment is accurate, then PBH ought to just say: “So sorry, we made a mistake. This isn’t in our domain.”

The whole assessment by PBH of what Professor Kaiser believes is so odd that we were anxious to read the professor’s assessment ourselves.

KAISER RESPONSE: I find nothing odd about the assessment I made. As far as I can see, your comments above have not clearly indicated anything that is odd about my remarks, all of which are based on previous research by myself and other economists.

We agree with Professor Kaiser. Nothing he said was odd, but PBH’s assessment of his analysis is a very problematic situation. PBH is all about increasing consumption, but nothing we know about supply-and-demand curves in produce makes us think that if we have meaningful across-the-board price increases this will increase consumption. Far more likely is that if we have lower prices, consumers will be more attracted to produce vis a vis other alternatives.

So PBH finds itself between a rock and a hard place. It must argue that this will result in increased production because that is the only way to get increased consumption in ounces of produce — which is all PBH cares about. On the other hand, PBH must argue that this promotion will raise prices so that a grower who is maxed out will still think he can benefit. Yet for these two conditions to co-exist, higher prices and higher unit consumption is very unlikely.

VI) PUNDIT ORIGINAL CONTENT: As they say, the answers you get depend on the questions you ask, and here, Professor Kaiser addresses the incidence of cost when businesspeople are typically concerned with the incidence of risk. In a field such as produce, where margins are thin at every stage of the distribution chain, business executives hope and expect that all their investments will ultimately be covered by the consumer. But sometimes they are not.

The relevant question for many is who gets stuck with the bill if markets do not adjust to cover these expenses? Clearly, the answer is the guy who pays the expense. So, for example, if retailers, in pursuit of a “value” reputation, refuse to increase the FOB price they will pay for a given item, it is someone before the retailer in the supply chain who has to pay the bill.

Professor Kaiser is, of course, correct that input costs tend to be allocated to those who are least concerned with paying more, but there is no guarantee that one will be able to pass on costs of any type, and the incidence of risk thus remains with the one paying the bill. For many, this is a risk they would prefer not to take. Many first handlers would like to see the incidence of risk spread over various sectors of the supply chain rather than concentrated with them.

KAISER RESPONSE: I was addressing a question that I am told has been raised by a lot of concerned people in the fruits and vegetable sector, many who are concerned with who actually pays for the program. It is an important question. Risk may also be an important issue, but all you talk about is one side of the equation, the cost side while ignoring the benefit side.

The correct metric that growers would want to know is risk in net benefits (benefits less costs) due to promotion. The risk, therefore, is not getting stuck with the costs of the checkoff, but that the net benefits of the program are negative. The benefits of the program would be an increase in net revenue (again accounting for the costs of increased production due to the increase in demand) due to any promotion-induced higher price and quantity, while the cost is the assessment. The overwhelming majority of published studies have found positive net benefits.

Going back to the incidence of the costs, if the proposed generic promotion program was adopted, the cost of the program would be spread out over the entire industry, including first handlers and growers, but would be primarily borne by consumers in the form of a price increase. Note that the level of the assessment is so small that even if it were fully passed along to the consumer, the increase in price would be barely noticeable.

We don’t ignore the benefit side, but the cost is a certainty and the benefit is only hypothetical; in that circumstance, those who have to pay the cost will be concerned about it.

In addition, the Professor is addressing a theoretical question: How will the pricing in the industry change so that those writing the check will de facto get reimbursed by higher prices?

Obviously all business people understand that you make investments and hope to recoup those investments through higher prices or additional volume, and they understand that this is what the hope is for the generic promotion program. But, as in the game musical chairs, they do not want to get stuck without a place to sit when the music stops.

It is a great myth that entrepreneurs love risk and live for risk. Successful entrepreneurs almost always carefully look to avoid and manage risk.

One reason this plan is having trouble gaining traction in the industry is that one segment — the first handlers — will be stuck with paying the bill. If it is so definite that the industry will cover the assessment through higher prices, many of these handlers would just as soon give the honor of writing the assessment check to some other industry segment.

VII) PUNDIT ORIGINAL CONTENT: There is a little confusion here, and it is probably caused by Professor Kaiser’s work being so heavily focused on dairy. In the produce industry, first handlers often handle produce on a commission basis. The contracts typically explicitly call for first handlers to deduct all expenses from grower returns. So these first handlers will bill back for USDA inspections, delivery costs, warehousing, and, most assuredly, for any fees or assessments.

Now, first handlers selling on a commission basis will also certainly try to get their growers a higher price that will compensate for any expenses. It is very common for a handler to ask his grower “What return do you need to come out?” If he knows the grower needs $5, the handler will certainly aim to achieve that, but, of course, markets are unforgiving and it is not always possible.

This whole issue is especially problematic because it leads to a division between voting authority and paying the bill. In most generic promotion efforts, the one who pays gets the vote. Under this system we have in produce, very often the first handler will get the vote but the grower will actually pay the bill: A kind of taxation without representation.

KAISER RESPONSE: It is far more likely that most of the assessment will be pushed forward to the consumer. The rest of the assessment will be split between the grower and the first handler. Perhaps in the very short run, the grower will bear more of the incidence of the assessment than the first handler, but given enough time for the market to adjust, the grower and first handler will bear some of the incidence with the consumer bearing most of it.

We don’t disagree with the good Professor. We just are answering different questions. In the produce industry, the grower will typically have the cost of the assessment charged back to him, and the cost will appear as a line item on the accounting he receives from his sales agent. So the grower will pay the bill, the first handler will get the vote and that strikes us as wrong.

As to how the market will ultimately divvy up the cost, well ultimately, all costs are borne by the consumer. Though as an economist even more famous than Professor Kaiser cautioned us: “In the long run, we are all dead.”

VIII) PUNDIT ORIGINAL CONTENT: We’re not sure why the professor decided to omit footnotes, thus making going back to his full research difficult. What we can say is that several things about this point need much more exposition: First, it is not clear how one can measure an increase in demand to the third decimal place on a product with fixed supply. Second, the research does not seem to actually identify the impact of the promotion; instead, it seems to use promotion as a kind of residual.

KAISER RESPONSE: I would be happy to send you the full list of references for these studies. Normally, in popular press pieces, references are not included.

Supply is only fixed in the very short run, and these studies are long run in nature. So, for example, a promotion elasticity of 0.05 means that holding all other demand factors constant, a 10% increase in promotion expenditures will increase per capita demand by 0.5%.

In these studies, promotion is not a residual. Indeed, the use of “econometrics” allows us to identify the impact of promotion. The econometric approach quantifies economic relationships using economic theory and statistical procedures with data. It enables one to simultaneously account for the impact of a variety of factors affecting demand.

These demand-determining factors (called “determinants”) include the price of the commodity, prices of complementary products, consumer income, population, consumer tastes and preferences, brand advertising, and generic promotion expenditures. By casting the economic evaluation in this type of framework, one can filter out the effect of other factors and, hence, quantify directly the net impact of the generic promotion on demand.

Econometric models have gained wide usage and are often the best tool we have for modeling complex economic activities. It is worth remembering, however, that econometric models failed massively to predict the most recent financial crisis. Econometric models also failed in the 1997 East Asian financial crisis, which led to the downfall of Long Term Capital Management, whose partners included Nobel prize-winners Robert C. Merton from Harvard and Myron Scholes from Stanford.

Models, by their nature, cannot account for everything that might impact the price of a commodity because humans do not know all these inputs. Jack Kennedy decided not to wear hats and men’s hat purchases collapsed. The models keep getting better and better but, in the end, there are, as Shakespeare said: “More things in heaven and earth than are dreamt of in your philosophy, Horatio.”

The long list of things that Professor Kaiser indicates the econometric models consider — the price of the commodity, prices of complementary products, consumer income, population, consumer tastes and preferences, brand advertising, and generic promotion expenditures — simply adds to our point. After considering all those things, what is left — the residual — is attributed to marketing until one day when someone discovers that the number of hours spent commuting is a variable that impacts produce consumption, then we add that to the model. So this is how the models get better over time.

As simple a thing as the quality of the marketing can make an enormous difference, so to speak so definitively as if a dollar spent will automatically produce some set return is to allow models to obscure reality.

IX) PUNDIT ORIGINAL CONTENT: So the researchers identify an increase in consumption, then deduct for things they know could influence consumption, say an increase in population and then whatever is left, they declare that to be due to the promotion. Yet this claim is unsupported. It is more a measure of our ignorance than a measure of the effectiveness of promotion.

KAISER RESPONSE: No, this is not at all what any of these studies have done. All have used the econometric approach of directly measuring impacts of all the demand determinants as described above.

We would hold that there is no way to directly measure the impact of more advertising on a national industry because you cannot run controlled experiments. Ted Goertzal, a Professor of Sociology at Rutgers, put it this way:

Although economists are the leading practitioners of this arcane art, sociologists, criminologists and other social scientists have versions of it as well. It is known by various names, including "econometric modeling," "structural equation modeling," and "path analysis."

All of these are ways of using the correlations between variables to make causal inferences. The problem with this, as anyone who has had a course in statistics knows, is that correlation is not causation. Correlations between two variables are often "spurious" because they are caused by some third variable.

Econometric modelers try to overcome this problem by including all the relevant variables in their analyses, using a statistical technique called "multiple regression." If one had perfect measures of all the causal variables, this would work. But the data are never good enough. Repeated efforts to use multiple regression to achieve definitive answers to public policy questions have failed.

X) PUNDIT ORIGINAL CONTENT: In our piece, Got Produce? The Rent-Dissipation Hypothesis And The Issue Of Cui Bono, we specifically looked at the generic catfish advertising and drew from it the conclusion that Professor Henry W. Kinnucan of Auburn University drew:

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.

In other words, products that are difficult or expensive to increase production of tend to benefit from higher prices due to stimulated demand from generic promotion, whereas products for which production is easily and inexpensively increased do not realize higher prices due to the supply response.

We find Professor Kaiser’s explanation that actual evaluation studies of existing generic promotion efforts rarely show such an effect unpersuasive because the Professor does not account for the “establishment and survival bias” in this comparison.

Survival bias is often illustrated with mutual fund advertising. A quick glance at the ads in the business section of the local paper shows that virtually every mutual fund seems to have had exceptional performance — yet actively managed mutual funds underperform the indexes. What accounts for this discrepancy? It is called “survivor bias” — the mutual fund companies know consumers don’t like to invest in funds with losing track records, so they are constantly closing or merging out of existence poorly performing funds and leaving only the winners extant.

The consequence of this is that if you study all existing mutual funds, you will get a performance record far exceeding that of all mutual funds that ever existed.

In the same way, Professor Kaiser’s studies are all on programs that actually exist. But the very establishment of a program is a selective act. So, in the produce industry for example, Northwest pears, an expensive crop to plant with a long lead time, has a generic promotion program, and California avocadoes, once again an expensive crop to plant with a long lead time and one with real restrictions on availability of land and water, both have generic promotion programs. In contrast the California Iceberg Lettuce industry voted to end its program. Leafy greens, a row crop relatively easy and inexpensive to expand production, has only the small and voluntary Leafy Greens Council.

KAISER RESPONSE: It is certainly true that all studies are on programs that actually exist. While I am not familiar with the history of the Leafy Greens Council, I do know that a major reason generic promotion programs are voted out is NOT that they are ineffective, but rather there are firms that believe it is unfair that they are forced to participate in a mandatory program

Some people oppose generic promotion programs on ideological or constitutional grounds. They believe it is wrong or unconstitutional to compel individuals to pay mandatory assessments against their will.

Others oppose it because, although it may be profitable for the whole industry, they do not believe it will be profitable for their own company.

Still others may think it will be profitable for their company, but they have alternative investments they believe would be more profitable.

We do think that an issue with research in this field is that you simply cannot project from the experience of programs that exist to what programs that do not exist would be like. Logically, only those programs with the best chance of being successful will be enacted, so their results are not projectable to programs not yet launched.

XI) PUNDIT ORIGINAL CONTENT: When Dr. Kaiser points to research on existing programs, he is looking at programs that passed through many stages of approval and maintenance and comparing them to a proposed program that has not gone through such a process. That is inherently an asymmetric comparison.

KAISER RESPONSE: There have been studies done on programs that have been voted out of existence. One example is PromoFlor, the mandatory fresh-cut flower program that was in existence for a couple of years prior to being voted out. Ron Ward from the University of Florida published a study on this program that found a net BCR of 5.62.

As the study states, “one must recognize that the total promotion experience was relatively short since PromoFlor only had one year of promotion activities to study,” so the data is probably not enough to tell us a lot. After all, there might be a special excitement in the first year of a program that leads to more display space, more in-store promotion, etc., and this dissipates over time.

Or, perhaps. PromoFlor could have been very successful. The industry was angry because it was adopted under a procedure that established the program, and the assessment, first — and then had a vote later. This may have doomed it. But flowers, sold for aesthetic reasons, may not hold many lessons for produce, which is food and thus a necessity of life.

In addition if PBH is to achieve its goal of “better health,” it needs to persuade people to eat more produce and fewer Twinkies. Floral doesn’t have that constraint.

XII) Think about this kind of comparison in your own company or organization. Five projects are proposed… as they go through the process, only one meets the Return on Investment criteria and is implemented and is highly successful. You cannot deduce anything about the four projects that didn’t make it from the one project that cleared the vetting process.

KAISER RESPONSE: Why would you care about the 4 projects that never were implemented if you were a stakeholder in this company? You did not spend a dime on them, so why would you care? If you spent millions on a project, then you would very much care whether you made or lost money.

The issue is simply whether or not one can say very much about projects that have not been voted in, like the produce generic promotion program, by looking at programs that have been voted in, like the milk or dairy programs. We would say the lessons are limited.

XIII)PUNDIT ORIGINAL CONTENT: Equally we can’t deduce anything about the rent dissipation process on produce commodities that do not have a commodity promotion program from commodities that have gone through the process and chose to establish and sustain a commodity promotion program.

Question: Are these programs profitable for the participants that pay for them?

Answer: This is the bottom line and most important question that first handlers and growers should ask. Here, the evidence from evaluation studies is overwhelming that the benefits of these programs exceed the cost. Economists typically measure the benefits of these programs as the incremental net revenue resulting from the increase in demand and market price due to generic promotion, while the cost is generally measured as either the cost of the promotion, or total cost of the checkoff program.

Of these 14 studies, the median average benefit-cost ratio (BCR) was 10.0, indicating the average benefits were ten times larger than the costs, and none of these studies had a BCR that was below 1.0. The average BCR was 16.0, indicating average benefits were 16.0 times larger than the costs. Also noted in Table 1 are other commodity promotion benefit-cost ratios, with a median average BCR of 5.7 and an average BCR of 6.3. Indeed, a more thorough perusal of the literature reveals very few studies that have measured a BCR that was less than 1.0 for any checkoff program.

This is actually quite interesting and tells us that academics in this field have chosen a biased measurement of success. Read the key line:

“Economists typically measure the benefits of these programs as the incremental net revenue resulting from the increase in demand and market price due to generic promotion, while the cost is generally measured as either the cost of the promotion, or total cost of the checkoff program.”

Note that Professor Kaiser is taking the increase in revenue and comparing that revenue increase to the cost of the promotion or of the checkoff. In other words, he is saying that economists in this field choose to ignore the cost of production!

KAISER RESPONSE: No, this is not true. Economists in the majority of these studies DO account for the cost of the incremental production. The benefits in the BCRs are net revenue, net of production costs.

Ok, three swipes with a wet noodle for us if we misunderstood what the Professor was saying. But still, the phrase “net revenue” is an awkward phrase not used typically in business.This seems to be distinct from “net profit,” as it seems not to include normal allocations, say the Sales Manager’s salary. But larger organizations have larger expenses so to simply look at the direct cost of product is insufficient.

XIV) PUNDIT ORIGINAL CONTENT: More realistically, if we want to measure the profitability of a promotion or program, we should take the increase in revenue caused by increased demand or higher prices, deduct not only the cost of the promotion, but also deduct any costs involved in expanding production or purchasing more supplies and deduct the costs involved in selling these added items.

KAISER RESPONSE: That is precisely what is done in the majority of economic evaluation studies.

Each study has to be evaluated individually, but we see this “net revenue” number as being a simpler calculation, looking at cost of goods sold, rather than the full gamut of expenses. That is why they don’t use the phrase “net profit.”

XV) PUNDIT ORIGINAL CONTENT: In other words, the proper “benefit” to look at is the additional net profit, not net revenue, realized by an entity and contrast that with the costs of the program.

KAISER RESPONSE: That is precisely what is done in the majority of economic evaluation studies.

Our understanding is that “net revenue” is not identical to “net profit” See previous question.

XVI) PUNDIT ORIGINAL CONTENT: There are two other troubling matters in the way Professor Kaiser defines profitability. First, he seems to be speaking of profitability for the industry as opposed to for the entity that is actually paying the assessment.

KAISER RESPONSE: It is true that these studies do look at the industry as a whole, rather than the individual. One cannot look at each farmer or grower, as this would be virtually impossible to do. So the total benefits and total costs to all growers is examined.

So when we say that a program has a BCR of say 5, this means that every $1 invested returns $5 in net revenue to the entire industry. That would mean that the average grower in the industry would receive that, but there would be some differences among growers in the industry.

The phrase, “some differences among growers in the industry,” might be a appropriate for two California Avocado growers. Comparing a zucchini grower in Georgia to a pear grower in Oregon is night and day. We would like to see some money invested so that we can do some econometric models on 10 different types of farms, with different constraints on expanding production, and see what the results are for various types of operation.

XVII) PUNDIT ORIGINAL CONTENT: In an industry such as produce with many family farms, it is reasonably common to find a farmer with 500 acres who is not really looking to buy more land. If the industry becomes more profitable by increasing production and consumption, this farmer will be paying to allow other farmers to expand production. If prices remain fixed, but an additional expense is imposed, our family farmer’s profit will go down.

KAISER RESPONSE: This is basically the rent-dissipation issue covered earlier. Production will likely increase when the price increases due to the promotion-induced demand increase. However, the evidence from previous studies is that the price won’t fall all the way back to the pre-promotion level. The key to this is that prices will not remain fixed, but should increase.

Actually this is slightly different. Some producers could get an increase in profit from both increased prices and increased volume. Here we are holding volume constant and asking about price. The question is: If prices are going to rise, does that make volume increases likely? They usually go in opposite directions.

XVIII) PUNDIT ORIGINAL CONTENT: The second issue is that investments are typically measured against a cost of funds or hurdle rate. Lots of investments that would be profitable are not made because the profitability is less than some alternative investment or less than the cost of funds. Even accepting generic advertising is profitable, would product-specific generic advertising be more profitable than the proposed multiproduct/multi-format (canned, frozen, fresh, 100% juice) generic promotion order?

KAISER RESPONSE: The question about whether product-specific advertising is more profitable than the proposed multi-product advertising is impossible to answer since there are no examples of these broad-based programs. There have been no economic evaluation studies that have actually compared broad-based programs to individual product specific programs.

A more pertinent question is would the proposed program be profitable. The 3-A-Day dairy program is an example of a broad-based program that has been found to increase overall consumption of farm milk (see USDA Report to Congress on the Fluid and Dairy Acts). It is my judgment that the proposed program would increase overall consumption of fruits and vegetables.

Of course, dairy farmers are going broke, so it is not clear what good this has done them. In any case, the pertinent question is most decidedly not whether thisinvestment would be profitable; what good is an investment that earns an 8% return if you are borrowing from the bank at 10% to finance the investment? The obligation on the advocates is to show that this investment is more profitable than the cost of money or alternative investments.

XIX) PUNDIT ORIGINAL CONTENT: Finally what is the time lag? Time is money. How long must one invest before one realizes a return?

KAISER RESPONSE: The time lag is not very long in generic promotion. Promotions tend to be very immediate in impact. Advertising has a carry-over effect, and can be longer lasting, but does not take much time to have an impact.

Well that is good news and a point in favor of the program.

XX) PUNDIT ORIGINAL CONTENT: Professor Kaiser is highly esteemed, yet we are perplexed at on what basis he determines that it is “very plausible” that a $30 million total budget — not a $30 million dollar campaign — could possibly increase produce prices by 5%. If this did happen, Professor Kaiser’s estimate of the benefit to the industry is wildly low.

KAISER RESPONSE: The point of the Kinnucan and Zheng article was that it does not take a very large increase in price to give a BCR that is larger than 1.0. Indeed, they show that for specific commodities, the average increase in price would be under 1% to produce a BCR=1.0.

I did not say I expect that the proposed fruits and vegetables program would yield a price increase of 5% (I said that in the context of specific commodity programs, a 5% price increase is very plausible). However, I would expect an overall price increase for the category of fruits and vegetables, and it would not take much of one for the program to be profitable, as you actually show with your (not my) assumed 5% increase.

The Professor said, and we quote: “To the extent that generic promotion could increase the farm price by 5%, which appears very plausible, the potential BCR for a $30 million fruit/vegetable campaign would be 8.2, delivering $246 million in returns to the producer.”

We would guess that on a $30 million budget, by the time we hire staff, set up an office, do research, get an ad agency, produce the ads, etc., etc., we actually will spend $15 to $20 million on measured media, but even if we spent the whole $30 million, a 5% increase in prices on produce seems to us very unlikely and, in any case, completely counter to PBH’s goal of increasing consumption.

Basically, the Professor’s point is that if the whole industry is only spending $30 million dollars, it won’t take much success to earn the $30 million back plus some profit. This might be true, but considering the risk that it might not be profitable for individual producers, the risk that the funds could be expended more profitably elsewhere, etc., is it worth doing this to spend $30 million and get some return that is a rounding error on the trade’s total volume?

XXI) PUNDIT ORIGINAL CONTENT: The Produce Marketing Association had Battelle do an Economic Reach and impact of the Fresh Produce and floral industry study. It includes floral but excludes frozen and canned, and it came up with a sales number at the production source — that is before processing, marketing and distribution of over $33 billion dollars.

So, using the PMA number, a 5% increase in price at the production level would be over $1.6 billion. PBH says an assessment rate of 0.046% will realize $30 million… that means that they are saying the industry size is $65 billion, which means a 5% increase in price would represent a $3.25 billion increase in value. These seem bizarrely outsized returns to expect from a $30 million-a-year investment.

Question: Would the proposed fruits and vegetables promotion and research checkoff program have as high of BCR as those listed in Table 1?

Answer: While it is impossible to predict with absolute certainty what the BCR for a future program would be, based on the past performance of generic promotion programs for individual fruits and vegetables, it is highly likely that the benefits of the future program would be substantially higher than the costs. Based on the median BCR from Table 1 of 10.0, this would mean that the $30 million per year investment in generic promotion of fruits and vegetables would return $300 million in additional net revenue to the producer.

One of the questions related to this whole enterprise is the degree to which experience with individual commodity promotion can be extrapolated to a national campaign covering many fruits and vegetables sold in many forms. Most efforts to increase sales are modest. Promote one snack fruit and one typically depresses the sales of other snack fruits. Many shopping lists just say “fruit” and so a great deal on pears can affect apple sales.

For a total industry program to be a success, the additional sales have to come from elsewhere in the store. So an increase in pear sales has to either lead consumers to spend more in the supermarket or that pear sale has to reduce, say, chocolate chip cookie consumption.

This whole area of study is known as Beggar-thy-Neighbor Advertising, and there is some indication in this UC Davis paper that the produce industry could benefit by closer cooperation between individual commodity promotion groups.

What there is not, however, is any real evidence that we can project the success of this much harder task — taking sales from chocolate chip cookies — based on the much easier task of getting someone to buy a pear rather than an apple.

KAISER RESPONSE: The trick to making this program effective will be to design the promotions to be as complementary as possible to all fruits and vegetables. I think it is unlikely that promoting the broad category will actually hurt specific commodities within the category. Cooperation among commodity groups in the industry will, as you say, be important for the proposed program to be effective.

Yes, we agree. If the industry is going to proceed, a mechanism for coordination must be established. Most people don’t realize that the famous “Got milk” campaign was developed for the California Dairy farmers and only later went national.

XXII) PUNDIT ORIGINAL CONTENT: …this difference in “demand impacts,” combined with a difference in “supply response,” is very problematic.

In the dairy industry, the milk can be used to make cheese, butter, various types of milk, and the “demand impacts” don’t matter because it all comes from the same cow.

In produce we face a real situation in which the supply response will be so different on different commodities that it is quite possible that, for years and years, leafy green growers could be subsidizing pear growers.

What if the industry segments that have high barriers to entry vote for this plan and the industry segments with low barriers to entry vote against –are we prepared to just shove this down their throats?

Question: Most checkoff programs have been commodity-specific. Would a promotion program with the broad category of all fruits and vegetables be as effective?

Answer: There have not been many examples of generic promotion programs that are as broad as the fruit and vegetable category combined. However, a recent study by Global Insight, Inc., evaluated the combined impact of all of the USDA’s Foreign Agricultural Service generic export promotion programs on U.S. exports. The results of this study found a BCR of about 5 for all programs combined. That is, a $1 investment in all generic export promotion returned $5 in export revenue.

We’re not really sure the relevance of this data. First of all, the funds are provided by USDA specifically because they don’t believe that the producers would pay for the export promotion if USDA didn’t ante up. Nobody in the industry would object if USDA or HHS wanted to promote produce consumption for, say, reasons of public health. Second, the USDA programs are not mandatory. So the hurdle is much lower. It is a serious thing to compel a man to fund a program when he would prefer not to. Third, there is no basis to extrapolate from these export programs to domestic programs.

KAISER RESPONSE: The funds are provided by the USDA AND producers. Individual programs have to put money into export promotion in order to receive a match from the USDA. Also, many of the activities done in export promotion are similar to those of domestic promotion, e.g., advertising, retail programs, etc. Hence, they are similar forms of marketing, one for domestic consumers and the other for foreign consumers.

We are very familiar with this program, but that study the professor refers to seems to compare investment vs. sales. As the Professor states: “…a $1 investment in all generic export promotion returned $5 in export revenue.”

We still don’t think that the point is being realized: There is a very diverse group in the produce industry and their interests conflict as they are often competitors. Professor Kaiser keeps talking about it as if this is a unified industry. Most Maine potato growers really are not going to worry much about firms that make 100% orange juice.

XXIII) PUNDIT ORIGINAL CONTENT: Finally, this “BCR” is a wacky number. We have to look at profit increases, not sales increases.

KAISER RESPONSE: That is what the BCR does. Benefits = increased profits to the payers of the program due to the promotion, and Costs = increased costs to the payers of the program.

OK, we keep reading it as “not quite” the same as net profits. Figuring net profits is very complicated. Typically, for example, a company has tiers of customers. Its first 50 loads may go to great customers who pay the price. If it has an additional 10 loads, it may sell them to an exporter to get the volume out of the country even at a lower price or it might do consignment or price-after-sale deals in the wholesale markets, even though this produces a lower price. We do not see the BCR concept as typically being executed to catch these kinds of nuances.

Yet even if it does, there are no examples of studies of BCR on a diverse product group like produce being sold in multiple formats like fresh, frozen, canned and 100% juice — so it simply may not matter.

**********

We thank Professor Kaiser very much for taking the time to explain all this to the trade. And thank those valiant readers who slugged through all this. It was a lot to read but this is a big and controversial issue.

If the industry commits, we are talking about spending $300 million over the next ten years. That is worth some heavy reading.

Once again, many thanks to Professor Kaiser and Cornell University.

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