Chapter 2 Agribusiness marketing environment

Introduction Successful marketing requires that managers know how markets work. This is important for several reasons. First, supply and demand have a great deal to do with market size and product prices, both of which should be of interest to an agribusiness manager. Second, a successful marketing program requires that marketing managers understand how consumers make their buying decisions and how they respond to changes in price and other factors. Third, long term profits require that the product seller has a correct picture of costs, and how prices of inputs to the production process and products purchased for resale are decided. Fourth, success in the marketplace requires that managers be able to see the market setting that their firm faces and alter their decision making accordingly. Understanding Consumer demand Profit equation: setting an acceptable price has a great deal to do with consumer happiness and company profit. The lower the price, the more consumers are likely to buy and consume. The price of inputs or materials needed to make products is also of great interest to producers. The lower the prices paid for inputs and the higher the price paid for the final product, the larger the firms profits. Profit = total revenue total cost Or symbolically = TR TC Profit is the difference between price paid (total revenue) and cost of product (total cost). The objective of the firm is to make the difference between TR and TC as large as possible by raising TR, lowering TC, or doing both. Total revenue: another important part of any firms profit potential is total revenue. It is simply calculated by multiplying the price received per unit sold by the total number of units sold (quantity). Total revenue (TR) = price per unit (Py) X quantity sold (Y)

Or symbolically TR = Py X Y It is important for firm managers to remember the main goal of the firm is to increase longterm profits, not just increase the quantity of products sold. For firms that use a production or selling approach to the market, the corporate goal becomes increased sales. Profits are supposed to take care of themselves. Unfortunately, they rarely do. If the selling price is too low or costs are too high, increased sales could result in a large loss. A good part of the success in trying to increase profits comes from knowing the relationships between total revenue and levels of price and quantity. Table 2.1: demand schedule Price $ 5.00 4.50 4.00 3.50 3.00 2.75 2.50 2.00 1.50 1.00 (plot a graph) Quantity 10 20 30 40 50 55 60 70 80 90 = Total revenue($) 50 90 120 140 150 151.25 150 140 120 90

A close look shows that as price and quantity move in opposite directions, the level of total revenue does not remain the same. One of the major concerns of marketers is the effect on total revenue when a products price is changed. As price goes down, the quantity demanded goes up, showing that the law of demand works. At first, TR increases as expected, but after a while it reaches a maximum price of $2.75 and a quantity of 55 units sold.

Consumer demand In a free market economy where the customer is king, the customer directs what is produced by what he or she purchases. From the study of consumer behaviour, it has been discovered that consumers always seek the highest level of total happiness from the

collection of goods they consume. When choosing each additional good to consume, they always pick the one that gives them the greatest addition to the overall total level of happiness. This means individual consumers select the goods that give them the greatest total satisfaction. The second guideline is that the amount of satisfaction received from consuming each additional unit of a product decreases as more is consumed. If satisfaction did not decline with increased consumption, people would consume enormous amounts of single products that gave them the greatest happiness to the exclusion of everything else. Decreasing satisfaction for individual products makes consumers demand a wide selection or variety of products to increase their total satisfaction. Role of price Consumers by showing a willingness to pay a certain price for an item, show that they are getting at least as much satisfaction from the consumption of a good as they could get from the consumption of another good available at the same price. If the price is lowered, more consumers will feel this way, and the quantity demanded will go up. Producers operate in much the same way. They have a limited amount of money to invest to produce items demanded by consumers. By paying a certain price for an input, producers show that it is worth at least that much to them in the production process. How much producers are willing to pay for the input really depends on how much they think the consumers are willing to pay for their products. In this way, the producers demand for inputs, or materials, depends on the consumers demand for the firms products. The demand for tractors, feed, dairy cows, processing plants, e.t.c. comes in part from the consumer demand for retail food items. For example, the demand by farmers for fertilizer, in part, comes indirectly from the consumers demand for chicken. The producers want to enlarge their flocks to meet the demand for chicken. Larger flock sizes lead to greater demand for chicken feed, which leads to a greater demand for corn, and finally the fertilizer to grow it. Thus, the chicken grower, the corn farmer, the chicken processor, and the fertilizer producer are all linked together in the agribusiness system. At each step along the way it is price that helps each of the firms to make its decision, and price that quickly communicates any changes in the agribusiness system. Factors that Influence Demand

There are seven factors that influence the level of consumer demand. They include the following: 1. Own price: the lower the price, the greater the quantity. 2. Price of substitute: increasing the price of a good will lead to increased demand of its substitute 3. Price of complement: a rise in the price of a complementary good discourages the consumption of the good in question. 4. Income: the level of consumer income changes the level of consumer demand. For most goods, there is a direct connection, or relationship between income and demand. 5. Population: changes in population can change the level of product demand. More people in a market create a greater demand for a good at every price. 6. Taste and preference: consumer demand rarely stays constant. Consumer tastes and preferences are always changing. If the long term use of a product is decreasing, it may no longer fit the need of consumers; a marketer needs to know this to change the marketing mix or even switch to the production of a different product. 7. Seasonality: consumer demand is influenced by the time of the year. A marketer must know the seasonal patterns of consumption for a product to schedule the production and plan marketing activities. Demand Shifters Another area of consumer demand is the difference between a change in the quantity demanded by consumers and a shift in consumer demand. If a change in the own price of an item brings a change in the number of units sold, then there has been a change in quantity demanded. However, if price remain the same and the quantity sold changes, this means a shift in demand. Price 5.00 4.50 4.00 Quantity 1 10 20 30 Quantity 2 20 30 40

3.50 3.00 2.75 2.50 2.00 1.50 1.00

40 50 55 60 70 80 90

50 60 65 70 80 90 100

The factors that cause this movement of the demand schedule are called demand shifters. They include the following: 1. Price of substitute goods 2. Price of complements 3. Income 4. Population 5. Taste and preference 6. Seasonality. Changes in any of these conditions can lead consumers to demand more or less of a product even though the price does not change. These shifts can have a powerful impact on the longrun level of producer sale and profit so one needs to pay attention so as not to be caught off guard.

Understanding Agribusiness Supply Production Process Production is the use of inputs to create an output that has economic value. The production process is how an agribusiness combines the various inputs to create an output. Agribusiness uses materials, equipments, buildings, people and a variety of other things to produce the goods and services they sell to others. Managers are responsible for using these items in a profitable manner in the production process.

Inputs to the production process include items such as grain, animals, chemicals, labour and anything else that an agribusiness uses to make an output. Output from the production process can be a commodity such as feeds, fertilizer, milk and so on. It can also be a food product such as ice cream hamburger, e.t.c. services such as financial planning, insurance, and market price news are also considered inputs. Production Decision When agribusinesses decide to produce an output they must make four major production decisions: 1. What to produce? What products and services can this business profitably offer? 2. How to produce? What is the best combination of inputs to use in producing the output? 3. How much to produce? What is the correct amount of output to produce that will increase the firms long term profits? 4. When to produce? What is the correct time to produce the output or to offer the service? Answers to these four production decisions rests heavily on the demand for the product or output. The answers are also changed by the costs of the inputs. Being a successful manager means having a production process that is both technologically and economically efficient. A process is technologically efficient when the maximum or highest output per unit is obtained at all levels of input use. This must be done first. Once this efficiency is reached the manager can turn his or her attention to reaching economic efficiency. A process is economically efficient when the level of output reaches the highest profit. This is determined by the cost to produce the product (input cost) and the selling price of that product (output). The managers primary goal is to increase the long-term profits of the firm; therefore, he or she must be interested in both efficiencies.

Production Function

The heart of the production process is the production function. The production function sums up the output possible from various levels of inputs. For example, it might describe the amount of grain output possible from various levels of fertilizer use. A representative production function is shown below. The amount of ice cream production possible using various amounts of labour is shown by the line labelled total product (TP). The more technically efficient the plant is the greater production at each level of labour use (TP2). The less technically efficient plant produces a lower amount at each level of labour (TP2) Tp3 TP2 Greater technical efficiency TP1 less technical efficiency

output

Input Total Product Curve The shape of the curve shows the level of output possible as more and more inputs (workers) are added to the production process. From the curve, output rises rapidly with the addition of the first few workers. Beyond point A, output continue to go up, but at a smaller or lower rate
C beginning until output reaches a maximum, or its highest point, point C, then falls. than in the

The drop happens because at some point. Adding more workers causes the efficiency to go down. The extra workers get in the way of the others. We could draw curves for each of the
TP

other inputs used in the production of ice cream and show similar results.
B

Rational production A Range

140 120 100 80 60 40 20

The total product curve tells the level of output possible from various levels of input. It gives useful information about: 1. The level of contribution each additional unit of input makes to output. 2. How efficiently each added unit of input is used in the production process. Other inputs are held constant. Measurement of cost A useful way to look at cost of production is to separate the costs according to whether they occur as a result of: 1. The passage of time 2. Undertaking of production Fixed cost comes with the passage of time and do not change with the level of output. Fixed costs usually include such items as insurance, property taxes, rent, or mortgage payments. These costs must be paid regardless of output, even if nothing is produced. Variable costs usually include materials, shipping, packaging, and so on. The level of these costs change with output.

Determination of Economic Efficiency.

It is important to know that maximum profit does not happen at the point where input efficiency is highest or where the highest output occurs. Maximum profit is measured by the cost of inputs compared with the revenue earned by selling outputs. Revenue Output(s) 0 30 100 168 220 240 252 245 @ $10/unit 0 300 1000 1680 2200 2400 2520 2450 Number labourers 1 1 2 3 4 5 6 7 of Labour cost@ Profit(s) $ 200 0 200 400 600 800 1000 1200 1400 0 100 600 1080 1400 1400 1320 1050

The highest or maximum output from dairy plant happened when six workers were employed. Output sales gave revenue of $2.50, but the plant had a profit of only $1,320. When only four workers were employed the plant had revenues of $2,200, and profit of $1,400. Without looking closely at costs and revenues, the plant manager might have assumed the plant was making maximum profit where output was greatest. Only by looking at the numbers was she able to determine the economic efficiency of the production process. Law of Supply In trying to achieve maximum profit, the agribusiness manager has to keep one eye on the cost of production and the other eye on the price received for output. Although both factors could change dramatically, usually the managers greatest worry is selling price. What the manager does not want to happen is to produce a large quantity of a product only to have the selling price drop. This could wipe out any profits the manager might have been counting on. If the selling price looks like it will be too low to make a profit, the manager will simply not make the product. This is the idea that underlies the law of supply.

Table 2.3 shows the relationship between selling price and quantity supplied. Price $5.00 $4.50 $4.00 Quantity supplied 1000 900 800

$3.50 $3.00 $2.50 $2.00 $1.50 $1.00 $ 0.50 (plot in a graph)

700 600 500 400 300 200 100

At a price of $0.50 per unit only 100units are offered for sale by the suppliers. Only the lowest cost producers can make profit. It is very likely that at this price no one can make a profit. They remain in the market only to keep their products before consumers with the hope that prices will soon rise. As selling price increases each seller is willing to offer a greater quantity of the product for sale, and more sellers enter the market. At even higher prices each producer can make a nice profit and is willing to offer a larger quantity for sale. This relationship between price and the quantity supplied by sellers is called a supply schedule. Price is not the only factor that will affect supply. The non price determinants of supply are: 1. Changes in the price of other goods: for example, if a diary plant manufactures both cottage cheese and ice cream. Imagine what happens when the price of ice cream goes up and the price of cottage cheese stays the same. the manager will reduce production of cottage cheese and produce more ice cream. 2. Expectations of future selling price: if prices are expected to rise, sellers will produce and offer more quantities for sale and vice versa. 3. Number of sellers in the market: if there is only one seller of a product say doughnut in the neighbourhood, who produces 500 doughnuts at $0.50 per doughnut,. If another seller comes on board and also produces 500 doughnut at $.50 per day. There will be a rightward shift of the supply curve because there are twice as many doughnuts for sale at the original price. 4. Changes in production costs: increase in the cost of production will result in less profit for the seller if the selling price does not change. Suppliers will not be as eager to offer product for sale in this situation. Price Determination and Price Discovery

Until now, when we talked about supply and demand curves, price was always known with certainty. Changes in price caused the quantity demanded or the quantity supplied to change along the supply or demand schedule. When price was held constant, and the factors that influence demand and supply changed, the demand and supply curves shifted. Now at the same price, more or less quantity would be demanded or supplied depending on the change. One may think from the discussion that price is set by someone, it is not. Price is determined by the interaction of supply and demand. When a supply curve for a product is shown in the same graph as the demand curve for that same product, price is determined where the two curves cross. This is called price determination price P S

D quantity Q

An important point to note is that where the curves cross supply and demand is in balance, the quantity supplied by the marketers of the product just equals the quantity demanded by the consumers of the product. There is neither a surplus of product in the market, nor is there a shortage. In the real world, a supply-and-demand curve does not exist, they are estimated. Any attempt to determine price by these methods will not truly reflect what is going on in the marketplace. That brings us to price discovery. Sellers and buyers constantly haggle over price. It is a negotiation process where neither party has complete information about supply, demand, or the factors which affect either one. The process of negotiating a price is not exact. Whether the agreed-on price is above or below the general price level for similar transactions in other parts of the country depends on the following: Amount, quality and timeliness of the information available to both parties.

Bargaining ability of each participant.

One can see that information plays an important role in being successful in the price discovery process. The price discovery process usually works very well, meaning there are few transactions at prices very much above or below the current market price. Some people are better at bargaining over price than other people. They can negotiate a little higher selling price or a little lower buying price because of their skill. It is important that marketers know and understand the difference between price determination and discovery. Both are important because price sets both the size of the market and the amount of profit possible. Price determination helps researchers understand the long-term effects of changes in the marketplace, and price discovery helps agribusiness managers set prices for day-to day operations. Law of one price The law of one price state that when markets are operating normally, there should be only one common price for each product in a market, after adjusting for the cost of storage, transportation, and processing. If prices differ by more than the cost of storage, transportation, and processing, then price is out of line. When this happens, there is an economic incentive to shift from an area of low prices to another area where prices are being paid. The process of capturing extra profits in settings where prices are out of line is called arbitrage Time: in markets separated by time, the difference between the current price and an expected market price sometime in the future must be equal to the cost of storage for that period. For example, the price of wheat at harvest time should be lower than the price of wheat six months later by the cost of six months storage. Place: in markets separated by distance, the difference in price between the two locations must be equal to the cost of transporting the product between the two points. Form: in markets separated by differences in product form, the difference between the prices paid for the raw commodity and the price received for the processed product must be equal to the cost of processing.

In this way, the law of one price keeps markets in balance that are separated by time, distance, and form. There is a natural tendency for markets to move toward the balance defined by the law of one price. If markets are walking correctly, whatever differences exist will be small so that resources are always being used correctly and prices only differ by the cost of storage, transportation and processing. Markets Environments Markets are the heart and soul of a capitalist economy and varying degrees of competition lead to different market structures, with differing implications for the outcomes of the market place. Several characteristics of a market environment determine its structure. Each of these characteristics is briefly discussed below: Number of firms in the market: this forms an important basis of classifying market structure. The number of firms in an industry determines the extent of competition in the industry. Control over product prices: the extent to which an individual exercises control over the price of the product it sells is another important characteristic of market structure. Types of the product sold in the market: the extent to which products of different firms in the industry can be differentiated is also a characteristic that is used in classifying market structures. Barriers to new firms entering the market: the difficulty or extent to which new firms can enter the market for a product is also a characteristic of market structures Existence of non-price competition: market structures differ to the extent that firms in industry compete with others on the basis of non-price factors, such as difference in product characteristics and advertising. Four types of ideal market settings or situations have been established and they are 1. Perfect competition 2. Monopoly 3. Monopolistic competition

4. Oligopoly Perfect Competition When economists refer to perfect competition, they are particularly referring to the impersonal nature of this market structure. The impersonality of the market is due to the existence of a large number of suppliers of the products- there are so many suppliers in the agribusiness industry that no firm views another supplier as a competitor. Thus the competition under perfect competition is perfect. This ideal setting requires that certain conditions be met. The three conditions that are necessary before a market structure is considered perfectly competitive are: i. ii. iii. Homogeneity of the produce sold Existence of many small buyers and sellers Perfect mobility of resources or factors of production.

First, the product must be similar, or homogenous. This means that the product produced by each producer is exactly like that produced by all other producers. Agricultural commodities are good examples of similar products. For example, yellow corn from a farm in Harare is the same as that from a farm in Hwange. Second, there must be many small firms in the market. No single firms actions can influence prices if they are all small in size. This means that prices are set solely by market supply and market demand. The individual firms must take the market price as their selling price and have no power to set their own price. The third condition, perfect mobility of resources requires that all factors of production can be readily switched from one user to another. The implication is that resources move to the most profitable industry. It should be easy to enter and leave the production process. This means that if prices get high enough to be attractive it should be fairly easy to become a producer. It means also that if prices get low it should be easy to stop being a producer. Production agriculture has long been used as an example of perfect competition. However, with the changes that have occurred in production agriculture in the last two decades, this is no longer a good example.

Firms in a perfect competition are price takers. They do not compete against one another. They compete against the market. They can produce and sell all they want at the price the market gives them. They have no control over price. There are no excess profits to capture, which means firms can only make enough money to cover costs. Consumers are not much better off. They get a plain vanilla product. All firms products are just the same. There are no product differences to fit individual consumer needs or tastes. The reason perfect competition is held up as the ideal market setting is that it does result in economic efficiency. Resources are allocated properly, business firms do not make excess profits and consumers pay the lowest possible price. As a result, society as a whole is made better off. However, individual business people and consumers are likely to be happy Monopoly Monopoly can be considered the opposite of perfect competition. It is a market form in which there is only one seller. Monopolies can be very rare if not impossible in the agricultural/ agribusiness market. There are many factors that give rise to a monopoly. A monopoly can exist in an industry because a patent was obtained for a product by its inventor. A monopoly can also arise if a company owns the entire supply of a necessary material needed to produce a product. A monopoly can be created by a government agency when it sells a market franchise for a particular product or service. Finally a monopoly can arise due to declining cost of production for a particular product leading to case of natural monopoly. For the producer, monopoly seems to offer the best of all worlds. In this market setting, a single large producer provides the entire product that the market needs. There is only one firm and that firm makes up the entire industry. It can set either market price or market output because it has total control over supply. While some under good market circumstances might prefer this market environment, consumers and society do not. The presence of a monopoly means less output is available at higher prices than would be the case in a perfectly competitive market setting. This is the reason society seeks to prevent monopolies. Monopolistic Competition Monopolistic competition is characterized by the existence of many sellers. Usually, if an industry has 50 or more firms producing products that are close substitutes of each other , it is

said to have a large number of firms. in monopolistic competition, the firms are about the same size. The most distinguishing characteristics of monopolistic competition is the fact that the firm have highly differentiated products, this means that consumers believe there are significant differences between the products offered for sale by different firms. It is in fact, immaterial whether these products are actually different or simply perceived to be so. So long as consumers treat them as different products they satisfy one of the characteristics of monopolistic competition. In many agribusiness markets, producers practice product differentiation by altering the physical composition, using special packaging, or simply claiming to have superior products based on brand images and/ or advertising. In addition to the above requirements, relative ease of entry into the industry is considered another important requirement of a monopolistically competitive market organisation. Examples of monopolistic competitions are: fast food stores and many food retailers and manufacturers. Overall consumer happiness may be better served this way, because monopolistic competition results in a wide variety of products available to consumers. If a differentiated product is to capture extra profits over the long term, then the product must truly be different enough to prevent other producers from duplicating the difference. If not, competitors will quickly copy the product, and the extra profit will soon be bid away. Fierce competition among firms keeps prices and profits relatively low and this is very good for consumers. Oligopolistic Competition The key features of oligopoly are Only a few large firms present in the industry. A firms actions influence the level of production and prices within the market. Each firm is aware of other firms and take their reactions into account. Competition is through product differentiation, heavily promoted to buyers.

There are oligopoly characteristics in the markets for most agricultural inputs e.g. fertilizer, seeds, e.t.c. and few food processors and manufacturers e.g. soft drink manufacturers.

An important characteristic of an oligopolistic market structure is the interdependence of firms in the industry. The interdependence, actual or perceived, arises from the small number of firms in the industry. Thus, an oligopolistic firm always considers the reactions of its rivals in formulating its pricing or output decisions. Because there are only a few firms in this type of industry, they can watch their competitors closely and probably react to any market strategy their competitors choose to pursue. Producers in an oligopolistic market face an unusual market setting. there is little reason to compete on the basis of price in this market setting because a firm cannot win. A price increase will result in a loss of sales and lower profits. A price decrease will cause competitors to lower their prices also. Sales of each firm will remain the same, but selling prices will be lower and so will profit. Understanding of Agribusiness Markets The markets of agricultural commodities and food products are often very different from those of other consumer products. Physical Characteristics The first step is to look at the physical characteristics. Most agricultural commodities are: 1. Bulky 2. Low in value per unit of weight 3. Perishable 4. Produced in areas distant from consumers 5. Fixed supply in short time. This means that commodity handlers must seek the most efficient means to process and move the products to distant consumers quickly. Perishability is a constant problem for firms in agribusiness. There is an old saying about this problem. in agribusiness, you sell it or you smell it". The fixed supply means agribusiness firms can be hurt by large, unexpected price changes. Characteristics of Agricultural Supply

The biological nature of the production process gives producers little control over how much is produced once the process is under way. Overall production during the crop or marketing year is largely set by such uncontrollable factors as weather and disease. For commodities such as grains, unless imported, the supply is fixed between harvests regardless of price. Once the crop is planted, quantity supplied will not change much in response to price changes. But small changes in supply will cause very large changes in price. Characteristics of Agricultural Demand Unlike supply, domestic demand for agricultural commodities is usually stable from year to year. There may be seasonal changes for a product from year to year, but overall demand remains the same. This is because consumer demands for food are largely a function of habit. The lower limit on food demand is hunger. If you are really hungry you will pay a lot of money to get food. At the upper limit of food demand, your stomach holds a certain amount of food. No matter how low food prices go, you can eat only so much food before you fell uncomfortable. For most of us, the difference in the amount of food that leaves us feeling hungry or full is small. For this reason, food demand is relatively stable and not very sensitive to rice changes. A closer look at food demand leads to several interesting facts. First, the demand for specific food products tends to e price sensitive. This means a change in price will cause the quantity sold to change. The availability of substitutes causes this response. Second, the demand is less sensitive to price the closer one gets to the farm level because there are few substitutes for farm-produced commodities. Agricultural Price Patterns The prices of many agricultural commodities show patterns over time. These patterns relate to the biological nature of food production and slight variations in consumption. Those patterns that happen yearly are called seasonal price patterns. Patterns that repeat longer than a year are called price cycles. Seasonal price patterns are caused by the seasonality of production and consumer demand. For grains, fruits and vegetables there is usually only a single crop year, while demand is constant throughout the year. This difference in supply and demand produces the pattern of prices throughout the year.

A graph of monthly prices would show price is lowest at harvest time, followed by a slow rise each month afterward. The price is highest just before the next harvest. The increase in price each month after harvest is the markets method of rewarding someone who stores part of the annual crop to meet year round demand. Price cycles go beyond one year. They also have their origin in the biological nature of production, as do seasonal patterns. In these cases the biology does not permit a rapid adjustment in supply adjustment patterns. A full cycle of rise and fall for hogs may take 3.5 to 4 years, while for cattle it may take as long as 11 to 12 years. Knowing where you are in the price cycle is critical to planning./ producers do not wish to expand output at the peak of the price cycle knowing they might face a pattern of falling prices for years. But they might consider expanding if they were at the bottom or on an upward swing of the price cycle.