The sustainability of European food supply chains - Defra Science

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The sustainability of European food supply chains

A report by Ethical Corporation March 2006

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Executive summary......................................................................................... 3 Section 1........................................................................................................ 13 Food Value Chains........................................................................................ 13 The ‘Value Chain’ ........................................................................................ 14 The first link in the demand chain ................................................................................ 17 ‘Value chain governance’ … ........................................................................................ 17 How to turn a supply chain into a demand chain.......................................................... 21

‘Credence claims’ ......................................................................................... 23 Traceability ................................................................................................... 27 Standards: the codification of retailer demand. ............................................ 34 Contracts ....................................................................................................... 45 Vertical Coordination ................................................................................... 59 ‘Forward Integration’.................................................................................... 67 Buyer Power.................................................................................................. 71 Private Label ................................................................................................. 88 Summary – the hourglass.............................................................................. 99 Section 2 A sustainable system?............................................................... 101 Environmental impacts of the modern food industry. ................................ 102 Agriculture .................................................................................................. 111 Impact 1 – pollution .................................................................................................... 116 Impact 2 – loss of ecosystems and biodiversity.......................................................... 123 Impact 3 – soil degradation......................................................................................... 135 Impact 4 – water stress................................................................................................ 140 Plenty more fish in the sea? ........................................................................................ 148

Distribution ................................................................................................. 159 2

Food miles................................................................................................................... 160 Production and storage................................................................................................ 174 Processing ................................................................................................................... 180

Consumption ............................................................................................... 183 Waste........................................................................................................................... 183

Human health .............................................................................................. 194 Appendix:.................................................................................................... 197 the food supply chain – in detail................................................................. 197 Retailers ...................................................................................................... 198 The Four Trends: Globalisation, Horizontal integration, Concentration and Internationalisation ..................................................................................................... 198 Top transnational retailers: company profiles............................................................. 208 A closer look at Europe’s food retail market .............................................................. 210 Expansion into Central and Eastern Europe (CEE) .................................................... 216 Discounters ................................................................................................................. 221

Processors ................................................................................................... 228 Trends ......................................................................................................................... 228 Top transnational processors: the company profiles.................................................. 232 Processors in the US: leading the way in concentration ............................................. 236 Concentration in Europe ............................................................................................. 238

Input Suppliers ............................................................................................ 239 Agrochemicals ............................................................................................................ 239 Seed Companies.......................................................................................................... 241

Producers..................................................................................................... 245 Trends ......................................................................................................................... 245 Concentration.............................................................................................................. 246 Europe ......................................................................................................................... 247

Food Service Sector .................................................................................... 256 Trends ......................................................................................................................... 257 Concentration.............................................................................................................. 258

Executive summary

Introduction

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In today’s European food system – •

Large retailers are dominating...



Small retailers and manufacturers are going under...



Farmers everywhere are struggling...



Consumer choice is contracting...



Energy that produces food is running out…



Food is travelling thousands of miles…



Fish stocks are vanishing...



Desert is spreading into farmland...



Animal species and plant varieties are endangered...



Water is over-used and polluted...



Waste mountains are rising...



Human health is being threatened...

...and these are just some of the major problems.

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Scope This report examines the sustainability of European food supply chains. It describes the structure of these supply chains and how they operate. It also considers the environmental impacts of food production, distribution and consumption. Food supply chains, or value chains, cover every stage of the food system from production through to final consumption. Or all that happens ‘from farm to fork’. This report focuses mainly on Europe. But a European food supply chain will soon be a thing of the past. As European retailers expand internationally, the links in the chain are lengthening. Food is sourced all year round from all over the world. We are moving rapidly towards a global food supply chain. The sustainability of the food system is considered in terms of its energy consumption and emissions. It also covers the environmental impacts of intensive farming, which are threatening long-term food production.

Actors in food value chains Retailers – also referred to as ‘supermarkets’. They control the ‘point of sale’ where food is sold to consumers. Processors – food and drink manufacturers, whose business is to alter the composition of raw ingredients to create new types of food products. Producers – farmers who grow the food. Suppliers – all actors in the chain who supply products for retailers to sell. Suppliers can cover exporters / importers, wholesalers, processors and producers, depending on the product.

Structure The first section of this report – Food value chains – examines the relationships between the different actors in the value chain. It describes how a few, large retailers coordinate the activities of other actors along the chain. Section two – A sustainable system? – looks at the broader impacts of current food production. It considers the environmental impacts of the food system at its various stages, from agricultural production to household waste. It provides clear evidence that 5

the current system, given its rate of energy consumption and use of natural resources, is unsustainable. The appendix takes a more detailed look at the food system. It provides facts and figures on retailers, processors, producers and food service. It also highlights the consolidation trends that are affecting the industry as a whole.

Summary The changing structure of European food supply chains…

From supply to demand… Retailers were once the final link in a supply chain. Now they are the first link in a demand chain. Power concentrates at the most strategic part of the value chain. The actor who occupies this part of the chain is able to capture the most value from it. Once, producers determined food supply. They decided what was produced and how. People ate whatever food was available or in season. But after the Second World War, power started to shift to manufacturers and processors whose brands ‘added value’ to food products. Now, retailers occupy the strategic part of the chain. A handful of large retailers dominate European and increasingly global markets. Retailers are the gatekeepers to the market, since most food sales now go through them. They can use information on customer purchases to make demands on suppliers. It is retailers who have the power to determine what is produced and how. If these trends continue, global food supply will soon be controlled by just a handful of retailers. The chairman of Royal Ahold predicts that only 5-8 value chains will survive globally, competing against one another.

Why retailers dominate – concentration and buyer power… Retailers today have more power than ever before. This is because the European food industry is becoming highly concentrated. In the UK the top four supermarkets have a 75% market share. In some European countries the consolidation of retail is even greater. In parts of Scandinavia the top three firms account for 95% of the market.

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The leading firms are household names. In the UK it’s a simple list of four names: Tesco, Sainsbury’s, Asda, and Morrisons. It’s the same in virtually every other country in Europe and increasingly the world – a very short list of names. Economists would define this system as an oligopoly – or, a market dominated by a small number of large firms. Normally an oligopoly exists when the top four firms account for more than 60% of the market. The top four UK retailers account for 74% of the market. Large firms have buyer power. They can make better margins. They can also demand lower prices from suppliers than their competitors. Buyer power allows retailers to impose strict conditions on suppliers. These can include demands for additional payments for access to shelf space, or discounts on orders. Buyer power allows retailers to shift financial risk on to suppliers. For example: some retailers delay payments by as much as 90 days. Suppliers must wait, while a retailer uses their capital to fund its own expansion. In this way, retailers cut their costs, boost their profits and drive competition further down the chain. Increasingly hard-pressed suppliers are left to scrap for a share of the supermarkets’ business.

How retailers dominate – supply chain management and vertical coordination… Retailers are driving a new system of food production – a demand chain where they coordinate the flow of products from the producer all the way through to the store. In a demand chain producers deliver what they are told to produce when they’re told to produce it. And they deliver the shape, the colour and the size they are instructed to. Retailers use several tools to organise the value chain. They develop relationships with small numbers of preferred suppliers. They introduce product standards and traceability systems to chart the progress of food through the supply chain. This process of organising the activities in a value chain is known as vertical coordination. This report examines the tools of vertical coordination. These include: •

distribution centres



factory gate pricing



efficient consumer response (ECR)



category management



open-book pricing

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But the two most important tools of vertical coordination are: •

Standards



Contracts

Standards are the codification of retailer demand. Standards specify what a supplier is to produce and how. They also cover how food should be packaged and distributed. Standards now apply to nearly every aspect of food supply: from the seeds used to grow vegetables, the pesticides to be used, harvest schedules and even the temperature of containers in which those vegetables are air-freighted to a supermarket outlet half way across the world. Contracts are an even more explicit form of vertical coordination. Like standards, contracts are a codified expression of retailer demand. Through contracts, retailers specify their demands: the quantity, quality, delivery time and price of food. In fact, food production is coordinated to such an extent that the lead company in a demand chain can dictate the size of an apple grown 6,000 miles away to within a tolerance of two millimetres. And as standards and contracts proliferate, retailers grow bigger and extend their control over the supply chain.

Results of retailer domination – the food industry consolidates… Standards contribute to consolidation of the value chain. The transaction costs associated with monitoring and enforcing standards mean that retailers start to work with a small number of ‘dedicated’ or ‘preferred’ suppliers. •

In 1989, the UK supermarket share of fresh fruit and vegetable sales was 33%. By 2003 it had risen to 80% - none of which was sourced through wholesale markets.

This can have disastrous effects on small suppliers. The evidence shows that when standards are introduced, small producers lose out. •

In Brazil, 60,000 dairy producers went out of business between 1997 and 2000 when supermarkets started demanding that milk be refrigerated on farms.

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In Kenya in the early 1990s, smallholders produced 70% of vegetables and fruits shipped for export. By the end of the decade they were left producing just 18%.

Standards act as barriers to market entry because of the extra costs that they impose on producers. Although voluntary, standards and assurance schemes are in effect mandatory. And as markets mature, meeting standards ceases to guarantee a premium. Traceability has become a key feature of the modern food supply chain. The need to verify standards means that products must be traced through every stage of production. Retailers are also making ‘credence claims’ about their products. Credence claims differentiate goods by identifying characteristics that give them increased value. Credence goods include free range or organic produce, or Fairtrade. Credence claims and traceability go hand in hand. Retailer reputations rest on the claims they make about their food. If products can be traced, retailers are able to back up their credence claims. Traceability is driving further coordination of the value chain. As the food system consolidates, retailers switch to a small number of preferred suppliers. But this in turn increases the risks and costs associated with failure, which demands greater traceability and so more vertical coordination..

Private label: reification of retailer power Private labels are retailer brands. Private labels are a way for retailers to differentiate themselves from their competitors. As a result of private labels, retailers are no longer identical. Instead they acquire ‘identity’. Private label gives retailers the flexibility to source products from different suppliers, enabling retailers to reduce their margins in the supply chain. One clear example is supermarket own-label fresh fruit and vegetables. Retailers can source similar or identical products from a number of different suppliers. Private label both confirms and reinforces the buyer power and status of retailers as governors of the value chain. In a food demand chain, suppliers are left at the mercy of the retailers who sell their products. Retailers hold all of the cards when deciding prices and conditions.

Environmental impacts of European food supply chains…

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Supermarkets may be the first link in the demand chain. But the origins of the 21st century food system pre-date their existence by several years.

Converting fossil fuels into people… The modern food system began in 1908, when a German chemist called Fritz Haber discovered a way to turn air into nitrogen fertilizer using natural gas. His discovery eventually heralded the ‘Green Revolution’: a revolution that grew into a movement to increase crop yields using new crop varieties, irrigation, fertilizers, pesticides and mechanisation. The Green Revolution enabled the development of intensive agriculture, which produced huge increases in crop yields. And these yields supported a massive increase in human population. Global population grew from 1.6 billion in 1900 to 6 billion in 2000 – and it is currently growing at the rate of 83 million a year. All supported and sustained by the fruits of the green revolution. The real basis of the food system is energy. The food we eat today depends upon the fossil fuels that go in to agriculture. Fossil fuels – in the form of fertilisers, pesticides and petrol for farm machinery and delivery vehicles – keep the food system running. The modern food system is essentially a way of converting fossil fuels into people. Put simply, without oil and gas we would starve. Given that fossil fuels are an unsustainable resource, and that world population will continue to rise, this is a problem that is yet to be solved.

Devastating impacts – at every stage of the chain… The seeds of the green revolution were sown on shaky ground. The fossil fuels upon which we all depend are running out. What’s more, their use is causing environmental damage that threatens future agricultural production. Industrial agriculture has damaging environmental effects: air and water pollution; the destruction of ecosystems and loss of biodiversity; soil degradation; and water shortages. But agriculture is just one part of the chain. Processing and distribution account for much of the food system’s energy consumption. Food is increasingly processed and pre-packaged before it reaches the store. What’s more, demands for all year round supply and just in time delivery are increasing global

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sourcing and the development of refrigerated supply chains – a major cause of climate change. Here are just some of the environmental impacts associated with European food supply chains: •

The food system as a whole expends 10-15 calories of energy for every calorie of food energy produced.



Some UK fertilizer manufacturing plants use more gas than the entire City of Birmingham.



The cost of cleaning up chemical pollution, repairing damaged habitats and coping with human sickness caused by industrial farming is as much as €3.3 billion per year.



The external costs of intensive farming in the UK amount to as much as €300 per hectare.



Today, 75% of the world's food is generated from just 12 plants and five animal species.



Over 2,300 apple varieties exist in Northern Europe – but just two varieties account for more than 50% of the current apple market.



To produce 1 kg of meat involves as much water as ten month’s basic household water requirements (50 litres per person per day).



To produce just one egg using industrial methods takes an estimated 63 gallons of water.



The food on the typical American family’s dinner table has travelled on average 1,500 miles.



The UK imports carrots from South Africa. Every calorie of carrot imported requires 66 calories of energy to get it here.



The energy needed to fly a kilo of mange tout 5000 miles from Zambia is enough to keep a 100-watt light bulb glowing for over 40 years.



The edible food thrown away in the UK is enough to feed more than 250,000 people.



A typical American child now gets a quarter of his or her vegetables in the form of French fries or potato chips.

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The current food system is unsustainable.

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Section 1 Food Value Chains

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The ‘Value Chain’ What a value chain is, how it works and how it is used…

"You are looking at how to re-engineer the value chain [in order] to lower the price…There are clear rules about who sets the prices and we believe we, as retailers, are the ones.”1 Anders Moberg, chief executive of Dutch retail group Ahold

"The future will not be one farmer competing with another farmer, one distributor competing with another distributor, one retailer competing with another retailer. It will be one value chain competing with another value chain."2 Professor David Bell, Head Agribusiness Program, Harvard University

Retailers today have more power than ever before. In the UK the top four supermarkets have a 75% market share. In some European countries the consolidation of retail is even greater. In parts of Scandinavia the top three firms account for 95% of the market. And in Australia the top two supermarket chains make over 74% of national grocery sales and an even higher share of the country’s total supermarket sales.3 Supermarket dominance is now so great that the food industry can, in most countries (even developing ones), be accurately described as an oligopoly, or “a market situation with only a few sellers” In fact, classical economic theory states that when four firms control more than 60% of a market it is an oligopoly (see box). This means that routes to market for suppliers – farmers, food processors, wholesalers – are dramatically reduced. Supermarkets are not just ‘sellers’, but ‘buyers’ further down the supply chain. As supermarkets grow and become more powerful, suppliers are feeling the squeeze. As one economist observes: “Oligopoly does not result in the end of competition so much as the redirection of competition downwards as lead companies capture more power to set supplier against supplier.”4 Barry Lynn, Senior Fellow, New America Foundation

Oligopoly: a small number of large sellers… An oligopoly is “a market situation with only a few sellers, each anticipating the other’s reactions. Each firm has a sufficiently large share of the market to need to consider those reactions of the others…” (Oxford Dictionary of Economics). An oligopoly is a market dominated by a few large firms, each of which has control over the market. It is an industry where there is a high level of market concentration.5 14

Normally an oligopoly exists when the top five firms in the market account for more than 60% of total market demand/sales.6 But market competitveness begins to decline when the top four firms reach a 40% market share.7 However, oligopoly is best defined by the conduct (or behaviour) of firms within a market rather than its market structure.8 Key features of an oligopoly are: •

Interdependance of firms. Firms behaviour is affected by what they believe their rivals might do. This means that each firm must take into account the likely reactions of other firms in the market when making pricing and investment decisions.



Market dominated by a small number of firms



Large firms are involved in selling either identical of very similar products



Significant barriers to entry



Price may be relatively stable across the industry



Goods can be homogenous or highly differentiated



Branding and loyalty may be a potent source of competitive advantage



Non-price competition may be prevalent.9

But it was not always this way. Over the last century or so, control of the food system has changed hands. Once, it was the producers and wholesalers who determined what was produced – and how. And so there was a food supply chain, controlled by suppliers. Then along came brand companies, manufacturing highly processed foods. As brands grew popular, power began to shift to those leading manufacturers. Now, as retail consolidates on a huge scale, it is the retailers that have most control. And so we now have a food demand chain – where power lies in the hands of a few giant multinational processing and retailing companies who control demand. Retailers were once the final link in a supply chain. Now they are the first link in a demand chain.

Three defining features of today’s global food industry 1. A few, large buyers dominate the market. Retail chains consolidate through mergers and acquisition, and start to expand internationally.

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2. Supermarkets control the supply chain, which is increasingly coordinated through the use of sophisticated technology and product information. 3. Retailer brands (so-called ‘private label’) develop to challenge manufacturer brands.

Food is now increasingly produced and distributed through supply chains. And food supply chains are not markets. In fact, they rule out normal market relationships. Supply chains are instead vertically structured and are usually controlled or managed by just one particular company.10

Value chains: definition Value chains are the chains that link all the activities involved in making a product. In the case of food, the chain starts with the farmer and ends with the consumer. At every point in the chain value is added to the product. Value is also taken away – as each actor in the chain captures a share of the profit. The distribnution of value reflects the distribution of power along the chain. Those actors at the most strategic part of the chain – the parts where power is concentrated – are able to capture the most value from the chain.

Increasingly, private – secretive - contracts and coordinated food supply chains are replacing traditional open markets such as wholesale markets or exchanges. “We want to turn all public markets into tourist attractions in two years time”11 Retail chain executive, Croatia 2003

If these trends continue, global food supply will soon be controlled by just a handful of retailers. The chairman of Royal Ahold predicts that only 5-8 value chains will survive globally, competing against one another.

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The first link in the demand chain Why it is essential to be the “first link” in a value chain

“The goal of today’s powerful oligopolies has been described as ‘the oldest in commerce – to fence in the place where deals are done and to tax producers and consumers for the right to be there’.”12 Barry Lynn, Senior Fellow, New America Foundation

Retailer power lies in their control of the key part of the chain – the store, or the place where deals are done. Retailers stand at they interface between the consumer, on one side of the checkout, and the suppliers on the other. Control of this point enables supermarkets to capture the largest share of the ‘value’ along the chain. As supermarkets grow, they shed many of their traditional functions. Supermarkets no longer process and package fresh fruit and vegetables at the back of the store. They no longer have specialist knowledge ‘in-house’ (someone who knows about fish on the fish counter, for instance). In fact, the trend for outsourcing has even extended as far as outsourcing the choice and purchase of stock – a role traditionally regarded as central to retailing. What supermarkets can do - given their strategic place in the value chain – is to collect information on customer purchases. This information can then be analysed, codified and communicated back to suppliers. Supermarkets have market intelligence, which they can use to make demands on suppliers, while their control of the final, most crucial stage of the value chain means they can demand ever-better terms for themselves.

‘Value chain governance’ … Who calls the shots? Global value chain governance is the way a lead company, such as a food retailer, controls all the product standards and processes along the value chain. The lead company decides: •

What is to be produced



How it is to be produced



How much is to be produced, and when

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As the first link in the demand chain, retailers are in a position to tell supplier what to do. Suppliers at the second, third and fourth stages of the chain have no option but to bow to these demands. Retailers codify their demands in a set of standards. These standards are monitored and enforced by carefully selecting suppliers, whose compliance is verified by third-party auditors, and then regular inspections to make sure the supply chain is working properly. Preferred suppliers reveive rewards – such as higher prices and larger volumes than other suppliers. Lead companies punish any failure to meet their standards with sanctions – such as the threat of exclusion from the supply chain, or at the very least reduced purchases and financial penalties. “Value chain governance (or vertical coordination) is such a strong characteristic of agribusiness supply systems that it is easy to take it for granted or regard it as inherently superior to arm's-length market relationships. However, value chain governance involves considerable cost in monitoring and enforcement. The up-front costs of developing systems and relationships with suppliers also lead to less flexible sourcing.”13 John Humphrey, Global Value Chains initiative, Institute of Development Studies, University of Sussex

This marks a complete shift in the organisation of food production and supply. The control of the value chain by one lead company is happening for three main reasons:14 1. Retailers are trying to set themselves apart from their competitors by selling nonstandard products. The different and distinctive packaging, labelling, varieties, processes and so on, require retailers to work directly with suppliers. 2. Retailers need to know their supply chain is working. Modern supply systems depend upon a frequent, reliable delivery of products. Any failures by suppliers put retailers’ reputations at risk, so a tight coordination of the chain is needed. Retailers also increasingly use ‘credence’ claims which require systems to check and enforce the processes that underlie these claims. 3. Any innovation in the production and supply of food requires simultaneous changes at all the different points in the value chain. Crucially, this process is self-reinforcing. The more vertical coordination of the value chain there is, the greater the tendency of retailers to rely on a small number of suppliers. This in turn increases the risks and costs if there are failures in such a consolidated system.15

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What’s the difference between a demand chain and a supply chain? Producer-driven supply chains tend to be industries that are capital- and technologyintensive – for example: automobiles, aircraft, semi-conductors. The profits are greatest for those with scale and technology – ie. the manufacturers. Buyer-driven supply chains tend to be industries that are labour-intensive – for example: garments, toys, electonics... and food. The profits are greatest for those with supply chain information and marketing expertise – ie. the retailers. Retailers are in the best position to capture the most value from these chains – at the expense of regional wholesalers, small farmers and small processors.

“At its heart, it [modern food production] is a move from an economy based on the production of goods to an economy based on the production of knowledge.”16 Lawrence H. Summers, President, Harvard University

Control of these knowledge-based value chains hinges on three things:17 1. Information… the volume of information needed to flow through and coordinate the chain 2. Standards… how easily retailer demands can be turned into usable information for the different actors in the supply chain 3. Supplier compliance… the ability of suppliers to meet these standards, or demands. And the amount of information needed for the modern food system is growing. The production of complex foods like chilled and fresh ‘ready meals’ that need to be delivered quickly and in the right conditions demand a huge level of coordination and control. There is much greater coordination of deliveries, product development (such as new products, new varieties, new packaging and so on) and control over production processes (mostly to do with product, labour and environmental standards). And as the complexity and sophistication of food value chains grow, retailers are trying to push down the costs of coordinating supply chains by: 1. Investing in the competences of existing suppliers and by working only with the most competent suppliers. Both of these strategies lead to further concentration of the value chain.18

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2. Codifying the knowledge that flows through the value chain.19 3. Restructuring and simplifying the whole value chain so that the ‘handover’ points between the actors in the chain are either completely eliminated through vertical integration or reduced in complexity. The increasing use of an exporters’ own farm production is an example of vertical integration. The introduction of category management by UK supermarkets is an example of how information and functions within the value chain can be transferred between agents.20 All this leads to greater concentration along the entire value chain because dealing with just a few of these large suppliers is easier than dealing with many small ones. Large buyers have more buying power and therefore more opportunities to enforce compliance with their wishes. Control and governance of the value chain is therefore associated with buyer power.21 “We punish farmers very hard if they don't deliver what we order.”22 Bernardo Roehrs, a spokesman for the Ahold chain .

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How to turn a supply chain into a demand chain In double quick time This example shows how retailers have managed to coordinate and control many of the functions of the value chain by turning a supply driven food chain into a demand driven food chain. The result of this change is almost total vertical coordination and the introduction of a set of standards that apply to nearly every aspect of food supply: from the seeds used to grow vegetables, the pesticides to be used, harvest schedules and even the temperature of containers in which those vegetables, designated for export, are airfreighted to a supermarket outlet half way across the world.

How to take full control of the food supply chain… a ‘step-by-step’ guide All quotes below are taken directly from a paper detailing Royal Ahold’s business strategy for streamlining its supply chain for its TOPS supermarket chains in Thailand, and commissioned by KLICT, an international research initiative funded by the government of The Netherlands. .

1 Set up a supermarket chain in a country with a low supermarket share of food sales “Most of the total output is sold through the traditional market outlets… In Thailand only 5% of food sales go through supermarkets.”23

2 Assemble the major actors in the supply chain. In the case of the TOPS Thailand project it was “Royal Ahold (a global leading retailer)”… “Syngenta (crop solutions company)”… “Rabobank International”…“TNT Logistics”(an global logistics company)…“SGS (a certification and inspection company).” 24

3 Set up a logistics and distribution centre “The strategic initiatives that were taken included: The creation of a logistic service provider (the World Fresh Distribution centre).”25 “The formulation and implementation of the logistic strategies in Thailand was based on the following aspects…simplification and scale exploitation.”26

4 Implement and promote low prices 365 days per year 21

“introduction of the ‘Supercheap’ pricing program with everyday low prices.”27

5 Emulate the ambience of traditional markets “Tops uses lighting with a natural feel to highlight its food, especially the fresh fruit and vegetable displays which have been designed to give the look and feel of a traditional wet market.”28

6 Implement a demand-driven system “The direction and content of the improvement strategy has been demand oriented. Performance criteria for the fresh goods supply chain reflected the consumer requirements.”29

7 Dramatically reduce the number of suppliers and then develop relationships with a small number of preferred suppliers “Improve the quality and safety of perishable goods by developing preferred supplier relationships… The Preferred Supplier Approach reduced the total number of suppliers from 250 to 60 after critically benchmarking their performance and development potential.” 30

8 Be tough on suppliers “Continuous benchmarking of the performance of these suppliers kept them ‘sharp’ and alert. Main supplier positions were no long-term guarantee and occasionally there was a re-shuffle of suppliers.” 31

9 Develop and impose standards and certification schemes on suppliers “Quality and safety assurance had to be guaranteed by a certification procedure. Depending on the circumstances the appropriate certification system or command and control mechanism had to be determined”32

10 Then take the lessons learnt and implement them in other countries “The lesson’s learned from Thailand are being duplicated in Brazil and Ghana. This includes the tools for a chain analysis.”33

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‘Credence claims’ ‘Most food is sold with a story’ Here’s an example of how food is sold with a story. In fact, this story uses 211 words to sell six slices of bacon. Or 35 words per slice. This excerpt from Waitrose packaging illustrates the value of credence claims. Free Range. Unsmoked English Dry Cure. 6 Back Rashers. Specially selected Waitrose free range pork, produced from Hampshire breed, renowned for tenderness and flavour is cured by hand and matured slowly, allowing the meat to develop a fuller flavour. The gently rolling countryside of Norfolk and Suffolk, its climate and free draining soil, is perfectly suited to rearing pigs outside all year round. The Hampshire breed, distinctive by its markings, produces pigs that thrive in the outdoors and are allowed to roam and root freely. The curing process is the traditional way of preserving pork. The recipe has been specially developed using the finest natural sea salt which is carefully rubbed into the pork by hand. It is then left to mature slowly into bacon allowing the flavour to develop before being sliced into rashers. Roger Newton supplies Waitrose with English Free Range pigs from his farm in Norfolk. Pigs reared outside are kept in small family groups and fed on a balanced cereal diet with vitamins and minerals. Warm shelters and straw bedding protect them from the winter, while mud baths keep them cool in the summer. By combining Roger’s expertise over many years with the characteristics of the Hampshire breed we can provide the best quality meat. Care, commitment and high standards of animal welfare ensure succulent tender bacon. Waitrose packaging for 6 bacon slices

The academic Susan Friedberg points out that ‘most food is sold with a story’.34 In an increasingly consolidated retail market, the major supermarket chains are embarking on a strategy of product differentiation, selling their products by making claims about how and where food is produced. And so standards have been developed by companies to help communicate to consumers that their products are superior to those of competitors.35 Product differentiation based upon such claims is part of a broader trend towards the increasing importance of credence claims in the food industry. Credence goods are defined in the following way: “A credence good is a complex, new product with quality and/or safety aspects that cannot be known to consumers through sensory inspection or observation-in consumption.”36 John Humphrey and Hubert Schmitz Global Value Chains Initiative Institute of Development Studies University of Sussex

Credence claims differentiate goods from competing products by identifying characteristics that give them increased value. These claims act as a form of product branding, so that particular labels (free range) are associated with particular characteristics (a good bacon sandwich) which may in turn come to be valued by consumers.37

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How to add an extra 10% to the value of coffee The Food Brands Group in the UK markets a variety of coffees under the "Percol" brand name. Its top end product is called “Sanctuary”™ which claims to be a “Bird friendly, single estate, organic Arabica coffee”. The packaging makes the following claims: •

The product has superior quality because it is grown on a single estate, organically. These claims are supported by certification from the UK Soil Association (whose logo is also displayed) as well as information about the precise location where the coffee is likely to have been grown.



The product is “bird-friendly”. Shade-grown coffee does not destroy the forest canopy, a claim supported by certification from the Smithsonian Migratory Bird Centre.



The product has social benefits. A claim is made that Percol is committed “to the coffee growing communities and environment” and that the company has “a mission to care for the people and the environment where it is grown”. Reference is made to “The Coffee Kids Charity” and “raising money for health and education projects to improve the quality of life for children and their families where coffee is grown”.

The result is a product that sells for a 10% premium over other Fairtrade organic coffees.38 So credence claims enable retailers to economically exploit certain ‘qualities’ of food, which are not immediately verifiable by the consumer. •

health benefits



product safety



regional origin



high levels of animal well-being



ecological soundness

Credence attributes can describe the content of a food or the processes which made it. Content attributes are the physical properties of a product. They can be difficult for consumers to perceive. For example, consumers are unable to determine the amount of 24

isoflavones in a glass of soymilk or the amount of calcium in a glass of enriched orange juice by drinking these beverages.39 Process attributes These do not affect final product content but refer to characteristics of the production process. Process attributes include country-of-origin, freerange, dolphin-safe, shade-grown, earth-friendly, and fair trade. In general, neither consumers nor specialized testing equipment can detect process attributes.40 The table below shows how these credence claims come into effect. The different guises of credence claims41 Private Voluntary Initiatives Some are private voluntary initiatives, such as Starbucks’ ‘C.A.F.E. (Coffee and Farmer Equity) Practices’. This programme uses independent third-party verifiers to audit farms on environmental and social indicators. In this case, a service sector company establishes a claim for its particular product, basing its credibility on thirdparty certification.42 Branding the Enterprise Other claims encompass the branding of an entire enterprise. One example is the Thandi brand, developed for wine and fruit: “Thandi’s aim is to empower previously disadvantaged farming communities. With support and mentorship from leading players in the fruit and wine industries, these communities export top class produce to countries all over the world” (http:www.thandi.com). This claim is allied to one about the quality of the product.43 Regional Branding Claims about product characteristics, quality or production processes can also be made at the regional level – this is known as regional branding. Examples are Jamaican Blue Mountain coffee, the Copper River brand of wild salmon. This type of branding can be developed through regional associations, both public and private.44 Certification Schemes Product differentiation can also be based on schemes that are not geographically specific. Broad certification schemes are designed to identify particular characteristics of product or production processes originating from designated producers. Fairtrade and organic certification schemes are just two examples.45

Consumer food choice may be influenced by product prices and product quality, but consumer ideas about food “quality” have changed considerably in recent years. One

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major US study finds that today’s European consumer sees food quality as something that involves the following four features…46 • Sensory qualities are the traditional aspects of food quality: taste, appearance, and smell, with taste being dominant. Taste is an experience that can be evaluated only after a product has been bought and consumers use a host of market signals, like brand, price, and quality labels, in trying to predict the taste experience. • Health qualities have become increasingly important during the last 50 years, and studies indicate that consumers give equal weight to health and sensory attributes. Many health effects of food are too abstract to be experienced directly. Consumers therefore have to interpret various signals. More recently, manufacturers have developed ‘functional foods’. These are food products that have an added health benefit such as yogurts with probiotic ingredients or margarine made with cholesterolreducing ingredients. These health attributes require active communication. • Process qualities relate to the processes used in food production – even those that have no analyzable impact on the final food product. Some consumers pay more money for organic products or for products produced with due concern for equitable income distribution. These products look and taste the same as products without these attributes. • Convenience qualities are those features of a food product that save the time or energy that consumers spend on shopping, food storage, preparation, eating, and food disposal.47 Microwaveable meals are a good example of ‘convenient food’, as are prewashed carrots and food which is packaged so that it can be eaten ‘on the move’. Crucially, these quality attributes become more valuable the more marketable they are.48 In other words, if there is a large potential market for a particular quality, then there is a big incentive for retailers to invest in the technology and resources to ensure any claim about that product’s quality can be backed up. But the key to monetising these credence claims is traceability.

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Traceability Food is worth a lot more if it can be traced from plough-to-plate, from farm to fork. Or, from DNA to sausage (via satellite)

“Consumers in Japan can use their camera cell phones to scan a code on the outside of shrink-wrapped fruits and vegetables that’s embedded with information about the produce.”49 CIO magazine, 2005

Retailer reputations rest on the claims they make about their food. If a product can be traced through every stage of production, then the retailer can back up its ‘credence claims’. Traceability – ‘from farm to fork’ – is now tremendously important. A German study, for instance, found that when selecting a supplier, traceability is six times more important for a retailer than quality.50 This is leading to the emergence of traceability systems which can track food all along the supply chain. “Traceability is an indispensable part of any market for process credence attributes—or content attributes that are difficult or costly to measure.”51 USDA, 2004

Because it is difficult – or sometimes impossible – to verify credence claims by simply looking at the product, any foods subject to credence claims need to be completely traceable and identifiable as they move along the value chain.52 The development of these credence goods requires the coordination of different agents along the value chain, so that claims made to consumers in distant markets can be backed up. It requires the coordinated activities of producers, certifiers and retailers.53 With existing technology it is now possible to trace information on both content and process attributes. two types of information….. product information and process information. •

Product information is information about the food’s identity, location and processing time. This information is useful for ‘recall management’ and logistics. This form of traceability is regarded as a way to improve operational efficiency and reduce costs.54



Process information offers extra information on process conditions such as temperature. Process information can be used to provide quality assurance and product differentiation and is often referred to as ‘quality-oriented traceability’.55 27

Traceability systems can also provide the information to determine whether supply chains are operating correctly.56 This is crucial. The rising profile of supermarket brands means that that just one error in the supply chain would damage the reputation of the retailer’s entire stock. Traceability systems also help firms to establish the extent of their liability in cases of food safety scares and possibly shift liability to others in the supply chain. The traceability systems themselves do not determine liability, but because they provide information about the production process they can provide evidence for any glitches in production.57 In the food industry, supply chain management and infrastructure for traceability is a crucial area of competition. “An indispensable element of any supply management strategy is the collection of information on each product from production to delivery or point of sale.”58 USDA

The table below shows the sophistication of the tracking and tracing systems used by one leading UK retailer, J Sainsbury, to chart the progress of goods through its supply chain. A ‘corporate file management’ system for instance stores data on all of the company’s suppliers. The table also shows how traceability systems are integrated into retailer buying practices. A ‘sales-based replenishment’ system is used to make orders based on actual and forecast sales in store. A ‘supply chain integrated ordering network’ generates orders for suppliers to deliver goods to distribution centres. The result is a faster, more coordinated supply chain.

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RDC: regional distribution centre

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From individual genes to checkout counter… Today, it’s got to be traced all the way Modern food supply chains demand a near-totalitarian control of information. Such an information trail starts with the DNA of a cow or the genetic code of a seed… …and is traced through the production and processing of food all the way to the checkout counter where sales information is scanned and then stored in customer databases. These information trails – or traceability systems – are the basis of today’s supermarket supply chain management. A supermarket’s traceability system is essential to find the most efficient ways to produce, assemble, warehouse, and distribute products. The greater the level of coordination along the supply chain, the greater the benefits of traceability systems for supermarkets.60 Technology is crucial to the generation of information and is shaping the way retailers are taking control of the value chain. The US retail industry now spends about 2.1% of its turnover a year on technology, up from 1.8% in 2001.61 Nowhere is the trend towards total traceability in the food chain more apparent than in the meat industries. “The ultimate objective will be to track every piece of meat from plate to farm through each step in the value chain: retail, distribution, processing, slaughter, production, nutrition, breeding and genetics”.62 John Webb, Maple Leaf Foods (Global food processing company)

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How animals get an electronic license plate with “Bio-tagging” Genomics – the study of organisms and their DNA – is the fastest growing technology for recording food quality and other attributes.63 A number of genomics companies are already developing DNA tracking systems for meat.64 DNA tracking can link meat back to the farm of origin and so bypass the expensive step of tracking it through a processing plant.65 Major global food processor Maple Leaf Foods called upon Pyxis Genomics66 to help them implement a DNA tracking system for the pork produced in their plants “The success of identifying the gene panel significantly enhances our ability to provide live animal tracking systems that can directly link store-bought product back to its origin in a matter of hours, instead of days or weeks.”….“This is critical in an industry seeking to offer the highest standards of assurance to consumers.” Dr. Lawrence B. Schook, President and CEO of Pyxis Genomics Inc

DNA animal tracking can track animals through slaughter and processing plants and eventually provide consumer information through product codes and a website.67 Farm animals are already tracked and traced in a number of ways: •

Electronic tags (bio-tagging) – an “electronic license plate” for animals. Tags contain codes, which are scanned every time the animal arrives at a new spot in the production chain.68



Retina scanning.



Implantable computer chips.69



RFID - the US Department for Agriculture (USDA) has recommended that all livestock in the U.S. be tagged with radio frequency identification devices. The information on each animal’s origin and location would be stored in a national database.



Paper bar codes and spray-on bar codes – for tracking inside the slaughter and processing plant is trickier. Options include paper bar codes that can be read at each point where a cut of meat is made.70 Possibly in the future, spray-on bar codes could be used to identify a particular cutting line.71

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Check out your Christmas dinner while its still “alive and gobbling” Heritage Foods already provides consumers of their turkeys with a certificate of its origin.72 By visiting the company’s website consumers can type in the turkey’s certificate number and find out everything from its age, farm of origin, its diet and where it was processed. Consumers who pre-order their turkey can even access the company’s 24-hour webcam to watch their turkey while it’s “alive and gobbling”.73

Radio frequency identification (RFID) Where cows talk to satellites, crates talk to trucks, empty shelves talk to suppliers. And retailers overhear everything Retailers are well positioned to take advantage of new technology. They can also demand that their suppliers adopt new tracking and tracing systems. And, once installed, these systems in turn increase retailers’ ability to oversee all aspects of the chain. Studies show that use of advanced technology is directly linked to increases in market share. And only those retailers with a large market share can afford to adopt advanced technology. No technology has been as important as the development of affordable radio frequency identification (RFID). Demands for traceability and cost-efficiency mean that RFID will soon become standard across the food industry. Analysts believe RFID will be essential technology for most supply chains within the next ten to 20 years.74 •

In 2004, just 35% of European retailers were experimenting with RFID, but by the end of 2006 89% plan to use RFID.75



By 2015 about 900 billion food items could be RFID tagged, with a further 824 million livestock having more sophisticated tags on – or implanted in – them.76

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What is RFID? RFID is a tracking technology, which enables the flow of information across the value chain. RFID tags contain a microchip and a tiny antenna that send the price and other information about the product to a computer.77 They contain more information than bar codes, and can be read from a longer range (about 15ft). An RFID reader can be placed at the entrance to a distribution centre or stockroom, allowing reading of large quantities rapidly.78 Below is a short list of the main capabilities of RFID: • Real time tracking of products throughout the value chain • Access to “live” sales data (as opposed to the usual 20 to 30 days) • Inventory management and accuracy • Display product availability • Monitoring when products are made and when perishables expire • Verification of product authenticity • Direct consumer marketing79

Customer information Who cares when you last bought a 500g pack of muesli with real strawberries? The tracing of information does not just stop once food is placed on the retailers’ shelves. The ownership and control of information puts retailers into the driving seat when it comes to food supply.80 Every time a can of soup or a pack of fresh pasta is passed through the check out, point of sale data is transferred from barcodes81. This data helps to build sophisticated customer profiles and develop marketing strategies. This information is a major source of competitive advantage both to retailers and the chain ‘insiders’ with whom it is shared.82

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In the UK, Tesco has led the way, gathering huge amounts of data about its customers’ buying preferences. Before the Tesco’s Clubcard came along, the largest consumer panels that suppliers could use consisted of around 20,000 people. Suppliers now pay for access to Tesco’s enormous database.83 •

Tesco has issued 12m Clubcards, which allow it to record exactly what, when and where people are buying food.84



Shoppers each buying 20 items a week would generate more than 12 billion pieces of data each year.85

“We believe we have one of the largest databases anywhere in the world.”86 Martin Hayward, of Dunnhumby, (who manage Tesco’s databse)

Electronic systems for tracking inventory, purchases, production, and sales have become an integral part of doing business in the United States. A few big retailers such as WalMart and Target have even created proprietary supply-chain information systems that they insist their suppliers adopt. •

In the mid-1990s Wal-Mart’s database contained 7,000 gigabytes of information. Now it contains 10 terabytes…that’s 10,000,000,000,000 bytes…. making it the largest commercial data bank in the world.87

At the same time, retailers can access information along the entire value chain. Tracking technologies enable retailers to control and monitor food production all the way back to the farm. Put simply, information about consumer preferences is used to shape the demands retailers make of their suppliers. The complex way this information now passes up and down the value chain has stemmed from major developments in supply chain management. There are many barriers to achieving total traceability. The complexity of supply chains – especially where a foodstuff is split into different parts (i.e. when a cow is made into hamburgers) – can make it difficult to track food. Short chains with a constant series of links obviously have an easier traceability than long and complex chains and networks with flexible and changing connections.88 Also some food products are so small that it does not make economic sense to track them individually. So, to maintain a traceability system requires several companies to share commercially sensitive information.89 But larger retailers can overcome these barriers by laying down the main requirements – in the form of contracts and private standards.

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Standards: the codification of retailer demand. Understanding the DNA of the food supply chain Because retailers increasingly sell ‘food with a story’ and make specific claims about the products that they sell it is important that these claims can be verified. To do this they have created sophisticated traceability systems and built the infrastructure to monitor each process along the entire food chain. Private standards are the rules which specify what those processes are. Whilst technology has enabled the control of information, private standards are the codification of retailer demand. They are the rules by which retailers coordinate their supply chain. “… a ‘standard’ is to be understood….as a set of technical specifications that may be adhered to by a producer, either tacitly or as a result of a formal agreement.”90 Standards specify and harmonize product and delivery attributes, thereby enhancing efficiency and lowering transaction costs.91 Standards can specify two aspects of a finished product: 1. Product standards – cover the physical characteristics of the finished product. For example a cucumber might have to be a certain colour, length, girth and wrapped in a particular type of plastic. “Now they are telling us that the size of a Fuji apple is ideally 65mm, not 63mm so when you are thinning you have to tell the workers to cut more deeply … There is more skill involved, but it also takes longer and there is more labour.” 92 South African apple farmer, commenting on European food standards

2. Process standards – cover how the product is produced, including social and environmental practices that are not ‘visible’ in the finished product. A cucumber might have to be produced using certain agricultural methods or treated with particular pesticides “Waitrose British Pork comes from pigs that are reared naturally on carefully selected British farms. The pigs always have soft straw to sleep on and space to roam around. Claire and Trevor Carlton-Moor produce pigs for Waitrose on their farm in East Anglia.”

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Waitrose advertisement

Anecdotal evidence suggests some supermarkets specify that the vegetables they sell are produced using only mains water irrigation methods. Some examples of private standards There are a few main trends in standards. Firstly there is the increasing complexity and importance of public, mandatory standards in global markets. But increasingly important are the private, collective standards on agribusiness trade and value chains.93 Retailer brands are hugely influential and because of their economic power, retailers are a major force in driving quality standards.94 Although often labelled as ‘voluntary’, in that they are not imposed by regulatory authorities, standards often act as entry tickets into the market – producers must comply with certain standards, and demonstrate that they have done so, or their products will not reach the supermarket shelves.95 Here are some examples of private retailer standards: EUREP/GAP (Euro Retailer Produce Good Agricultural Practices) covers agriculture, food-safety aspects as well as working conditions and environmental aspects EurGAP control points Production area Criteria assessed 1. Traceability 2. Record keeping 3. Varieties and root stocks 4. Site history and management 5. Soil and substrate management 6. Fertiliser use 7. Irrigation 8. Crop protection 9. Harvesting 10. Postharvest treatment 11. Waste and pollution management, 12. Worker health, 13. Incremental issues 14. Complaint form 96 BRC (British Retail Consortium standards) – offers an extended developed checklist for food-safety specifically for the UK market GMP+ (Good Manufacturing Practices) – implemented in the animal sector. It requires traceability of feed.

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SQF (Safe Quality Food) – emphasizes capabilities of tracking and tracing throughout the supply chain

Private standards Retailer rules in action Companies at all stages of the value chain are developing high-profile standards to differentiate products their competitors’. Retailer standards include Tesco's Nature's Choice, Carrefour's Filière de Qualité and Loblaw's President's Choice.97 •

Carrefour applies its Carrefour Quality Certificate to 200 items around the globe98



Somerfield, sets out its criteria for cauliflowers over three pages, including a demand that all should be 12cm-16cm and uniform in colour with no more than two spots per leaf. They must also be at exactly 6C when they are delivered to the store’s depot.99

Processors are also introducing private standards…

Bottom of the heap: ‘Not-traced and not-controlled’ Danone is a leading European manufacturer of fresh dairy products. In Bulgaria, the company has introduced a system of standards for its suppliers, the Danone Quality Control System (imposed by the International Danone Group). Every year all milk suppliers are visited and evaluated on the basis of 26 criteria relating to quality and safety of milk production. Suppliers that pass on all 26 criteria are labelled ‘Traced and Controlled Danone’ and are granted preferred supplier status. Suppliers that do not fulfil all 26 criteria are labelled ‘Traced and Controlled’, ‘Traced and notcontrolled’, or ‘Not-traced and not-controlled’. 100

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And so are fast-food companies… Fast-food companies make the most stringent demands Food-service companies, especially international chains such as McDonald’s, are very demanding – much more so than even supermarkets – in terms quality attributes and standards. They insist their suppliers control water quality, seed varieties, pesticides, packaging, and temperature, along with rigid standards specifying the size, colour and texture of the foodstuffs they sell in their food outlets.101 Most fast-food restaurants also demand daily microbiological control and audit monthly the “fresh-cut” companies which supply them.102 More importantly, fast-food chains take their sourcing strategies with them wherever they go. In developing countries small producers often find it hard to obtain information on standards, let alone make the investments needed to meet them.103 This drives small farmers out of business which leads to bigger farms that use more technology-intensive growing methods, as well as larger, more centralised food processing plants.104

Assurance schemes…and retailer value It’s best to link your credence claims to a worthy organisation. Private quality assurance schemes are designed by third party organisations often in collaboration with retailers. Examples include “Farm Assured British Lamb” or “Farm Assured British Pigs”. Third parties not only help design the schemes, they often help to enforce them. Many retailers ‘sub-contract’ the role of source verification to the various producer-driven farm assurance schemes in operation.105 Farm assurance and whole-chain assurance schemes lead to the production of food with certain extra qualities – which back up the credence claims made by retailers. These credence qualities also have extra value for the retailer, as they might be able to sell them at a premium to a particular range of customers. In this way, retailer product differentiation strategies in the UK impose retailer standards further down the chain. The consequence of this is that much of the market is closed to farmers who do not embrace one or more of the assurance schemes designed to give added value. 106

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For UK farmers and processors, memberships in the Farm Assured British Beef and Lamb (FABBL) and other such schemes are voluntary. But studies suggest that failure to comply with the standards is not really an option. Membership has become a de facto mandatory requirement of major processors, who are in turn responding to pressure from major food retailers, restaurants, and food service.107 • In 2000, about half of English beef producers and around a quarter of English lamb producers belonged to Farm Assured British Lamb and Beef (FABBL). They produced 76% of beef and 51% of lambs slaughtered in England. • About 30% of English pig producers belonged to Farm Assured British Pigs (FABPIGS) in 2000, but they produced about 85% of the pigs slaughtered in England.108 In other words, it is the bigger producers that belong to these certification schemes.

How standards create private labels Major food retailers have implemented ‘proprietary’ quality assurance schemes in order to develop their own private label products. These schemes require suppliers to be members of one of the generic farm-level schemes, but then specify a variety of additional requirements – such as carcass specifications, age limits, breed, additional feed constraints, and enhanced ability to document the animal’s source and how it was produced.109

Retailers are driving in the spread of assurance schemes. This exerts substantial pressure on producers who might otherwise be unwilling to bear the costs of membership and of meeting scheme standards, but who are aware that if they don’t they will be excluded from the market. Furthermore, as markets mature, meeting stringent new standards is no guarantee of a market premium for suppliers. In fact, new standards often become an ‘unfunded mandate’ and arguably demonstrate a disproportional allocation of costs and benefits between standards ‘makers’ and standards ‘takers’. When combined with buyer power, the costs and efforts necessary to meet the standard, to prove that it has been met and allow for traceability down the supply chain, are likely to fall on the producer.110

Standards and consolidation Standards favour large farms 38

These standards also drive concentration further down the food chain. The cost of compliance means that standards discriminate against small farms. Although often described as ‘voluntary’, private standards can act as entry tickets or barriers to the market.111 The stringency of the standards discourages many small farmers from entering into contracts for supply. And in countries or regions where just four retailers can control up to 90% of the market small suppliers are effectively excluded from everything but the scraps. To make matters worse, emerging evidence points to a distinct preference by supermarkets to source from larger producers. •

In Malaysia, for example, one chain had 200 vegetable suppliers in 2001 - by 2003 this number had fallen to just 30 “preferred suppliers”.112



In Chile it has been found that the scale of fresh produce operations of 50 or 75 associated small growers, each with one or two hectares, is often not sufficient to offset the cost of supermarket procurement practices.113 Only large-scale farming operations can meet the demand.

The extra demands of supermarkets In Ecuador, the traditional open market demands from potato growers only four criteria be met: 1. a certain set of varieties 2. a maximum level of mechanical damage 3. a minimum size 4. a certain color In contrast, the supermarket channel demands fourteen criteria be met: 1. a certain set of varieties 2. a certain form 3. a maximum level of mechanical damage 4. a level of cleanliness 5. a level of food safety 6. a certain odor limit 7. a certain size 8. a certain color 9. a certain maturity 10. temperature maintenance 11. specific packaging 12. a certain volume 13. timing and place restrictions 14. a specific payment period114

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Food service companies also impose standards that shut small suppliers out of markets and help to consolidate the food supply chain. •

The Association of Small Irrigation Users of Palencia (ASUMPAL) is a cooperative supplying salad tomatoes, that comply to stringent specifications, to McDonald’s in Guatemala. Its membership fell from 330 in 2000 to 30 in 2001 to just 6 in 2002.115 ASUMPAL’s members lacked the expertise, as well as the money to invest in the modern greenhouses, drip irrigation and pest control that would have helped them meet supermarket specifications116

Distribution and packaging Standards do not just apply to production. They often specify how food should be packaged and distributed. Standardised packaging and supply are essential to the smooth operation of large scale global distribution networks. Supermarkets demand standard quality of produce (appearance, size, colour, crates, pallets) so that they can run their stock efficiently and standardise pricing.117 So, for suppliers, understanding the right packaging, the right case pack sizes and the right unit loads demanded by supermarkets can make or break the profitability of their business.118 If, for example, a supplier does not use the right size crate then they cannot supply the retailer. This means that even packaging can act as a barrier to new suppliers who want to enter the food supply chain. Standardised packaging can also lead to discriminatory requirements which eat into the profitability of producers. •

Wal-Mart now demands that packages of chicken breast must weigh exactly 5lb and that is all that the supplier is paid for.119 Because the supplier is not paid for any extra chicken in a package, any small oversupply will mean the supplier consistently loses out.

The traceability systems driven by retailers are forcing suppliers – manufacturer and farmer alike – to follow suit and adapt to those new systems. • Tesco and Metro introduced RFID at individual case level in 2004. All of their suppliers were told to be RFID compatible from 2006.120 Wal-Mart has required its top 100 suppliers to be RFID capable since January 2005. Its next 200 suppliers had to put RFID tags on cases and pallets from January 2006.121 40

And so suppliers have two choices: either implement RFID across their own operations or lose an outlet for their produce. For many suppliers a large retailer like Wal-Mart accounts for most of their business and so suppliers have no option other than bear the cost of this expensive technology. • Wal-Mart suppliers have collectively spent $250 million to implement the technology, according to AMR Research released this past winter.122 US manufacturers will spend $400,000 per facility to become RFID compliant, plus another $6,600 annually per $1 million in sales for the tags themselves.123 Suppliers faced a stark choice: adapt or face commercial ruin. “It’s a significant cost to our company, but you’re either going to do it their [Wal-Mart’s] way, or they’re going to find another supplier.”124 Tillamook County Creamery, Oregon, US

The imposition of these costs further consolidates the supply chain. The impact of new standards can be particularly severe in developing countries, as these case studies show. Brazil: new standards transform the supply chain… and 60,000 dairy farmers go bust. In Brazil, the imposition of new supermarket standards in 1997 led directly to 60,000 dairy farmers going out of business in just 36 months. Following pressure from supermarkets, dairy processors in Brazil began to demand the instillation of expensive refrigeration tanks on all dairy farms. However, the smallest tank available for farmers to buy helds 200 litres of milk, requiring production of at least 100 litres a day. Since average farm production was just 50 litres a day most farms were unable to afford the new system. In fact, fewer than 6% of dairy farmers had a daily output of 100 litres or more, so there was an instant and massive exclusion of small dairy farmers. Dairy processing in Brazil is highly concentrated. In 1996 the top 3 firms (Nestle, Parmalat, and a domestic firm) had 61% of the dairy processing market. Tetrapack, in conjunction with the major retailers, embarked on an aggressive strategy to promote vacuum packing UHT milk. This combined with Parlamat’s promotion of UHT milk caused UHT to take over the fluid milk market from just a 5% share in the late 1980s to a 75% share in 2001. “The consequences of this substitution are important. Most UHT milk is sold in supermarkets, while pasteurised milk used to be sold by bakeries. This means that milk retail has shifted rapidly into supermarkets, whose relentless quest for cost-cutting was

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passed on to the dairy processors. Private standards were instituted by the leading processors to reduce costs….” These standards required milk cooling at the farm level which reduces procurement costs and improves the quality of the raw material. To take full advantage of the refrigeration system, the farmer has to invest in herds and costly equipment… During the period 1997-2000, the number of farmers delivering milk to the top 12 companies dropped by 60,000 (35% of suppliers) and there was a 55% increase in their average size (litres/day/farm). Nestlé alone shed 20,000 farmers from its supply lists – a drop of 49%. Since the demands were imposed the average scale of a supplier increased by 135%.125

It is a similar story in Kenya… Kenya’s fresh fruit and vegetables. swept aside •

Fewer, bigger farms. Small-holders

In 1989, the UK supermarket share of fresh fruit and vegetable sales was 33%. By 2003 it had risen to 80% - none of which was sourced through wholesale markets.126

The changing nature of fresh vegetables trade between Kenya and the United Kingdom highlights a shift from market-based global value chain governance to more explicit coordination, and it reveals the importance of the competitive strategies of UK supermarkets in driving this change.127 Fresh produce is one of the few products that can persuade consumers to move from one supermarket chain to another… so it is very important to retailers. To differentiate their products retailers emphasise the quality of their fresh produce and have introduced new, non-seasonal and processed items in a bid to attract customers. In the UK much of this produce comes from Kenya. Retailer emphasis on quality and variety has changed the structure of the value chain In the 1980s, trade in fresh produce between the UK and Kenya went through a series of arm’s-length open market relationships. Traders in Kenya bought produce in wholesale markets or at the farm gate and exported it to the UK, where it was sold in wholesale markets and distributed to independent shops. Supermarkets have transformed this open market. As UK retailers grew and became more powerful, they began to take a greater share of fresh food sales. Supermarkets then used their buyer power to introduce a more explicit form of coordination into the chain. They developed closer relationships with UK importers and Kenyan exporters, and moved to 42

renewable annual contracts with suppliers whose capabilities and systems were subject to regular monitoring by third party performance auditors. Supermarkets began to inspect suppliers prior to incorporation in the chain, and made regular spot checks at all points in the chain, right down to the fields where the produce was grown. Supermarkets then started to specify exactly how products should be grown, harvested, transported, processed and stored. These requirements were specified and monitored by •

the use of detailed, written procedures for growing (including the use of specific pesticides and chemicals), harvesting, processing and transport



swapping information with a small number of "preferred" suppliers



auditing and inspection of importers, exporters and farms.

Firstly they reduced the number of UK suppliers/importers for each product range. They then adopted a system of category management, which meant the remaining suppliers were given more and more responsibility for sourcing, product development, and even consumer research. Then as many processing functions as possible were transferred to exporters in Kenya, where costs are lower. In fact, one company went so far as to fly chives from Europe to Kenya, so that packers there could use them to tie small bunches of green beans and miniature carrots together – to make them appeal to British shoppers. The plastic trays these were sold in were also flown from Europe to Kenya.128

Result – smallholders excluded, as consolidation is driven further and further down the chain Supermarket standards have led leading exporters to increase own-farm production at the expense of purchasing vegetables from both smallholders and large contract farmers.129 •

In the early 1990s, smallholders produced 70% of vegetables and fruits shipped from Kenya… by the end of the decade they were left producing just 18%.



By 2000, 40% of fresh produce was grown on farms owned or leased directly by the importers based in the developed countries, and another 42% on large commercial farms.130



In 2002, 1,600 Kenyan growers lost their contracts.131

There has been concentration of exporters too.

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The top five exporters now control over 75% of all fresh vegetable exports.

But it doesn’t stop there, these remaining exporters are now consolidating vertically. Kenya’s largest exporter, Homegrown has entered into a joint venture with MK airlines which flies cargo planes each night to the UK.132 And Kenyan exporters are beginning to merge with UK importers either through outright ownership or equity participation.133

Smallholders excluded As supermarkets transfer their global sourcing patterns to the developing world, large numbers of smallholders will find themselves excluded from the supply chain.134 The figures show that global retailers are rapidly increasing their penetration in developing countries (see appendix). As they do so, they switch their sourcing from the wholesale markets used by small suppliers and retailers to a small number of preferred suppliers and introduce their own grades and standards that shut out small suppliers. These “preferred suppliers” are driving through the demands of multinational retailers. They cut the retailers coordination and enforcement costs, and enforce private standards and contracts on their behalf.135 In Nicaragua for instance, fresh produce supplier Hortifruti works on developing farmer ‘competences’. The company’s agronomists visit farms to oversee crop planning and provide other technical assistance. Hortifruti is the ‘buying arm’ for most of the stores in the Central American Retail Holding Company (CARHCO), which is a third-owned by Wal-Mart.136 Through contracts with growers it has streamlined the supply chain, leading to cost reductions on tomatoes of up to 60%.137

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Contracts One of the most effective ways to grow your company (with someone else’s money) “…development economists and agribusiness researchers generally agree that the growing number of complex contractual arrangements replacing spot markets is a defining characteristic of the agroindustrialisation phenomenon”138 Agricultural Economics, 2000

“We are likely to see a continuing shift to more explicit forms of vertical coordination, through contracts and processor ownership, as a means to ensure more consistent product quantity and quality.”139 US Department of Agriculture

Contracts are a more ‘explicit’ way of coordinating the value chain. Like standards, contracts are a codified expression of retailer demand. A contract is, in essence, a formal or informal agreement between two parties that is costly to break either because of a monetary penalty or lost future business.140 The FAO defines a contract as, “an agreement between farmers and processing and/or marketing firms for the production and supply of agricultural products under forward agreements, frequently at predetermined prices”.141 In today’s food supply chain contracts are frequently used for the following products: Product

Contractor

Fruit and Vegetables

Retailer or Preferred wholesaler

Dairy

Retailer or Processor

Poultry

Retailer or Processor

Meat

Retailer or Processor

Cereals

Retailer or Processor

Through contracts, retailers and processors specify their demands: the quantity, quality, delivery time and price of food. •

In Germany around one-third of the total value of agricultural production was produced under various types of contract in the 1990s.142

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Retailers, for example, make contracts either directly with the producer or with suppliers, who in turn make contracts with producers. The retailer benefits from a consistent supply and a guarantee that food has been produced in accordance with standards specified in the contract. Suppliers and producers receive a guaranteed income. But there is another important feature of contracts. Growth. Contracts as a cheap way to achieve vertical integration There are two basic ways that a company can get bigger. It can do so either through direct ownership, by which firms “grow larger”, or through agreements, by which firms are “effectively larger”. The first way, known as vertical integration, is achieved through mergers or acquisitions, where one firm purchases the assets of another firm at another stage of the value chain. The second way, known as vertical coordination, is achieved when firms gain access to larger markets, a wider product line, or higher quality produce through formal or informal agreements.143 Standards are a type of informal agreement. Formal agreements are known as contracts. They are a more explicit form of vertical coordination. Contracts are part of what industrial organization literature terms “vertical restrictions”, which fall short of full vertical integration (which supermarkets and food processors usually avoid) but approximate in certain ways the outcome of a vertical merger. These contracts can also be established when a retailer (via its wholesaler or directly) “lists” a supplier. That listing is an informal (usually) but effective contract—in which delisting carries some cost, tangible or intangible.144 But, contracts do not come without risks, especially for producers. Farmers, in particular, are at risk of becoming dependent on a sole contractor, and may lack bargaining power to obtain fairer terms. Or, the contractor may manipulate quality standards in order to reduce purchases.145 Yet despite their weaker position, producers still end up being liable for the on-farm investments often specified in contract production as well as all the environmental liabilities which can be substantial. Contracts also lead to a lack of price transparency… What is a contract? A standard farming contract includes provisions for price, production practices, product quality, and credit facilities, etc146 In agriculture, these are the areas that contracts typically cover:

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Market provision: The grower and buyer agree to terms and condition for the future sale and purchase of a crop or livestock product



Resource provision: In conjunction with the marketing arrangements, the buyer agrees to supply selected inputs, including on occasions land preparation and technical advice



Management specifications: The grower agrees to follow recommended production methods, inputs regimes, and cultivation and harvesting specifications 147

In addition to this, for livestock, there are two further “sub-categories” into which contracts fall: production contracts and marketing contracts. .



Production contracts: these are where the contractor owns the animals and the farmer is paid for feeding and looking after them



Marketing/pricing contracts: these are where the farmer owns the animals, but has some prior agreement with the contractor regarding purchasing arrangements or pricing

In the U.S. the first type predominates in the poultry sub-sector, while marketing or pricing contracts now account for a majority of sales in the hog market.148

Contracts more and more popular Contracts are now the primary method of handling sales of many different livestock foods such as milk, pigs, and poultry, and also the sales of major crops such as fruit and vegetables. And contracts will govern a growing share of global agricultural production over the next decade, for the following reasons… •

Demand for differentiated agricultural products to meet specific consumer preferences should continue to grow, and these products are generally produced under contract.



Pressures will grow to ensure traceability of products for health and consumer concerns, and contracts provide one way to ensure traceability.



Large farms continue to account for sharply growing shares of agricultural output. Contracting is closely associated with farm size, and contract use can be expected to grow along with the increase of large farms.149

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Example: Processing Tomatoes in California Almost all U.S. processing tomatoes are grown in California, the vast majority under contracts. There are few participants in the California market—51 processors in the 1990s and about 500 growers. The 50 largest growers account for 40% of production. Different processors need different tomato characteristics for the huge variety of different tomato products: paste, juice, sauce, ketchup, soup products and so on. These market characteristics lead to a reliance on contracts and contracts are designed to provide incentives to growers to produce the tomato characteristics desired by buyers.150

Example: French Fries McCain Foods is the world’s largest french fry processor, it produces one-third of all french fries consumed in the world and at least 40% more than any other company. Most of McCain’s potatoes are grown by producers that enter into contracts before the year’s crop is planted.151

US leads the way in contracts Contracts have governed an increasing proportion of US agricultural production since the 1950s152 and now cover over one-third (36%) of the value of U.S agricultural production, up from only 12% in 1969.153 In some sectors of US agriculture contracts are used even more widely: •

Contracts covered nearly one half of all livestock production 2001, up from onethird just 5 years before. 154



Contracts dominate the production of poultry and eggs… 88% of the value of production in 2001155



The number of pigs produced under contract has rocketed in a just short space of time: in 1997, 56.6% of hog production was contracted. By January 2005 the number of non-negotiated or non-spot purchases accounted for 89.4% hog purchases.156

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Source: USDA data157

Fruit and vegetables… more and more contracts too Conventional retailers are gradually reducing the number of suppliers per product and beginning to contract with just two or three preferred vendors capable of offering consistent, year-round volumes, quality, and traceability systems.158 This system essentially functions as a contract between the retailer and the grower.159

How this shift takes place… 1. A private wholesaler emerges and grows the share of its business from supermarket chains. 2. The wholesaler shifts the majority of its business to supplying just a handful of retailer chains. It also adds services such as packaging and quality control that it did not do as a ‘traditional’ wholesaler. 3. The ‘dedicated’ wholesaler stops buying on the open spot market or from a list of customary suppliers and instead starts outgrower schemes where it contracts production that meets the specific standards of the retail chain.

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4. The retail chain often acquires or enters in a joint venture with the wholesaler firm. This acquisition has the advantage of control, exclusivity so that it also ‘captures’ a supplier base, and making the wholesaler a profit centre.160 The result of all this is that leading supermarket chains are shifting toward ‘direct’ purchase from growers. This direct purchase is managed by the dedicated wholesaler as a ‘preferred supplier programme’. And most of these dedicated wholesalers are actually owned by the retail firms or are run as joint ventures.161 This process is currently in action in Croatia, where the largest chains have recently begun to buy up the specialized wholesalers so that they can run their own “preferred supplier” programmes.162

Food processors and producers… more and more contracts

Case study: Pork under contract The pig livestock industry – especially in the US - is a classic example of agricultural production being increasingly carried out under contract at the behest of processors. This is happening for three major reasons.163 1. Simplicity and guaranteed supply.Working with a fewer and larger producers who meet tight production schedules gives processors assured supplies so that the processors’ facilities are always kept fully utilised.164 2. Captive market. By turning independent producers into contracted pig farmers, processors can profit by supplying the inputs into the production process (such as feed and even the pigs themselves).165 3. Uniformity. A processor’s direct role in the management of production means it can deliver the uniformity and productivity levels required.166 The net result of this trend for pork production in the US: •

Pork production coordinated through production contracts or direct ownership of production units by processors (vertical integration) increased from 11% in 1993 to 59% in 1999.167



The percentage of pig-to-finish production units with contracts increased from 11% in 1992 to 34% in 1998. The share of output taken by these contracted units increased from 22% to 63%.168

And just like in other agricultural business conducted under contract, this is leading to concentration in the industry and larger farms…

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The four largest pork processing companies in the US accounted for 32% of the market in 1985. This share had grown to 63% by 2003169



Production operations in the US with more than 1000 pigs raised their share of the total number operations from 37% in 1987 to 71% in 1997.170

171

An example of how supermarkets encourage food processors to wider use of contracts In the US, retailers recently began demanding processors supply case-ready and branded pork (case ready is pre-cut, pre-packed and pre-labelled meat). This in turn influences the processors’ methods of production. This demand for uniform ‘pork products’ leads to processors taking more control over the breeding stock and production practices. Because, consistent inputs – as specified by the processor – can help to produce pigs of the particular size and weight needed for a ‘standardised’ pork product.172 And, in many cases, integrated processors have now even taken control of the genetics of pigs by retaining – through contract – the ownership of the genetics of the livestock supplied to the farmer.173

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Larger farms in a concentrated pork industry are having serious impacts in Europe too. Consider the recent activities of the world’s largest pig processor.

Large processors prefer to contract with producers on large farms. But farm concentration creates environmental risks – especially in the pig industry. Smithfield, the largest American pork processors, has recently expanded in Europe. In 2004, the company moved into the UK, Spain and Romania. But in Europe, Smithfield’s largest operations are in Poland. •

In 1999, Smithfield acquired a 67% share in Animex S.A., Poland ’s largest meat and poultry processing company for $51.2 million.174

Through Animex, Smithfield… •

slaughters 1.2 million pigs per year.175



has supply contracts with 1,600 Polish farmers.176



owns 47,000 sows in the country – up 14,000 since 2003.177

By 2006 an additional 10,000 animals will come from farmers raising Smithfield-owned stock under contract.178 The presence of Smithfield is drving consolidation in Polish pig farming. •

After buying Aniemx, Smithfield closed three of the company’s large slaughterhouses and cut nearly 2,000 jobs.179



Farmers contracted with Animex (Smithfield) have seen a dramatic change in lifestyles. Where they once had 20 or so pigs, many now have 1,000 or more.180

But concentration in pig farming creates environmental risks. Smithfield’s intensive pork production methods in the past have created a number of problems with waste disposal. •

In the US, the Department of Justice and Environmental Protection Agency have alleged almost 7,000 violations of the Clean Water Act by Smithfield since 1991.181

There is a danger that these waste disposal problems will be exported to Europe: •

In 2003 Prima Farms – a Polish company funded by Smithfield – was found guilty in 2003 of dumping huge amounts of waste without permits.182 52

The big and the less of contracts: fewer but bigger farms

Contracts go hand in hand with concentration in the farming sector. As retailers, “preferred wholesalers” and food processors push to reduce the number of their suppliers the inevitable consequence is fewer and larger farms are supplying the demands of fewer and bigger customers. “90% of our produce is supplied by 40 farms and the last 10% is supplied by 100 farms. This is simply not viable anymore.”183 Large fresh produce processor "Working with one strawberry grower … we helped develop ways of extending the growing season. He started with 100 acres and now has more than 1,000 dedicated to producing just for us" UK supermarket Morrisons184



In the US farms with $1 million or more in sales have nearly half their production under contract.185



Research indicates that vertically integrated firms tend to rely on large farms for contract production and are less willing to work with small or medium-sized farms which provide less output volume.186

The net result if all this is that, for all practical purposes, producers often end up with just a single buyer even if there are several buyers who could theoretically compete to buy from them: buyers in effect create captive suppliers.187

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Problems with contracts: Risk of dependency Proponents of contracts say that they are a way of reducing most output price risks and many input price and yield risks. But contracts also bring the new risks of supplier dependence, insecurity and potentially unfavourable terms. Contracts do not guarantee long-term income security. Farmers are kept on their toes by the constant possibility of losing their supply deal with a retailer or processor. “We don't really encourage any long-term contracts, we used to. But for both sides it doesn't work… We have entered into longer term things, but it’s very much the exception.”188 Anonymous retailer interview, December 2001

The example of American pork production In the US, many pig farmers no longer own any animals. Multinational food processors provide the animals and even the seeds to feed them. The whole production cycle – genetics, feed rations, scheduling and procedures, and even the weight of animals at processing – is controlled by these firms. Moreover, the buildings and equipment used by the farmer are specified by the integrating firm. At the end of the season, the full-grown animals are brought to the company's processing plants, where they are weighed. Each farmer's performance is rated in pounds. Then the company deducts all its charges – for the animals themselves, for feed, transportation, and any other services or products it supplied, such as propane to heat the buildings. If there is anything left over, the farmer is compensated. The only things the company allows the farmer to own are the heavily-indebted buildings and land where the company raises its animals.189 In many cases, the food processor that handles the farmer's product is linked (by ownership, joint venture, or strategic alliance) with the firm that provides the farm's inputs. These clusters of firms dominate the farmers, reducing their independence and choice. With no one else to buy seeds, pesticides and fertilisers from – and no one else to sell to – the farmer loses all control over price and profit. On most American pig farms, all of the significant management decisions, such as selection of facilities design, genetic stock, health program, breeding dates, when to place on feed, feeding system, when to price, when to deliver, are made by the contractor – not the farmer.190

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This means that the grower/farmer doesn’t contribute much to a contract pig operation, and so cannot expect to get much back in return. The contractor provides the technology, the management and the market and so the contractor is going to make the money – not the farmer.191 However, to get involved in contract production, the farmer must often borrow heavily to finance the construction of the facilities – typically $200,000 to $1 million – and generally assume the financial risks associated with raising pigs for a pork company. Although these farmers are dependent on the contracting firm, the law regards them as equal parties in the contract. They must therefore accept liability for anything that might go wrong during production. For example, it is the farmer – not the pork companies which owns the pigs – that bears the environmental risks associated with the vast amounts of waste generated at factory farms.192 The processor makes the big money, yet the contract producer remains responsible for dealing with the vast amounts of waste that and for any violations, waste lagoon ruptures, or other environmental problems.193 •

A single average factory in North Carolina has about 3,700 pigs and produces 38,480 pounds of faeces and urine every day.



In all, North Carolina pork factories produce 19 million tons of waste a year. That's 2.5 tons of pig waste per North Carolina citizen per year.194

Death of the ‘wholesalesman’ Supermarket purchases now involve not only larger quantities than traditional marketing systems, but entirely new methods of procurement. Traditional wholesalers have been unable to supply the quantity, quality and consistency required by supermarkets….or meet their price requirements.195 The World Bank and the European Bank for Reconstruction and Development (EBRD) saw the need for wholesale market development in Eastern Europe and so financed the construction of many new markets. These markets are now redundant. It has been proposed that they could be used as enormous banana ripening rooms or cold storage facilities for the new retailer-owned dedicated wholesalers that dominate food supply in Eastern and Central.196 The irony of this is that the region has gone full circle in just ten years: from a centralized communist system of agriculture and production pre 1990, to an open market system during the 90’s and now back again to a centralized system run by retailers.

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In Poland alone, 50% of local food wholesale trading companies amalgamated or went out of business as supermarket share of retail sales increased - the meat industry shakeout in Poland was especially severe – half of the remaining firms expected to merge or go bankrupt. 197



In 1998, 42% of fresh produce handling in South Korea was done by wholesale and conventional markets, but four years later this had dropped to 29.5%.198



In Mexico, raditional wholesale markets in the main cities have experienced a fall in volumes traded by 25 - 30% between 2003 and 2005.199



The Malaysian supermarket, Giant, had 200 vegetable suppliers in 2001 but by 2003 this was down to just thirty.200

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Problems with contracts: Lack of price transparency Relationships between contractors and producers are essentially ‘closed’. Contract details, including information about price, are not generally made public. For external parties this means that there is less opportunity for price discovery – and this can lead to market distortions. Under contracts, pricing becomes subject to manipulation, and its role in regulating the economy, by establishing equilibrium between supply and demand, is weakened. In other words vertical coordination can bring about market closure and becomes a barrier to pricing efficiency.201 Contracting also reduces ‘price transparency’. Contract terms are generally not published and often vary from contract to contract. This reduces the opportunities for ‘price discovery’ along the chain. Price transparency is an important indicator of a well-functioning, competitive market place. Perfect competition depends on a free flow of price information between market participants. This of course is rarely realized, but open and wholesaler markets come reasonably close. In a market scenario where there is an arms-length relationship between seller and buyer, there is more opportunity for suppliers and buyers alike to find out how much is being paid for food, as everyone shops around for the best price. ‘Perfect competition’ does not occur in buyer-driven chains.202 Farmers should have access to similar price information as the processors and retailers – but increasingly, they do not. Some of the ways that contracts cause problems for farmers •

Contracts make it difficult for producers, particularly smaller-sized ones and those that want to use open cash markets, to determine a ‘fair’ market price203



In America, many livestock farmers, not under contract, say that they are unable to obtain the data needed to quickly and easily compare bids from different buyers in order to negotiate the best possible price for their livestock204



Farmers wishing to enter into contracts may find it difficult to compare prices across contracts, because contract terms may contain language specialized to the farmer or circumstance of production, and—particularly in livestock—terms are not generally publicized.205

The tail that wags the dog. Contracts can now distort open market prices

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“In the old days I would have been able to offer you $67.50 for these cattle (on a $66 market), but now paying more would screw up 20,000 formula cattle.”206 Cattle buyer to a cattle feeder, quoted in US Department of Justice / Federal Trade Commission Workshop on Merger Enforcement

The cattle feeder, mentioned above, did not receive a fair price (in this case $67.50) because the price for animals farmed under contract is tied to the price of cattle sold on the open spot market (in this case $66). The buyer could not offer a fair price because to do so would increase (“screw up”) his costs to other contracted farmers by $30,000. Even with pricing information, contracts make it harder for producers to receive a fair price. This creates a ‘distorted incentive’ – where contract farmers are not rewarded for producing animals of superior quality, because their price has been fixed in advance. And farmers not under contract have less incentive to produce better quality because, indirectly, the open market price is linked to the contracts price. Contracts lack the flexibility of spot markets. Unlike spot markets, contracts fail to reflect the fluctuations and seasonality of supply. Typically, growers expect to receive high spot market prices when there are shortages, which compensate for periods of low prices. But this potential for higher returns in periods of short supply is lost under contracts. Suppliers that have forward-contracted with buyers at a lower average seasonal price may be unable to return the temporary high prices (to their growers) which other growers may receive when marketing through suppliers who sell mainly on the spot market.207 Moreover, the lack of transparency in prices also creates the potential for large firms – whether buyers or sellers – to unfairly wield market power.208 This ability to distort the market, by keeping prices down or imposing extra costs on other parts of the chain, is explored in the next section. To summarise, in a vertically coordinated chain, the head of the chain controls the information flows and information is shared between ‘chain insiders’. ‘Chain outsiders’, those suppliers who are not contracted to major retailers or processors, lose out.

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Vertical Coordination Retailers are now driving a new system of food production – a demand chain in which they control the flow of products from the producer all the way through to the store. The use of standards, contracts and the development of preferred suppliers as ways of organising and governing the chain is set to continue. These changes turn the food system into a vertically coordinated supply chain. This section looks in more detail at the retailer infrastructure – distribution centres – and management practices – factory gate pricing, efficient consumer response (ECR), category management and open-book pricing – that make such governance possible. It also shows how, as these trends continue, all aspects of the food system are becoming more integrated.

Distribution and Logistics

“Centralization proceeds in steps, with a shift from by-store procurement to use of distribution centers handling distribution in a zone— then a country, then a region, then globally”209 Supermarkets have rendered traditional wholesalers and wholesale markets redundant by replacing them with their own Distribution Centres (DC’s). And these Distribution Centres are crucial to the vertical coordination of food supply chains. They are also crucial to the development of private-label products. A DC is effectively a huge warehouse owned by the supermarket chain. Primary producers and food manufacturers deliver their products directly to DC’s 210 and the supermarkets then distribute them to their individual stores. •

Carrefour, the world's largest supermarket chain, owns a huge distribution centre in São Paulo, Brazil. It serves a market of more than 50 million consumers.211 To put this into perspective, a single Carrefour DC serves a market greater than the combined populations of: Switzerland, Luxembourg, Netherlands, Belgium, Denmark and Sweden.



Ahold in Poland operates over 180 outlets, all of which are supplied via five distribution centres. 59



Tesco opened a 40,000 m2 distribution centre on 6 January 2004 for the distribution of all processed/packaged food for all its stores in Poland. It is now building a second, for fresh food.212



Companies consider a network of 20 hypermarkets is necessary to justify a distribution centre.213

And as supermarket control reaches further and further back along the supply chain retailers are now beginning to take over parts of the upstream distribution network, collecting products directly from their suppliers and taking them to their distribution centres. This gives them further control of the coordination of food production.214 Today almost 30% of the cases delivered to Tesco's distribution centres arrive on Tesco trucks. 215

Increasingly, DC’s are being used not for storage but simply as transfer points where trucks are simply unloaded and reloaded. •

A German study notes a trend towards distribution centres with no storage space, where most of the goods are directly reloaded in a process known as cross docking.216

This means that the big retailers warehouse space is effectively becoming trucks on the roads.

Factory gate pricing Factory gate pricing (FGP) is a supply chain technique which aims to iron out all ‘unnecessary’ transportation costs and improve the general efficiency of distributing food. By asking their suppliers to release product costs “at the Factory Gate” (that is product costs excluding the cost of delivery to the retailer) supermarket chains are able to take further control of food distribution. The national port of entry might be the best place for the retailer or the retailer’s logistics provider to collect food products form the supplier. On the other hand, the site of production might be the desirable pick up point for the retailer’s distribution network. If cost efficiencies demonstrate that the original place of production is the most economic point to take control of the goods, a further link in the supply chain can be removed.217 Distribution centres are now often selected as the most efficient site for goods removal. According to one report farm gate pricing has the following effects: - Reduces overall transport and product costs - Increases the retailer’s control of the supply chain

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-

Increases the operating costs of competitors, such as smaller retailers, convenience operators, food service operators by removing crosssubsidisation.218

A 2005 PricewaterhouseCooper survey of the Australian grocery retail market estimates that by 2010, 30-40% of Australian grocery retailers and wholesalers will implement factory gate pricing for inbound goods.219 A respondent in a PricewaterhouseCoopers survey notes that “As always these programs are designed by the retailers to lower their costs and are not always in the best interests of suppliers”.220 •

By 2003 Tesco had contacted 90% of their Scottish suppliers about factory gate pricing.221

Efficient consumer response (ECR) These developments in the architecture of the supply chain – distribution and information technology – work hand in hand with the retailers’ theories of supply chain management – which also lead to a more coordinated system of food supply. It’s called “Efficient Consumer Response”. Wal-Mart is generally regarded as the pioneer of Efficient Consumer Response. The company has developed its own integrated supply/demand chain. At its core is the concept of sharing information about retail sales with suppliers. This enables Wal-Mart to squeeze more costs out of the supply chain and lower prices. It forced the rest of the industry to adopt a similar system and forge closer links with their suppliers. The data scanned every day at the check out is the beginning of the information chain for these relationships.222 “On the supply side, the ECR concept reengineers the whole supply chain. Currently, the flow of goods in the supply chain is based on the push principle. [But] by creating a seamless information flow among all key players in the supply chain, it is possible to transform it to a supply chain that is based on the pull principle”223 M. Lagace, Harvard Business School

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Background: Efficient Consumer Response (ECR) The concept – of sharing information about sales with vendors and developing a continuous and coordinated flow of products – was introduced to “non-Wal-Mart retailers” in 1992. It was institutionalised by a coalition of trade associations (the Food Marketing Institute and the Grocery Manufacturers of America), food manufacturers and suppliers, and a handful of big chains under the name of Efficient Consumer Response (ECR) in 1992.224 ‘Efficient Consumer Response’ does not actually have much to do with consumers. Essentially, its all about tracking consumer purchases at the point-of-sale and then sharing that data with suppliers, retailers can now tailor the delivery of goods to match the volume being sold.225 ECR has been constantly tweaked and improved upon since it’s introduction. Collaborative Planning, Forecasting, and Replenishment (CPFR), is another development fathered by Wal-Mart. It takes the ECR vision and implements it through the use of better information technology which allows for a greater, vertical exchange of information between retailers and manufacturers. By sharing retail information with the food manufacturer every day and working with a historical record of consumer sales, the manufacturer and the retailer can each forecast sales over some future time period, share their forecasts, and negotiate anticipated future sales if necessary.226 The basic goal of ECR was to copy Wal-Mart by implementing electronic data interchange (EDI) so as to control the supply of goods and reduce the product lines in each category in order to streamline delivery and their associated costs.227 With CPFR too, manufacturers deliver food products on a prearranged schedule and manage the inventory of their own products in each store.228 The next evolutionary step from ECR is ‘category management’.

Category Management Category Management is the practice of outsourcing the buying function from retailer to supplier. Supermarkets select suppliers to look after a specific category of products, such as cereal, pet food, fresh fruit and vegetables etc. These suppliers are known as ‘category captains’. They are often the supermarket’s leading suppliers or brand leaders. Category captains recommend brands for the store to sell and give advice on how they should be marketed.

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For suppliers there are clear benefits to being appointed as a category captain. Category captains have access to information, including pricing and promotional plans, about all the products in the category. With this information they are then able to develop comprehensive sales and marketing plans for the retailer (including shelf-allocation plans, pricing, and promotions). This gives them enormous knowledge about their direct and potential competitors.229 Retailers argue that category management is necessary because they do not have the inhouse expertise to cover thousands of specific products. They claim suppliers are better placed to know the times of year when a product will sell best, the most effective promotions, or the kinds of complementary goods that could be displayed in adjacent space.230 But category management as practised today – with sometimes just one supplier in charge of each category – raises competition concerns. Category management: a potential threat to open – and free – competition "As an antitrust matter, it seems rather strange that you'd have one company advising a store on how to handle the product of its competitors"231 US Federal Trade Commission member Thomas Leary

Category captains have control over the products of their direct competitors. They also have preferential access to commercially-sensitive information, including access to competitor sales data.232 They have the power to make decisions about product placement, promotions and pricing – not only for their own category-dominating brands, but also for those of their competitors.233 •

In the extreme, Wal-Mart (Asda in the UK) nominates just one supplier for each category, in a mutually exclusive deal. Most other supermarkets divide each category among two to four suppliers, giving each 30% to 40% of the business.234

Category management is another feature of co-ordination along the value chain. Through alliance – or ‘partnership’ – with preferred suppliers, retailers can reduce management costs associated with purchasing and merchandising. Category management is a further example of supermarket oligopolies driving costs and competition further down the chain. Supermarkets have successfully engendered a competition among suppliers for "Category Captaincies." Leading suppliers have built huge and expensive infrastructures to develop category strategies for each category in which their brands compete, and for each major retailer who they think will pay out on this investment 235

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In practice category management benefits the leading suppliers, since they are the ones who can afford to invest in the technology required. This leads to further consolidation – or the entrenchment of a few vertically coordinated relationships as the preferred means of organising the flow of products along the value chain. Open Book Pricing

This is a buying strategy where price is based on the supplier’s costs – rather than a price chosen by the supplier. The price the supplier eventually receives is the sum of its costs plus an agreed profit margin. Open book pricing is usually used for long term supply contracts. But the supplier must agree to allow the buyer free access to his accounts, which are checked regularly to make sure that all the cost are genuine and that there is no unnecessary expenditure. •

Retailers often use open book pricing to source private label products. Spanish discounter Mercadona has integrated 110 suppliers into what it calls its ‘inclusive’ philosophy. This relationship is characterised by an open book policy based on a ‘contract for life’.236



McDonald's has four core suppliers. One of them is OSI, which supplies 25% of its beef in the US, and 85% internationally. These four suppliers meet every quarter to discuss and share best practices. McDonald's pays them on a cost-plus basis with an open-book system, whereby the fast-food chain can inspect suppliers' costs at any time.237

But open book pricing is not without risk. Canadian studies report cases that “border on abuse” where open book is being used as just another tool to cut suppliers’ margins. In the extreme case this can remove all incentive for suppliers to reduce costs since any savings achieved are simply captured by the buying company. 238 From a wider economic perspective open book pricing essentially enables the retailer to decide and dictate returns on capital for each participant in the supply chain. Some may regard this as an unhealthy development.

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Vertical Integration In a vertically integrated supply chain the profits always gravitate to the top, which is why they are attractive to retailers. The companies that are best at coordinating all the activities of the food chain to guarantee the specific qualities they believe are demanded by consumers are either: • •

Vertically integrated firms Or firms that coordinate activities along the supply chain – for example, through the use of contracts.

These organisations can coordinate the production, transportation, processing, and marketing of food239 and are able to respond to consumer preferences for consistent and specific product qualities.240

Profits go up the chain “We have a high level of vertical integration in the fresh foods side of the business… one of the things we have always prided ourselves on is buying direct from farmers and growers…The more we can deal directly with farmers, the better” 241 Morrisons

Here are some ways in which retailers are able to create vertically integrated supply chains: • • •

Alliances with farmers, farm input suppliers and food processors or distributors Acquisition of food processors or distributors Development of their own wholesale distribution facilities

Vertical integration benefits retailers in the following ways: • • •

Cost savings – the suppliers' profit margin can be seized by the retailers Competitive advantage – the retailer can enforce a uniform set of standards across the supply chain and produce goods of a homogeneous quality Dependency on individual suppliers is reduced or eliminated

However there are drawbacks. By developing one-on-one relationships with the dominant manufacturers, and by gaining control over producers and distributors – the retailers threaten to smother the smaller members of the food supply chain. And, just as importantly, they make it difficult for new companies to enter into retailing. 65

Vertical integration ….it happens in developing countries too The trend towards global retailer ownership of their own suppliers also extends to developing countries. • Wal-Mart owns one-third of Central American Retail Holding Company (CARCHO).242 • CARHCO owns the Corporación de Supermercados Unidos (CSU) – which is a discount store, supermarket, and hypermarket operator in Costa Rica, Nicaragua, and Honduras • And finally CSU fully owns Corporación de Compañias Agroindustriales (CCA), which supplies the supermarket chain with all of its fresh produce…. ….CCA also develops private label items. It works throughout the agricultural sector sourcing and distributing fruit, vegetables and grain purchased from more than 1,000 producers in Costa Rica and other Central American countries. CCA participates in the poultry industry through more than 450 independent producers.243

US meat production… a prime example of vertical integration • 95% of U.S. poultry is produced under vertically integrated conditions, entirely in the hands of less than 40 firms. The four-firm concentration ratio for broiler slaughter was 56% in 2003244 • In the 1980s vertical integration spread to pig production. But the major change was in the 1990s when Smithfield became the largest producer and processor of hogs in the US and around the world. In 1994 processor-owned hogs accounted for 6.4% of US hog production. This share shot up to 27% in 2001, in part reflecting Smithfield Foods’ purchases of two leading hog producers.245 • Vertical integration is also increasing in the beef sector; a GIPSA report indicates 32% of all US beef marketed in 1999 was under captive supply – meaning that the processors own the cows.246 Vertical integration in the food supply chain is becoming the norm. And in many areas of food production large retailers in particular are driving this vertical integration. That is to say, they are extending their control back along the supply chain to food production, processing and distribution… as well as forwards to the consumer.

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‘Forward Integration’ The importance of the “last 10 feet”

"I want to help customers make choices about what is good to buy."247 (Anders Moberg, chief executive of Ahold) Consumers are also part of this increasingly vertically coordinated food chain. Retailers do not simply control the many stages of supply, they are also intimately involved with influencing consumer demand. Retailers gain influence over shopping decisions in two ways: by marketing and by their control of vital in-store media.

“The medium is the message” Not any more, today “the message is the medium” Control of the shopping space is especially important. According to marketing lore, the “last 10 feet” within a supermarket is where up to 75% of buying decisions are made.248 Retailers own and control the very media that can influence consumers as they make their shopping decisions. It is becoming more and more apparent that the supermarket floor itself is one of the most effective advertising media. Nestle’s former marketing director, Andrew Harrison, has suggested that supermarkets are the real ‘new media’ and “the next natural evolution in close relationships between brand owner and store owner”.249 In recent years there has been a general decline in advertising revenue across most traditional media – but retail as a medium is going in the opposite direction. The reach of the supermarkets is huge. “there is a clear opportunity to talk to lots of people in a short space of time in a very suitable environment.”250 John Owen, Starcom Motive

And this medium is exactly what retailers take advantage of… •

In 2003 the in-store radio station of UK supermarket Asda reached 12.4 million listeners – that is more than Capital Radio, the UK’s largest commercial radio station.251

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Shoppers equal viewers. And Tesco TV is equivalent to a top-rating TV programme One of Tesco’s latest marketing developments in the UK is Tesco TV. By the end of 2004, it was ‘available’ at Tesco’s 300 largest UK stores, which account for 530 million shopping trips each year and 10 million shopping trips per week. The supermarket can make big money by charging companies for showing their products for 2.5 or more seconds on its screens. According to Tesco, companies advertising on Tesco TV have seen their sales of advertised products increase 10%.252

Fully one quarter of the €24.5 billion spent on advertising in the UK each year is on goods available in supermarkets.253 But food marketeers have discovered an effective, new, way to influence consumers, retailers in-house magazines. Supermarket ownership of media is designed to drive sales and most importantly, it creates a closer link with consumers.254 The in-house retail magazine industry has grown exponentially by 244% over the last 10 years with the UK market now valued at £385 million and is set to increase past the £531 million mark by 2009.255 Readership Estimates for UK Food and Entertainment Magazines (October 2003February 2005) Magazine

%ge of population

ASDA Magazine

4.4

2,169,000

BBC Good Food

1.5

764,000

Family Circle

1.0

482,000

Observer Food

0.9

443,000

Sainsbury's Magazine

3.5

1,742,000

Somerfield Magazine

2.8

1,392,000

Tesco Magazine (from Sep04)

7.3

3,614,000

Waitrose Food Illustrated

1.4

675,000

Readership

256

Disparities in the figures above are down to differing assessments of what has been ‘seen’ or ‘read’. 68

The power of supermarket media •

Supermarket magazines are now seen by over half of all UK adults.257 In 2003 the combined readership of Asda, Safeway, Marks & Spencer, Tesco and Sainsbury's, totaled 25.65 million – more than 54% of all UK adults.258



The ABC Consumer Concurrent Release in the UK shows that Asda Magazine – with over 2.5 million readers – is the magazine that is second most-widely-read by British adults (after Sky Magazine).259 Tesco’s Club Card magazine is not listed but early 2005 estimates put its readership at just over 3.6 million.260 It is carefully divided into five versions to appeal to different segments of its audience.261



General consumer magazines have struggled to get advertising in 2002-2003. But Asda Magazine, Safeway Magazine and Sainsbury's Magazine increased advertising revenues during the period by up to 50%.262

Advertising that is effective •

Research by the Association of Publishing Agencies has shown that 60% of consumers read a customer magazine from cover to cover.263



Waitrose says it has seen sales growth of up to 25% for products featured in its free in-store title, In Season.

But, you maximise your impact when you combine the magazine with a loyalty card •

Data that retailers collect from loyalty cards is also used to measure the impact on sales of products featured in their magazines. This data is also useful to suppliers, who help fund the magazines. For example, Tesco agreed in 2003 to share customer data with catfood supplier Felix – in order to create a campaign aimed at cat owners.264

Then, you drive the message home… with 20 million emails a month •

Tesco is currently dispatching 16-20 million marketing emails per month to 4 million consumers.265 This is greater than all of its supermarket rivals combined and is proving hugely effective. According to a major digital marketing company, 60% of Tesco's online revenue comes from emails.266



www.tesco.com is the UK’s fourth busiest retail website, behind Amazon, eBay and Argos. In the US, supermarket companies Wal-Mart and Target are the third and fourth busiest retail sites respectively.267

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In October 2005 Tesco sent 44 separate messages, each promoting a different offer. In comparison, Sainsburys sent 2, Asda 7, M&S 4, Waitrose 3 and Lidl 8. So, Tesco accounted for 58% of the supermarket sector's emails268

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Buyer Power

In a 2005 survey, only 35.6% of retailers chose ‘retailer-supplier relations’ as an issue of importance. But, for suppliers, 67.1% thought it was an important issue.269 ‘Buyer power’ is the power lead firms in the value chain have, to exert a disproportionate influence on the market. Large retailers are able to distort prices and information. They can also use their power to demand better terms and conditions from suppliers than their smaller competitors. As food retail consolidates, the remaining supermarkets begin to acquire buyer power. They not only dominate the chain through standards and contracts. They can also use their position – as the link between producers and consumers – to capture extra value from the chain. One of the other ways they can do this is to shift costs onto and extract additional value their from suppliers. The UK Competition Commission, in 2000, identified a total of 50 supermarket practices concerning relationships with suppliers that it considered to be against the public interest.270

Definition: Buyer Power [A] retailer is defined to have buyer power if, in relation to at least one supplier, it can credibly threaten to impose a long term opportunity cost (i.e., harmful or withheld benefit) which, were the threat carried out, would be significantly disproportionate to any resulting long term opportunity cost to itself. By disproportionate, we intend a difference in relative rather than absolute opportunity cost, e.g. Retailer A has buyer power over Supplier B if a decision to delist B’s product could cause A’s profit to decline by 0.1% and B’s to decline by 10%.271

For suppliers, retailers are not just customers. They also act as suppliers and competitors For suppliers, retailers have three interlinked roles: customers, competitors and suppliers 1. Retailers as Customers The major UK multiple retailers typically account for 10 - 30% of a supplier’s total sales. 2 Retailers as competitors

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Retailers private label products compete head-to-head with suppliers branded products. And because retailers control stocking, shelf allocation, and retail pricing they have the power to promote own-label products at the expense of manufacturers’ brands. The threat to a branded goods supplier is twofold: the retailer can, if it chooses, undermine the supplier’s branded products (i.e. raise the price) or simply substitute the branded product with a private label one.

3. Retailers as Suppliers Retailers supply shelf space and advertising space to their suppliers. This role is especially important in concentrated markets because it puts retailers into a position where they are able to “sell” their shelf space. They do this by making widespread use of listing fees, shelf space (“slotting”) fees, promotional support (“pay to play”) payments, specific promotion payments (e.g., for “gondola ends” and funding the cost of “multibuy” promotions), required discounts for the range or depth of distribution of products, and even mandatory contributions to the cost of store refurbishment or the opening of a new store.

‘Exit power’ The power to say “get lost” ‘Exit power’ is the ability to turn elsewhere for cheaper produce. As a retailer, exit power is the power to hurt a supplier more than they can hurt you. If a retailer delists a supplier it might only suffer a small loss because it can easily find replacement suppliers and products. But if a supplier is delisted it will find it harder to make up the lost business elsewhere. Even the very largest suppliers usually account for only 1–3% of a major supermarket’s sales. But for a supplier, losing of a single contract with one of the top four UK grocery retailers would mean sales-losses of 10 - 30% – around ten times more than a supermarket might lose.272 Many suppliers now have little choice but to conform to retailers’ demands. Their access to regional and global supply networks means retailers can always obtain lower prices. •

In western Europe, 85% of the total retail food sales go through just 110 buying desks.273



In 2000, the big three chains in the UK (Tesco, Sainsbury and Asda) had a cost advantage of between 6% and 8% compared to some of the smaller chains.274

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The UK Competition Commission’s 2000 report on supermarkets shows that the largest supermarket, Tesco, can consistently obtain discounts from its suppliers 4% below the industry average, while the smaller players have to pay more.275

And this imbalance in the bargaining power between retailer and producer is leading to – and perpetuating – a situation of supplier dependency…. •

The largest grocery supplier in the UK provided less than 3% of Tesco’s total purchases and the average supplier provided less than 0.01% of their purchases276



For some food processors, 90% of their business comes from an individual grocery retailer.277 For all practical purposes, producers and suppliers/integrators can often end up with just a single buyer even if there are several buyers who could theoretically compete to buy from them.278



In 2002, Kraft Foods – at the time the world’s second largest food manufacturer generated more than $3.6 billion (12.2%) of its revenues from Wal-Mart alone.279

Retail buyer power can be very significant (to the extent of distorting competition) even if the retailer controls as little as 8 percent of the total market.280

Extra retailer rewards Large retailers in concentrated retail markets are able to get much more than just low prices from their suppliers. Buyer power also gives them the ability to impose strict contractual obligations on suppliers. Demand extra payments These can include demands for additional payments or discounts, including “listing charges,” where buyers require payment of a fee before goods are purchased from the listed supplier; “slotting allowances,” where fees are charged for store shelf-space allocation; retroactive discounts on goods already sold; and unjustifiably high contributions to retailer promotional expenses. Restrict competition Other practices benefit retailers in other ways. For example, contracts which prevent the supplier from selling to another retailer at a lower price. Or, exclusive supply arrangements which lock other retailers out and allow the retailer the advantage of product differentiation. Transfer risk to suppliers

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Buyer power also means retailers are able to shift financial risk onto suppliers. Retailers may force sale-or-return conditions on suppliers, demand compensation for product lines that fail to meet expected sales targets, or negotiate retrospective discounts where targets are met. Appropriate suppliers capital Or the retailer may simply make late payments knowing that the supplier will not discipline such action because of its fear of losing future contracts. The following table was originally published by the UK Competition Commission in 2000 and outlines some further practices used by supermarkets to exert their bargaining strength over suppliers.

281

Retailer fees In the US, retailer fees for fresh-cut produce account for approximately 1-8% of sales and it can now cost up to $2 million to acquire business from a national chain.282 Retailer fees are, in effect, compulsory. Supermarkets in the UK have claimed that many of the practices listed above are simply ‘requests’ to suppliers, but the UK’s Competition Commission concluded otherwise, holding that such practices are in effect ‘requirements’ given the extent of buyer power.283 These restrictive practices are not unique to the UK, they happen elsewhere too. Especially as retail markets become consolidated. Suppliers are often left at the mercy of the retailers who sell their products. Because of the way they manage their supply chains, the development of private label and their

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knowledge of – and proximity to – consumer demand, retailers hold many of the cards when deciding prices and conditions. “Wal-Mart has the critical mass to exact all kinds of concessions from the suppliers they deal with, and they have the demand side of the equation covered as well, because they bring the demand to the suppliers.”284 Paul Ritter, US online retail strategy consultant The power to punish Power is something which is usually derived from the ability to enforce one’s wishes. Generally, those wishes are complied with for fear of punishment if they are not met. Food retail is no exception to this rule: •

In one UK supermarket, if the barcode on a chicken reaching a checkout cannot be scanned the processor is warned. If it happens a second time, there is a fine of £500. A third ‘offence’ incurs a £1,000 fine, a fourth offence will cost the processor £3,000 and if it happens a fifth time, the processor is subject to a ‘possible volume restructure’.285

Carrefour in Thailand Carrefour opened its 23rd hypermarket in Thailand in December 2005,286 but commentators noted that the French-owned global retailer has recently become more aggressive in dealing with local small and medium-sized manufacturers. The company issues 12 page contracts and suppliers now have to pay various costs. These include ongoing ‘slotting costs’ dependent on the number of items and the number of stores, rebates of 1-6% of monthly or annual sales to maintain the business and promotion fees. Not to mention a wide range of other contributions extracted by the chain for advertising, new store openings, store remodeling and so on. One commentator estimates that in the mid-1990s a medium-sized firm might have to pay 44% of its total deal with Carrefour as additional fees (26% transparent, 18% hidden expenses). And at the same time the supplier would often sell its products at a loss.”287

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A ‘virtuous circle’ if you’re big. But a ‘vicious’ one if you’re not As a retailer, the bigger you are the more buyer power you have to get better prices from suppliers. These lower prices can be used to undercut smaller retailers who cannot obtain the same discounts. This allows the bigger retailers to get into a “virtuous circle” where size equals discounts… discounts equal undercutting smaller chains… weaker chains fail… bigger chains grow market share… more market share equals bigger discounts… and so on. In principle, this could carry on to the point where it becomes impossible for any small retailer to survive in the market.288 The knockout blow The smaller retailers are hit twice. Firstly, they don’t get the lower prices big retailers get. And secondly, the low prices that suppliers get from big retailers force them to charge higher prices to smaller retailers in order to cover their fixed costs.289

Retailer power pushed to the bottom of the chain Retailers with heavy bargaining power are putting enormous pressure on food manufacturers. The manufacturers, in turn, are putting pressure on the farmers. This is because manufacturers are more interested on serving the interests of the powerful retailers. And also because the farmers have the least power – they are at the bottom of the food supply chain and cannot pass the costs onto anyone else. But, in some cases, the farmers also get pressure directly from the retailers. And therefore, the farmers are getting the hardest squeeze of all. They are squeezed by a limited number of big buyers, a limited number of big suppliers (of animal feed, etc.), and global oversupply. Moreover, they are squeezed by cost cutting and the profit-improvement strategies of the dominant firms. Most importantly, farmers can only access the market through a few multinational companies.

Buyer power goes global The potential for sharing price information is increasing for retailers. With inter-linkage between buying groups and cross border alliances, and with multinational mergers and acquisitions becoming more common – a massive communication network for retailers is created... And this is on an international level. •

Ahold and eight other European retailers have formed an alliance that negotiates with private-label manufacturers when purchasing hundreds of products, from

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paper goods to soft drinks that are sold under the brand name Euroshopper.290 As the search for low prices becomes increasingly global, retailers are investing in online exchanges that allow business-to-business transactions via the Internet, at lower transaction costs. GlobalNetXchange (GNX) was set up early in 2000 by Sears, Carrefour and Oracle, and was quickly followed by the establishment of the WorldWide Retail Exchange (WWRE) by 17 international retailers. These two networks have since joined to form Agentrics.291 This consultancy serves over 50 global retailers and provides online auctions and ‘solutions’ for streamlining supply chain management and the collaboration of retailers. Before the Agentrics merger, more than 50,000 suppliers made $80bn worth of electronic transactions every year through the GlobalNetXchange.292 The WWRE is the premier Internet-based business-to-business exchange for retailers and suppliers. Designed to facilitate and simplify trading between retailers, suppliers, partners and distributors, the WWRE currently consists of over 230 members from Asia, Europe, North America and South America. To date, the WWRE has cut costs for its members by over $2 billion on more than $12 billion transacted through the use of its solutions. Members include: Ahold, Auchan, Casino, Coop Italia, Dairy Farm, Dansk Supermarked Gruppem, Delhaize, Edeka, El Corte Inglese, Laurus, Markant, Marks & Spencer, Publix Supermarkets, Rewe, Safeway, Tengelmann, Tesco Shift towards cross-border procurement systems. •

Central Europe, home of the “first wave” of retail transformation in Central and Eastern Europe, is also the cradle of “regional procurement”. Ahold announced in October 2002 the formation of Ahold Central Europe (ACE), which integrated its operations in Poland, Czech Republic, and Slovakia. ACE, based in the Czech Republic merges “backroom functions” such as product procurement and administration for 400 Albert supermarkets and Hypernova hypermarkets in Central Europe with combined 2001 sales of approximately Euro 1.3 billion.



In south eastern Europe (the Balkans), Metro is setting up a Southeast Europe Business Unit. It will serve as the buying desk for all Metro stores in the Balkans, sourcing from several countries293

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Value capture

“The economic gains by one player usually represent redistribution of income from other players in the (food) sector, particularly with market concentration”294 Democratic Staff of the Committee on Agriculture, Nutrition and Forestry United States Senate

Some economists view wide variations in rates of return within a given industry as one indicator of the disparity of economic power among participants. In America, for instance, the overall profitability of the food and agriculture sector ebbs and flows over time, but it is clear that certain sub-sectors have consistent ability to earn substantial, often double-digit returns on equity. 295 •

US Farmers’ return on equity averaged just 1.1% per annum between 1995-1999



In 1999-2000, the average return on equity in the food processing sector was 22.6%, up from 13 .5% in 1993



Returns on equity for American food retailers from 1980 to 2004 have fluctuated between 12% and 22% (2004 it was 18%) 296

Profits go up the value chain Across the world, retailer profits are increasing. But these increases are coming at the expense of suppliers further down the chain. To increase margins, retailers not only impose fees on their suppliers. They also offload risks (especially financial risk) and shift processing costs further down the chain. While, their market dominance means that they can also keep producer prices low. •

In 1950, the world’s agribusiness was worth $420 billion, and more than 30% of this was value added by farmers. By 2028, the worlds agribusiness market could be worth $10 trillion, and Dr Ray Goldberg, now Fellow of the American Agricultural Economic Association estimates that the farmers’ share of that will fall to just 10%.297

Where does all the money go? In 2000 US farmers received just 19% of the amount consumers spent on food. The remaining 81% went to pay for the marketing bill (see table below). The marketing bill is the costs associated with processing, wholesaling, distributing, and retailing foods298.

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Between 1990 and 1999, the marketing bill rose by 45% while, during the same period, the farm value of food purchases climbed only 13%.299

Growth share matrix of the food supply chain

Retail food price

What farmers get

1950s

1990s Retailers’ share Manufacturers’ share Farmers’ share

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Total food marketing bill USA percentage allocation Percentage allocation (rounded) 1967

1987

2000

Percentage received by farmer

33

24

19

Marketing bill 3

67

76

81

Labor 1

28

36

38

Packaging materials

8

8

8

Transportation

5

5

4

Fuel

n/a

4

5

Corporate profits

4

3

5

Other 2

24

22

22

Source: Calculated by ERS based on data from government and private sources. 1 Includes employee wages or salaries and their health and welfare benefits. Also includes estimated earnings of proprietors, partners, and family workers not receiving stated remuneration. 2 Includes depreciation, rent, advertising and promotion, interest, taxes, licenses, insurance, professional services, local for-hire transportation, food service in schools, colleges, hospitals, and other institutions, and miscellaneous items. 3 The marketing bill is the difference between the farm value and consumer expenditures for these foods at both food stores and restaurants. Thus, it covers processing, wholesaling, transportation, retailing costs, and profits.



An investigation by the UK’s National Farmers Union in 2002 found that a basket of farmed produce, including beef, eggs, milk, bread, tomatoes and apples, typically cost £37 at retail; however, farmers only received a value of £11 for it at the farm gate – only 28% of the retail value.300



According to a recent United Nations trade conference, annual export earnings of coffee-producing countries in the early 1990s were US$10–12 billion and global retail sales about $30 billion. Now, retail sales exceed $70 billion, but coffeeproducing countries receive only $5.5 billion.301



In 2005, US growers of perishable foods received the equivalent of only 19% of the retail price.302



In Florida tomato growers have seen the real price paid for their tomatoes fall by a quarter since 1992, but US supermarkets have raised the real price to consumers by 46% during the same period.303



In Tasmania, Australia, 6,000 potato farmers rely on just two buyers. The price per tonne of prime potatoes has not risen in ten years. Moreover, fast food outlets get €10,000 Australian dollars per tonne of fries they sell. Only €120 of that goes to the grower.304

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US Farm value share for selected foods % Farm Value Share of Retail Price Milk (½ gal) Pork (1 lb) Cheese (natural cheddar, 1 lb) Potatoes (10 lbs) Grapefruit (1 lb) Corn (1 lb) Green beans (cut, 1 lb)

98

99

2000

41 25 39 15 18 8 7

39 25 32 19 18 8 6

34 31 29 17 16 7 5 Source USDA

Fresh fruit and vegetables – ripe for value capture Fresh fruit and vegetables are good for supermarket profits as they typically provide retailers with 30-40% gross profit margins. This is among the highest in the food retail business.305 Supermarket produce buyers typically manage a product category for 12–18 months. They have to prove themselves fast and are judged, rewarded, and promoted on the overall profit they make.306 A report using data from the Deciduous Fruit Producers Trust and interviews from importers and exporters, estimates the breakdown of the price of South African apples in UK supermarkets. It finds that supermarkets take a 42% share in retail, whereas the costs paid in farm labour account for only 5% of the price and farm income only 4%. Shipping the apples accounts for 12% of the price UK consumers pay for apples. The remaining 27% of apple price is down to customs, farm inputs and packaging, import commissions and UK handling costs. 307 At the same time the farmers have seen their revenues fall sharply. In the ten years since 1994 real export prices paid for South African apples have fallen by 33%.308

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Costs pushed down the value chain In addition to cutting the prices paid to suppliers retailers are also offloading processing costs. A good example of this is the switch to ‘case-ready’meat, this is meat which is delivered to the retailer pre-cut, pre-packed and pre-labelled. This practice shifts the cost of cutting, packaging and labelling from supermarkets to suppliers. Structural change in the food system requires a new division of labour along the value chain. “Now about 90% of our dry groceries are shipped through our DC [Distribution Centre]… when we started up our fresh DC it was about 60% processing and 40% receiving and shipping. Now it’s about 80% receiving and shipping and 20%, maybe even less than 20% actual processing. It’s now being processed off site” 309 Anonymous industry interview, January 2002. This trend is also prominent in the fast-food industry. The transfer of peeling, cutting, and blanching of potatoes from restaurant workers to processors, reduces labour costs and leads to cheaper and standardized supplies of French fries.310

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The case study below looks at the UK dairy industry. It exhibits the consolidation trends that are affecting the food industry as a whole. The timeline is taken from industry media sources from January 2004 to March 2006. It clearly shows the steps of buyer power in action: •

Retailers switch to preferred suppliers



Dairies close as suppliers feel the squeeze



Farm gate milk prices fall (in some cases farmers receive less than the cost of production for a litre of milk)



Retail milk prices rise (consumers pay more)



Retailer profits increase

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We pay you less Buyer power in action… when markets consolidate, competition gets pushed to the bottom of the supply chain The take-over of Safeway by Morrisons in 2003 further consolidated the UK retail landscape. Inevitably, it also set off a further round of consolidation amongst their suppliers. This is what happened to milk prices… Jan 04

Asda plan to cut milk suppliers Asda announced that it would consolidate its milk supply chain. Under its Total Category Management scheme, Asda plans to source all fresh milk from a single ‘dedicated’ supplier.311 June 04

Asda select single milk supplier Asda selects Arla Foods as its sole supplier. “This move means that for the first time in 40 years we will have a direct relationship with every single farmer who supplies us with milk. … a segregated supply chain using a dedicated group of farmers. This will enable us to trace our fresh milk from the farm through to the bottles in our customers' trolleys.”312 June 04

Asda aim for cow-to-consumer tracebility Asda say that the move to single supplier was prompted by concerns that farmers were not being paid enough for their milk. It emphasises the importance of Arla providing a direct link from “cow

to consumer”. Arla set about selecting dedicated milk suppliers for Asda.313 Aug 04

Tesco and Sainsburys de-list milk suppliers Three months later Tesco and Sainsbury reduced their fresh milk suppliers from three to two. Tesco chose Arla and Robert Wiseman, while Sainsbury’s opted for Wiseman and Dairy Crest.314 Sep 04

Retailer milk margins up by 25% Milk Development Council announce that retailer margins on liquid milk and dairy products have increased significantly over past 10 years. “As a result, the six pence per litre fall in the farm-gate milk price between 1994 and 2003 has generally increased retailer margins.” From 2003-04 report.315 Nov 04

Asda supplier to close plants Arla announce plans to close two production facilities in London and Newcastle.316 Dec 04

Tesco/Sainsburys supplier to cut farmgate milk price Robert Wiseman announces it plans to the “slash” price it pays to dairy farmers. The move will reduce the price paid by 0.5ppl (pence per litre). To 19.16ppl. 317 Jan 05

Asda supplier to cut farm-gate milk price Arla announce that it will consider cutting milk prices in a review scheduled for 1 April. It also announces the closure of its east London distribution center.318 Jan 05

De-listed Asda supplier to close plant Dairy Crest – de-listed by Asda – announce the closure of its Yeovil 84

factory, the only remaining UK factory dedicated entirely to the production of fresh dairy products.319 May 05

Asda supplier in price cut rumours Reports circulate that Arla Foods are to cut their milk price by 0.35ppl from 1st June.320 May 05

Morrisons to cut milk suppliers Morrisons announce plans to consolidate its supply chain and reduce suppliers from three to two. Arla and Dairy Crest retain contracts. Wiseman is de-listed.321 June 05

Another farm-gate milk price cut Joseph Heller announce milk price cuts of 0.6ppl from June. Reasons include increased costs of fuel and packaging. They also claim competitiveness of pricing from other cheese manufacturers Over the last 8-10months they claim their margins have been eroded simply to maintain their market share. However, consumer data shows that there has been around a 5% increase in territorial cheese price (Heler's predominant product) over the past year. This would suggest that if the processors are not receiving this price increase then it is potentially increasing retailer margins.322

Asda supplier requests “secret” price negotiations Arla say that as their arrangement with Arla Foods Milk Partnership (AFMP) accounted for 60% of volumes, price negotiations should be able to take place outside of the public arena.324 June 05

Tesco/Sainsburys supplier announce farm-gate milk price cut Wiseman announce that it is to cut its milk price from July, there has been a decrease of 0.25ppl for Wiseman's base price as well as changes to its seasonality profile payments, with a further increase in penalties during spring and further reductions down to 0.3ppl for autumn milk. 325 Aug 05

Another farm-gate milk price cut Golden Vale creameries announce 0.3ppl price cut on contracts from 1st September.326 Sep 05

Asda supplier enforces farm-gate milk price cut Arla Foods announce that its farm-gate milk price is to be cut by 0.35ppl from 10 September. The proposed price cut was put to the 1,600 contract farmers who comprise the Arla Milk Partnership, but was rejected by them. As a result the price cut has been enforced by Arla.327

June 05

Asda supplier justifies farm-gate price cut Arla announce it will cut the price paid to farmers for milk by 0.35p to 19.65ppl. It said the cut was necessary to “recover the exceptional cost increases from the marketplace”. NFU say that farmer’s average cost of milk production is 20ppl.323 June 05

Sep 05

Farm-gate milk price at lowest since 2002 DEFRA provisional farm-gate milk price for July is 17.98ppl. The lowest July farm-gate price since 2002.328 Sep 05

Another farm-gate milk price cut First Milk announce a milk price cut of 0.2ppl from 1st October. The company

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cited recent downward pressure on milk prices as well as increased cost of transporting milk due to high oil prices as reasons for the cut.329

“the development of a more powerful supply chain” Dairy UK also warns contract farmers, unhappy with low prices, not to break contract agreements by striking.335

Sept 05

Retailer profits for liquid milk up 25% The Milk Development Council reveal that retailer profits for liquid milk have risen by 25% in 10 years, growing more rapidly since 2003.330 Sept 05

De-listed Asda supplier issues profit warning Dairy Crest, de-listed by Tesco and Asda, say profits for the six months ending 30 September will be significantly lower than in the first half of the year.331 Sept 05

Tesco/Sainsburys supplier hints at more price cuts Wiseman express concern over rising derv, plastic and energy costs, suggesting further price cut.332 Oct 05

More farm-gate price cuts Dairy Crest announce price cut of 0.275ppl.333 Oct 05

De-listed Spar supplier closes diary Longslow Diaries to close of 50 million litre Welsh dairy, and possibly close Manchester depot. Spar’s decision to consolidate supply chain to single supplier is given as reason.334 Nov 2005

Dairy UK critical of OFT Dairy UK Chairman complains of “incessant and rigorous scrutiny” by the competition authorities and says OFT will jeopardise the sector if it prevents

Dec 05

Asda supplier warns: farm-gate price to drop, but consumers to pay more Arla chairman says the group is seeking to increase milk selling prices to reflect the realities of “increased packaging and fuel costs”. He also warns that market competition spells “downward pressure” on farm-gate milk prices.336 Jan 06

Retail milk prices up by 2.2ppl and up by 12% in last 12 months All major supermarkets confirm they have raised the retail price of milk 2.2ppl. There has been a 12% increase in the retail price of milk in the past 12 months. A 4 pint-polly bottle now costs £1.16.337 Jan 06

Tesco/Sainsburys supplier benefits from retail milk price rise but warns farm-gate prices to fall Wiseman benefits from some of the 2.2ppl retail price rise being passed back to help with higher costs but warns farmgate prices under pressure.338 Jan 06

Asda supplier cuts farm-gate prices Arla Foods announce 0.3ppl price cut from February. Plus an extra 0.6ppl price cut for February and March.339 Mar 06

Tesco/Sainsburys supplier cuts farm-gate prices Wiseman announces 0.65ppl farm-gate price cut effective 1st March.340

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Mar 06

Farm-gate milk prices Contractor March Price(PPL) DC Sovereign 19.5 Wiseman 19.15 Arla-Asda 18.80 Arla 18.30341 In June 05 the NFU claimed that farmers average cost of milk production was 20ppl.. 972 English and Welsh dairy farms closed in the 12 months to December 2005. (Ref. Dairy Hygene Inspectorate)

The power of private label

Buyer power enables retailers to develop their own brands. The development of private label goods is discussed in the next section. The key point is that private label offers retailers a double benefit: increased sales and customer loyalty while also obtaining lower supplier prices.342 Private label goods allow retailers to drive down supply prices by playing off one supplier against another or using closed – private - online auctions to determine contract winners. This, in turn, allows for higher gross margins on these products, especially because retail prices are typically set with reference to the “umbrella price” for the leading brand stocked. This puts pressure on branded goods manufacturers to reduce their supply prices in order to secure shelf space.343

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Private Label 100% capture of the value chain

"From time to time, I am sorry to say, some suppliers might not understand customer needs and sentiment the way they should do… There are clear rules about who sets the prices and we believe we, as retailers, are the ones. We will continue to do so and use our private label as a very efficient weapon."344 Anders Moberg, chief executive of Dutch retail group Ahold

Private label is both the realisation of retailer power over the food supply chain and the future of food production…. Retailers are taking more control of the food supply chain by developing their own storebrands (from now on referred to as ‘private label’). The rapid growth of private label does not just signal the emergence of a new, strong retail brand. It does more. It both confirms and reinforces the buyer power and status of retailers as governors of the value chain. And as retailers develop their own products to compete with branded goods they are able to use their buyer power to determine the prices of increasingly diverse food products.….. •

Private label product now account for 21% of global food sales and are expected to grow to 30% by 2020.345



In less than 15 years’ time, nearly a third of global food sales will be private label.346



Wal-Mart’s ‘Great Value’ brand - the best selling store brand in the U.S. grocery market – is the first truly global store brand….. available in Argentina, Brazil, Canada, China, Germany, Mexico and South Korea.347



The retail share of private labels among food products is high in many European countries, reaching 50-60% in Switzerland and 20-40% in most other Western European countries.348

Private label: Retailer brands Private label is a way for retailers to differentiate themselves from their competitors. As a result of private labels, retailers are no longer identical. Instead they acquire ‘identity’. Importantly, this shifts the basis of competition away from price. They are now also able to use “identity” as a competitive weapon. And “identity” is something which it is not possible to put a number on.

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Private label products shift brand identity from the food manufacturer to the retailer.349 And. the company that controls and defines the brand is in a stronger position to capture the value of the food supply chain. “The point in the value chain at which a brand is defined has an impact on the options for the different companies in the chain, and through this the returns they can expect to obtain.”350 Humphreys, 2005

Depending on who defines the brand, the supply chain can be organized in completely different way. So if a bottle of wine is branded by the producer (Chateaux Margaux), a geographical area (Champagne), a manufacturer/wholesaler/distributor (Taylor’s port, Gilbey’s gin), or a retailer (Tesco Shiraz)….it has major implications for the chain. The location of brand control has many potential consequences…. When a brand is controlled by the retailer Retailers can develop own label produce, giving them the flexibility to source product from different suppliers, this therefore enables them to reduce margins in the supply chain. One clear example is supermarket own-label fresh fruit and vegetables. Multiple suppliers can be used to source similar or identical products.351 So private label brings some major advantages for the retailer. But the strategic development of private label can only be achieved once retailers have a significant market share. Only when retailers control enough of the market to pose a direct competitive threat to branded goods, can private labels succeed and grow. Another essential ingredient for private label is the Distribution Center. Without DC’s retailers would be unable to handle and distribute their private label products. Traditional wholesalers would not become an instrument of their own demise by getting involved in private label products.

Concentrated food retail markets are clearly linked to the growth of private label. “Euromonitor believes that the single most important factor in the rise of the global private label market has been the development and consolidation of chained grocery stores”352 Euromonitor, 2005

The table below refers to all retail (food and non-food sales), but it gives an idea of how retail concentration correlates with private label. Of the ten most developed Private Label countries, nine had retailer concentrations over 60% - meaning that in nine of those ten countries the top five retailers had a market share of over 60%.353

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COUNTRY

REGION

Switzerland Germany UK Spain Belgium France Netherlands Canada Denmark United States

Europe Europe Europe Europe Europe Europe Europe North America Europe North America

354

PRIVATE LABEL SHARE 45% 30% 28% 26% 25% 24% 22% 19% 17% 16%

RETAILER CONCENTRATION 86% 65% 65% 60% 80% 81% 64% 62% 89% 36%

Generally, when retailer concentration was low, the share of private label was also low,355 thereby confirming a link between concentration and private label. As the big chains are greatly expanding their private-label offerings, private label is set to grow and take an increasingly large share of the food market. •

Own-label manufacturers have become huge concerns in their own right. Hazlewoods, a private label manufacturer, for example, has over 10,000 staff and plants stretched across Europe making ready meals, sandwiches, pizzas, cooking sauces and cakes.356

And in Europe, private labels are growing their market share faster than in any other region. Private label value sales (including non-food categories) have a 23% share across 17 markets and had a growth rate of 4% between 2004 and 2005. This growth rate is even faster in the emerging markets of Croatia, Czech Republic, Hungary, Slovakia and South Africa where private label sales grew by 11%. •

Consumers in the UK were found to have private label products in their shopping basket on 82% of their shopping trips.357

Private label share of sales, by country and by store UK Safeway Tesco Sainsbury Asda

47% 51% 54% 54% 90

Somerfield National Average

36% 45%

Germany Aldi Rewe Tenglemann Metro Markant National Average

90% 22% 19% 14% 6% 33%

France Carrefour Auchan Intermarche Leclerc Casino National Average

20% 16% 29% 18% 23% 22%358

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Manufacturer brands lose out

By developing supermarket own-brands, retailers are absorbing the market shares of food processors and increasingly taking the role as coordinator of the food chain. Studies show that national brand manufacturers are hit hard when store brands are introduced. Retailers use their power to market their own private label products and national brands in a way that favours the private label brand. 359 And so just as private label is on the rise, the brand owners share of food retail is falling: •

Nestlé’s food sales in Europe slipped 0.4% in 2004 and sales of its bottled waters such as Perrier and Vittel dropped by 8.4%.360



Global brands’ share of Europe's bottled water market plummeted from 53% in 1997 to 40% last year, as retailers turned to private-label producers.361



Private label sales in Slovakia grew by 14% in 2004-2005 compared to a fall by 6% of manufacturers’ sales.362

In response to the challenge of private label, manufacturers are changing their strategies – reducing the number of products in their portfolios and heavily marketing their bestperforming brands. •

Heinz – once famous for its ‘57 varieties’ – is now focusing on what it calls its 15 power brands.363



Unilever had a five year programme to cut about 1,200 under performing brands by 2004.364 In the same year the company’s European sales dropped by 2.8%.365

In 2003 it was estimated that if the US closes the private label development gap with the UK by half, brand manufacturers would loose an additional $20 billion in sales. This would mean an operating profit loss of between $2 billion and $4 billion.366

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Source: The changing face of the global food industry, presentation OECD conference the Hague 6 Feb 2003, Jan-Willem Grievink

And so the balance between traditional brand-owners and retailers is shifting. Retailers are no longer beholden to the brands. And there are many ways that retailers are able to speed this process along. The retailer introducing a store brand can ‘create room’ for the store brand in the market in many different ways: • • •

By providing the best location in the aisles (in the centre of the aisle or beside the best selling brand in the category) By reducing the promotions of national brands By raising the relative prices of national brands compared to the store brand.367

And retailers go to great lengths to promote their private label products….. “because 90% of people are invariably right handed, the retailer invariably places the store brand to the immediate right of the leading national brand.”368 Meza and Sudhir, 2003

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The development of private label

The development of private label has two distinct phases: ‘low cost, high value’ private label goods, and ‘premium’ private label. The two types of private label 1. ‘Low cost, high value’: these products undercut the manufacturers’ brands. Retailers use their dominant position within the value chain to set suppliers against each other as they demand ever-lower prices. 2. ‘Premium’ private label. These products challenge the more up-market manufacturer brands. Retailers use their control of the value chain to set standards and back up credence claims about ‘niche’ products. ‘Low cost, high value’ Retailers begin by offering a product under their own label in the easiest categories, such as those categories with weak brands or low investment in brands, for example, fresh food and meats. Then they push their own-label brand into categories not typically associated with private label. Finally, after moving into as many categories as possible, they stretch their brand within categories, which allows them to appeal to a diverse customer base. At this stage the supermarket will offer good, better and best food products within the same category.369 Discounters demonstrate the power of private label Aldi, which already accounted for 16.7% of the German grocery retail market in 2003, relies almost exclusively on its own store brands.370 Private Label products account for approximately 95% of its sales.371 Below is a quick run-down of the status of private label among some European discounters. • •



In Germany’s Lidl and Penny, private labels account in both instances for over 60% of total grocery sales. Spain’s Dia and Mercadona are not only the country’s largest discounters, but also the two most important Spanish grocery retailers. They both rely heavily on private label brands. Mercadona is a particularly interesting case as it increased its private label share from about 3% in 1997 to 51% in 2002, while its market share increased from 3.5% to 12.6% over the same period.372 In the UK, KwikSave’s private label sales represent over half of total grocery 94

sales.373 Discount style operations are on the rise across developed food systems.

But the ‘low cost, high value’ model, epitomised by Aldi and other discounters, is just one form of product differentiation. Once a supermarket’s brand is recognised and trusted, it becomes well-placed to launch new niche products to target the increasingly precise and diverse demands of consumers. ‘Premium’ private label The approach of retailers to private label, particularly in more developed markets, has advanced far beyond simply meeting the consumer demand for lower priced products the more traditionally perceived role of ‘value’ store brands.374 Private retailer labels are now critical to providing and meeting the highly differentiated demands of wealthier consumers, particularly in Europe. “Strategically, retailers worldwide seem to be placing more and more of an emphasis on branding and marketing their private label wares to match the lifestyles and values of their shoppers”375 ACNielsen Report, 2005

Retailers are now starting to differentiate themselves on the basis of their private label offering.376 •

Tesco was one of the first supermarkets to sell it’s own branded produce. Since then it has launched Tesco Value, Tesco Finest (spanning most product areas in the store), Tesco Organics (launched over ten years ago), Tesco Free From (150 products which are gluten, wheat or milk free), Tesco Healthy Living, Tesco Carb Control, Tesco Fair Trade and Tesco Kids377



Carrefour introduced a line of low-priced private-label goods in 2003 that now generates $1.6 billion in annual sales.378



U.K. retailer Tesco now sells caviar under its own name, and “charges a really big premium”.379

Competition pushes Sainsbury towards premium private label When Sainsbury’s realised it was being outperformed by rival Tesco, the company was forced to rethink its strategy on low-priced own label products. Sainsbury's worked hard

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to turn itself around and create an image of quality, partly with the help of celebrity Chef Jamie Oliver. Now the UK's two leading retailers, Sainsbury's and Tesco, offer premium ranges under the "Taste the Difference" and "Finest" private labels respectively, as well as a number of other value added ranges, such as organic products.380 As their customers’ trust in the brand increases, retailers are able to shrink the price gap and improve the economics of private label. They reduce space for manufacturers’ brands, eliminate ‘second tier’ (lesser-known) brands and invest in their own proprietary merchandising.381 This means that the private label food products developed by retailers can be sold at a premium to consumers. •

The organic private brand of Auchan (a major French retailer) carries the highest premium, about 40% over the price of standard products, but accounts for less than 10% of the total beef shelf space.382



All beef sold in France must adhere to nationally required safety and quality standards, but private label beef is promoted as being safer and higher in quality than the standard product, which is unlabeled and generally sold at a lower price. To promote sales, retailers allocate most of their beef shelf space to the brand. This product may carry up to a 5% premium over prices of standard beef products.383



Danish retailer, Dansk Supermarket, offers a series of different private brands for dairy products as higher quality alternatives to the major manufacturer Arla brand commonly seen in the market. The Dansk brands are advertised as being superior in quality due to the use of local production under traditional cultural practices with due consideration given to food safety concerns.384

Private label increases vertical coordination

The use of private retailer labels places full accountability for product quality and safety on the retailer. To ensure that these retailer-branded products meet the desired quality and safety standards, it is essential that retailers coordinate and develop relationships with other upstream sectors in the food supply chain. The level of coordination and cooperation depends on the desired level of product differentiation.385 The more differentiated the product the greater the coordination. Private labels are essential to retailer strategies of product differentiation. And as retailers make ever greater credence claims about their food products, they need traceability systems and standards to back up these quality claims about their goods.

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Private label is both the vehicle for communicating the retailer’s product claims and the means to deliver them. From the food retailers’ point of view, this implies managing relationships with processors and producers to ensure demands for product traceability and the long-term relationships with these supply chain members.386 Retailer control of the supply chain makes the development of private label possible; and the success of private label depends upon retailer control of the supply chain.

Is private label better value?

As the quality and acceptance of European goods has improved, their price gap with manufacturers’ brands has narrowed. In the 1970s, private label (food and non-food goods) sold at a 40% discount to name brands. By the 1990s, the price gap had narrowed to between 5% and 20%.387 More importantly, a recent private label report by AC Nielsen found a number of examples where private label products had an average price that was actually higher than the manufacturer brands388 As retailers began acting as marketers, they embraced private label because overheads are low, the marketing costs are miniscule, and consequently….the margins are on average 10% higher than branded goods.389 The UK Competition Commission has estimated the basic cost differences between brands and private label……

Suppliers Cost Saving Lower Supplier Margin Retailers Purchase Saving Lower Retail Price Higher Retail Margin

10.6% 18.8% 29.4% 19.3% 10.1%390

The results of this are clear. Retailers with strong private label programmes make higher profits.

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Retailers with strong private label programs make higher profits

Sales

WEAK Private Label % $B

STRONG Private Label % $B

100%

$30.00

100%

$30.00

5% 95%

$1.50 $28.50

30% 70%

$9.00 $21.00

35%

$0.525

35%

$3.15

25%

$7.125 $7.650

25%

23%

($6.90)

23%

$5.25 $8.40 ($6.90)

2.5%

$0.75

5.0%

Division of sales between Private Label and Branded

% Private Label % Branded Gross margin Private Label Gross margin Branded % of operating expenses Operating profit

$1.50

Source: Globalization: Who's Winning? Coriolis Research This also means that retailers are able to earn high margins on national brands in categories where private label has a high share…

As private label starts to dominate a product category, the price differential between private label and manufacturer brands drops. This means that as the trend towards private label increases, cost-savings to consumers shrink. In the ‘frozen meat/poultry/game’ category, private label has a market share of 39% and is only 2% cheaper.391 Once consumers trust and purchase significant volumes of private label products within any given category of food, retailers can raise the price of the private label products. Studies have shown that retailers often increase the prices of national brands after private labels are introduced. Prices rise in aggregate despite the appearance of lower priced private labels. The launching of private labels also stimulates higher advertising on the part of the manufacturer. In America studies show that retail prices and retail profit margins tend to increase after the store brand introduction.392

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Summary – the hourglass Increasingly the food supply chain begins to resemble an hourglass. The diagram below refers to 85% of the food retail trade in Western Europe. At the bottom of the hourglass is the produce from a huge number of farmers. Before this produce can reach the top – the millions of consumers in different countries – it must first pass through a small number of processing firms and an ever-diminishing number of retailers.

393

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Section 2 A sustainable system?

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Environmental impacts of the modern food industry.

Foreword…

Section one showed how retailers coordinate food value chains. Here we consider the environmental impacts of the food system at its various stages, from agricultural production to household waste. The food system consumes vast amounts of energy, while its emissions have a huge impact on the environment. This section is divided into three main parts: agriculture, distribution and consumption. There is also a fourth section on the food system’s effects on human health. Agriculture looks at the rise of energy intensive farming and its environmental impacts. These are: air and water pollution, the destruction of ecosystems and loss of biodiversity, soil degradation and water shortages. Distribution covers all stages of the value chain between farm and store. It examines the energy consumption and emissions of food transportation, storage and processing. Consumption looks at the waste created by the food system and the environmental problems associated with its disposal.

But first, the energy requirements of the modern food system…

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From fuel to food “Modern agriculture is a device to convert large amounts of fossil fuel into human food.”394 Folke Gunther, ‘ecosystem consultant’

The modern food system converts fossil fuels into people. The food system depends on fossil fuels. Increases in food production since 1950 are directly attributable to fossil fuels. This has lead to rapid increases in world population, which is projected to reach nine billion by 2050.395 More people require more food, which means more fuel. Humans have always drawn their energy from the food they eat. But we did not always rely on oil as the source of food energy. Before the industrial revolution, all food energy was derived from the sun through photosynthesis. Either you ate plants or you ate animals that fed on plants, but the energy in your food was ultimately derived from the sun.396 •

In 1850, the United States relied on biomass wood or solar power for 91% of its energy.397 Now that situation has reversed. Fossil fuels account for 92.3% of total energy consumption, with solar energy sources making up the remainder.398 As much as 20% of total energy consumption is attributable to the food system.399

Today’s food system relies heavily on fossil fuels to produce, process and transport food to consumers. Ever since the Green Revolution (see box) crop yields have been maintained or increased because of the availability of cheap fossil energy for inputs like fertilizers, pesticides, and irrigation.400 Background: The Green Revolution The Green Revolution is the name given to the vast increases in food production after the Second World War. Per capita production has now increased every year since 1950 thanks to the use of improved strains of wheat, rice, maize and other cereals.401 •

In the 50 years since 1950, global agricultural production increased by 60% whereas the 1950 level of production had been reached only after 10,000 years of agricultural development.402



Between 1950 and 1984, world grain production increased by 250%.403

But higher yields come at a cost. The energy for the Green Revolution is provided by fossil fuels in the form of fertilizers (natural gas), pesticides (oil), and hydrocarbon-

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fuelled irrigation.404New crop strains are geared towards fossil fuel inputs. These strains are developed to be more efficient at exploiting chemical fertilizers and easier to harvest mechanically. Agriculture today runs on energy-intensive technologies that require heavy fossil fuel inputs. The flow of energy input in modern US agriculture for instance is 50 times higher than in traditional agriculture.405 The current U.S. daily diet would require nearly three weeks of labour per capita to produce.406 And not all this energy is converted into food. Between 1945 and 1994, energy for agricultural use has increased about 4-fold while crop yields have increased about 3-fold.407

Energy for food – the US example In the US, an individual consumes 400 gallons of oil a year in food - about 17% of all energy used in the country each year.408 This percentage is similar in other developed countries. In Sweden, as much as 20% of energy consumption goes towards supplying food.409 The following table gives a breakdown of energy consumption in the US food system. The largest single contribution comes from food processing. This is because to preserve shelf-life, food is either heated or dehydrated. Much processed food is now also chilled. All of these processes require large amounts of energy.

410

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The food system uses huge amounts of energy… •

The U.S. food system consumes around ten times more energy than it produces in food energy. 411



The U.S. food economy uses as much energy as France does in its entire economy412 - 10,551 quadrillion Joules.413



One hectare of land uses 1,000 litres of oil.414



One pound of beef requires 3 litres of oil.415

It also ‘loses’ a great deal of energy… •

The average U.S. farm uses 3 kcal of fossil energy in producing 1 kcal of food energy416.



If one considers the whole supply chain, including processing and transport – the food system expends 10-15 calories of energy for every calorie of food energy produced.417

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A sustainable system? Sustainable development is “development that meets the needs of the present generation without compromising the ability of future generations to satisfy their needs.”418 Energy consumption in the food system continues to rise. Research on thirteen European countries (Europe-13) in the period 1970-2002 showed that agriculture, food processing and transport have increased their energy consumption at a rate of 1.6%, 1.8% and 2.3% per annum respectively.419 World population is also rising. Turning fossil fuels into food has lead to a massive increase in the number of mouths to feed. World population growth since the 13th century:420

Current population levels are sustained by our ability to turn fossil fuel energy into food energy. We would be in grim trouble if we had to derive our energy needs from current basic photosynthetic production, as our ancestors did.421 For the United States to sustain itself using solar energy – given its land, water, and biological resources – its population would have to fall from 250 million to less than 100 million.422 •

The US currently consumes 40% more energy annually than the total amount of solar energy captured yearly by all U.S. plant biomass.423

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Without fossil fuels, the US would have to need to use four times more land than it does at present.424 Almost three-quarters of its land area is already devoted to agriculture and commercial forestry.425



For the UK to meet its energy demand using solar power, it would have to convert 10.8% of its land to solar panels.426

Put simply, without oil and gas we would starve. Given that fossil fuels are an unsustainable resource, and that world population will continue to rise, this is a problem that is ahead of us rather than behind us.427 Peak oil ‘Peak oil’ is a theory that tries to predict when worldwide petroleum will peak. US oil production peaked in 1971 and has been devreasing since then. As oil runs out it becomes harder to extract. The peak signals the moment when oil extraction becomes mnore costly and less energy-efficient. There is no question that oil will peak. The question is when. According to some estimates, we may have passed it already. Predictions of the size of oil reserves fall into three broad groups based on how the authors see future oil production.428 Group 1, which mostly comprises geologists, calculate that global oil production will peak sometime between the years 1996 and 2020, and thereafter decline.429 Group 2, mainly government agencies, anticipate that there will be enough oil to meet demand to at least 2030.430 Group 3, mainly economists, dismiss the possibility of a hydrocarbon peak occurring in the near or medium term. They see no need to quantitatively assess future oil production.431 There is no simple technological fix to the problem of depleting natural resources and a growing population. Technology can be used to manage and exploit natural resources. But it cannot increase the flow of natural resources available for exploitation.432

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Environmental impacts The current food system is unsustainable. The energy that supports it will soon run out. In addition, food production and distribution are damaging the environment – and human health as well.

Climate Change As we have seen, the modern food system runs on fossil fuels. Burning these fuels increases levels of greenhouse gases in our atmosphere – which in turn drive temperature changes and, more importantly, increase the risk of climate change.

ATMOSPHERIC CO2 CONCENTRATION (PARTS PER MILLION)

Atmospheric CO2 Concentrations, 1750-2000 380

360

340

320

300

280

260 1700

1800

1900

2000

Climate change: facts •

The global average surface temperature in the year 2003 was nearly 0.8 °C above the average temperature at the end of the 19th century, making it the third warmest year in recorded history.



The 10 warmest years have occurred since 1990, including each year since 1997.433



Scientists project that the global average temperature will rise an estimated 1.4 to 5.8 degrees Celsius by the year 2100, according to the United Nations Framework Convention on Climate Change.434



In the event of climate change, floods, droughts and storms are likely to become more frequent and severe. The results? Loss of lives, dangers to harvests, and a

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threat to global economic stability.

What does the production of food have to do with it?

The food system is one of the single largest sources of greenhouse gases, contributing an estimated third of global emissions. And some studies suggest that most climate change policy overlooks the trends of the food system which are increasing those emissions.435 Agriculture especially has a major impact on global warming. The chart below summarises the contribution of agriculture to global warming. The contribution includes fossil fuel usage on farms and is not solely due to the nitrous oxide and ammonia produced by agriculture.

436



One study estimates that 20% of all greenhouse gases in the world come from agriculture.437



In terms of energy use and CO2 emissions, the food industry is the UK’s third largest industrial energy user.438 One report estimates the food system’s contribution to greenhouse gas emissions to be ‘at least’ 22% of the UK total.439



Each year, the average family of four in the UK emits 4.2 tonnes of CO2 from their house and 4.4 tonnes from their car. But the food they eat – due to production, processing, packaging and distribution – would account for as much as 8 tonnes of CO2 emissions.440

The ecological results of an industrialised food system are problematic – short term and long term. Here are just a few of the main issues: •

Air pollution 109



Water pollution



Loss of ecosystems and biodiversity



Soil degradation



Pressure on water sources

The price of food may be falling – between 1975 and 2000 the price of food fell in real terms by 31% when compared with the All Items Retail Price Index.441 But consumers pay the price for the food system in other ways. “The myth of cheapness completely ignores the staggering externalised costs of the food, costs that do not appear on supermarket checkout receipts.” 442 Given the environmental and social destruction involved in industrial agriculture, the real price of modern food production for future generations is incalculable.443

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Agriculture Energy-intensive farming There are two ways to increase agricultural production: either increase the amount of land, or increase the amount of yield per land unit. The first method – increasing the area of land under cultivation – puts pressure on natural resources. It can threaten ecosystems and biodiversity. The second method – increasing land productivity – requires large amounts of fossil fuel inputs, in the form of chemicals and farm machinery. Intensive farming in the UK: bigger yields at environmental cost Almost 77% of the UK’s land surface has been managed for agricultural production. But it has not always been managed efficiently:444 •

Since 1945, poor farming practices have damaged about 550 million hectares – an area equivalent to 38% of all farmland in use today.445



The external costs of UK intensive farming are as much as €300 per hectare.446

Farming is energy-intensive. Agriculture is ultimately a process of energy conversion: converting solar energy, along with various chemical and fossil energy inputs, into food energy that will sustain a human population.447 Agricultural energy consumption is broken down as follows: •

31% for the manufacture of inorganic fertilizer



19% for the operation of field machinery



16% for transportation



13% for irrigation



8% for raising livestock (not including livestock feed)



5% for crop drying



5% for pesticide production



8% miscellaneous.448

Since the Green Revolution, the amount of energy used in agricultural production has

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risen by an average of 50 times more than the energy input of traditional agriculture.449 In the most extreme cases, energy consumption by agriculture has increased 100 fold or more.450 Producers use energy directly for operating machinery and equipment on the farm, transporting products to market and indirectly in fertilizer produced off the farm. In the US: •

Average energy-related expenses for rice, sugar beets, and peanuts were about $128, $108, and $97 per acre, respectively.



Energy-related costs for corn, sorghum, and wheat averaged $66, $51, and $34 per acre, respectively.

Expressed as a percent of per acre total US farm expenses, which includes land and depreciation, energy-related costs are the highest for sorghum, 23%; rice, 21%; corn, 19%; and wheat, 18%.451

Fertilisers spur soil revolution Fertilisers put nitrogen – the essential plant nutrient – into the soil. Crop production now relies on fertilizers to replace soil nutrients, and therefore on the fossil fuels needed to mine, manufacture, and transport these fertilizers around the world452 The manufacture of inorganic fertilizer is the single largest contributor towards agricultural energy consumption – accounting for 31%.453 • Just one kilogram of nitrogen for fertilizer requires the energy equivalent of 1.4-1.8 liters of diesel fuel.454 • According to The Fertilizer Institute, in just one year between June 2001 and June 2002 the US used over 12 million tonnes of nitrogen fertilizer – requiring the same energy to produce as that provided by 96.2 million barrels of diesel fuel.455 • Fertilizer is effectively manufactured from natural gas: some fertilizer manufacturing plants use more gas than the entire City of Birmingham.456

In fact, it is estimated that fertiliser production consumes approximately 1.2% of the world’s energy and so is responsible for approximately 1.2% of total greenhouse gas emissions.457

Specialisation

A key aspect of industrial farming is specialisation – when production focuses on a limited range of crops or animals, also known as monocultures. 112

Not so long ago, the small farms of a region would produce a wide range of products for nearby consumers. In today's globalised food system, however, every region is pushed to specialise in whichever commodity its farmers can produce most cheaply – and to offer that product on global markets. Specialisation tends to go hand in hand with concentration, as farmers seek to maximise efficiency and productivity through economies of scale. •

33% of Germany's poultry is bred in just a few districts to the north of the country.458



A cattle feedlot with 20,000 cows – modest by industry standards – processes as much sewage as a town of 320,000 people.459



Some European piggeries have up to 62,000 pigs on a single site, with pen density of 0.7 square metres per finisher pig.460



In the early 1970s, there were some 36,000 family farms rearing pigs in Ireland. By 1996, only 700 pig farmers remained.461



In Sweden, half of the farms are expected to go out of business in the coming decade.462



In 1988, when the drive for industrial pig farming began, there were about 690,000 pig farmers. Now there are fewer than 100,000 independent pig farmers remaining. Moreover, in North Carolina there were 28,000 pig farmers. In 1998, there were only 3,000. And today there are so few pig farmers that you could almost count them on your fingers.463



Twenty years ago, 60,000 Danish farms produced around 13 million pigs. Now some 13,000 farmers produce nearly twice as many.464



Two decades ago there were an estimated 27,000 family farms in North Carolina today 2,200 remain – most of them pig factories of the kind pioneered by companies such as Smithfield, producing genetically engineered pigs.465

Monoculture – is it really efficient?

It has been argued that the old agricultural system – with many small, unspecialised farms – can in fact be more efficient than the globalised and concentrated system dominating today. It may seem that large monocultural operations are more efficient and productive...

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But – “that is in large part a myth.” “...the small farm doing traditional polyculture (raising more than one kind of crop, using different root depths or soil nutrients on the same piece of land) makes more intensive and efficient use of resources and can produce significantly more food per overall acre.” 466

Concentration in agriculture means larger farms. In the middle of the 20th century, agricultural structures began to change radically – and they are still evolving today. Before, the farm and its infrastructure were part of a decentralised system – the traditional family farm was the norm. Now, the system is one of centralised ownership and control. The 21st century farm has become industrialised.

Average size of European farms in terms of full-time workers 1989 to 2000 number of full time workers Year: 0 -