Regional & Production Appellations for Rural Development Can they help?

1. Regional & Production Appellations for Rural DevelopmentCan they help? John M. Crespi Kansas State University

2. The issue is whether producers -- either in a region or using a distinctive production process -- can collectively “brand” themselves to increase profits. • Goal for this session is to discuss what the economic theory says about this type of collective product differentiation.

3. Handouts (shameless promotion) • Two papers written by myself and Stephan Marette. • Can Quality Certification Lead to Stable Cartels? • Eco-Labelling Economics: Is Public Involvement Necessary? • aside: the answers are, respectively, “Yes” and “Occasionally”.

4. Appellations • I am being loose with the term. • Any mark or label that is used by a producer association to differentiate a product based upon region and/or regional production process. • A mark of product differentiation that differs from a brand because it is not owned by any one firm.

5. Protected Geographic Indicators/Protected Designation of Origins • Legally different from “Appellations” (which is used mostly for wines) but same idea. • Very popular in Europe • Very contentious for exporters seeking European markets. • This month Colombian coffee growers became the first non-EU group to seek a protected food name in Europe.

6. Labels & Appellations

7. Examples. Parma Appellation: Medoc

8. Do these labels improve profits? What does economic theory say?

9. Background: Experience vs. Credence Claims • “Tastes” are experience claims. Easily verified after purchasing. • “Sweet & Juicy”, “Tender”, “Spicy”, “An Approachable Little Pinot with a soupcon of Camembert and Mushroom”, etc. • Credence claims are harder for a consumer to verify either before or after purchasing: • “Organically grown”, “Alexander Valley”, “Contains no GMOs”, “I-80 Beef”, “Highly Regarded Economist”, etc.

10. Moral Hazard Issue with Credence Labels • If consumers cannot check the claim, anyone can make it: high-quality good will not emerge on the market. • Relatedly with appellations, if consumers are uncertain what the claim means, any firm can try to make a similar claim: Kraft Parmesan vs. true Parmesan cheese. • Premia will dissipate as consumer uncertainty grows.

11. Appellation Characteristics are often Credence Goods • Although there are experience attributes, • many claims (Parma’s fresh mountain air) have to be taken on faith, • as such consumers will want some verification that the product is what it claims to be. • The literature on credence goods shows that these attributes are often tough—but not impossible—to market.

12. The reason credence claims are tough to market are: • consumers have to believe the appellation conveys some premia-necessitating quality, • and consumers have to believe the appellation (hence, the claim) is credible.

13. Issues emanating from cartels exist here, too. • Obviously we’re talking about some type of cartel for producer quality or regional restrictions. Issues... • Antitrust issue, though Co-ops, Mktg. Orders, PDI’s etc. provide legal rationale. • Cartel stability: can price be maintained and if not, is deviation a worry? • Relatedly, if the label is profitable what prevents new producers from entering and eroding premia. • If the cartel pays the cost, can free-riding by similar-sounding appellations or claims erode premia? • Worry is over keeping the cartel distinct, stable and profitable.

14. Quality Signaling and Cartel Stability • Much has been written on why cartels break down. • Little has been written about cartels formed for purpose of signaling some quality differentiation. • Theory shows that cartels that differentiate themselves via quality signals can circumvent cartel breakdowns and can also... • Improve overall welfare. • Thus cartels for appellations – if consumers truly desire the good – may be in both producers’ and societies’ best interest. • Marette & Crespi

15. Why don’t more products with appellations exist in the U.S.? Is this a feature of credence goods?

16. Claim: If it were profitable it would already exist. • “The fact that no major supermarket company has joined the voluntary program... tells you all you need to know about whether this program is a good idea or not.” • Tim Hammonds, President Food Marketing Institute, on country-of-origin labeling.

17. Claim: If it were profitable it would already exist. In the case of credence characteristics, in my opinion, this claim is mostly a myth for 3 reasons.

18. Claim: If it were profitable it would already exist. • Reason #1 this is a myth. The logistics of modern commodity agriculture with its commingling and bulk handling are great for cost efficiencies but lousy for relating consumer signals back to producers. • Hayes & Lence • Doubly true with respect to consumer demand for credence attributes. • The innovation of the organics movement had to begin outside the typical ag. marketing channels. • Now, that organic is established and profitable the major agbus players are getting involved and will take it to the next level: ConAgra, General Mills, Gallo Wine*, Heinz, Phillip Morris-Kraft, M&M Mars, Coca-Cola. • see also Barkley

19. Claim: If it were profitable it would already exist. • Reason #2 this is a Myth. Market power affects firm decisions on both the quality content and the signaling of that quality. • Competitive firms address quality desires of “average” consumers. • Monopolies address quality desires of “marginal” consumers. • Marginal consumer’s desire for quality could be higher or lower than average consumer, but are likely not the same. • Market power will have an effect on product quality. • Market power will have an effect on how firms signal that quality and, thus, how producer associations signal that quality. • Nicholson; Marette & Crespi; Mooman, Du & Mela

20. Claim: If it were profitable it would already exist. • Reason #3 this is a Myth. Market failure occurs when consumers are uncertain about the attribute. • In the case of uncertainty about an attribute, consumers’ WTP is hedged downward, and will send an inaccurate signal of consumer desires. • Result, firms willing to provide the credence attribute will not be able to adequately signal its presence and attribute may not emerge in the market. • Akerlof; Salop; Stiglitz.

21. Signaling credence attributes. What does the literature say? The literature shows that the most important feature of profitable credence labeling is an accurate, understandable, and verifiable signal.

22. Accurate & Understandable Signals

23. Literature on Appellations’ Effectiveness? • Not much, but there is a large literature on effectiveness and consumer response to other types of voluntary and mandatory labels.

24. Issue of effective labeling comes down to Credence Issues. • With credence claims, surveys and literature show that outside verification is a must. • For credence attributes, consumers do not trust the firm itself. • Aside, European consumers generally don’t trust gov’t labels, but U.S. consumers do. • Crespi & Marette, Teisl & Roe, Priest et al.

25. Does the label mean anything? • Credibility is just one issue. Another is whether the attribute itself is more than just fluff: does the label really mean anything? • “Sustainable” ~ meaningless • “Bird Friendly” ~ meaningless • “Shade Grown” ~ meaningful (but few people know what it is). • “Organic” ~ meaningful • “Cruelty Free” ~ meaningless • “Grass Fed” ~ meaningless • “Grass Fed Only” ~ meaningful • “Natural” ~ ???

26. Does the label mean anything? • Meaning gets trickier with regional and production appellations. • For regional labels (e.g. Napa, Sonoma, or Calaveras wine), the label’s meaning is only as important as what the producers of that region are able to promote or what outside agents are able to verify. • Exs. To many, Parma is a strong signal for ham; Vidalia for onions, Napa for wine. • But, what about Stockton for asparagus? Iowa for beef?. • Big bonus to Iowa beef is that Japanese wholesalers already ask for “I-80 beef”. So the signal is already there. – See Hayes & Lence

27. What makes a label a success? • Common themes emerge in the literature. • Label is Standardized • Claim is Verifiable • Claim is Accurate • Meaning is Succinct • Label is Legible • Consumer Education • Think about the US nutrition label, for example.

28. Too many labels Label proliferation is as mind-numbing as too much noise.

29. Label Proliferation : NOISE. • Label proliferation occurs when a consumer is inundated with too many labels. • Ex. Big problem in Europe with regional appellations on wine. • There are so many regional appellations (450!) for moderately priced French wines, that the appellations have become mostly meaningless to consumers. • Not surprisingly moderately priced French wines are losing market share to Californian, Australian and Chilean brands.

30. Label Proliferation • “Three quarters of all wine produced in Europe now bears a specific geographic reference. The more this happens, the more devalued it becomes, and the less consumers want to pay for it.... We wanted to use AOC to help differentiate our offering in the New World, but now they have it too.” • Patrick Aigrain, wine economist, April 26, 2005

31. Conflicting Messages • Label proliferation can also add to confusion when consumers must choose among competing claims. • Ex. The use of “GMOs” can be “Environmentally Sound” and “Sustainable” but in the U.S. cannot be “Organic” which to many consumers means “GMO” must be environmentally unsound leading them to pass on GMO in favor of “Natural” or “Earth Friendly” both of which can sometimes be neither “Environmentally Sound” nor “Sustainable”. HUH? • Confounding messages lead to reduced premia. • Loureiro et al.; Tesil & Roe

32. Beware Eco-Labels!!! • Of all labels studied by economists thus far, eco labels seem most prone to label confusion. • Ex. “Shade grown,” “Bird Friendly,” “California Clean.” • Practical impact is that if producers tie their appellation strictly to environmental friendliness, premia may be short lived because such claims are: • too easy to duplicate, and • too easy to obfuscate.

33. Piggybacking Helps. • Regional/Producer appellations with little consumer identification are helped if they piggyback on another label that consumers know better • In other words, “Don’t go it alone.” • Ex. 1 - Producer groups in France who have added their appellation to the popular “Label Rouge” program for quality obtain higher premia than those groups who use only the regional appellation label. • Recent INRA study. • Ex. 2 - Teisl & Roe find that adding the USDA’s organic logo to and eco-labeled product significantly increases premium. • As the “USDA Organic” or “Certified Angus Beef” labels become better known for standardized quality, U.S. producer groups with regional appellations may be wise to piggyback on them.

34. Our Survey Says... • The economic literature on consumer preferences for food attributes shows that surveys can provide guidance on preferences but little guidance on WTP. • Ex. Consumers will say, “Yes, I’d pay a lot more for that...” but when given the chance, pay a lot less... or nothing. • While surveys often show large premia, typical revealed premia are much less: in the neighborhood of 3-5%. • See surveys in Crespi & Marette, Lusk et al, Henneberry & Armbruster.

35. How easy is it to duplicate a product? • Easy for a Taste/Hard for a Region. • Alexander Valley, Napa Valley, Iowa Beef, Parma Ham, Vidalia Onions, Washington Apples (though Wash Apples, don’t get a premium anymore). • Premia can exist and remain for products that are first in the minds of consumers. • Not logical, but often true. • “Why buy ‘the NEXT Taco Bell’ when I can buy ‘Taco Bell’?”-Lynch • Premia on products that have generic substitutes shows this to be true for many brands. • Even if substitutes are perfect: Bayer gets a premium over chemically identical generic aspirin.

36. Controlling Quality may be Easier than Controlling Production or Number of Producers • If profits go up, how will producers keep newcomers out? • With regional appellations, this may be possible if there is a limit on available land. • With production methods, this is much harder, though not impossible (see Dermot’s work on this). • Marketing orders? • Can control quality and to some extent production in the short run (but not number of producers). • Survey of marketing order market power in Crespi & Sexton shows that markups from “monopoly” control are small.

37. Room for optimism • Consumer Incomes are Up. • Budget Share for Food is Down. • Those are good things for niche markets. • More money available for a food budget of perceived higher quality foods. • Anecdote #1. Organic is fastest growing segment of retail food market (organic + natural = $48 Billion). • Anecdote #2. Whole Foods is building new supermarkets while Safeway is closing supermarkets.

38. Grocery-store chains such as Safeway Inc., Albertsons Inc. and Fred Meyer's owner, The Kroger Co., grew into national forces over the past century by marketing to the masses. But the giants are losing their grip. Shoppers have locked into new habits, rolling their carts into an ever wider array of food stores at either side of the retailing spectrum. At one end, they steer toward lower prices at big-box discounters: Costco Warehouse, WinCo Foods, Wal-Mart Supercenter, SuperTarget. At the other, they search out upscale and organic offerings at specialty stores, from Portland-based Zupan's Markets and New Seasons Market to national chains --Trader Joe's and Whole Foods Markets. The Oregonian, June 12, 2005

39. Room for optimism... • Don’t need to be Pepsi, just need to have a defensible niche. • Whole Foods Market (Mkt. Cap.=$7.7B) and Wild Oats Market (Mkt. Cap.=$325M) actively source local/regional foods when they open new stores. • Studies of promotion checkoffs (for the most part) show joint producer promotions can raise industry revenues. • See Kaiser, Alston, Crespi & Sexton.

40. So, what does the literature suggest about the link between appellations & income? • Does the absence of an appellation mean that a market does not exist? • Not necessarily. The key is whether or not the attribute is a credence one or not. • Can an appellation increase profit? • Yes. • Will it increase profit? • ??? • Big issues are quality perception, credibility of the claim, label proliferation and noise.