Market Concentration and Farm-Retail Price Asymmetry in the U.S. Fluid Milk Market

1. Market Concentration and Farm-Retail Price Asymmetry in the U.S. Fluid Milk Market Brian W. Gould Joseph Schoen Kyle Stiegert Send comments to gould@aae.wisc.edu Applied Economics Workshop October 19, 2005

2. Overview • Introduction • US Fluid Milk Prices: Farm and Retail • Overview of Food Retailer Concentration • Previous Evidence of Milk Price Asymmetry • Overview of the Econometric Model of Price Transmission • Use of Non-Reversible Functions • Panel Data with AR errors • Overview of Market Level Data • Preliminary Results (“Farm” Price Change) • Conclusions/Next Steps

3. Asymmetric Price Transmission • Why has the pricing of fluid milk become a major concern to the point that a Government Accountability Office (2004) inquiry was undertaken in 2004?

4. Fluid milk price volatility has dramatically increased in recent history

6. Retail-farm price spread continues its upward trend

7. Asymmetric Price Transmission • Increased food retailing concentration over the last 3 decades • A measure of concentration: Herfindahl-Hirschman Index (HHI) where si is the value of sales by the ith firm and S is the total value of market sales in a particular market • U.S. Dept. of Justice Guidelines wrt HHI: • 1000-1800: “Moderately Concentrated” • >1800: “Concentrated” • Mergers adding ≥ 100 to HHI in “concentrated” markets “raise antitrust concerns”

8. Retail Grocery Sector HHI Values: Selected Cities

9. Asymmetric Price Transmission • Evidence of asymmetric cost pass-through for fluid milk retailers • Kinnucan and Forker (1987): Annual U.S. Aggregate Data for Major Dairy Products • Hansen et. al. (1994): Annual U.S. Aggregate Fluid Milk Data • Romain et. al. (2002): Aggregate Monthly New York State Fluid Milk Data • GAO (2004):Meta analysis of fluid milk pricing • Estimates of price transmission of farm price increases were greater than for decreases • Capps and Sherwell (2005): Monthly Sales Data for 2% and Whole Milk, 7 US Cities

10. Asymmetric Price Transmission • Why should we be concerned with the characteristic of the price transmission process for fluid milk? • Relationship between farm and retail prices provide insights into marketing efficiency • Asymmetric price transmission may indicate possible market failure or abuse of market power • Higher market power can increase asymmetry (Carman and Sexton, 2005; Sexton, Xia and Carman, 2004) • Implications as to consumer and producer welfare • Higher than “normal” retail prices • Cotteril(2003): $1.00 more due to market power in NE • Continued trend of variability of farm milk prices • Continuation of concentration in food retailing

11. Asymmetric Price Transmission w/ Monopoly and Concave Demand P MC″-MC = MC-MC′ but P″ – P > P – P′ → Cost increases are passed on to retail prices more completely than cost decreases P” P MC” P’ MC MC’ MR D Q • Under oligopoly, firms price between MR and D • More competitive → less asymmetric

12. Research Questions • Is there evidence of asymmetric farm-retail price transmission in the US fluid milk sector? • What is the role of imperfect competition? • To what extent does spatial as opposed to market concentration explain asymmetric price transmission (Azzam, 1999)? • Does the magnitude of asymmetry vary with market and spatial concentration across cities? • What is the role of price variability in the degree of asymmetry? • Implications of increased farm price variability

13. Econometric Model • Based on the model originally developed by Wolframm(1971) and extended by Houck (1977) • Approach has been used extensively in analyses of agricultural commodity price transmission • Pork: Boyd and Brorsen (1988) • Fed Cattle: Bailey and Brorsen (1989) • Peanuts: Zhang, Fletcher and Carley (1995) • Wheat: Mohanty, Peterson and Kruse (1995) • Apples: Willett, Hansmire and Bernard (1997) • Rice, Beans, Tomatoes: Aguiar and Santana (2002)

14. Econometric Model • Houck (1977) approaches used in the analysis of fluid milk price asymmetry • Kinucan and Forker (1987) • Romain, Doyon and Frigon (2002) • Capps and Sherwell (2005) • Carman and Sexton (2005)

15. Econometric Model • We improve upon previous research • More current data encompassing periods of dramatic farm (Coop Class I) price increases and decreases • April 2003: $13.74 • June 2004: $25.16 • Incorporate explicit measures of concentration as explanatory variables • CR2, CR4 (% of total retail sales accounted for 2 and 4 largest firms, respectively) • Herfindahl-Hirschman Index (HHI) • Spatial Concentration (Supermarkets/1,000 pop.) 83.1% ↑

16. Econometric Model • We improve upon previous research • Incorporate a variety of definitions of our dependent variable to examine asymmetry to examine robustness of our conclusions • Change in retail price (reported here) • Change in farm-retail margin • Percent change in farm-retail margin • Given our use of city/retail firm data can examine differences across city and/or firms • Incorporate alternative methods for accounting for panel nature of our dataset (Fixed Effects used here)

17. Econometric Model • Basic Houck model • RPt≡ retail price in the tth period • WPt≡ wholesale price in the tth period (COOP price) • ΔWPIt ≡ change in wholesale price if there is an increase from t-1 to t • ΔWPDt ≡ change in wholesale price if there is a decrease from t-1 to t • WPIt ≡ sum of period to period increases in wholesale price • WPDt ≡ sum of period to period decreases in wholesale price • Trend ≡ trend variable

18. Econometric Model • Basic Houck model • Nonreversibility (asymmetry) occurs if β1 ≠ β2 • The value of RP at any point t is: • Substituting this into the basic model

19. Econometric Model • Basic Houck model > 0 < 0

20. Example Data Construction WP ≡ Wholesale (Farm) Price RP ≡ Retail Price

21. Econometric Model • Our empirical model • Analysis of Private Label Whole Milk eliminates • Brand effect differences across firm/city • Milk quality effects (fat content) across firm/city • Test for asymmetry wrt both farm price and marketing cost changes (only farm price discussed) • Incorporate Almon lag structure for marketing cost and coop price variables (displayed β’s derived from estimated Almon lag coefficients) • AR(1) error structure (city/firm-specific ρ’s) • Test for long-run and short-run asymmetry

22. Econometric Model Number of Lags • Our empirical model t ≡ time period, j ≡ city/firm, T ≡ total no. of months, J ≡ total no. city/firms, N & P refer to pos/neg changes, MC ≡ marketing cost index, COOP ≡ cooperative Class I price, MONTH ≡ monthly DV’s variables, CITY_FIRM ≡ city/firm DV’s, NE_COMP ≡ Northeast Dairy Compact DV, Q ≡ volume of milk sales by firm

23. Hypothesis Tests • Long-run farm price transmission asymmetry (H.1) • Short-run farm price transmission asymmetry requires at least one of the following to occur (H.2) • Incomplete transmission of farm price changes (H.3) • Speed of Adjustment joint test (H.4)

24. Description of Our Data • Retail Price Information • Information Resources Incorporated (IRI) • UPC Level • For this analysis: private label, whole milk • Sales Values and gallons sold by firm (not outlet) • 10 cities included in this analysis • 1 city in each Federal Order • Atlanta, Boston, Charlotte, Chicago, Cleveland, Dallas, Kansas City, Phoenix, Salt Lake City, Seattle, Tampa • Monthly (weekly): March 1997-Dec. 2004 (94 months) • Data for “Key Players” (firms) in each city

25. Description of Our Data • Farm Level Milk Price • Announced Cooperative Class I price • Prices charged fluid milk distributors by dairy cooperatives and bargaining federations • Assume uniform processor costs • Reasonable proxy for the cost of raw product to fluid milk bottlers • Monthly • Prices specific to each city

26. Description of Our Data • Marketing Cost Index • Based on Romain, Doyon and Frigon (2002) • 54% Processing • 26% processing labor • 24% packaging costs • 4% energy • 36% Retail • 31% retail labor • 5% energy • 10% Transportation • BLS data used for all components • Aggregated using Tornquist-Theil Index with budget shares assigned as above

27. Description of Our Data • Market Concentration Measures • Obtained from bi-annual Market Scope publication • Complete census of value of sales in major markets across the U.S. for all firms • Markets defined to match IRI data • Values are interpolated between publication periods

28. Description of Our Data • Food retailers in each city included in our analysis Above DOJ Limit

29. Preliminary Econometric Model Results • The above assumed a one-way fixed effects model • Tested using F-test proposed by Baltiga (1995) • H0: Pooled Data • F-Stat of 71.8 → reject H0 → Fixed Effects • Lag length for MC and COOP determined using AIC criterion • → All lags for MC removed • → Two lag periods for COOP price change

30. Preliminary Econometric Model Results • Summary of AR(1) Results: 31 ρ values • Estimated via Cochrane-Orcutt procedure All ρ’s significantly different from 0

31. Preliminary Econometric Model Results • Summary of Results: Fixed Effect Coefficients (City/Firms) Indicates stat. sign. 15 out of 31

32. Preliminary Econometric Model Results • Summary of Results: Misc. Coefficients *significant at least the 0.05 level

33. Preliminary Econometric Model Results • Summary of Results: Cumulative Change Variables, MC and COOP *significant at least at the 0.05 level

34. Preliminary Econometric Model Results • Summary of Results: Hypothesis Tests *significant at the 0.001 level

35. Preliminary Econometric Model Results • Summary of Results: Hypothesis Tests *significant at the 0.001 level

36. Next Steps • Extend method by which market concentration incorporated into the model • Change functional form to allow market concentration measures to impact hypothesis tests wrt price asymmetry • Current model does not allow for this • Modify HHI to account for population differences across city • More fully explore the time series aspects of the data • Co-integration-type model (Error Correction Model, Capps and Sherwell, 2005)

37. The End!