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close this bookExporting High-Value Food Commodities: Success Stories from Developing Countries (WB, 1993, 119 p.)
close this folderII. Economic and institutional issues in the marketing of high-value foods
View the documentMarketing high-value food products
View the documentFood commodity systems: Organization. coordination, and performance
Open this folder and view contentsCommodity system competitiveness
Open this folder and view contentsGeneric barriers to entry and coordination in food commodity systems
Open this folder and view contentsTechnologies, institutions. and other solutions to generic food marketing problems

Marketing high-value food products

2.1 A high-value food product represents the outcome of a multiple and sequential series of investments, decisions, activities and decisions; the outcome of a process which begins with the articulation of consumer demand, leads to decisions by farmers and fishermen to produce, raise, or catch particular crops, animals, and fish, and continues through a series of activities which produce and subsequently transform the crop or animal product in form, time, and place to match consumer demand (Breimyer (1976)). Hence, in the case of high-value foods, all profitable and sustainable production, post-harvest, and distribution activities must be demand-driven: they must cater to and adjust to changes in consumer preferences for quality, variety, convenience, location, price, etc.

2.2 Food marketing is the physical and economic bridge which links raw material production and consumer food purchases. It involves a set of interdependent decisions, investments, institutions, resource flows, and physical and business activities (Kohls and Uhl (1985). As the bridge between producers and consumers, the main roles for food marketing are to: a) Stimulate and Support Raw Material Production-- food marketing plays a critical role in stimulating, orienting, and facilitating raw material production at the farm level. This entails the communication of information to farmers regarding what (and when) to produce, the provision of financial (and other) incentives to farmers to produce food items for sale, the reduction of transaction costs between producers and consumers, and the facilitation of farmer access to those production resources (e.g. credit, material inputs) needed to respond to such incentives. b) Balance Commodity Supply and Demand-- food marketing institutions must provide the organizational framework to coordinate production and consumption. It must balance the supply and demand for food raw materials and commodities, not only in quantity terms, but also in terms of quality, time, and place. This entails logistical and informational tasks, transacting for current or future supplies, quality control measures, and making physical changes to the raw materials/commodities themselves. c) Stimulate Demand and Enhance Consumer Welfare-- food marketing should promote increased effective demand, consumption, and consumer welfare by introducing new products, improving product quality, reducing consumer costs, making foods available on a more consistent basis, and educating consumers on the merits and alternative uses of products. These tasks will require the development and application of processing and logistics technologies, the dissemination of information, and the development of efficient mechanisms for the exchange of goods.

2.3 The process of marketing high-value food products transcends several different industries and markets and may cross international borders (Marion et al. (1986)). In this process, the physical commodity can be conceived of as 'flowing' from one value adding stage to another, with each of these stages being associated with a particular industry as conventionally defined (e.g. transport, food processing, packaging, retailing). The product gains value as its form is changed and/or as it is graded, stored, packaged, and transported to more closely match consumer demand. Preceding, accompanying, or following these physical commodity flows are additional flows, namely for a) product, market, and technical information, b) financial resources, and c) ownership rights to the commodity.

2.4 In the marketing of high-value food products, many of the pertinent production, post-harvest, and distribution activities require specialized technical or market knowledge, skills, or assets and/or require the presence of participants in particular locations. This suggests possible gains from a division of labor, whereby potentially many different individuals and organizations specialize in the performance of one or relatively few physical and business activities. However, given the nature of food marketing, there will remain a strong degree of interdependence among these various individuals/organizations; an interdependence which must be reflected in effective coordination of participant decisions and activities, whether through market, administrative, or other means (Davis and Goldberg (1957)).

Food commodity systems: Organization. coordination, and performance

2.5 Recognizing that production and food marketing activities are interdependent, that those individuals and organizations performing such activities are themselves interdependent, and that such activities and economic entities are linked through a network of exchange relations and additional coordinating mechanisms, it is appropriate to view them as elements of a 'system' (Arthur et al. (1968). Faced with enormous problems in both conceptualizing and empirically studying national food systems, agribusiness and agricultural marketing analysts have focused their attention on individual commodity systems", defined by Marion et al. (1986) as: "small economic systems, . . . incorporating an interdependent array of organizations, resources, laws, and institutions involved in producing, processing, and distributing an agricultural commodity." Commodity systems may involve the production, processing, and marketing of only a single commodity or else that of a set of very closely related commodities (as in dairy product, poultry, oilseed, or citrus fruit systems).

2.6 Individual commodity systems exhibit widely different organizational characteristics, both within and among countries. Most commodity system studies by agricultural economists and agribusiness specialists describe both 'horizontal' and 'vertical' structural elements, the former being entry and competitive conditions prevailing at each industry stage (e.g. processing, retailing); the latter relating to the location/ timing/ clustering of marketing functions, inter-stage differences in size, seasonality, etc., the number of parallel marketing channels, and the incidence and forms of contractual or ownership integration. Government programs affecting the commodity's production and marketing are also described in most studies.

2.7 In commodity system analysis, a central focus lies on the problems and mechanisms for coordination (Goldberg (1968); Marion (1976)). Coordination is a general problem of arranging for interdependent conditional activities: a problem of linking the decisions and actions of different technical or ownership units when collective or overlapping tasks are performed. In food systems, a major challenge is that of 'vertical coordination: the process of harmonizing the decisions and actions of input suppliers, farmers, processors, and traders so as to match the supply and demand for food raw materials and products (in terms of quantity, quality, timing, and location) at the various value-adding stages (Mighell and Jones (1963). This process entails significant flows of information and other resources which define and shift incentives. It also entails the definition and redefinition of required, permissible, and impermissible patterns of behavior for system participants. In a food marketing context, the absence of effective vertical coordination is likely to result in resource misallocations, technical inefficiencies, and enhanced production and marketing risks.

2.8 Research on food marketing and commodity system performance has utilized a large number of indicators and norms. While, most food marketing work has given attention to dimensions of operationally and allocative efficiency, more selective coverage has been given to issues related to the longer term development patterns and the broader economic impact of commodity systems. When one assumes that marketing is a demand-driven process (as in the case of high-value foods), an analysis of performance should also gauge the quality of marketing services, whether through quantitative indicators or through the subjective views of marketing intermediaries or consumers.

2.9 When recognizing the importance of (vertical) coordination in the process of producing and marketing a highvalue food product, it is important to include measures or qualitative indicators of transaction costs when evaluating commodity system performance. Transaction costs--the whole array of costs associated with buying, selling, and transferring ownership of goods and services--may in some contexts be as significant as direct production costs and/or the costs of physical marketing functions such as storage and transport. Transaction costs include: a) the information costs incurred in identifying and screening different trading opportunities, outlets, and partners, b) the costs of negotiating exchange agreements, c) the costs of actually transferring goods, services, money, and ownership rights, d) the costs of monitoring trade conditions to determine whether the agreed ferms are complied with, and e) the costs of enforcing stipulated terms through legal, social or other means (Dahlman (1979); Williamson (1979); Leblebici (1985)). Despite their considerable importance, transaction costs have rarely been examined (or measured) in studies of food marketing in developing countries.


2.10 In contrast to the burgeoning literature dealing with the performance of manufacturing sectors, the food marketing and commodity system literature devotes little attention to the issue of the competitiveness of commodity systems, except in the narrow sense of comparative costs of production, transport, etc.. A food commodity system must be competitive in two different ways in order to be sustainable and provide remunerative returns to producers, processors, and traders. First, it must be competitive with other industries or agricultural commodity systems within the same country in attracting or mobilizing resources needed for its functioning (e.g land, labor, capital, or other resources). Second, except in a totally autarkic or protected situation, a commodity system must also be competitive absolutely against similar commodity systems or industries from other countries. The commodity system may have to compete against these rivals in international markets or may be threatened by them through imports into the domestic market. This is what the literature refers to as 'competitive advantage' or 'international competitiveness'. This second form of competitiveness is of primary interest here.

2.11 Writing in the context of manufacturing industries, Porter (1990) argues that they are two basic types of competitive advantage which firms or industries may have vis-a-vis their rivals. These are:

1) lower cost of production and delivery which allows the firm/industry to underprice its competitors or to obtain superior returns when prices are at or near the level of competitors, and

2) differentiation of product through its quality and through accompanied technical or marketing services which allows the firm/industry to command premium prices and fill profitable niches in the market.

2.12 Porter argues that it is difficult, although not impossible to be both a lower cost and product differentiated supplier compared with one's competitors. This is because achieving the higher quality or level of service needed for differentiation can be very costly. While some technological or institutional methods may simultaneously reduce production and/or marketing costs and add scope for differentiation, Porter contends that competitors will imitate these innovations over the long run, forcing the firm or industry to choose which of the primary sources of competitive advantage to emphasis in its strategy. In the course of an industry's development, technical, economic, or other changes may lead to shifts from a strategy of low cost supply to one of differentiation (or vice versa). In a competitive environment, whether such a shift can be efficiently achieved may be the difference between industry (or firm) prosperity or bankruptcy. This perspective can be applied to patterns of development in food commodity systems.

2.13 In the context of export-oriented agriculture, it is important to recognize a third potential source of competitive advantage. This we may call complementary supply. This arises either when the seasonality of one's production complements rather than overlaps that of other producers or when one's own production faces far less seasonality or inter-annual variability than that of competitors. The commodity system may be in a position to service the 'offseason' market in major consumer countries, and/or capture short-term rents by expanding consignments in the face of production shortfalls in major producing/consuming countries (deriving from adverse weather, outbreaks of disease or pests, or other factors). Complementary supply is not a competitive strategy per se when considering medium-to-long-term trade development. Even when serving an 'off-season' market niche, a firm or industry must still position itself either as a low-cost or product-differentiated supplier.

Determinants of competitiveness

2.14 What factors determine the comparative and competitive advantages of particular food commodity systems? In neoclassical trade theory a country's comparative advantage is associated with its human, physical, and financial resource endowments and the opportunity costs of using such resources to produce (and market) different goods and services. The focus is on comparative costs with countries having a comparative advantage in those industries which intensively use those resources in which the country is relatively well endowed. As noted above, competitive advantage may be based on product (and service) differentiation, rather than lower costs. The determinants of effective product differentiation are many, but may primarily include the quality of human capital and physical infrastructure, the effectiveness of technological development and application, and the receptiveness and competitiveness of consumer and intermediate markets.

2.15 In the trade and manufacturing industry literatures, it is now widely recognized that both comparative and competitive advantage are a product of various policy, technological, human capital, infrastructure, and management factors, in addition to given resource endowments. Table 2 draws on this literature as well as selected studies on agricultural competitiveness to outline a range of factors thought to be important in influencing commodity system competitiveness and growths Such factors condition the incentives to invest in specialized commodity production and marketing activities, influence the likelihood of a supply response to such incentives, and determine the competitiveness of that supply response.

Table 2: Factors Influencing Commodity Sector Competitiveness and Growth

(International) Market Demand Factors

Macroeconomic and Sector Policies

Income and Population Levels and Growth

Fiscal and Monetary Policies

Income and Price Elasticities

Exchange Rate Policies

Consumer Tastes

Trade and Licensing Policies

Settlement and Work

Patterns Policies

Tariff/Non-tariff Barriers into Import Markets

Labor Policies

Resources/ Political Strength of Competing Suppliers

Natural Resources and Human Capital

Physical, Technical, and Social Infrastructure

Land, Water, and Other Natural Resources

Transport Infrastructure

Climate and Sunlight

Communications/Utilities Infrastructure

Skilled and Unskilled Labor

Marketing Facilities

Entrepreneurial and Trade Experience

Agricultural Research and Extension

Post-Harvest Technology Research

Credit Facilities

Market Information

Micro-Marketing and Coordination Elements

Costs/Efficiency of Physical Marketing (Processing, Storage, Transport)
Costs/Efficiency of Buying + Selling
Coordination of Production + Marketing
(New) Product Development
Quality Control
Quantity Control for Sales and Market Power
Risk Sharing/Reduction Measures
Marketing Research and Promotion

2.16 The scope for commodity system development and growth is intimately tied to the size and patterns of rood demand and, in an international context, to the scope for entry into foreign markets. Major changes taking place 'outside' of food marketing systems, including increases in income, changes in taste, changes in work and living patterns, and new technological developments (e.g. refrigeration), strongly influence food demand and create both food marketing opportunities and challenges. Access to particular international markets may be blocked by tariff and non-tariff barriers, or, conversely, be facilitated by preferential treatment on the basis of historical ties or importer foreign policy objectives. Sustained import penetration may thus depend on political bargaining as much as economic competitiveness. Of course, international competitiveness will be strongly influenced by the resource endowments, experience, and political strength of firms and industries in other countries.

2.17 Macroeconomic and sector policies also have a very significant role in shaping the incentives for investment in production and marketing activities. Such policies strongly influence the costs and returns on farm inputs and food products, the relative prices among these products, and the conditions for entry into trade. A stable macroeconomic environment and improvements in that environment strongly influence investment decisions and hence long-term productivity. The incentive to invest and the cost competitiveness of a commodity sector will be undermined by high rates of inflation, high costs for capital, rising labor costs, and an overvalued exchange rate-- all variables subject to influence from government policies.

2.18 While macroeconomic and pricing policies influence product costs and prices, there are important non-price characteristics of food products (e.g. nutritional properties, physical appearance, freshness, timely availability, packaging) which may be just as significant in international competitiveness. In addition, macroeconomic and sector policies do not determine the capacity and speed by which producers and marketing enterprises respond to changes in market and technological opportunities and hence, maintain competitiveness. These are determined more by organizational, institutional, and human capital factors.

2.19 As recognized in neoclassical trade theory, an important basis for comparative (and competitive) advantage is a country's natural resource and human capital endowment. These are certainly important in influencing a country's capacity to be competitive in the production and marketing of particular food products. To the traditional components of this category of resources we add entrepreneurial and trade experience which is vital to any effective marketing effort. In a particular commodity system, such experience can be acquired over time (e.g. 'learning by doing'), transferred in from another local industry, or imported via a foreign or joint venture.

2.20 Well-developed physical and social infrastructure are the second category of goods which are required for an efficient supply response to the incentives provided by market opportunities and favorable macroeconomic conditions. Physical infrastructure such as roads, ports, telephone lines, power systems, railways, terminal markets, and storage and processing facilities are fundamental to a well-functioning marketing system. The same is also the case for the social infrastructure which develops and adapts technologies, provides training and information, and provides financing.

2.21 The final set of factors influencing international competitiveness relate to micro-marketing activities, the coordination of production with downstream requirements, and physical logistics. This is the management element of commodity system development-- the management of physical resources and of interpersonal and organizational relationships. While typically ignored in economic analyses emphasizing quantity/price relationships, these management and coordination elements are central to commodity system operations and competitiveness. It is primarily at the farm and firm levels and in the interfaces between them where levels of productivity, product quality, and transaction costs are determined.


2.22 Food products, raw materials, production, marketing infrastructure, and marketing services have intrinsic technical and economic properties which, particularly in developing countries, frequently lead producers and marketing entities to experience severe problems related to production and market risk, inadequate or asymmetric information, transaction costs, logistics, and overall marketing costs. Each can therefore serve as major barriers to production, exchange, and coordination in commodity systems. In this section, we briefly discuss some of these intrinsic problems in food marketing-- problems which will commonly arise even in favorable policy environments.

Food product technical characteristics

2.23 Compared with most other products, food products and raw materials are more bulky and perishable. Bulky commodities generate physical handling and transport problems related to the development and utilization of infrastructure capacities and to potentially high unit logistical costs. For very bulky goods, it may be necessary to establish processing facilities and the attendant power and water supply in close proximity to farm production areas. Perishability limits the marketable life as a fresh commodity and the period of time over which it can be used as raw materials for processing. Commodity perishability greatly limits the marketing flexibility of producers, enhances their market risks, and potentially places them in an unfavorable bargaining position vis-a-vis buyers who have alternative supply sources. Commodity perishability enhances risk of product loss or value decline during transport and storage, may necessitate investment in highly specialized and 'lumpy' transport and storage facilities and equipment, limits the role of storage in balancing supply and demand over time, and raises the risk of contamination in food processing. In addition to these losses or special costs, rapid perishability raises transaction costs since it requires that the raw materials or commodities be repeatedly screened or graded for quality at each level in the commodity system.

2.24 While agricultural commodities are frequently regarded as being relatively homogeneous, food commodities and raw materials do exhibit considerable variability in their quality from unit to unit and from one supply period to another. Food commodities and raw materials tend to have multiple quality attributes, some of which are difficult to measure (or observe), and most of which are valued and weighted differently by specific groups of users and consumers. These features sometimes limit the scope for informative grading, create potential information asymmetries related to quality, and reduce the likelihood that market prices will signal complete information about the quality of these goods.

Food commodity production characteristics

2.25 The farm-level production of many food commodities and raw materials has features which render such production inherently risky, heighten transaction costs in a market setting, and inhibit effective coordination of production with downstream operations and consumption. First, compared with manufactured products, food products tend to be produced over a geographically more dispersed area and by individual producers who are smaller in scale and less specialized. This production pattern may result in high costs for crop intelligence and transmitting information to producers regarding consumer preferences. This production pattern also contributes to potentially high transportation costs in the collection of raw materials or animals, thus interrupting physical commodity flows. The output of a small producer may also be insufficient to warrant investment in proper storage facilities or standardized containers, perhaps leading to additional handling activities or requiring additional quality inspection. All of these imply added transaction costs.

2.26 At the same time, small, dispersed producers may possibly face a situation of monopsonistic competition with only one or very few active buyers in their area. There is frequently a considerable mismatch between the efficient scales at the level and in subsequent processing operations. A market structure featuring a relatively large processor and multiple small suppliers may emerge with asymmetric information and considerable inequality of bargaining power. The mismatch in efficient operating scales serves as a barrier to forward integration by unorganized producers and requires the processor to develop multiple supply sources to enable it to utilize its full capacity. A coordination problem arises since the production schedules for different suppliers must be scattered over time rather than overlap one another.

2.27 A second common set of food production characteristics concerns the yield lag, yield uncertainty, and seasonality of production. The production of most food crops and animal products is dependent upon the life cycle of plants and animals. In some cases (e.g. tree crops; beef cattle), this life cycle involves an extended gestation period before commercial yields are attained. This creates a need for medium-term financing and presents a potentially considerable commercial risk for the producer. Agricultural production is inherently highly risky due to the important influence of weather and the possible incidence of plant diseases or pests. Adverse natural or manmade events can undermine total supply or the supply from one geographical area, resulting in farmer losses, un(der)-utilized marketing and processing facilities, and unmet consumer demand. The seasonality of crop and animal production creates problems for cost-efficient utilization of transport and processing facilities. For perishable commodities, processing requirements may make it necessary to extend planting and harvest activities into more risky production periods.

Production support by marketing enterprises

2.28 Food marketing enterprises often have an important role in stimulating and directly supporting raw material production. They can do this by various means, including the supply of market and technical information, the supply of production financing, and the supply of certain material inputs (e.g. seeds, chicks, fertilizers). The incentives for marketing enterprises to provide such services will depend upon their ability to appropriate the benefits deriving from them; benefits such as increased output, enhanced product quality, and output better timed for marketing or processing requirements. The scope for appropriability of benefits will depend upon the nature of the goods/services themselves as well as the prevailing market structure.

2.29 For example, the dissemination of technical and market information has public good properties: such information is non-rival in its consumption and it is very difficult or costly to exclude individuals benefiting from the information without contributing to its cost. The marketing enterprise is unlikely to capture the full benefits from its supply of information since in a competitive environment, producers can utilize the information and then sell to a competing buyer. Where such 'free-riding' is widespread, there will be little incentive for private firms to provide more than minimal market or technical information. The provision of technical and market information may also be associated with so-called 'moral hazard' problems. The directed message may be biased toward the particular needs of the buyer rather than properly informing the producer about the wider range of technical and market options. The provision of technical information and the direct supply of production inputs can also give rise to negative externalities as when the recommended practices (e.g. heavy chemical use) adversely affect neighboring farmers or residents.

2.30 With respect to production financing, barriers arise due to limited collateral and asymmetric information. The producer is generally better informed than the marketing enterprise about his creditworthiness. The firm's ability to recover the loan may be better in a non-competitive than in a competitive market, since in the former case producers will have little or no alternative market outlet, enabling the lender to deduct the loan amount from the payments due for the commodity.

Processing and distribution functions

2.31 Several types of infrastructure, information, and other resources needed for efficient food processing and distribution functions have characteristics which may inhibit private investment in specialized activities, contribute to non-competitive market structures, and/or weaken the competitiveness of a commodity system. For example, certain types of infrastructure necessary for marketing have either public good properties or are subject to such large economies of scale as to result in natural monopolies in all but very large countries. Roads are an example of the former and rail and port facilities of the latter. Private firms engaged in food marketing will generally lack the capacity to invest in such facilities, the absence or poor quality of which will reduce producer incentives, raise marketing costs and restrain trade in certain directions.

2.32 While not featuring economies of scale as significant as for rail and port facilities, others types of marketing infrastructure do nevertheless entail 'lumpy' investments which can serve as a major barrier to entry. Investments in certain modern processing, storage, transport, and trading facilities provide the investor, at least initially, with an operational capacity far in excess of current supplies or supplies expected within a few years. The large unit operating costs in these initial years, together with uncertainty about future raw material or commodity supplies, may inhibit many private firms from undertaking such investments. In the absence of a well functioning stock or financial market, there may be few local means to pool the risk associated with such investments. Hence, in certain cases, private firms may not be able to perform the necessary risk-bearing function. For some infrastructure, there are also possible negative externalities as with the environmental effects of marketplaces and abattoirs.

2.33 Uncertainty will be especially strong for a new or highly specialized product which requires specialized processing or other facilities and equipment. In the short run, while supplies of the targeted product(s) are being built up, the specialized equipment may not be applicable to other, currently available, raw materials and commodities. Under such a condition of 'asset specificity', the processor/storer/transporter is locked-in to a certain type of operation and becomes vulnerable to the bargaining pressures of raw material suppliers and product buyers who possess alternative production, trading, or consuming options.

2.34 The processing, transport, and storage of raw materials and commodities takes time. The ability to participate in such activities thus depends on access to finance, both to pay for raw materials/commodities purchased and to cover the interest and other costs of goods held in storage or transit. The availability and cost of credit is thus an important factor in the entry and viability of firms and individuals in the marketing system.

Many private financial institutions have limited experience lending for agricultural marketing and processing. Limited recognized collateral and information asymmetries are again a potential problem.

2.35 Several additional functions are associated with economies of scale which may inhibit entry and therefore result in concentrated market structures. Both crop intelligence and market research feature economies of scale and scope with certain 'lumpy' investments in assets (e.g. computers, databases) and with advantages accruing to those with information sources in several locations and those trading in multiple commodities. Product promotion is also associated with economies of scale or scope, with a certain threshold level of trade and supply capability being necessary for such promotion to be worthwhile. There are both large sunk costs and large commercial risks associated with launching a new product, this again serving as a potential barrier to entry or sustained competitiveness.

2.36 Product promotion may also give rise to externalities, although this may depend upon the specificity of the promotion. Promotion of generic products (as opposed to individual brands) presents 'free rider' problems as some producers/traders can benefit from promotion without contributing to its costs. A related issue is the promotion of an overall industry or country within international markets. This too features economies of scale and externalities. For some product groups, especially fresh produce, there are potential advantages in promoting a national image for quality. This image or reputation is a public good: all firms in the industry are associated with it and new entrants into the trade inherit it. The reputation needs to be protected. The supply of substandard produce by one producer/exporter can jeopardize a whole commodity system's reputation, with adverse affects on market access or realized prices.

2.37 In an international context, transaction costs alone may serve as a major barrier to trade for many individuals and firms. In setting up a trade, exporters are likely to incur higher search and bargaining costs than domestic market traders. Physical distance to the target market(s) constrains access to information about trading opportunities, while an expectedly less dense information network will yield less complete information regarding the capabilities, financial solvency, and other characteristics of buyers or agents. Physical distance and/or language barriers may prevent face-to-face negotiations and contribute to an extended bargaining process. International traders may be unfamiliar with the standard trading practices in the opposite country and this may contribute to misperceptions about respective bargaining positions and tactics. Large geographical distances between traders increases logistical costs and risks and limit the scope for direct monitoring of trade partner performance. The enforcement of international contracts may prove very difficult and costly due to weak legal integration of countries and to the more limited scope for social group or trade association pressures on contract defaulters.

2.38 Table 3 summarizes some of the economic properties of major marketing infrastructure and functions. The table indicates that while relatively few of the facilities and services have public good properties, many are associated with externalities, economies of scale/scope, and/or moral hazard problems. Such properties, together with the important problems of risk, transaction costs, and logistics management might inhibit private investments in specialized production and marketing activities and/or reduce the degree to which such investments are privately and socially efficient. Table 4 summarizes the discussion in an alternative way by identifying possible gaps or bottlenecks in the flows of physical commodities, information, and/or financial resources within commodity systems which might stem from the inherent technical and economic characteristics of food products, production, processing, and marketing.

2.39 This analysis leads to the conclusion that while direct public sector involvement in the production and marketing of high-value foods can be economically justified in only very limited circumstances (e.g. in 'infant industry' contexts), the public sector may have important roles in commodity system development through the provision of physical infrastructure, the supply of market and technical information, the design and enforcement of standards (for inputs, products, and facilities), the implementation of programs and other measures to reduce or spread risks, and/or the encouragement of entry and competition.

Table 3: Economic Properties of Infrastructure and Functions Associated with Food Marketing


Public Good Properties


Economies of Scale/Scope

Moral Hazard

Overhead Infrastructure



Rail and Port Facilities





Power and Water Services



Production Support Services

Inputs Supply




Production Finance


Technical Info Supply




Market Info Supply



Post-Harvest Assessment/ Transformation

Crop/Production Intelligence


Initial Grading/Selection



Product Assembly



Quality Control





Marketing and Distribution

Local/Int'l. Transport




Market Research/Intelligence


Product Promotion






Country/Industry Promotion



Table 4: Generic Barriers to Commodity System Flows


Physical Product Flows

Informational Flows

Financial Flows

Commodity Characteristics







Production (Support) Characteristics

Geographical Dispersion



Unstable Production



Extended Gestation Period



Public Goods Nature of Market/Technical Information


Information Asymmetry in Credit


Processing/Distr. Characteristics

Scale Econ./Public Goods Nature of Transport Infrastructure


Scale Econ./Public Goods Nature of Communication Infrastr.


Asset Specificity in Processing



Information Asymmetry in Credit



Scale Econ. in Crop Intelligence and Market Research



2.40 A wide range of technical, institutional, and other measures can be adopted to facilitate the flow of information, goods, money, and product ownership rights in commodity systems, to achieve economies of scale and reduce the risks and transaction costs associated with food procurement and marketing, to internalize externalities, and to provide those public goods necessary for efficient market development. Many of these measures are essentially market or quasi-market responses on the part of private firms and individuals; others entail government interventions which stimulate, re-direct, constrain, or supplement private activity. While the available space here does not permit a comprehensive discussion of this wide array of technologies and institutions, this section does examine an illustrative sample of such measures, noting their potential for promoting improved efficiency, coordination, competitiveness, and other objectives.

Technological measures

2.41 Certain technologies can be introduced at the production level which have strong marketing implications. For example, crop varieties can be developed and adopted which yield commercial harvests sooner, which have a more extended seasonal yielding pattern, and whose harvested product has improved storage, taste, and other properties. Certain cultivation practices and chemicals can induce or delay crop maturity. Production under controlled irrigation or under controlled temperature, lighting, and other conditions can again influence the timing or seasonality of production as well as the quality of raw material output. These (and many other) production technologies may reduce production risks, enable producers to diversify their crop/livestock mix, and facilitate closer coordination between production and subsequent processing or distribution activities.

2.42 There are a wide range of well-established or emerging technologies which can facilitate the post-harvest flow of food products and raw materials by countering their perishability and/or bulkiness, and thereby lowering the risks and/or costs of commodity storage and transport. These include controlled atmosphere storage and transport, advanced mechanical handling techniques, vacuum and polyethylene packaging, wax coating, irradiation, and containerization in internal and international transport. Computerized warehousing and computer monitoring of goods in transit can improve physical commodity and informational flows, plus provide early quality control warnings.

2.43 Many processing and related food technologies can facilitate improved physical product flows, counter the uncertainties and costs of raw material procurement, and enhance consumer demand. Many processing functions directly reduce the bulkiness of and perishability of raw materials. The use of ultra-high temperature processing, together with aseptic packaging, can extend the marketable life of ordinarily highly perishable commodities (e.g. 'long-life' milk). Some technologies enable the replacement of natural raw materials with tailormade fat-, sugar-, beverage-, and other product substitutes. This obviates the need to coordinate processing with farm production. New processing technologies can facilitate greater uniformity of output, greater hygiene, or lower unit costs of production.

2.44 Still other technologies can facilitate improved monitoring of demand and improved communications between commodity system participants. Laser scanners at retail locations are an example of the former. Scanning not only speeds up retailer inventory management, but provides detailed information about the buying patterns of consumers: information which can be very valuable both to the retailer and to food manufacturers. Improved communications via facsimile, computer networks, and other devices can lower the costs of doing business and keep suppliers and buyers in up-to-the-minute contact regarding available suppliers, delivery times, prices, etc..

Laws, rules, and standards

2.45 All commodity systems operate within an institutional environment, consisting of a set of fundamental political, social, and legal ground rules. These ground rules establish the basis for production, exchange, and distribution. According to Ruttan and Hayami (1984, p.204), these ground rules "...facilitate coordination among people by helping them form expectations which each person can reasonably hold in dealing with others...[They] provide assurance respecting the actions of others and give order and stability to expectations in the complex and uncertain world of economic relations." The institutional environment governing a commodity system consists of several different types of rules, the most important being: l) rules defining, allocating, and enforcing property rights (for example, property and bankruptcy laws); and 2) rules and conventions defining permissible and nonpermissible forms of cooperation and competition (for example, standards, licensing rules, laws of contract and liability, company and cooperative laws, and 'fair trading' conventions).

2.46 A well articulated and consistently enforced system of property rights is a fundamental precondition for efficient exchange within commodity systems. Clarity over the ownership and the rights to use, trade, and alter assets is vital to market development since this assigns to individuals the rights to benefits (and the burden of losses) from specialized production and marketing activities (Bromley (1986)). The general system of property laws places boundaries on participant behavior and expectations and, in doing so, increases the scope for coordination.

2.47 Rules and conventions specifying entry conditions and boundaries on cooperative and competitive practices may also facilitate exchange and coordination. For example, The establishment and enforcement of standards can reduce transaction costs by increasing the available information to buyers and consumers. Standards, which may include basic weights, measures, and quality grades, provide farmers and marketing agents with a more exact language to communicate offers, a norm to compare actual with expected behavior, and a more detailed and objective view of the actual outcome. Quality standards may be mandatory or voluntary; they may be minimum standards or include multiple grades. They are especially important when trade takes place over large distances and among strangers as standardized goods can more easily be traded 'on description'.

2.48 The licensing of producers and marketing agents can also facilitate trade by reducing transaction costs. This would occur where the criteria for licensing centers around the asset-holdings, past experience, financial solvency, and other proxies for competence for the enterprises in question. In such cases, a public or collective authority would provide an initial screening of the capabilities and credibility of alternative suppliers and buyers. Performance incentives are built in since suppliers of substandard produce would risk revocation of license.

2.49 As food products become more complex and varied, consumers cannot be expected to have full knowledge about the choices available to them and the quality of products on offer. The food supplier has the incentive to supply just enough information that will differentiate its product(s) from its competitors, but no more. In order to enable consumers to make more informed decisions and to protect themselves from potentially harmful products and practices, regulations may be established requiring certain tests or inspections of products, certain handling or processing procedures, certain nutritional or other labels, and truth-in-advertising.

Spot marketing trading

2.50 The conception of market exchange found in most textbooks is one of an impersonal, one-time encounter between a buyer and seller of a standardized good or service. In such transactions, goods, services, money, and titles are transferred simultaneously: ie. 'on the spot'. Trade takes place in goods which have already been produced with market prices serving as the primary source of exchange-relevant information, constraints, and incentives. Each of the participating parties make independent decisions based on their own conditions and preferences and on the available information about the preferences and behavior of others.

2.51 There are several potential advantages of spot market trading over more elaborate trading or organizational ties (Hayek (1945); Williamson (1985)). First, the market price system offers clear and powerful incentives. Prices automatically meter and reward productive effort and, unlike in the case of many alternative institutional arrangements, the distributional consequences of spot market exchange are not complicated by past or future considerations or by the provision of non-measured services. Second, trade in this mode offers wide scope for flexibility to respond to changes in market conditions as it is generally easier to negotiate an adjustment in price levels alone than to agree upon and implement changes in trading rules or lines of command. Third, market prices place clear and powerful constraints on individual behavior-- factor prices provide budgetary constraints, while final goods prices provide purchasing constraints. In contrast, under alternative institutional arrangements, most behavioral constraints must be negotiated and supervised. Finally, in a competitive environment, spot market trading provides informational economies with market prices 'summarizing' all or most of the information which transactors require to conduct trade.

2.52 Spot market transactions can occur across several different types of markets, including auctions, private treaty, and posted price (Cassady (1974); Marion et al. (1986)). Auction markets feature an impersonal competitive bidding process which 'discovers' the market price. Auctions provide for very low transaction costs when large quantities of standardized products are traded. They also provide for great flexibility of prices which tend to change from minute to minute. If the auction is well supplied, trading may provide up-to-date information on supply and demand conditions. Auction markets generally feature standardized procedures for the exchange of payments for and title to goods.

Reputations, brand names and advertising

2.53 Reputations are one means of signaling competence and credibility. The reputation of an individual (or firm) will incorporate perceptions about the quality of the goods/services he offers, the trustworthiness of his words and actions, his competence, and various other real or mythical aspects of his character and behavior (Casson (1982)). 'Good' reputations reduce the costs of arms-length trade as buyers and sellers will have greater confidence in one another, permitting them to lower their initial screening efforts and subsequent monitoring of product quality. In contrast, when a firm or individual has a 'bad name', this is a signal to other parties either to pass up potential trades or else to closely monitor product quality, ask for prepayment for goods, and employ other defensive techniques. Reputations, both good and bad, provide a proxy for a large amount of information which may not be readily available to potential trading partners. A 'good' reputation may facilitate entry into new markets and can spillover onto other goods and services which its bearer may provide.

2.54 One means of facilitating this spillover of reputation effects is to develop and promote a brand name, either for a company or a country. Where the link between producers and ultimate consumers is weak or nonexistent, the reputation of the seller and his brand name may serve as an effective proxy for quality. The brand name establishes responsibility for the product, thus increasing the scope for compensation should quality be substandard (Demsetz (1964). Branding not only helps in the introduction of new products, but helps to forestall consumer substitution of the product with cheaper items. Advertising is another direct means of providing information to buyers and consumers and of persuading them of the merits of generic or branded products. Advertising can support the growth of firms and of markets and therefore contribute to the realization of economies of scale.

Personalized trading networks

2.55 Actual market relations frequently differ from idealized markets in that each established buyer and seller frequently develops groups of suppliers or customers with whom they are more inclined to deal with than anyone else. Through experience, each market participant locates specific parties with whom they have confidence in and with whom personalized, repetitive trading relationships develop under the aegis of unwritten, informal understandings. Such repetitive trading helps to reduce information costs and, with the development of norms and the build up of trust, reduces bargaining, monitoring, and enforcement costs (Wilson (1980)). In examining the 'bazaar economy' Geertz (1978) noted the importance of 'clientization' (e.g. the pairing of buyers and sellers in recurrent transactions), in reducing information costs in an uncertain trading environment. Richardson (1964) notes a similar process whereby buyers and sellers who are loyal to one another may obtain favorable attention or services, such as priority in times of product scarcity.

2.56 In environments in which formal (e.g. legal) procedures for monitoring and enforcing agreements are absent or inadequate, the generation of trust and the build-up of relationships based on reciprocity are likely to be crucial factors in the development of trade: they serve as a proxy for laws (Posner (1980)). Trust can allow transactors to build flexibility into their trading relationships since adjustments can be made sequentially with less risk of information distortions (Macauley (1963). The parties are aware that opportunistic behavior can undermine the basis of trust and therefore threaten the privileged trading status which each holds. Trust and reciprocity can enable trade to take place even in a very uncertain and unstable economic environment.


2.57 Brokers are intermediaries who do not take title over the commodities traded, but who link suppliers and customers. They are commonly found in agricultural markets and in all forms of international trade. For several reasons, brokered trade can be less costly for suppliers and customers. First, as regular players in the market, brokers are likely to be better informed about market conditions than the buyers, sellers or both. Brokers can assist buyers and sellers in sifting through and selecting the data relevant for them to make proper decisions. Second, a broker may have the social standing, experience, and bargaining skills to effectively bring together buyers and sellers from different locations, clans, or social settings. The broker, who cultivates the trust of both buyer and seller, can bring an element of personalization to trades between parties which do not know or directly communicate with one another. Third, brokers can achieve economies of scale in deal-making by accumulating small supplies/offers from many parties and selling to many other parties. Use of a broker may enable a supplier (or buyer) to stabilize his sales (or purchases) given the plethora of market outlets (and supply sources) which the broker can offer.

Contract coordination

2.58 Contract coordination represents an intermediate institutional arrangement between spot market trading and the vertical integration of production and marketing functions (Mighell and Jones (1963); Macneil (1975); Goldberg (1976). It can provide many of the benefits of integration, while still enabling its participants to retain at least some degree of autonomy. Market and production contracts formalize a degree of continuity or futurity in a trading relationship, covering a production cycle, a marketing season, or a longer time period. In contrast with spot market exchange, the agreed exchange is in promised goods and services rather than in already produced goods/services. Contractual details can vary enormously as can the overall intensity of the contractual relationship.

2.59 Two generic types of contracts can be identified, namely: a) forward market contracts involving future commitments by sellers and buyers to sell and purchase a particular commodity at or over a stated time period. Such contracts specify either particular weights or volumes of the commodity to be exchanged or else some minimum or maximum quantities. Specifications are also generally made regarding quality attributes. Pricing arrangements vary, although agreements are generally made on the basis of fixed prices or a formula for determining price upon delivery. Forward market contracts are commonly made between farmers and first-handlers, between exporters and importers, and between wholesalers or manufacturers and retailers. b) forward resource/management contracts which combine forward market sale and purchase commitments with stipulations regarding the transfer and use of specific resources and/or managerial functions. In such cases, the exchange of the raw material/commodity is made contingent upon the application of specified inputs and/or methods, while the buyer or seller may act to advise, supervise, or take over the management of particular production or trading activities. Such arrangements, which internalize some though not all product and factor transactions, are found in many sub-contracting (Mead (1984)), franchising, distributorship, and marketing/management agreements (Casson (1987)) and many contract farming schemes in agriculture (Wilson (1986); Watts et al. (1988); Glover and Kusterer (1990).

2.60 Both of these arrangements can serve as an effective vehicles for buyers to transfer complex information to sellers regarding their future delivery time, location, and quality preferences. This can be done through direct specifications or by erecting price schedules according to timing, quality, etc. By creating a forward market, these contracts may reduce the uncertainty of buyers regarding access to supplies and the uncertainty of sellers regarding access to markets. Such arrangements can also reduce the price and/or income risks of one or both parties, although this will depend upon the pricing methods used and the actual sources of price instability. Forward resource/management contracts can also serve as a means of transferring complex technical information, production inputs, and credit despite prevailing market imperfections in these areas (Minot (1986)). Production contracts can sometimes also be used as a form of collateral by farmers seeking credit from third parties.

Cooperatives/associations/voluntary chains

2.61 A cooperative enterprise, association, or voluntary chain of stores is formed by a group of economic entities who agree to act collectively in order to further their joint and own private interests. Such enterprises or associations can be formed by farmers, processors, wholesalers, retailers, or exporters, in order to undertake joint investments, common practices, or collective self-regulation of competition. The members essentially enter into a series of explicit and implicit contracts with one another, agreeing to certain membership terms and agreeing to certain standard operating procedures (Staatz (1984); Zusman (1989)).

2.62 Voluntary cooperation can support commodity system investment and coordination in at least the following ways: a) it can counter the problem of 'lumpy' investments in marketing infrastructure and services since the fixed costs of such investments can be spread among the group members. b) it can serve to internalize certain externalities and allow for private provision of certain public goods. One area for this is in product promotion which may not be worthwhile for an individual producer or trader, but profitable for a group since costs could be spread and benefits internalized. A group or association can also serve to promote and protect an industry's reputation for quality, reliability, etc. by monitoring its members and punishing (perhaps through loss of membership) those parties which provide substandard service to buyers/consumers. c) it can reduce or pool member risks by guaranteeing commodity purchases and sales on behalf of members, and by providing insurance and/or credit to members. When performing the sales function, the cooperative will pool the market price and access risks of members. Cooperatives or associations may be better placed to provide insurance and credit to members because of having more detailed and reliable information about their risks and creditworthiness. d) it can lower transaction costs for members and for non-members trading with members by settling disputes and by obtaining, interpreting, and disseminating information about production, markets, and farmer/trader competence and creditworthiness. A trade association can be an important 'first stop' for a prospective buyer of an industry's output and can provide a channel for consumer/buyer complaints. A farmers' cooperative can synthesize information about its members' production and be used as a low-cost channel for information from processors or traders. e) it can serve to exercise or counter market power for its members through collective negotiations with suppliers or buyers, by controlling/withholding member supply into the market, and by informing members about prevailing terms of trade.

Vertical integration

2.63 Vertical integration involves the combination of two or more separable stages of production or marketing under common ownership and management. It can take place via simultaneous investments in multiple, interlinked activities or through investments 'forward' or 'backward' to existing activities. Vertical integration can be complete or partial, the latter involving at least some sales or purchases of the focal intermediate products or services to or from outside parties. The economics literature stresses four major rationales for vertical integration, each being potentially relevant in the context of food commodity systems. a) Production/Logistical Economies: Vertical integration may reduce logistical costs associated with the procurement of raw materials and/or the sale of finished products. Where vertical integration involves bringing together in one location formerly distinct operating units, transport costs can be saved, particularly for bulky and perishable raw materials. Bringing under one management the suppliers and users of a raw material or other intermediate input can reduce the levels of required inventories because internal planning allows for a better match of supply and demand in terms of quantity and location. b) Transaction Cost Economies: With vertical integration information costs can be saved as the firm becomes the sole or predominant supplier to itself for certain goods and services (Coase (1937; Williamson ( 1979). Bargaining costs are saved as the firm engages in relatively few long-term employment contracts instead of many more short-term hiring and supply agreements. Streamlined information systems provide ample scope for transmitting complex non-price directives within the firm. Centralized decision-making within the firm provides scope for rapid adjustments to changing technical or market conditions. Adaptations can be made in a sequential way without having to consult, revise, or renegotiate agreements with other firms. c) Risk-bearing Advantages: Vertical integration may be a very effective institutional means of overcoming problems of risk and uncertainty (Arrow (1975). By internalizing flows of intermediate inputs, the firm may be able to eliminate certain risks such as variability of supplies, outlets, and quality, and the unauthorized use of technical information. More direct control over goods and assets can be exercised than under any arms-length or voluntary cooperation scheme. This reduced uncertainty may render the integrated firm better able to invest in highly specialized processing and marketing facilities and to take advantage of potential economies of scale. Partial integration (as with nucleus estate and outgrower schemes) may provide an even better combination of flexibility and risk-reduction or sharing (Carlton (1979)). d) Advantages in the Presence of Market Imperfections: In the early stages of market development when certain production or marketing functions remain slow in developing, vertical integration of multiple stages may be necessary to both stimulate consumer demand and guarantee the availability of the commodity (Stigler (1951). In the presence of taxes, price and exchange controls, and other regulations, the mere act of internalizing transactions may provide pecuniary gains as the firm. Governments treat market transactions differently from those which occur within firms. Vertically integrated firms may thus be able to bypass or minimize the effects of taxes and market controls." Finally, vertical integration may enable the firm to increase its market share and its leverage vis-a-vis suppliers and customers.

Government intervention

2.64 In circumstances where private supply of goods and services remains below the social optimum and where market, contractual, and cooperative mechanisms fail to effectively coordinate production and marketing activities, there may be justification for government interventions. Interventions by the State can reduce the risks and transaction costs faced by private firms and individuals, can compensate for missing or deficient markets, and can influence the organization and performance of commodity systems so as to enhance the benefits to the country or to particular interest groups (e.g. consumers, farmers, manufacturers). Government intervention need not entail direct government provision of goods and services. Regulation, taxation, and subsidization are alternative modes of intervention. As relatively few food marketing activities have public good properties, it is these types of interventions, rather than direct government participation, which are usually more appropriate.

2.65 The government has certain fundamental roles to play, these being either areas where only a sovereign body has the legitimacy or capability to act or areas where, for economic or technical reasons, the private sector will have insufficient incentives to provide a good or service at socially optimal levels. One of these fundamental roles lies in the definition and consistent enforcement of a reasonable set of property rights and regulations pertaining to acceptable and non-acceptable competitive and cooperative actions. Such property rights and regulations should not only facilitate production and trade, but also protect consumers against misleading claims and health-threatening foods.

2.66 A second fundamental role of government is to negotiate and define the rules for international trade and market entry. Governments can negotiate, either in bilateral or multilateral forums, to facilitate a particular commodity transaction (e.g. a deal with a state importing company) or to arrange longer term access for national firms to foreign markets on terms equal or superior to those accorded to competitive suppliers. At the same time (and usually under the influence of domestic interest groups), governments must determine the general rules for foreign entry into domestic input, financial, and commodity markets. Such rules will influence the competitiveness of food commodity systems vis-a-vis imported products as well as the availability and costs of production and other resources.

2.67 A third fundamental role of governments is to directly undertake or support the provision of goods and services which have public good properties, give rise to significant externalities, or feature economies of scale which are so significant as to result in natural monopolies. This pertains to several forms of physical and social infrastructure, including roads, rail and port facilities, power and water systems, technical research and training, and selected quality control and market information services. Because of the inherent economic properties of such goods and services, private supply may not be profitable or at least may not result in a socially optimal level of supply. While many governments have directly provided such goods and services, other options are to subsidize private supply, contract out supply to the private sector (thus assuring payment for services), or provide particular private or cooperative organizations with exclusive supply rights (e.g. on utility supply) or coercive powers (e.g. on quality control).

2.68 There are many other common types of government interventions in commodity systems. While of a less fundamental nature, these interventions can serve to counter market imperfections, reduce or alter the distribution of risks, influence the volumes and prices of traded products, and/or influence the distribution of opportunities and income. Comments follow on a sample of such common interventions.

2.69 Governments sometimes attempt to compensate for missing or deficient markets. This is particularly common in the area of credit where risk factors and major information imperfections are at play. Weak credit markets may result in limited funds available for small-scale farmers, cooperatives, and commodity traders, and for farmers and firms seeking to invest in assets carrying long gestation periods or being 'lumpy' in character. Being less risk-averse, governments may be better positioned to extend credit for these and other commodity system participants. An 'infant industry' argument for government support may be applicable in the early stages of development of particular commodity systems.

2.70 Another service commonly provided by governments is price stabilization. Stabilized prices can be regarded as a public good for farmers, consumers, processors, or other commodity system participants. Price stabilization-involving such instruments as price controls, floor prices, buffer stocks, variable taxes, and quantity controls-- is ostensibly undertaken in order to lower the risks and stabilize the incomes of producers and/or consumers. However, price stabilization is often very costly to undertake, generates allocative distortions, and can adversely affect producer or trader incentives.

2.71 Still other government interventions are geared toward influencing the competitive structure of markets, thereby affecting the volume and value of trade and the distribution of income. Regulations may be geared toward promoting or protecting a competitive market structure or conversely, toward promoting the concentration or monopolization of trade. The former would be more common in a domestic market setting-in the interface between farmers and processors or at wholesale or retail levels. The latter is more common in export-oriented industries where economies of scale and improved bargaining power can be achieved through some degree of trade concentration.

2.72 Where voluntary cooperation fails to control 'free riders', capture the benefits from scale economies, or enable suppliers to exercise market power, governments can institute schemes for compulsory cooperation. The most common and well-documented forms of compulsory cooperation are one-channel procurement and sales through marketing boards, and supply and pricing controls through marketing orders (Jesse (1979); Hoos (1979). Both marketing boards and marketing orders can be used to control physical commodity flows, enforce quality standards, and pool market risks.

2.73 With monopoly export marketing boards, an entire commodity system can 'behave' like a single firm vis-a-vis the world market, regulating the mix and quality of products going to different markets and negotiating with transporters and buyers with a single voice. While export marketing boards can achieve certain economies of scale, pool producer and processor risks, and provide a means for asserting or countering international market power, the boards can become a major barrier in the flow of information between foreign buyers and local producers and processors. In addition, export marketing boards can become either the tool of certain vested interest groups (e.g. the political leadership, influential farmers, or processors) or an unstable arena in which various interest groups battle over policies and the spoils of trade (Bates (1981); Arhin et al. (1985)). In either case, marketing board policies may result in reduced production incentives and a processing and marketing strategy which is not demand-oriented and thus not sustainable in a competitive world market.

2.74 Table 5 summarizes this discussion by indicating whether the noted technologies or institutional mechanisms facilitate improved commodity and other flows, reduce raw material procurement and market risks, internalize externalities, etc.

Technological/Institutional Measures to Facilitate Commodity System Coordination, Efficiency and Market Power