(introduction...)

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

Table 4: Generic Barriers to Commodity System Flows