Retail Oligopoly Power and Fluid Milk Prices in Boston

Transcription

1 Retal Olgopoly Power and Flud Mlk Prces n Boston Benassa Chdm, Rgoberto A. Lopez, and Ronald W. Cotterll Department o Agrcultural & Resource Economcs, Unversty o Connectcut 1376 Storrs Rd., CT Phone (860) Benassa.2.chdm@uconn.edu or rlopez@canr.uconn.edu Abstract Ths paper assesses the ndependent and jont mpacts o olgopoly power o market ntermedares and the Northeast Dary Compact (NEDC) on lud mlk prces n Boston. Emprcal results reveal that prce ncreases due to olgopoly power ar outweghed those caused by the NEDC by more than 10 tmes. In act, markups are estmated at approxmately 33% o the retal mlk prce, translatng nto approxmately $1/gallon overcharge at 2002 mlk prces averagng around $3/gallon. Paper Prepared or presentaton at the Amercan Agrcultural Economcs Assocaton Annual Meetngs, Montreal, Canada, July 27-30, 2003 Copyrght by B. Chdm, R.A. Lopez, and R.W. Cotterll. All rghts reserved. Readers may make verbatm copes o ths document or non-commercal purposes by any means, provded that ths copyrght notce appears on all such copes.

2 Retal Olgopoly Power and Flud Mlk Prces n Boston 1. Introducton Market power, the ablty o rms to control market prce or quantty, oten coexsts wth other market mperectons. Allegatons o market power n the Boston mlk market stems rom observed ncreases n concentraton n processng and retalng as well as rom retal mlk prces that are hgher than n neghborng states. In addton, other market dstortons stem rom recent publc polces that aect raw mlk prces, such as the Northeast Dary Compact (NEDC) and, more recently, ederal subsdes based on the Class I mlk prce n Boston. 1 For polcy analysts, an mportant queston when evaluatng the ndependent mpacts o market power or publc polces s whether or not the presence or absence o the other dstortons should be taken nto account. That s, should mpacts be evaluated n a rst-best or second-best world? The relevant polcy queston depends on a polcy maker's degrees o reedom n elmnatng market mperectons. The Boston lud mlk market provdes a useul case study. Frst, publc polces have strred a hot debate n polcy and research arenas, partcularly regardng the NEDC whch controlled supply n order to support raw mlk prces. 2 These polces have co-exsted wth ncreasngly concentratng processng and retalng sectors that have also rased market power concerns. Nonetheless, amd crtcs and economc nterests o leadng mlk-producng states, the NEDC was dsmantled n September Now that the NEDC s gone, the ssue o hgh retal mlk prces and markups n the Boston area reman n the spotlght. Furthermore, the newly created Natonal Dary Program that reles on the Class I Boston prce rases the stakes o the potental mpact o the olgopoly behavor o retalers (whch would curtal volume sales to attan hgher prces) on raw mlk prces n the Boston area and beyond. 3 Ironcally, the zero cost to 1

3 taxpayers o the NEDC has been replaced by a program pad or by taxpayers that wll benet processors, dary producers at the natonal level and to some extent New England dary armers (relatve to the alternatve o no program at all) and consumers (to the extent that the cost savngs are passed onto them). Ths paper assesses the jont and ndependent mpacts o olgopoly power o processors and retalers and o the NEDC on retal mlk prces and markups n Boston. The paper draws rom the model o Appelbaum (1982) to measure departures rom compettve behavor and the mpact o the NEDC on markups. Emprcal ndngs ndcate that although the NEDC ncreased the retal prce o mlk by 7.9 cents per gallon under pre-exstng olgopoly power, the ncrease n consumer prces due to olgopoly power s more than 10 tmes that amount. Fndngs ndcate that approxmately 33% o the retal prce s due to olgopoly power, translatng to approxmately a $1/gallon overcharge at current mlk retal prces o about $3/gallon The Boston Flud Mlk Market The Boston lud mlk market provdes an nterestng case study or a number o reasons. In partcular, t has undergone sgncant changes n both market structure and raw mlk polcy programs. In addton to beng subject to regulaton through the NEDC rom July 1997 through September 2001, at the processor level, the market share o the top our lud mlk processors n the Boston area ncreased rom 66 percent to 88 percent between 1997 and 1999 (GAO, June 2001). Ths ncrease n concentraton s manly the result o mergers and acqustons. 5 At the retal level, the market share o the our top supermarkets (Stop & Shop, Shaw s, DeMoulas, and Star Market) n the Boston area ncreased rom 55 percent to 70 percent between 1997 and 1999 (GAO, June 2001). By July 2000, these supermarkets controlled more than 84 2

4 percent o lud mlk sales (Table1). The retalers are the domnant players. Frst, ther prvate label mlk accounts or more than 68 percent o total mlk sales. Second, ther poston n the chan makes them the ultmate-prcng makers. Thrd, ther prces appear to be hghly coordnated. Usng the our-weekly data rom Inormaton Resources Incorporated-Inoscan (IRI), the partal correlaton coecent o the retal mlk prces or these supermarkets ranges rom 0.94 to 0.98, and thus move together to a great extent as shown n gure 1. Table 1: Characterstcs o the Mlk Retalers n Boston Stop & Shop Shaw s DeMoulas Star Market Others Mlk Market Share (%) Grocery Market Share In-Store Prvate Label Mlk na Share (%) Square Footage Source: IRI ( ) and Trade Dmensons (1998).. 3. The Model Consder a lud mlk ndustry n whch N rms produce and dstrbute a homogeneous good. Each rm s assumed to be vertcally ntegrated nto processng and retalng mlk. Total ndustry output s gven by N Q = q = 1, where q s the level produced by rm. Let the market demand acng the ndustry be gven by: Q = ( p, Z), (1) r 3

5 where p r s the retal prce o mlk and Z s a vector o demand shters. The varable prots made by the th retaler/processor are gven by: π = pq p q C ( q, w), (2) where p s the arm prce and C ( q, w) s the cost o processng and dstrbutng mlk ncurred by the th rm, and w s a vector o prces or non-mlk nputs n processng and dstrbuton actvtes. The rst order condton or maxmzaton o (2) yelds: p r = p + MC θ 1+ η, (3) where θ s a conjectural varaton elastcty = lnq / ln q ) and η s the prce elastcty o ( market demand = ln Q / ln P ). Note that the margnal cost has two components: the mlk ( r margnal cost P and the non-mlk margnal cost MC. The larger θ j or the lower η (n absolute value) s, the wder wll be the markup over margnal cost or the spread between retal prce and arm prce. To ner market power wth market level data, two problems arse rom equaton (3): the aggregaton o non-mlk margnal cost MC and the aggregaton o conjectural varaton elastctes across rms. We specy a Gorman polar orm so that margnal costs are constant across rms wthout mplyng that cost unctons are dentcal or all rms: MC j = MC. Then, as long as the assumpton o constant total margnal cost s mantaned, at equlbrum the conjectural elastctes are the same or all retalers ( θ = θ ) j. Wth these assumptons, ndustry equlbrum s depcted by: 4

6 p + MC pr =. (4) θ 1+ η Under perectly compettve behavor θ = 0, and the retal prce equals margnal cost. As the conjectural varaton elastcty ncreases, the markup over margnal cost ncreases. The null hypothess to be tested concerns the market conduct parameter θ and ts devaton rom perect competton as well as any changes n conduct due to mplementaton o the NEDC. In order to evaluate the mpact o the mplementaton o NEDC, the parameter θ s allowed to vary wth a NEDC dummy varable. Assumng a lnear non-mlk margnal cost uncton wth m nputs purchased at xed prces ( = 1, K, m), equaton (4) becomes: p = w m p + βw = 1, (5) ( θ0 θ NEDC) + η r where β, θ 0 and θ 1 are parameters to be estmated. The market demand uncton (1) aced by retalers s assumed to take the double logarthmc orm gven by 0 ln( pr / d) n ln Q = α + η + α Z, (6) = 1 where ln ndcates the natural logarthm operator,q s the total quantty o lud mlk, d s a prce delator, Z denotes demand shters, and the α s and η are parameters to be estmated. To determne the mpacts o olgopoly power and the NEDC, t s necessary to separate out the two eects. To do so, one can decompose equaton (5) nto our scenaros: 5

7 Table 2. Retal Prce or Flud Mlk under Alternatve Scenaros Olgopoly Perect Competton NEDC A: p r p + NMMC = (θ 0 + θ1nedc) 1+ η B: p = p NMMC r + No NEDC C: p r = p * + NMMC 1+ θ 0 η D: p p NMMC r = * + NMMC 1β s the non- * p represents the arm level prce n the absence o the NEDC, mlk margnal cost = m = w Scenaro A llustrates the actual stuaton wth smultaneous dstorton o retal olgopoly power and the NEDC. Under compettve prcng wth the absence o the NEDC, the retal prce s equal to the total margnal cost, whch ncludes the raw mlk prce and the cost o processng and dstrbutng mlk. Departure rom the compettve prce mples that there s a markup above total margnal cost. Scenaro C llustrates the mpact o the olgopoly market power on the retal prce o lud mlk n the absence o the NEDC. Smlarly, scenaro B llustrates the mpact o the mplementaton o the NEDC on retal prces or lud mlk when the market s compettve. 4. Data and Estmaton Equatons (5) and (6) are the bass or emprcally assessng the market power o lud mlk processors/retalers n the Boston lud mlk market and the mpact o the NEDC. The model s estmated wth data rom the Boston mlk market. The core data came rom the Inormaton Resources Incorporated-Inoscan (IRI) database provded by the Food and 6

8 Marketng Polcy Center at the Unversty o Connectcut. It ncludes 58 our-week-endng observatons coverng the perod rom March 1996 to July The IRI data provded the values o lud mlk sales by each supermarket chan, the volume sold, and the percentage o lud mlk sold through promotons and merchandsng. The retal mlk prce was computed by dvdng total dollar sales by total volume. Regardng nput costs, the arm level mlk prce s the most mportant cost n retal packaged lud mlk. The Federal Mlk Market Order announced Class I prce was used to measure P. Wage rate ($/hour) data was used n the non-mlk cost uncton speccaton. The Boston area wage rate or ood manuacturng was obtaned rom the webste o the Bureau o Labor Statstcs. Other non-mlk nput costs (.e., a natonal prce ndex or the prce o energy) had to be excluded due to multcollnearty and pervasve results. Addtonal demand uncton data ncluded per capta ncome, the prce o orange juce (as a complement/substtute good), and the percentage o lud mlk sold under promoton. Prces and ncome n the demand equaton were delated by the consumer prce ndex or Boston. The system o equatons n (5) and (6) s recursve, nonlnear n parameters, and has a cross-parameter restrcton (η ). The system o equatons was estmated usng the Generalzed Method o Moments (GMM). The GMM estmaton method ntroduced by Hansen (1982) goes beyond the non-lnear two-stage least squares method o Amemya (1974) n that t ncorporates nonlnear moment condtons beyond moment condtons generated by orthogonalty o nstrumental varables and dsturbances n a model (Lee, 2001). 5. Emprcal Results The parameter estmates or equatons (5) and (6) are summarzed n Table 3. The results ndcate that the conjectural varaton elastcty estmate ˆ θ +θˆ ) s sgncantly ( 0 1 = 7

9 derent rom zero at the 5% level, meanng that market conduct s not perectly compettve. On the other hand, the hypothess that θ +θ 1 was also rejected, meanng that the processors/ retalers are not perectly collusve ether. 0 1 = Although the rst term o the conjectural varaton elastcty ( θ 0 ) s postve and sgncant at the 5% level, the second term ( θ 1 ) s postve but not sgncantly derent rom zero (at the 5% level). Ths result suggests that the NEDC dd not have a dscernable eect on the conjectural varaton elastcty. Ths does not mean that market conduct was any more compettve ater the NEDC mplementaton. Rather, prcng conduct contnued mostly at the pre-exstng level and markups dd not sgncantly ncrease. The computed Lerner ndex ( L = ) s sgncantly derent rom zero at the 5% level. The value o the Lerner ndex suggests that the processors/retalers do exert a sgncant degree o olgopoly power by settng lud mlk retal prces above the level dctated by compettve prcng. The markup over the margnal cost, whch serves as the compettve benchmark, s approxmately one-thrd o the retal mlk prce. At current mlk prces o about $3/gallon, ths translates approxmately a $1/gallon overcharge. The mpact o the mplementaton o the NEDC s determned by means o dervaton o the equaton (5) wth respect to the NEDC varable. 6 The results show that the total eect n the Boston mlk market o the Compact s an ncrease n the retal prce o mlk o 7.9 cents per gallon. In comparson, Baley (2000) concluded that the NEDC s mpact rased retal mlk prces 14 cents per gallon, whle Cotterll and Frankln (2001) ound the mpact to be a 4.5 cents per gallon ncrease. Dhar (2001) ound prce ncreases rangng rom 7 cents per gallon or Hood 8

10 mlk to 17 cents or prvate label mlk ater the mplementaton o the Compact. Thus, the magntude o the prce ncrease ound n ths paper s n the range o those n prevous studes. Besdes derences n the magntudes o the ncrease n retal mlk prces due to the Compact, stark derences reman n the nterpretaton o the sources o the ncrease. Baley (2000) asserts the Compact s responsble or the ull ncrease n prces, takng ndustry markups as gven and exoneratng processors and retalers It should be noted that the ndngs o ths paper do support Baley s methodology n that percent markups dd not change wth the Compact. Cotterll and Frankln (2001) argue that under prce certanty equvalence, the Compact should have rased prces at most 4.5 cents per gallon and should have nduced a lower ncrease n consumer prces due to prce stablty. They put the blame on processors and retalers or retal prce ncreases. Dhar (2001) attrbutes these margn wdenng ncreases to more collusve market conduct ater mplementaton o the Compact. Fgure 2 depcts the actual Boston mlk prces and the estmated prces, whch would preval the Boston mlk market segment were perectly compettve. The gap represents overcharge attrbuted to the estmated olgopoly power o processors and retalers. The average overcharge s about $0.86/gallon or $0.92/gallon n constant July 2000 dollars (usng the Boston consumer prce ndex as a delator). Although the NEDC captured much o the meda, poltcal and academc alteraton, t s worth notng that estmated overcharges attrbuted to the NEDC pale n comparson to the olgopoly overcharges ound n ths study. The estmated olgopoly markup s more than 10 tmes the sze o the prce ncrease attrbuted to the NEDC prce ncrease. The emprcal results urther show that the prce elastcty o demand or mlk at the retal level n Boston s estmated at approxmately , llustratng that lud mlk demand s 9

11 nelastc. The estmate derved here s consstent wth estmates presented by Johnson, Stonehouse and Hassan (1992). The low elastcty o demand also corroborates the large potental olgopoly power o the processors and retalers as current consoldaton trends contnue. 6. Concludng Remarks In concluson, the ndngs reported n ths paper strongly support the noton that retalers/processors do exert a sgncant degree o olgopoly power n the Boston lud mlk market. They reveal that prce ncreases due to olgopoly power have ar outweghed those caused by the Northeast Dary Compact. Olgopoly generated markups are estmated at approxmately 33% o the retal mlk prce, translatng nto approxmately a $1/gallon overcharge at current mlk prces averagng around $3/gallon. The results also show that ater the mplementaton o the Northeast Dary Compact retal mlk prces ncreased by 7.9 cents, wth 3.4 cents o that ncrease due to olgopoly power. The Northeast Dary Compact dd not sgncantly change prcng behavor or percent mark ups n the Boston lud mlk markets. Ultmately, the ndngs o ths study llustrate that ncluson o market power by ntermedares should be consstent when desgnng a more comprehensve dary polcy program. Assumng that processng and retalng channels are perectly compettve can lead to deceptve equty and ecency conclusons regardng programs that purport to assst dary armers and help consumers. 10

12 Footnotes 1 In July 1997, the Northeast Dary Compact (NEDC) was created wth the presumpton that t would have several desrable socal benets, ncludng provdng stable arm prces or small amly arms wthout the nuson o ederal tax dollars (Baley, 2001). Researchers and polcy makers alke rased major questons concernng the mpact o the Compact on consumers,.e., the retal prce o lud mlk. Ths paper wll not deal wth postve externaltes arsng rom open space n dary lands n the greater Boston area (Lopez, Altobello, and Shah, 1994) or wth potental spllover prce eects to producers n other regons (Baley, 2001). 2 Researchers have taken several avenues o nqury and have reached contradctory emprcal results. One set o studes ocuses on asymmetrc prce transmsson, assumng a compettve mlk marketng channel (e.g., Lass et al., 2001); another set o studes speces rather than estmates a proportonal markup n a smulaton model ramework (e.g., Baley, 2000); and yet another set o studes compares prces, margns and costs beore and ater the NEDC (Cotterll and Frankln, 2001). Dhar (2001) uses a vertcal Nash game at the brand level n the Boston market and ntroduces the compact as a dummy varable n the prcng equaton. Cotterll (2002) revews and crtques these studes. 3 Ths 3 ½ year program provdes a ederal payment to producers each month equal to 45% o the derence between $16.94 and the Boston Class I prce. Payments are made on up to 2.4 mllon pounds o producton per year to a producer anywhere n the U.S. The estmated cost o ths program s approxmately $1 bllon. 4 A state hearng on November 12, 2002 n Boston turned up evdence that the regon s largest dary processors and supermarket chans may be earnng large prots on mlk or more than $1/gallon (Mohl, 2002). 5 As an example o merger and acquston, Suza Foods Corporaton acqured n 1997 Garelck Farms and Frankln Plastcs, a local lud mlk processor. Accordng to Cotterll (2001), Suza Foods Corporaton process most brands ncludng Garelck, Sealtest, and the store brands o Wal-Mart and nearly all supermarkets except Bg Y and Shoprte. 6 The mpact o the mplementaton o the NEDC s determned by dervng the ollowng decomposton based on equaton (5). T T P P P r MC MC L P θ = + + NEDC P NEDC P NEDC 1 L θ NEDC T where MC s the total margnal cost ( P + NMMC). The smulaton s conducted or an ncrease o 4.5 n the raw mlk prce due to the Compact (Cotterll and Frankln, 2001). The rst term s estmated at 4.5 cents, the second term at 2.2 cents and the thrd term at 1.2 cents. The sum o the last two terms (3.4 cents or 43% o the total ncrease) s attrbuted to olgopolstc market power. Our ndngs are consstent wth state polcy makers concerns. 11

13 Reerences Amemya, T. The Nonlnear Two-Stage Least Squares Estmator. Journal o Econometrcs 2, (1974): Appelbaum, Ele. The Estmaton o the Degree o Olgopoly Power. Journal o Econometrcs, 19 (1982): Baley, Kenneth. Report on the Operaton and Perormance o the Northeast Interstate Dary Compact. Department o Agrcultural Economcs and Rural Socology, Pennsylvana State Unversty, Baley, Kenneth. "Congress's Dary Dlemma." Regulaton 24(2001): Cotterll, Ronald W. Contnung Concentraton n the U.S.: Strategc Challenges to an Unstable Status Quo. In W. Ramsay ed., The Global Food Industry: Strategc Drectons. Fnancal Tmes Monograph Seres, London Cotterll, Ronald W. The Impact o the Northeast Dary Compact on New England Consumers: A Report rom the Mlk Polcy Wars. Unversty o Connectcut, Food Marketng Polcy Center, Avalable at Cotterll, Ronald W., and Andrew W. Frankln, The Publc Interest and Prvate Economc Power: A Case Study o the Northeast Dary Compact. Unversty o Connectcut, Food Marketng Polcy Center Monograph No. 1, May 2, Avalable at Dhar, Trtha. P. Two Stage Olgopoly Prcng wth Derentated Product: The Boston Flud Mlk Market. Unversty o Connectcut, Storrs, Ph.D. Dssertaton,

14 Hansen, L.P. Large Sample Propertes o Generalzed o Generalzed Method o Moments Estmators. Econemetrca 50 (1982): Johnson, S.R., D. Peter Stonehouse and Zuhar A. Hassan. Market Demand or Dary Products. Ames, IA:Iowa State Unversty Press, Lass, D. A., M. Adanu, and P.G. Allen. Impacts o the Northeast Dary Compact on Retal Prces. Agrcultural and Resource Economcs Revew, 30(2001), Lee, L.F. Generalzed Method o Moments Estmaton o Spatal Autoregressve Processes. Manuscrpt rom the Department o Economcs, Oho State Unversty at Columbus, Oho, August 2001 Lopez, Rgoberto A., Marlyn A. Altobello, and Farhed A. Shah. "Amenty Benets and Publc Polcy: An Applcaton to the Connectcut Dary Sector." Journal o Agrcultural and Appled Economcs 26(1994): Mohl, Bruce. "Economsts Fnd Hgh Markup o Regonal Mlk Prces." The Boston Globe, Wednesday, November 13, 2002, pages D1 and D6. U.S. Bureau o Labor Statstcs. State and Area Employment, Hours, and Earnngs. Washngton, D.C. Retreved January 15, 2002 rom: [ Unted States General Accountng Oce Dary Industry: Inormaton on Mlk Prces and Changng Market Structure. Resources, Communty, and Economc Development Dvson. Washngton, D.C. June. 13

15 Table 3. Parameter Estmates or Prcng and Demand Equatons n the Boston Mlk Market. Varable Parameter Coecent T-Rato Prcng Equaton: Pre-NEDC Conj Var. El. θ ** NEDC Dummy θ MC Constant β *** Wage β *** Elastcty o demand η *** Demand Equaton: Constant α *** Elastcty o Demand η *** Log o Income α *** Log o Orange Juce Prce α *** Log o % Promoton Sales α ** Lerner Index (Post NEDC) ( θ 0 + θ ) η *** Notes: Two and three astersks ndcate sgncance at the 5 and 1 percent levels, respectvely. N=58 our-weekly observatons between March 1996 and July

16 6/18/ Fgure 1: Retal Mlk Prces at the Top Four Supermarkets n Boston, March 1996 through July 2000 NEDC 6/23/1996 8/18/ /13/1996 8/12/1996 2/2/1997 3/30/1997 5/25/1997 7/20/1997 9/14/1997 9/11/1997 4/1/1998 1/3/1998 4/26/1998 6/21/1998 8/16/ /10/1998 6/12/1998 1/31/1999 3/28/1999 5/23/1999 7/18/ /9/1999 7/11/1999 2/1/2000 2/27/2000 4/24/2000 Average Boston Stop & Shop Shaw's DeMoulas Star Market 15 4/28/1996 3/3/1996

17 16

18 Fgure 2. Alternatve Scenaros o Retal Prces or Flud Mlk n Boston, 17 $/Gallon 3/3/1996 5/3/1996 7/3/1996 9/3/ /3/1996 1/3/1997 3/3/1997 5/3/1997 7/3/1997 9/3/ /3/1997 1/3/1998 3/3/1998 5/3/1998 7/3/1998 9/3/ /3/1998 1/3/1999 3/3/1999 5/3/1999 7/3/1999 9/3/ /3/1999 1/3/2000 3/3/2000 5/3/2000 7/3/2000 NEDC A B C D