Revised, January 2006
Alena Bosse
Graduate Research Assistant
Department of Ag Economics
Kansas State University |
Mike Boland
Professor
Department of Ag Economics
Kansas State University
mboland@agecon.ksu.edu |
 |
The trend toward fewer, larger, and increasingly corporate farms has created a concern that many midsize family-owned farms will disappear. Already less than 2 percent of all farms account for nearly 40 percent of the value of U.S. output. Many rural areas faced with declining numbers of farm jobs consider the food processing sector as a source of potential income and employment growth. By adding value to farm products, this food processing sector is seen by some analysts as a key element for rural growth, as well as a way to enhance farm income and provide rural jobs.
Leaders of local communities are looking for solutions to their local economic problems. If rural areas cannot find ways to attract or create jobs requiring the skills of highly educated people, they may lose the group most likely to be the catalyst for improving local conditions. However, any gains by rural areas probably will have to come about through intense competition with older, more-established industries in many metropolitan areas.
The information below describes why adding value is important. The farm value is the consumer food dollar compared to the value derived from processing and marketing and the return on equity of both is presented. Also the current transitional period of agriculture is described including the decline in the rural economy.
Farm Value versus Marketing Bill
The spread between the farm value of products and the retail value, often called the marketing bill, has increased steadily for the past 30 years (Figure 1). The farm value in real dollars (adjusted by the Consumer Price Index with 1982-1984 being the base years) has remained nearly constant, but the costs of processing and marketing have continued to increase.
Figure 1: Total Food Expenditures Divided into Farm Value and Value Added
*Source: USDA Economic Resource Service
Figure 2 compares the marketing bill and the farm value as a percentage of total food expenditures. In 2000, consumers spent $661.1 billion on food expenditures, with the farm value contributing 19 percent and the other 81 percent coming from value-adding processes. That contrasts with 1952, when the farm value was 32 percent of the total food expenditures.
Figure 2: Total Retail Food Expenditures Percentages Comparing the Marketing Bill and Farm Value
*Source: USDA Economic Resource Service
Be aware that risk in starting a value-added business is high. Startup costs can make it difficult to realize a profit during the early years. Each producer must decide how much risk is incurred if the opportunity is pursued compared to the risk if the opportunity is not pursued and make a choice based on expected risk and return outcomes and risk preferences.
Total Food Expenditures
Figure 3 shows that the percentage of disposable income that consumers in the United States spend on food has decreased steadily. The amount spent by consumers decreased from 23 percent in 1929 to 9 percent in 2004.
Figure 3: Percentage of Disposable Income Spent on Food in the US
*Source: USDA Economic Resource Service
Figure 4 shows how the real dollars spent for food compare to the total disposable income. Food expenditures in real dollars have remained relatively steady over the past 70 years. However, disposable income has increased about 6 percent per year, growing from $83.4 billion to $8,664 billion dollars. This suggests that consumers may be less sensitive to the price of food than in the past and more willing to pay for high quality and high convenience.
Figure 4: Total Disposable Income Compared to Food Expenses
*Source: USDA Economic Resource Service
Food purchases generally are considered to have an inelastic demand. Inelastic demand curves indicate that changes in prices do not have a large percentage effect on the quantity demanded. This theory implies that specialty food products designed for distinct consumer target markets can be priced higher, and the quantity demanded still will be nearly the same. Two specific examples of this are Certified Angus Beef, which sells for a premium and organic foods.
In summary, value-added activities targeted to particular consumer desires have the potential to become more numerous in the future. These opportunities could help those involved in value-added activities to capture higher economic profits.
Transitional Period in Agriculture
Several circumstances are contributing to an increasingly turbulent time in agriculture. They include a reduction in federal price support, changes in consumer desires, increased use of biotechnology and information technology, and increased world trade. Egerstrom states “…the individual farm is being transformed into a small manufacturing firm that makes component parts for an extremely sophisticated and integrated global food system.”
Federal Price Supports Scaled Back
Federal price support programs are being scaled back, and there is less reliance on federal coffers for bolstering farm income. Adding value to farm commodities may become an even more important income-enhancing strategy for producers. Commodity prices will be similar in the future to what they have been in the past, but periods of excess supply and low prices will occur. New risk-management tools will need to be developed.
Many producers will look for ways to be economically viable through voluntary, incentive-based solutions. Producers’ greatest opportunities may lie in activities that add value to their products and move their point of first sale downstream toward consumers. Adding value to bulk raw commodities is one way for producers to keep a larger share of the margins associated with further processing and market development. Progressive producers respond to market developments, determine what factors will drive the future of their industry, and use these results to their advantage by adapting to change.
Increased Focus on Consumers
Food processors respond to customer fragmentation by offering more uniquely targeted lines of food, while experimenting with novel forms of advertising and promotion to reach the intended segments more efficiently. When incomes rise, consumers tend to buy a wider variety of unique food products that are highly processed and highly advertised and are less price elastic than the traditional foods they replace. Consumers also increasingly rely on brand or company reputations as quality guides.
Preparation convenience is a key feature of foods purchased by busy, affluent households. In fact, the number of food service meals eaten away from home has increased by 50 percent in the last 20 years. Six significant growth trends in consumer demand have been identified:
- more convenience,
- ethnic-identity foods,
- aging of the population,
- low-calorie foods,
- fresh foods instead of frozen or canned, and
- healthy natural foods.
Value-added producers should focus on products that fill these consumer desires or market niches. By utilizing value-added precepts for business development, producers can identify the desires of consumers and target markets, rather than taking the commodity to the market and hoping that consumers will like it and use it. Target markets are tightening as retailers and consumers pay more for a narrower range of eating experience. Hitting these target markets means that value-added businesses must know their consumers’ desires.
In summary, producers should stay attuned to the needs of the marketplace, instead of concentrating only on production and ignoring the final marketed product. They should see themselves producing consumer products instead of farm commodity products.
Biotechnology
The evolution of biotechnology in the 21st century is expected to cause a restructuring throughout the world food and agriculture system. Newly formed life science companies will redefine the role of creating and capturing value through genetics and processing. More value-added crops with specific traits for food, industrial uses, and possibly even medicinal traits will be forthcoming. The costs of segregation and identity preservation of these unique crops can be high. However, when the value is truly evident, the marketing and distribution system will accommodate the special requirements of channeling products from producers to end users.
World Trade
Trade agreements including the North American Free Trade Agreement and pacts among the World Trade Organization have facilitated greater and freer trade of agricultural commodities among its member countries. These changes in the international trading environment are greatly influencing agriculture production, processing, and marketing industries through increased imports and displacing or complementing domestic production. Indeed, increasing access to foreign markets is essential for a profitable and growing agricultural sector, especially with value-added processing and marketing.
Declining Rural Economy
Steady declines in the number of farms and growth in average acreage per farm have occurred for a number of years in the United States and Kansas (Figures 5). Looking at the United States as a whole in 1997, 2,059,000 farms averaged 470 acres per farm. This contrasts with 5,648,000 farms averaging 216 acres in 1950. The USDA projects a 1.1 percent annual decline in farm numbers through 2010, when it estimates that 360,000 commercial farms will account for 82 percent of farm gross income.
Figure 5: Number of Farms (thousands) and Size of Farms in the U.S., 1950 to 1997
*Source: USDA National Agricultural Statistics Service
The pattern of economic growth in farm-dependent rural counties in the 1980s depended on either being an active trade center for a much larger region or having a concentration of food processing activity. Value-added product development provides excellent opportunities to stimulate economic development, as the following case study demonstrates.
* Based on Value Added Industry Profile, Department of Agricultural Economics, Kansas State University
REFERENCES
Akridge, J., D. Downey, M. Boehlje, K. Hariing, F. Barnard, and T. Baker. 1997. "Agricultural Input Industries." Food System 21 Gearing Up for the New Millennium, Chapter 15. Purdue University Cooperative Extension Service, West Lafayette, Indiana.
Barkema, A., and M. Drabenstott. 1996. "Consolidation and Change in Heartland Agriculture." Economic Forces Shaping the Rural Heartland. Federal Bank of Kansas City, Missouri.
Barkema, A., and M. Drabenstott. 1995. "The Many Paths of Vertical Coordination: Structural Implications for the US Food System." Agribusiness, 11(5)