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Date:

June 16, 2000

Subject:

Is There an Economist in the House?

 

Andrew,

I can't claim to be an expert on the organic industry, but I think I
can shed some light on your questions.

1. Generally speaking, you'd have to admit that organic production is
more costly than conventional agriculture. But market prices are determined
by more than just cost to the producer. Prices in an unfettered market
are determined by the confluence of both Supply and Demand. So even if
organic production was actually the same or less costly, the price of an
organic foodstuff could still (at least temporarily) be higher than the price
of an equivalent non-organic foodstuff, if consumers were willing to pay
more.

(And vice versa, if production costs were higher, but consumers were
not willing to pay more, there wouldn't be an organics industry in the
first place.)

I did say "temporarily". That's important because, generally speaking,
IF costs were the same or lower and IF producers were still willing to pay
a premium for organic foods, producers would have an incentive to switch
to growing and selling organic foods to capture more of that premium.
However, once producers were selling more organic food, the competition for
customers would tend to drive prices down to be roughly equivalent to
conventionally grown food.

Generally, one would have to assume that the higher price that organic
foods command is indeed a partial reflection of higher production costs. It
is possible that the higher price of organics at other stores is
artificial -- that farmers have figured out a way to grow organics less expensively
than before, and that the price disparity is only temporary. I certainly
can't say definitively, but I think that's highly unlikely.

Next, the possibility that Iceland could subsidize organics with sales
of other products is doubtful. To do so, it would have to sell its
non-organic foods at higher than market prices. But if customers could buy
non-organics from Iceland's competitors at a lower price, they would very likely do
so,which would make it a practical impossibility for Iceland to finagle
that type of subsidy. Another alternative is that Iceland is accepting a
substantially reduced profit on the organic foods it sells in an effort
to attract customers. But this too is highly unlikely for two reasons.

First,because the retail food industry is highly competitive, so any
customers Iceland wooed while prices were held artificially low would likely be
lost once prices were set back at the market clearing level. And Second,
profit margins in the food industry are already quite low, which means that
there's very little "play" in the numbers for Iceland to work with (this is a
direct result of point number one).

2. You're probably on to something here. What really is organic? And
who's to say that something really isn't? It's not hard to just say that
something is organic, because the term means different things to
different people. "Hard core" organic consumers will tend to look for a
certification. But (despite the organic industry's claims to the
contrary) most consumers only have a vague sense about what the term organic
means, and they don't really care. For most people, the term organic simply
means grown without synthetic chemical pesticides. They don't necessarily
buy into the "holistic" view that organic growers adhere to. Lot's of
typically organic retailers, like Whole Foods, will make some effort to sell
only products certified by agents with a good reputation. But we have no
knowledge of how Iceland is making its purchasing decisions.

3. In part, the "commodification" of organics should work to drive
prices down (especially in the US if the USDA's no exceptions rule becomes
effective). However, there seems to be a general trend in the food
industry toward "branded" goods. Most people will pay more for a branded good
than for a generic one (the commodity) because branded goods TEND to be
superior in some way -- quality, consistency, etc. Producers of branded goods
have an incentive to ensure at least slightly better production value than
non-branded goods, and to ensure that every single item meets the same
level of quality. You see this trend primarily in processed foods (cereals,
etc.), but it's beginning to also take root in lightly processed foods,
like poultry (though for some reason, not beef), and increasingly even in
produce. We shouldn't expect organic foods to be any different.
Consequently, the effect of branding will run counter to the effect of
commoditization, and it's impossible to know at this point which will
be more significant.


4. I wouldn't worry too much about Iceland cornering the market in
organic foods. For one thing, I suspect that consumer demand is a mile
(kilometer) wide, but only an inch (centimeter) deep -- what economists call
highly elastic demand. Faced with a choice between an organic product with a
dramatically increased price, lot's of consumers will shift to
non-organics without too much effort or concern. Plus, as I noted above, farmers
would respond to the higher price by supplying more. There would be a
fairly lengthy lag time, however, as most organic certifiers usually demand
that a farm be synthetics-free for at least three years before granting full
certification. But I suspect you'd see the development of a lot of
"organic in transition" certifications in the mean time -- assuming of course
that any of this ever really comes to fruition.

==============================================================

From: Andrew Apel <
Subject: Is there an economist in the house?
Colleagues,
You may all by now be aware that Iceland, a leading British grocery
chain, has managed to lock up 40 percent of the world's 'organic'
vegetables with supply contracts and will sell only organic frozen