Chicken prices, consolidation and a couple of pending lawsuits

The Wall Street Journal reports that “Food distributors sue Tyson, Pilgrim’s Pride and others alleging collusion on chicken prices.” Sysco and US Foods, the two largest food distribution companies in the US, separately filed lawsuits against the top poultry processing firms, accusing them “of conspiring to limit stocks and manipulate wholesale prices, fueling a legal battle that has pitted buyers and consumers against chicken processors.”

Any student of basic economics knows that market prices are affected by both demand and supply conditions. Thus, when prices are rising, there must be an increase in demand or a decrease in supply (or both), but only if market conditions are competitive. According to the Wall Street Journal, “poultry companies were struggling in 2008 due to rising grain prices, and it was logical for the poultry industry to cut back on production to reduce risk.” This suggests rising prices following 2008 was due to supply factors.

The following chart shows monthly wholesale chicken prices between 2007 and 2017, according to USDA data (collected from here). In 2009, poultry prices were rising, consistent with the cost-squeeze argument. The period between 2011 and mid 2013 saw rising prices. There are also periods of significant decline, such as in 2014 and 2015. But the inserted trendline does show an overall increase in wholesale prices over time.

However, when market are not competitive, firms with monopoly power have the ability to affect market prices by manipulating the amount of output they produce.

The poultry industry is not an example of textbook market competition. The top four poultry processing firms, Tyson Foods, Pilgrim’s Pride (owned by JBS), Sanderson and Perdue, currently control more than 50 percent of the market. Thus, they can affect poultry prices, if they choose to do so.

The lawsuits allege that the top poultry processing firms coordinated their production plans through information gleaned from industry data. This allowed them to manipulate a pricing index they used to set prices to wholesale food distributors and other customers. This pricing index, the Georgia Dock index, listed prices “about 32% higher than similar benchmarks such as one maintained by the USDA,” according to the Wall Street Journal article. Another Wall Street Journal article (here) also examined allegations about problems with the Georgia Dock index.

Industry executives and some economists argue that consolidation provides efficiency benefits to firms, which in turn can pass cost savings on to consumers through lower prices. The challenge here is incentives. Why pass cost savings on to consumers when there is no competitive reason to do so? This is why industry consolidation is an ethical as well as economic issue. Ideally we want an economic system where firms have an incentive to innovate, seek cost-saving efficiencies, and pass those benefits on to consumers, and where consumers have incentives to seek out best products and services from firms. Healthy competition does this. Consolidation, however, warps these incentives.

I have no prediction on the outcome of the lawsuits. But if I were an executive at Sysco or US Foods, I would tread carefully here. These “food-distribution giants represent roughly 25% of the domestic food-distribution business,” quoting the Wall Street Journal. Thus, the same arguments these companies make in court against the top poultry processing firms might be used by their own customers against them. Ethically, it is best to treat one’s customers like you want to be treated by your suppliers.

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What does it mean when corporations are as economically powerful as governments?

In 2016, a non-governmental organization by the name of Global Justice Now, based out of the UK, produced a report listing the largest governments and corporations by revenue. Their report stated that the “10 biggest corporations make more money than most countries in the world combined and that 69 of top 100 economic entities are corporations not countries.” The complete listing of governments and corporations is here.

An article in the Journal of Economic Perspectives by Luigi Zingales of the University of Chicago provides the following commentary about corporations that rival the size of governments:

In some cases, these large corporations had private security forces that rivaled the best secret services, public relations offices that dwarfed a US presidential campaign headquarters, more lawyers than the US Justice Department, and enough money to capture (through campaign donations, lobbying, and even explicit bribes) a majority of the elected representatives. The only powers these large corporations missed were the power to wage war and the legal power of detaining people, although their political influence was sufficiently large that many would argue that, at least in certain settings, large corporations can exercise those powers by proxy.

The 2015 list produced by Global Justice Now consisted of 26 governments and 24 corporations in the top 50. Walmart was number 10, ahead of Spain, Australia and the Netherlands. I’ve updated the list for 2016 (see below). Walmart is now number 9 on the list, and there are 26 corporations in the top 50 in terms of revenue.

What does it mean when corporations are as large and economically powerful as governments? Is this a good thing? Governments can coerce people, while companies grow by persuading people to buy their products, unless businesses use their economic power and resulting political influence to suppress competition—a common practice in both the developed and developing world. But are governments a more effective and appropriate steward over the vast wealth they control than corporations? Politicians and government bureaucrats are not likely more altruistic or caring of people than business executives and managers. (This reminds me of an excellent interchange between the late Milton Friedman, a Nobel Prize winning economist and academic at the University of Chicago, and talk show host Phil Donahue about the relative greed of people in business and government, here). Perhaps the more important question is whether appropriate checks and balances remain between business and government when businesses rival the size and economic power of governments. I don’t know. I’m just asking questions.

Here is the ranking of governments and corporations by revenue in 2016. Data on government revenue (not GDP) from the CIA World Factbook for 2016 and on business revenue from the Fortune Global 500 list.

Rank	Type	Name	Revenue, $billion
1	Government	United States	3,363.0
2	Government	China	2,300.0
3	Government	Japan	1,696.0
4	Government	Germany	1,523.0
5	Government	France	1,308.0
6	Government	United Kingdom	996.3
7	Government	Italy	842.5
8	Government	Canada	594.7
9	Corporation	Walmart (US)	485.9
10	Government	Spain	461.3
11	Government	Australia	420.5
12	Government	Netherlands	340.8
13	Corporation	State Grid (China)	315.2
14	Government	Brazil	311.9
15	Government	South Korea	297.3
16	Government	India	273.3
17	Corporation	Sinopec Group (China)	267.5
18	Corporation	China National Petroleum (China)	262.6
19	Corporation	Toyota (Japan)	254.7
20	Government	Sweden	248.3
21	Corporation	Volkswagen Group (Germany)	240.3
22	Corporation	Royal Dutch Shell (Netherlands)	240.0
23	Government	Belgium	232.3
24	Government	Mexico	224.3
25	Corporation	Berkshire Hathaway (US)	223.6
26	Government	Switzerland	215.9
27	Corporation	Apple (US)	215.6
28	Corporation	Exxon Mobil (US)	205.0
29	Government	Norway	199.8
30	Corporation	McKesson (US)	198.5
31	Government	Austria	187.3
32	Corporation	BP (UK)	186.6
33	Government	Russia	186.5
34	Corporation	United Health (US)	184.8
35	Corporation	CVS Health (US)	177.5
36	Corporation	Samsung Electronics (South Korea)	174.0
37	Corporation	Glencore (Switzerland)	173.9
38	Corporation	Daimler (Germany)	169.5
39	Corporation	General Motors (US)	166.4
40	Corporation	AT&T (US)	163.8
41	Government	Denmark	156.9
42	Corporation	Exor (Italy)	154.9
43	Corporation	Ford Motor (US)	151.8
44	Government	Saudi Arabia	149.7
45	Corporation	Industrial & Commercial Bank of China (China)	147.7
46	Government	Turkey	146.4
47	Corporation	AXA (France)	143.7
48	Corporation	Amazon (US)	136.0
49	Corporation	Foxconn (Taiwan)	135.1
50	Corporation	China Construction Bank (China)	135.0

Because they can, but should they?

Mylan is the company that produces the EpiPen, a device that injects a measured dose of epinephrine when someone has a severe allergic reaction. Mylan didn’t invent the drug or device. The company acquired it in 2007 from Merck, which bought the rights for the drug years earlier from another company. By some estimates, Mylan’s EpiPen controls roughly 90 percent of the market for epinephrine injection devices. When Mylan purchased the rights to the EpiPen in 2007, the drug cost about $100 for a two-pen set. It currently retails for more than $600.

Mylan isn’t the only company to buy a drug and then dramatically increase its price. Earlier this year, the Wall Street Journal (as well as other news outlets) reported on pharmaceutical companies that buy rival’s drugs and then jack up the prices. A noteworthy example is Martin Shkreli, a hedge fund manager and CEO of Turing Pharmaceuticals, who bought the drug Daraprim and raised its price from about $13 a dose to $750. The drug is used to treat a variety of infections and other diseases. Turing bought the rights to the drug from a company, which bought the rights to the drug from another company, which bought the rights to the drug from another company, …

Why did Mylan increase the price of the EpiPen? Why did Turing increase the price of the drug Daraprin? Because they can. The companies control exclusive rights to the drug and the demand for the drugs are highly inelastic. First, by having exclusive rights over the drugs and with little if any competition, they possess monopoly power. This means they can act as price makers rather than price takers. Second, as I explained to my microeconomics students today, demand for the drugs is inelastic because there are few substitutes to them and they are necessary. This means that consumers will not (or cannot) be very responsive to large changes in prices. If you are subject to severe allergic reactions, you probably will not forgo the drug if its price increases. You will grumble and complain but buy it anyway. Thus, the combination of monopoly power and inelastic demand makes raising prices economically rational.

The drug companies and other commentator point to other reasons for high drug prices. Some argue that the patent system and long and costly regulatory approval processes are to blame. While these affect the initial costs for many drugs, they don’t explain why the price rose so quickly years after the drug has been on the market. If Daraprim was profitable at $13.50 a dose, then patenting and regulatory costs won’t explain the 5,000 percent increase in its price after Turing bought it.

According to an article in today’s Wall Street Journal, drugmakers are pointing a finger at middlemen for rising drug prices. Drug company executives say that the system is to blame. Everyone has to take a cut, such as pharmacy-benefits managers. Drug companies say that they have to offer increasingly larger rebates to pharmacy-benefits managers to induce them to accept their drugs as part of their company’s health plans. These benefits managers, in turn, are blaming drug prescription services and health insurers. While there might be some merit here, it’s hard to believe that middlemen and insurance companies are largely responsible for the dramatic increases in drug prices. I can’t imagine that a benefits manager will say “no” to the only drug that is available to treat severe allergic reactions or some infections. Drug companies won’t have to offer large rebate inducements if their drug prices were not already very high.

To be sure, the problem is complicated. Should we force drug companies to price their products “reasonably”? What is a reasonable price for a life-saving drug? Who’s to say that $20 or $30 or even $50 is unreasonable for Daraprim? These companies also employ thousands of workers and their stocks are part of savings, retirement and other investment portfolios for many people. If we mandate lower prices for drugs, then what happens to drug company employees and investors?

If drug companies can raise prices, and justify the price increases on economic grounds, then should they? Economic considerations are important, but they are not the only values that matter. Fairness matters too. Is it fair to ask patients to pay 5000 percent more for a lifesaving drug?

Fairness can be more difficult to justify than economic rationale. But we can simplify things. While there are many bases for arguing “fairness,” all of them are grounded in expectations. When our expectations are met, then we have little grounds for arguing unfairness. However, when expectations are not met, people typically feel justified in claiming unfairness. Consumers with a history and experience in paying $13.50 for a drug to treat infections will continue to expect that prices will be about the same the next time they buy the drug. While most people can expect gradual increases in prices, for instance due to inflation, there is no reasonable argument anyone can make that would convince me that consumers would expect a 5000 percent increase for Daraprim or a 500 percent increase for the EpiPen in a relatively short period of time. If drug companies want to increase prices more than what consumers expect, then the companies need to speak directly to consumers and change their expectations. That is fair. But I expect that will be quite a challenge for drug companies.

 

Potash peril

Potash refers to a variety of compounds that contain potassium. Plants require potassium (chemical label is K) for their development, along with Nitrogen (N) and Phosphorus (P). These three chemicals are the key ingredients of fertilizers and are thus widely used in plant agriculture.

The largest potash producer in the world in terms of production capacity and market value is Potash Corporation of Canada. It has a market value of roughly $14 billion and controls 15 percent of global production and 19 percent of production capacity, according to the company’s website. There are larger companies in minerals and mining (e.g., the UK’s Rio Tinto Group), but none dominates potash production like Potash Corp.

The Wall Street Journal reports today that Potash Corp is merging with Agrium, also a Canadian fertilizer company, the combination of which will be a company with $21 billion in annual revenue and controlling 23 percent of global potash production capacity but 60 percent of capacity in North America. The two companies justify the merger as we might expect–stabilizing prices, lowering production costs, accessing other markets, etc.

Now, if US farmers want to buy fertilizer, they will likely have to get if from the combined company. Farmers are concerned, as they should be. According to the WSJ, “The deal likely would sow further unease among North American farmers wary of reduced competition and higher prices as top seed and pesticide developers pursue their own tie-ups. Already grappling with a three-year slide in major crop prices, some farmers are concerned that mergers between some of the world’s largest farm-supply companies will consolidate pricing power among fewer players and lead to higher costs at a time when farmers are scrimping to eke out profits.”

Efficiency is good, as are lower costs. But as I noted in a previous post, so is choice. Where do we draw the line when struggling with efficiency versus choice? Will the combined company pass on the cost savings to farmers by lowering prices of fertilizer? I hope so. But then I hope for $100 bills to rain on my home, too.

Consolidation in the agricultural seed and chemical industry

The Wall Street Journal reported that German company Bayer increased its share-price offer for the purchase of Monsanto. If (or when) the merger happens, the combined company will dominate an already-concentrated agricultural seed and chemical industry. I don’t have current figures on global industry concentration ratios, but the main players in agricultural seed and chemicals are Monsanto, Syngenta, DuPont, Dow Chemical, BASF and Bayer. According to the WSJ article, Monsanto previously tried taking over Syngenta but failed, DuPont and Dow Chemical are merging, and China’s National Chemical is buying out Syngenta. Monsanto is also seeking an alliance with BASF.

These companies are already tightly aligned. For example, all participate in cross-licensing agreements with each other in a host of technology sharing arrangements, most notably in genetically-engineered seed traits. Phil Howard, a sociologist at Michigan State University, graphically documented these relationships in 2013 (see his cross-licensing agreements and seed industry structure graphics). The Farm Journal provides a similar report (here), with graphics for the top five seed companies in each year from 2010 to 2014.

Many economists support mergers like these in the name of increased efficiency. Often there are economies of scale associated with the development and distribution of technologies, such as genetically modified crops and agricultural chemicals, which can lower costs for firms and, in theory, for buyers of the companies’ products. This is a good thing. But when choice is reduced in the name of efficiency, I wonder whether it is always worth it. Having options is powerful. Limiting choices has the potential to create dependencies and redistribute power. Are farmers’ and consumers’ interests really served by having fewer companies serve them? Some may say that choices and options will not be affected, since the products offered by the companies would still be available. But when they are offered by one firm rather than many, is that really the same?

Efficiency is good, but so is choice. Can we seek a balance of efficiency and choice?