4 CHOICES Fourth Quarter 1994
Industrialization:
Steady Current or
Tidal Wave?
by Mark
Drabenstott
I
ndustrialization is becoming an accepted term
that describes fundamental changes in U.S.
agriculture. And while those outside agriculture
might associate the term with the Industrial Revolution, the current agriculrural revolution is far more
technologically advanced. The defming features of
industrialization now include a shift from food commodities to food products and a shifr from spot
auction markets to more direct market channels,
such as production contracts.
Though powerful, industrialization is not having a uniform effect on U.S. agriculrure. Some industry segments like broilers are almost completely
industrialized, at least in terms of the two main
defining fearures. But others, like grains, primarily
operate like traditional commodity markets.
Currently, a rapid move toward industrialization in the pork industry is leading to great public
interest in industrialization's future course. Farmers, consumers, state and federal legislators, and
industry regulators increasingly wonder whether industrialization is just a steady current of change, or
whether the pork industry reflects a new tidal wave,
ready to spill over to many other parts of agriculrure. A review of industrialization suggests that it is
both current and wave-it is not new, but it does
appear to be speeding up. Put another way, the
changes amount to a quiet revolution in agriculrural markets, with change that is fundamental but,
until recently, unheralded (Barkema, Drabenstott,
and Welch; Schertz and Daft).
Why industrialization?
At root, industrialization results from a new consumer and a new producer and the impact these
two players have on the markets where they meet
(Barkema) . The new consumer is a highly demanding sort, the kind of buyer who knows that its
actions can humble even huge corporations like
Sears and General Motors. The new producer is
armed with a panoply of new technology and management tools that enable food to be engineeredfrom the farm to the dinner table. A more demanding consumer and a more capable producer
would seem to be a match made in heaven-and it
is to a considerable degree. The only problem is
that the traditional markets that have moved food
from farmers to consumers don't broker these kinds
of marriages very well.
The new food consumer
New lifesryles, shifring demographics, and a growing appreciation for the link between diet and health
are leading to wholesale change in the way Americans eat and the foods they buy. These food consumption changes have splintered the mass food
market into myriad niches (Kinsey). Food companies can no longer launch a broadside of standardized products at a mass market and be assured of
marketing success. Rather, they must market customized products, each aimed at a separate food
market niche. Some products may derive from common production processes, but many do not.
Rather, a new generation of technology is permitting more and more products to be driven by the
characteristics consumers want-from start to finish.
This trend is increasingly recognized, but it is
worth noting that the food industry is actually just
sharing a broader trend that is evident in all consumer-goods industries. Whether a firm makes pens
or planes, buyers demand more and their patience
is shrinking. "Instead of choosing from what you
have to offer, the new consumer tells you what he
or she wants. You figure out how to supply it"
(Fortune). To be sure, shifrs in food consumption
CHOICES Fourth Quarrer 1994
pardy reflect a food consumer who has been given
more food choices by the industry. But consumers
are demanding more than choice; they also want
quality, consistency, and value. To a considerable
extent, therefore, industrialization is about converting agriculture from a "here's what we produce"
mentality to "here's what consumer's want" credo.
The new producer
Advances in agricultural technology increasingly
make possible food engineering from farm and
ranch to consumer. The new technology can be
usefully divided into biotechnology and information technology (Phillips 1994). Although U.S. agriculture appears to be only on the edge of a new
frontier of biotechnology advance, the possibilities
are quantum in scale. And, more importantly, they
lead to unprecedented precision. Biotechnology will
enable the food industry to isolate and incorporate
specific traits into food products, a paramount demand of the new consumer. For example, scientists
may be able to change genes so that cattle and hogs
convert feed into more lean tissue and less fat. Similarly, genetic changes might be achieved to reduce
the cholesterol level in eggs.
Equally intriguing, especially in the near term,
may be information technology. To date, the power
of scanning technology has not yet been fully harnessed in the food industry. But the day may soon
come when retailers will influence food production
much more than they do now. Scanning information is potentially the most potent weapon in targeting products for consumer palates and pocket
books. Many retailers now have precise information about which products sell and to whom. Such
information permits food companies to fine-tune
product formulations, packaging, and marketing
strategies with much greater precision than ever
before.
Needs are specific,
but markets are general
The combination of new consumers and new producers is bringing great change to the market institutions where consumers, producers, and processors meet. The change is driven by the need to
bring product specificity to markets traditionally
accustomed to moving broadly graded commodities. Historically, bulk commodities flowed through
commodity markets to food processors, who in turn
marketed standardized products to consumers. But
consumers now want tailored foods, and to ensure
that they get them processors want more specific
farm products.
In response, processors and producers in many
segments of U.S. agriculture now go around traditional spot markets to more direct market chan-
5
nels. These end runs range from market contracts
to outright ownership, or complete 'vertical integration. This trend was first established in broilers
and vegetables, but more commodities have moved
in this direction over the past three decades. T 0day, more than half of all production of vegetables
(both fresh and processed), citrus, potatoes, sugar,
seed crops, eggs, fluid milk, broilers, and turkeys
take place through production contracts or verticle
integration.
Why is industrialization accelerating?
Industrialization appears to be accelerating due to
a convergence of industry forces, all of which are
pushing the industry toward a product focus and
nontraditional market channels. The new consumer
and new producer are two of these forces, but they
are accentuated by two additional ones.
New technology will gain broad acceptance
quickly because it is arriving at the same time as a
new generation of producers. The average farm operator in the United States continues to grow older,
pointing to a likely acceleration in farmer retirements and farm turnover in the decade ahead. The
new generation of producers expects to produce different products, with different methods, and through
different markets. Moreover, many farm businesses
being purchased need new capital equipment.
Meanwhile, a new generation of food industry
firms are playing a bigger role in industrialization.
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Figure 1. The move to industrialization in seven industry segments
1990
6 CHOICES Fourth Quarter 1994
These firms-input suppliers, processors, and retailers-might be called the integrators. Through
the course of the 1980s, many of these fIrms grew
through consolidation and product line diversification.
These firms are capital-intense and thus must be
adept at managing their risks. Focusing on the consumer while keeping an eye o~ Wall Street, these
firms see industrialization as an effective way to
manage risks that are greater and more complex.
Industrialization can reduce many types of risks. It
reduces supply risk by assuring a steady flow of
food inputs. It reduces quality risk by guaranteeing
consistent, trait-specific products. It reduces financial risk by reducing the variability in input prices.
In sum, the move to production contracts and
vertical integration is not happening evenly across
agriculture, but the past three decades have brought
quite a bit of change. The seven industry segments
illustrated in figure 1 together point to considerable
movement toward industrialization. Broilers were
almost completely "industrialized" thirty years ago,
and grains still resist the trend. But the other industry segments are all moving in the direction of industrialization, with most more than halfway there.
Industrialization cuts to the core
of many fUndamental farm and
agricultural policies because it
makes agriculture more like many
other industries.
What lies ahead?
In light of the type and tempo of change ;een recently, what is the outlook for industrialization in the
decade ahead? Three key developments seem likely.
First, the tempo of change probably will quicken.
The period ahead will almost cenainly bring wholesale change in the hog industry. And while hogs
may not be a good barometer for all other industry
segments, the onward crush of new technology will
encourage more product engineering from the farm
to the consumer. A spate of farm roll overs to a new
generation of operators may hasten the tempo.
Second, livestock segments will continue to move
toward industrialization before grains. Poultry is
there now, pork is moving there rapidly, and cattle
feeding is probably next. Ranching will probably
never be industrialized, simply because there are
too many people for whom ranching is a way of
life and for whom market incentives are not decisive in business decisions.
But grains will move toward industrialization, even
if slowly, largely due to two complementary forces. A
likely cut in government suppon for traditional commodity programs will make "government contracts"
less arrractive. While only a small percentage of the
nation's major grain crops are produced under contract to private firms, the vast majority are grown
under contract. The contractor in this case just happens to be the federal government and commodity
programs are the marketing vehicle. Moreover, geneticists seem likely to unlock more special-use
grains-a development that would almost cenainly
encourage identity-preserved contracts.
Third, the nation will increasingly have two agricultures. Even though industrialization is increasing at a faster rate, it does not follow that commodity agriculture is over and done with. It will
cenainly continue for some time. Many parts of
the United States are highly efficient at producing
commodities, and there will be a market for such
products both here and abroad. Some economists
argue that there will be a significant food market
niche for foods made from basic commodities that
have been appropriately processed and flavored.
In shon, one can think of commodity agriculture as the "sea" that covers most of the Farm Belt.
But emerging out of this sea will be an ever-increasing number of islands of specialized production outside of traditional markets. Some of the
islands will be big, such as the pork industry, while
others will be small, such as white corn for corn
chips. The big difference between these two agricultures will be profit margins. Commodity agriculture will be low margin, and producers and processors will operate at low cost and high volume.
The islands of specialized production will be more
profitable, because more value is added. The question will be how the profits are divided between
producers and integrators.
What are the policy dilemmas?
Industrialization cuts to the core of many fundamental farm and agricultural policies because it
makes agriculture more like many other industries.
It becomes less defensible to argue that agriculture
is special, and thus deserving of special treatment.
At least four policy dilemmas loom on the horizon
as industrialization spreads across U.S. agriculture.
A commodity policy for a
product industry?
Industrialization blurs the lines that traditionally
separated links in the food chain, raising doubts
about whether programs aimed at supporting commodity prices effectively boost farm incomes or stabilize food prices. Industrialization will tie farm incomes more directly to the consumer marketplace.
CHOICES Fourth Quarter 1994
There will be battles between producers and processors over how to divide the value pie. In shon,
commodity prices simply become less germane to
farm incomes, whereas delivering customized products to consumers becomes much more relevant.
Save traditional farms or -'
benefit consumers?
If the hog industry is a guide, the farms versus
consumers debate will burn hot in the period ahead.
In states across the heartland, legislatures are debating whether to try to halt industrialization in an
effon to preserve a more traditional farm structure.
Setting aside for the moment whether legislation
can stop it, the point is whether citizens are willing
to pay higher food prices in exchange for a more
traditional farm structure.
The broiler industry may be an instructive case.
Arguably, consumers view broiler products as one
of the best values in the meat case, if not the whole
7
supermarket. This is partly a reflection of the price
of poultry vis-a-vis other meats, but consumers also
perceive chicken to be a healthy meat. This perception persists despite an industry structure that long
ago abandoned barnyard chicken coops.
The economies of scale in industrialization will
be hard for policy to lean against, even if society
wants it to. In the pork industry, for instance, new
technologies point to operations of more than 1,500
sows to fully capture the economies of scale. Even
so, the issue of whether we want the resulting farm
structure seems likely to be debated in statehouses,
if not in Congress. Opponents of industrialization
generally voice three objections: (1) that it will encourage fewer, larger farms and thus damage rural
infrastructure; (2) in the case of livestock, that industrialization will bring harmful environmental side
effects; and (3) that industrialization marks a diminution in the decision-making independence of the
family farm.
Agricultural Industrialization and Environmental Quality
by David E. Ervin and Katherine R. Smith
Whether agricultural industrialization will ultimately improve or
degrade environmental quality depends upon how shifting farm
structure interacts with three sets of forces: pollution processes,
technology innovation and adoption, and environmental regulation.
Pollution from agriculture has been characterized by nonpoint
sources diffused across many farms and, often, large geographic areas. Under an increasingly industrialized sector there
will be fewer firms, so it will be easier to track environmental
performance. However, if industrialization leads to more geographically concentrated operations and greater amounts of
waste per unit area, it becomes more likely that threshold
levels of pollution will be exceeded in various localities.
Agricultural source pollution can be prevented by the development and use of environmentally friendly technologies. The
question arises, then, whether firms under an industrialized
agricultural sector will be more or less likely to innovate and
adopt such technologies. Evidence from other sectors suggests that more industrialized firms adopt profitable new technologies earlier and at a faster pace. In addition, one might
hypothesize that industrialized firms, if subject to less competition, will eam larger profits and have greater capacity to invest
in research and development of pollution prevention technologies. On the other hand, if a significant portion of the stewardship behavior exhibited through current adoption of environmentally friendly production practices is related to farmers' autonomy and their majority ownership of capital assets, then
loss of empowerment through consolidation, coordination, and
integration may also mean a loss of motivation for farm-level
actions that conserve natural resources or enhance environmental quality.
The course of environmental regulation of agricultural activities will obviously affect technology adoption and innovation,
and industrialization can be expected to shift that course. Production agriculture now experiences less environmental regulation than do other major sectors, due, in part, to the diffusion
of its nonpoint sources of environmental problems and also
due to public sentiment for family farmers. The largely voluntary agroenvironmental programs now in place assume that
farmers possess both the independence to make changes in
production practices and the financial means to contribute to
these encouraged practices. As the bimodal distribution of farm
types that Drabenstott predicts for an industrialized sector occurs, we will see one set of farmers whose production practices are to some extent dictated by their coordination with
other firms, and another set that will lack the financial resources to make substantial changes. Thus, current policy approaches could prove increasingly ineffective. Furthermore, the
political economy of agroenvironmental regulation may be transformed as public interests find it easier to apply punitive measures to vertically integrated corporations than to 'individual
farmers, and as contracting food and fiber companies join the
melee of rent-seekers in that regulatory arena.
Given the projected pace of agricultural industrialization,
more thorough investigation of the environmental implications
of farm structure is not merely warranted, it is imperative.
Katherine Reichelderfer Smith is director of the Policy Studies Program at the Henry A. Wallace Institute for Alternative Agriculture.
David E. Ervin is professor of agricultural and resource economics at
Oregon State University, currently on leave with the Congressional
Office of Technology Assessment.
8 CHOICES Fourth Quarter 1994
Who monitors the "market" and
provides information?
The author is
vice president
and economist
at the Federal
Reserve Bank
of Kansas City.
This article is
based on
remarks made
to the symposium'The
Industrialization
of Agriculture:
Policy,
Research, and
Education
Needs" held in
Washington,
D.C. on May 12,
1994, and
sponsored by
the Council on
Food, Agricultural, &
Resource
Economics.
Traditionally, government has played a key role in
agricultural markets, helping them become established, providing information on market trades ro
all participants, and overseeing the operations of
those markets. Industrialization will challenge all
three roles.
As more products move to consumers outside
traditional markets, what role will the government
play in facilitating private contracts? The public
will want to assure a workable environment in which
parties can count on sound contracts and clear provisions for nonperformance. Whether the public
wants ro be the umpire for private contracts between producers and processors, however, is much
less clear. For instance, does the public want ro
regulate contract provisions between poultry companies and growers?
Meanwhile, the overall justification for many
USDA market information programs has diminished considerably. For instance, why should there
be a market information program for eggs when
nearly all the eggs now move under contract? Put
another way, there is much less need ro facilitate
markets than in the past. It is time for a comprehensive review of these market information programs and a phasing out of unneeded ones.
With a more concentrated food industry, on the
other hand, there may be greater public interest in
preventing firms from influencing prices. But what
does that mean for the U.S. Department of Agriculture in an industry where private contracts are
replacing open market trades? Does the public
want ro eavesdrop on private contracts between pork
processors and producers, for instance? Policy makers may want to invest more in tracking retail market outcomes and improving the consumert;' overall understanding of how greater vertical coordination affects food quality, price, and availability.
New public policies on market
access and market power?
Policy makers have always been concerned with
access ro agricultural markets, but industrialization
will make these questions more difficult. In the
past, access has traditionally been defmed in terms
of product markets. In the future, access will also
be a matter of concern in inputs and information
markets.
Consider, for example, the case of the emerging
pork industry. As more and more hogs move ro
market under contract, terminal markets become
less liquid and less viable. What role does public
policy have in keeping such markets open? The
new genetics are clearly superior ro the old, and
will create a wide price premium spread between
the haves and have-nots. Does public policy play a
role in making private party genetics available ro
the have-nots? Finally, imagine a new alliance between a major grocer with consumer scanning data
and a pork processor. Such information might be
useful in tailoring products in such a way that producers under contract benefit while independents
suffer. Should government improve the market information available ro independents?
Industrialization is a strong force that is likely to
continue changing U.S. agriculture. The resulting
policy dilemmas are many and will become more
prominent in the period ahead. [!J
• For more information
Barkema, A. "Reaching Consumers in the TwentyFirst Centuty: The Short Way Around the Barn."
Amer. J Agr. Econ. 75(December 1993):1126-31.
Barkema, A., M. Drabensrott, and K. Welch. "The
Quiet Revolution in the U.S. Food Market." Federal Reserve Bank of Kansas City, Economic Review, pp. 25-39, May/June 1991.
Fortune. "The Tough New Consumer," special
sue, autumn/winter 1993, p. 6.
IS-
Kinsey, J. "Changes in Food Consumption: From
Mass Market ro Niche Markets." Chapter in Food
and Agricultural Markets: The Quiet Revolution, Lyle
P. Schertz and Lynn M. Daft, eds., Washington
DC: National Planning Association Report No.
270, 1994.
Phillips, M.J. "Changes in Technologies: Opportunities and Challenges for American Agriculture."
Chapter in Food and Agricultural Markets: The Quiet
Revolution, Lyle P. Schertz and Lynn M. Daft, eds.,
Washington DC: National Planning Association
Report No. 270, 1994.
Schertz, L.P., and L.M. Daft, eds. Food and Agricultural Markets: The Quiet Revolution. Washingron DC: National Plarming Association Report No.
270, 1994.
The views expressed here are striccly those of the author, and do
not necessarily represent those of the Federal Reserve Bank of
Kansas City or the Federal Reserve System.