The future of the animal feed industry in Europe: the effect of CAP and GATT reform

The prosperity of the feed industry cannot be separated from the performance of the livestock industry. The performance of the livestock industry is largely determined by the demand for its products and the costs of supplying this demand. In a mature market – which by any yardstick describes the European Union (EU) meat market – there is little, if any, growth of demand. The combination of limited demand growth and a supply side – particularly the intensive livestock sector – incapable of controlling its propensity to increase production is a recipe for falling prices and economic hardship.

The recent experience of the UK livestock industry should be viewed against this background. In the case of the UK the situation has been compounded by a grossly overvalued currency and the aftermath of the BSE debacle. Whether we are talking at a European level, or focussing on the UK market, the message is very clear. In order to survive farmers must be able to produce at lower prices, and this creates pressure for lower prices from suppliers, particularly feed suppliers. If we are to understand how this situation has come about we must start by raising our awareness of the force that is changing the way industries, including farming, do business; namely, globalisation.

Globalisation is a process that includes the removal of trade barriers and growing financial and economic integration between nation states. The heightened competition from all parts of the globe has forced European and US businesses to become ever more efficient and to seek innovative ways of competing with low cost producers in other parts of the world. Efficient production certainly demands an absence of waste and willingnaess to take advantage of technological progress in order to keep costs low. Though necessary, low costs are not sufficient. The ability to correctly interpret and rapidly respond to market information involves cost, but can also be highly rewarding. Developing products that consumers seek out and recognise as delivering real value is the only basis for sustainable success.

Agriculture cannot be immune from the growing intensity of competition. As the instruments of protection – tariff barriers and subsidised exports – are brought to an end so the food chain must also change. In particular, the inward looking mindset engendered by protection must be replaced by a new vision: a global vision of markets and a co-operative vision for buyers and sellers.

From globalisation to CAP reform

The Uruguay GATT round, which was ratified in 1995, is a prime example of the process of globalisation. The inclusion, for the first time, of agriculture in multilateral trade talks has forced a paradigm change in the structure of the EU’s agricultural support policies. Following the Uruguay Agreement protection for agricultural products is now subject to multilateral trade rules. Driven by membership of the GATT and monitored by the World Trade Organisation, these rules have put the EU under persistent pressure to reduce both tariff barriers and export subsidies that protect key sectors of its agricultural industry and (to an extent) the agricultural supply industry.

What does all this mean for the Common Agricultural Policy (CAP)? As we saw with the latest attempt at reform – the so–called Agenda 2000 reform – there is reluctance on the part of some member states to face up to the realities of globalisation outlined above. Despite this reluctance, the portfolio of agricultural support policies is steadily changing in response. The EU is inextricably moving toward a system of farm support that leaves the (global) market to determine the price of European agricultural products and provides support to farmers in the form of pure decoupled payments, i.e., direct payments unrelated to what is produced. In short, the base upon which the CAP was founded, open–ended price support, is coming to an end. The pressures to control public expenditure – a further consequence of globalisation – will, in the not too distant future, ensure that direct farm payments are subject to degressivity and probably capped for large farms.

This is not some distant prospect. It is much closer than many people imagine. Many agricultural products produced in the EU, including cereals, will be operating at or near world prices by 2003. As regards milk, beef and sugar, much depends on the outcome of the Millennium GATT round. The round is certain to further reduce tariff walls and export subsidies. When the round finishes around 2003, the likelihood is that it will be clear that milk and sugar quotas – the CAP’s highest form of protectionism – will have to be dramatically reformed or abandoned.

Competing at world prices

Agriculture, like all productive industries, is driven by two fundamental forces: technology and knowledge. The effect of these forces, over a period of years, is to raise productivity by increasing the ratio of capital to labour; i.e., reducing the number of farmers and farmworkers required to produce any given level of output. In order to utilize this growing capital base efficiently, the economically viable size of farm must also increase. The CAP by (originally) guaranteeing twice the revenue for twice the output greatly encouraged research and technological innovation. But as the impact of technology spread through the industry, policy makers responded by attempting to offset its structural effects in order to protect smaller, technologically inferior farms. For example, milk quotas and set–aside were direct responses to rising yields. By attempting to hold back the influence of technology, the policy stance was deliberately tilted in favour of protecting relative small, less efficient farms at the expense of a much wider public benefit; namely, the supply of cheaper food.

I detected – if only between the lines – a recognition of this truth in the Commission’s Agenda 2000 document. In particular, the contradiction of attempting to develop a farming sector capable of competing at world prices and an agricultural support policy aimed at maintaining large numbers of smaller farms. Across the EU, and within all agricultural sectors – despite the CAP – the distribution of output is heading towards the Pareto principle: 20% of farms supplying 80% of output. It is these 20% of farms that should be the focus of a globally orientated food policy. Policies such as milk quotas and set–aside hold back these larger farmers. Such policies greatly increase the costs and risks of expansion not only for farmers but also for suppliers and processors.

European politicians, driven by the social consequences of agricultural reform, see the priority as managing the decline in farm businesses; that is, balancing the public expenditure costs of support with a politically acceptable loss of farm employment. The danger with this policy is that as a trade–off it will not satisfy either the objective of creating a truly world class agricultural industry or preventing the continued tension arising from growing numbers of economically nonviable farms. There is an urgent need for politicians to address the inherent contradiction in attempting to simultaneously achieve both a viable income for (generally) small scale, inefficient farms and preparing the industry for global competition. I fear however, that the issue will be ducked and that politicians and farmers will attempt to shift the justification for support from production to protection of the countryside.

Now that the EU, as a single market, is more than self–sufficient in food, the European food industry in general, and meat in particular, has reached a critical stage in its life cycle. If a European focus is adopted then it cannot expect growth. EU demand is at best static: a low rate of population growth being offset by changing eating habits. Individual firms and farms can grow by taking market share from rivals, but inevitably this will be accompanied by increasing margin pressure. At the level of the individual businesses, be they farm suppliers, farms or food processors, priority must be given to reducing waste and driving unit costs to the lowest possible levels. But this is not sufficient. To be globally competitive, supply chain costs, i.e., the costs that arise in the transaction between stages in the supply chain, must also be reduced.

Competition and the supply chain

Farm support, and the inevitable political focus on farmers, tends to obscure the fact that farming is but a link in the food chain. Much of what has been said above about the technology driven trend towards larger scale production units also applies for farm suppliers and food processors. It must not be overlooked that agriculture is not the only link in the food chain that must constantly evaluate its performance. In an increasingly competitive environment the final product depends heavily on earlier stages in the chain for competitiveness. Figure 1 shows my focus on the meat supply chain. I do not include consumers, not because the final consumers of processed food and drink products are not important, but because I believe the multiple retail chains – the food processors’ customers – are very effective at reflecting consumer views and concerns.

Figure 1. The meat product chain

Supermarkets are much criticised by livestock farmers for not reducing retail meat prices in the same proportion as the fall in farm gate prices over recent years. This is perhaps an understandable if misplaced complaint given the current state of the livestock income, but as a means of raising farm gate prices it is a non–starter. To my mind, supermarkets have done the UK meat industry a great service in their encouragement of higher standards. Higher standards and quality are all part of improving competitiveness even if the benefits are not immediately apparent to hard-pressed farmers. But in a mature market steadily becoming more open to overseas competition, we have to think beyond low prices. If any business relies on low prices alone to achieve sustainable competitiveness, it will sooner or later be confronted by a competitor offering a lower price.

Sustainable competitiveness arises out of organisational and marketing strategies that jointly have not only the ability to create products that are valued by the market, but also the ability to capture a fair share of the final value. Once this is acknowledged it is the first three sectors shown in Figure 1 that are the key to competitiveness with processors being primus inter pares (first among equals). It falls to processors to anticipate and satisfy the changing demands of customers; but as the competitive pressures mount they can do this more effectively if supported by a responsive food chain that is also focussed on precisely the same objective.

It is from the perspective of the supply chain that farm level agricultural support is now a negative influence on competitiveness. If farmers can expect the government via direct payments to provide a reasonable income, then this militates against the incentive to try that much harder to ensure that the value of what is produced accords precisely with customer needs. It is for this reason that I hope the authorities will soon put degressivity back on the CAP reform agenda and apply it ruthlessly to larger farms.

What is needed is a new mindset whereby farmers develop closer, integrated relationships with their processor customers and specialised suppliers. Agricultural policy has a role to play in creating an environment in which direct support can be steadily reduced, but the task for EU governments would be easier if processors and suppliers recognised and acted upon their role in creating a new environment for food production. Globalisation will increasingly offer processors alternative sources of raw materials and farmers alternative source of supplies. Domestic farms must therefore increase their attractiveness to processors not only by providing agricultural produce at competitive prices, but also by adding the value of a flexible, close business relationship.

Such integration helps secure competitive advantage by removing slack from the system, accelerating the response to changing demands and providing the assurances increasingly demanded by consumers. What is needed is the development of a cooperative ethic between processors and farmers not, as many farmers appear to be demanding, a perfunctory cooperative. The ideal is a close trusting relationship between buyer and seller, where each is prepared to invest in improved products and processes because both are driven by the incentive of improved profitability.

Suppliers and technology

All that has been said above about the benefits of closer integration applies to the relationships between suppliers and farmers, but suppliers are also at the heart of a new force for integration; namely genetically-modified organisms (GMOs). We noted above the importance of technological developments to competitive advantage. As regards the food chain, GMOs are vital to improved competitive performance because:
  • GMOs offer lower production costs by reducing the demand for inputs and increasing reliability.
  • They open up the prospect of more efficiently meeting the precise demands of processors. For example, the supply of agricultural produce with precise attributes.
  • GMOs widen the potential markets, food and non–food, for agricultural products.
  • The rest of the world – most notably the US – is developing GMO technologies and if we do not follow we will effectively be condemning our food industry to a declining share of the global market.

In the EU and in the UK in particular, genetic modification needs to be handled sensitively. We cannot change history; and BSE has greatly damaged consumer confidence as regards new food technologies. But, it is hardly a sensible response for either the industry or the government to backtrack in the face of a rampant and frequently irresponsible media. This only serves to give credibility to the quite outlandish, if not monstrous, headlines of the tabloids. It needs to be pointed out, if necessary over and over again, that it is technology that has banished the fear of hunger and greatly contributed to rising living standards by providing the average household with an increasingly varied basket of food at an ever-decreasing proportion of its income. Technology is on balance a force for good.

It also needs to be understood that the true cost, if the media and protest groups succeed in halting the development of GM food in the UK, will be a substantial reduction in the UK food industry’s competitiveness just as markets are being opened to global competition. Why, given the critical importance of GMOs, has the food chain adopted a rather lacklustre response to media criticism? To my mind it reflects a fundamental problem; namely, the lack of strategic leadership. This is in large measure the consequence of farm support policies, which have tended to call the tune.

For example, milk quotas limited the supply of milk and removed the need, let alone the incentive, for farmers and processors to seek new markets. The food chain needs a new mindset; longer term prosperity is not only dependent upon recognising the imperative of constantly improving performance and adjusting to meet customer needs, but also seeking and exploiting new markets. Integration involving suppliers, clusters of farmers and a processor will aid the development of strategic thinking and consequently a clearer focus on global competitiveness and expansion.

Globalisation and the food industry

I noted above that in addition to developing a closer, longer–term relationship with buyers and sellers, the food chain must adopt a global vision. This is not to deny the value of local and niche markets, but it is foolish in the extreme to ignore the facts that the food industry is now a global industry. This presents new competitive threats to all in the supply chain, but it also presents opportunities. With the inevitable simplification we can view the global food market as consisting of three economic regions: Europe, the Americas and Asia. Within these regions the EU and North America are the dominant markets for value-added products. Affluence drives the demand for value-added products; but the EU population is already well fed and growing at about 0.5% a year. Therefore overall, as observed in the opening paragraph, any EU food industry focussed on the EU can only look forward to very limited growth. Nor can EU food producers take much comfort from the potential markets in central and eastern Europe. The collapse of the Russian economy has set this back by a decade or more. The development of eastern Europe and the central European nations poised to join the EU present the threat of competitive supply as well as the opportunities of demand.

Looking to the next 10 to 20 years, the region of the world that should be of prime interest to a global European food industry is southeast Asia and China. The world’s fastest growing market for value-added food products is Asia. The region accounts for almost half of the world’s population; which is growing at three times the rate of the developed world; and almost 50 % of the population is under 25 years of age. It is a region that boasts ten of the world’s largest cities. A large, affluent middle class is emerging in the urban areas and mega–cities. Consumers are becoming more sophisticated, family units are becoming smaller, a higher proportion of women are working and ownership levels for refrigerators are escalating. The Asian economies are now recovering from recession and per capita income growth has started rising again. In the coming years Asia will exhibit a booming demand for convenience, branded food products.

Concluding thoughts

Post-war food protection policies are coming to an end. They are being replaced with social payments and limited support for the delivery of environmental benefits. Reluctantly or otherwise, EU governments are being forced to remove both tariff walls and export subsidies that have shielded farmers in particular, and the food industry in general, from the full force of global competition.

As this revolution takes hold there will be changes at all stages in the food chain. As with any business, responses to heightened competition will involve the removal of excess capacity and other forms of waste. But it would be a mistake to reduce the ability to respond quickly and flexibly. Most importantly, growing economic pressures must not be used as an excuse for cutting back on investment. On the contrary, increased investment will be needed at all stages of the food chain to develop new products, new processes and new technologies. This raises a host of challenges, not least as globalisation, in accelerating the pace of innovation, increases the risks associated with investment.

I have dealt at length on the consequences for farming of being forced to operate at or near world prices. One consequence for suppliers is that there will inevitably be downward pressure on the prices of purchased farm inputs. Like farmers, suppliers will respond in a number of ways: mergers and take-overs will be used to create competitive differentiation; and hopefully closer trusting relationships will become more common.


by Sean Rickard, Cranfield School of Management

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