What's fair? How food prices are set — and taken advantage of
After poultry price-fixing claims led to lawsuits and a new index, more attention is being paid to how commodity costs are decided.
Consumers often look closely at prices at the grocery store, but what’s happening behind the scenes with producer prices could make them more concerned.
In a prominent recent example, some have said price manipulation turned an institution of poultry pricing — the Georgia Dock Price Index — into an institution of price-fixing. The incident has led to a new index, a civil lawsuit, and a Security and Exchanges Commission investigation of pricing practices at Tyson Foods.
While negative news about price fixing has centered on poultry recently, it isn't the only industry where prices are set. Other commodities — including meat, poultry, eggs, grains, produce and rice — need to be kept at a fair level. Responsibility for fair prices is different for each one.
The U.S. Department of Agriculture publishes monthly average price values for meat. It also keeps track of retail prices for beef and pork cuts, turkey, whole chickens, eggs and dairy products, keeping prices somewhat even for all players.
However, that’s not always the case.
Since commodities are traded on exchanges, their prices are not set by a single individual or entity. Instead, those prices are set using futures contracts and futures prices — allowing speculation and fluctuation to impact prices.
And producers of those commodities also work to try to keep prices stable — or extremely low. While genetically modified plants have recently become a hot topic of consumer concern, farmers say that GMOs keep commodity prices down by increasing yields.
Why poultry pricing could lay an egg
The Georgia Dock came under scrutiny last year because poultry companies submitted the data — and prices often came in higher than those using other indices.The Georgia Department of Agriculture recently rolled out the Georgia Premium Poultry Price Index (GPPPI) as a replacement.
The new index gets around the problem of producers naming their own prices, according to the Georgia Department of Agriculture.
“By measuring the change in price rather than the price itself, the model is able to reflect a greater variability of products,” a department release announcing the GPPPI states. “The model measures the proportional change in price and combines that with the proportional change in price of all other companies resulting in an accurate reflection of the change in poultry prices over the given periods of time.”
Per Sjofors, founder and CEO of pricing research company Atenga, said that whenever prices are published in an index, it leads to commoditization. Producers cannot affect the selling price, therefore they work relentlessly to lower cost.
“It leads to lower consumer prices, but will eventually lead to so low margins that the quality of the product is affected,” he told Food Dive. “Likewise, if the quality of the product is fixed, like with oil and chemicals, producers may skimp on safety procedures to cut cost. Thus, in the long term, price indexes are neither good for producers or for consumers.”
Justin G. Gardner, associate professor of agribusiness at Middle Tennessee State University, said consumers should never be surprised to find that a firm is working to obtain a better price.
“From a policy perspective, we should not try to control prices. Rather, we should strive to create an environment where firms find it hard to manipulate prices,” he told Food Dive. “I believe that the Georgia Dock created a situation that facilitated price manipulation.”
Gardner said to imagine a continuum. On one side is a market with a large number of buyers and sellers — perfect competition. On the other side is a market with a single seller — a monopoly. As the number of sellers in the market decreases, each one has more market power and ability to set prices.
“If we were to look at the commodity exchange in Chicago, we would see something that looks a lot like perfect competition," he said. "These markets are derivative markets, meaning they trade contracts that are based on actual physical products. These markets have well-known price trends. Prices tend to be low at harvest, for example. But the day-to-day changes in the prices appear to be random. More importantly, it is very difficult for one individual or firm to exert control over the price.”
Poultry is very different, with relatively few producers in the market. Because of the size of the market, each company has the market power to name its own price — but the prices are held in check by the other companies and their mutual interdependence. If Company A raises prices too high, customers will switch to Company B. If Company A lowers prices, then Company B must follow in order to keep its customers.
But both companies will look for a way to charge higher prices. Gardner said there are two ways to do it.
“The first is illegal: collusion and price fixing. If we were to discover e-mails between firm A and firm B detailing a plan to either raise prices, or lie when reporting prices to the George Department of Agriculture, then these firms will find themselves in bit of legal trouble,” Gardner said.
“The second way is called tacit collusion and it is facilitated through signaling. If firm A were to raise prices, it would lose customers, but doing so would push the Georgia Dock up. Firm B would observe a higher price and realize that it had some wiggle room. So B follows, which pushes the Georgia Dock up more. This process will repeat itself until one of the firms breaks the cycle.”
Braden Perry, a litigation, regulatory and government investigations attorney with Kennyhertz Perry LLC, said the Commodity Exchange Act & Regulations (CEA) didn't have an insider trading rule until recently. The Commodity Futures Trading Commission (CFTC) saw a distinct difference between the stock market and the commodity market, and had no jurisdiction over insider trading in commodity cases. The rationale for an efficient market was more information is better.
“Yes, you can use whatever material and nonpublic information for trade commodities. However, times have changed and now sophisticated players are finding ways to skew that artificial market for their benefit,” Perry told Food Dive in an email. “New anti-fraud and manipulation rules under Dodd-Frank hint that trading on the basis of material nonpublic information in breach of a preexisting duty may be in violation of the CEA. Much like the Libor manipulation, large market participants may be able to manipulate the Georgia Dock index, and artificially increasing the costs of poultry.”
This is difficult to prove. Federal law prohibits manipulation and fraud in connection with “any swap, or a contract of sale of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity,” and lowers the knowledge standard for fraud-based manipulations.
Higher crop yields = lower prices
Brian Scott, a farmer at family-run Scott Farms in northwest Indiana, said the use of genetically modified plants for crops such as corn, wheat and soybeans can play a big part in the pricing.
“We grow GMO crops as one piece of our management plan to protect our crops from weeds and insect pests,” he told Food Dive. “Genetic modification expands the options we have to deal with these yield robbing stresses. For example, half of the corn acres we grow are Roundup Ready, but we don’t use Roundup herbicide on them. However, the option is there and would be a great way to clean up a grass problem in corn. GMOs have also played a part in reducing our tillage which reduces our costs, and preserves natural soil structure.”
GMO expert Stuart Smyth, an assistant professor in the University of Saskatchewan's department of bioresource policy, business and economics, noted if these crops were not available to farmers, the food industry would have to compensate the lower yields with higher food prices.
“Food prices are affected by a number of factors, including commodity prices and by other costs, such as wages, transportation, in addition to losses due to weather, pests or disease,” he told Food Dive in an email. “For example, foods that have to be shipped or hauled long distances will be affected when the cost of fuel rises.”
Research conducted by Brookes and Barfoot indicates that corn-based products would be priced 6% higher and soybean-based products would be 10% higher if GM crops were not grown. In fact, Brookes and Barfoot estimate that during the 19-year period of GM crop production, the technology has brought an additional 158 million tons of soybeans and 322 million tons of corn.
“Additional production resulting from GM crops provides stability to both prices and supply,” Smyth said. “Yield is the largest influencer of price and supply variability, so with GM crops increasing production, this is accompanied by greater stability or security.”
But crop pricing is not just based on volume. Sjofors said that pricing power comes from differentiation — producers find ways to make their product different so it appeals to a portion of the market that specifically appreciates it.
Sjofors said an example of this concept is organic produce. It is actually cheaper for the farmer because it does not require expensive fertilizers and pesticides. It leads to marginally lower yields, but it commands higher prices in the store, making it more profitable for the farmer, distributors and retailers. But this produce only appeals to a portion of the market.
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