A new discussion paper by Adelina Gschwandtner and Stefan Hirsch, KDPE 1612, December 2016
The present project analyses what drives profitability in the food sector and compares the results with the manufacturing industry in general but also between the European Union and the United States.
One of the main findings is that competition is stronger and profitability is lower within the food sector as compared with the manufacturing sector in general. This is mainly attributable to a high market saturation and to the fierce competition between the big retail companies. While the competition profits the consumer, it puts strong bargaining pressure on the producers. Therefore, one of the main drivers of profitability and profit persistence within the food sector is firm size. Larger producers seem to be in a better bargaining position against the retail sector and this seems to be both the case in the EU and in the US.
A determinant where the food sector seems to differ between the two regions is firm’s growth. While the impact of firm’s growth on profitability is positive in the US, it is insignificant in the EU. This may be because while growing firms have to take into consideration higher costs and this may decrease profitability.
And this may explain yet another difference between the determinants of profitability in the food sector in the US and in the EU. While the impact of (long-term) debt is positive in the US, it is negative in the EU. By having easier access to debt, US firms are presumably able to better counteract this potentially negative effect of growth. Long-term debt can enable firms to make the necessary investments that help to ensure competitiveness in times of crisis. In the EU firms indebted in the long run seem to find it more difficult to cope with risk.
The results have not only purely descriptive value but can also be useful when designing policies aimed at supporting food sector firms or the food sector as a whole. This is important as today firms are facing economic circumstances characterized by reduced entry barriers and possibilities to operate in previously hardly accessible foreign markets. Those developments are a consequence of intensified globalization represented by trade agreements such as the NAFTA or the formation of a single market for goods and services within the EU. However, these deregulations of borders and international trade have led to a significant intensification of competition among firms across many sectors. Pressure on the margins and competitiveness of food processors is further intensified by increasing uncertainty in raw material markets and strong concentration in retail sectors. A high and constantly growing share of private labels further increases power imbalances between processors and retailers. In the EU the food sector has already drawn attention of competition authorities with a focus of retailer’s buyer power visà-vis the producers. The present results confirm the need for policy interventions at the downstream level. Moreover, the positive impact of firm size and growth on profitability indicates that small firms and firms with low growth are in a disadvantageous position. Thus, policy measures which address the industry could focus on a decrease of administrative burdens particularly for the large number of small
enterprises. Furthermore, policy actions that decrease unfavourable financial risk factors -particularly short term risk in the US and long term risk in the EU- might strengthen processors and help to counter power imbalances. Finally, the US results indicate that in times of economic crisis measures that facilitate access to long term debt can counter the negative impact of the crisis.
You can download the complete paper here.