AS MOST people are aware, the profitability of primary production is a function of the difference between prices received and costs of production. Profitability suffers whenever prices are too low or costs too high.
For many people, the solution to low farm profitability is higher prices. Indeed, quite a few believe prices are kept low deliberately, with the assumption that everyone is making money at the expense of primary producers.
A recent investigation by another media organisation found farmers receive a relatively small proportion of the retail price of the food they produce. The average, according to the report, was 28 per cent, with a range between 2pc and 49pc.
Such a low percentage, some suggest, is proof that others are making money at the expense of farmers. Top of the list of usual suspects is supermarkets, with Coles and Woolworths the main supposed culprits.
One way of examining this argument is to take a counterfactual position. In other words, what would be the situation if everything supposedly wrong with the supermarkets were ‘fixed’? What if they did not exist? Or, perhaps more realistically, what if the retail market were much more diverse, with Coles and Woolworths each having less than 10pc of the market? Would there still be complaints about low prices?
That question is, or ought to be, occupying the minds of the Australian Competition and Consumer Commission (ACCC) in their quest to find something illegal about the way supermarkets do business or, if that’s not possible, to change the law so they can (find something illegal). Like those who blame supermarkets for low commodity prices, the ACCC’s starting assumption is that supermarkets are up to no good.
A substantially more diverse retail market would have considerably higher costs than at present. Coles and Woolworths each have very efficient logistics networks for moving produce from where it is grown to where it is purchased. If there were 100 different supermarket networks, for example, there would be 100 freight and warehouse networks to supply them, with everything on a much smaller scale. Goods now transported on B-doubles would be carried on tray trucks. The fixed costs of supermarkets would have to be recovered from lower turnovers.
The result of this would be higher consumer prices, but would it mean higher producer prices? Probably not. In the end, the same number of consumers are buying food. Whether they are buying it from Coles or Woolworths, or from one of 100 alternatives, they would buy the same amount.
However, they would not necessarily buy the same things. Although food is largely non-discretionary and demand is insensitive to price within a certain range, price has a big effect on substitution. When prices rise, consumers may not buy less food, but they will choose cheaper options.
It’s not uncommon to hear it said that Coles and Woolworths work in concert to keep prices down. Leaving aside the fact that this is illegal and would give the ACCC the opportunity it has been looking for, it makes no rational sense. Producers of tomatoes, potatoes, chicken, beef or any of the other food commodities that supply Coles and Woolworths are neither operating at a loss nor acting involuntarily. Indeed, most producers would love to have a contract to supply them. And if the prices they received were less, they would stop.
Some of the loudest complaints about low prices, and accusations levelled at supermarkets, come from beef and wheat producers. Yet in both cases, prices are determined more by international markets than domestic factors. Whether Russia allows its wheat growers to export their wheat, and by how much the US subsidises the conversion of corn into ethanol, have far more impact on prices than what Coles or Woolworths do in the process of retailing bread in their stores. Similarly, Korea’s quota for importing beef has much more impact on beef prices.
None of this is to suggest that profitability cannot be increased. It can be. But blaming others for low profitability is not only fruitless, it is wrong. The solution is within the grasp of each industry and producer.
Reducing the cost of production is obviously a good place to start. It is rare to find a farm where inputs cannot be used more sparingly to reduce costs or more effectively to boost output. That includes capital. And of course, increasing the scale of production will drive down unit costs. Buying out the neighbours is often a good way to achieve higher profitability.
Another obvious option is to increase demand, whether domestic or international. So long as supply does not increase in response, prices will rise. Thus access to export markets and discovering new uses for products can be very helpful.
Equally obvious is to reduce supply, by some producers switching to something else or selling the farm and letting someone else have a go. Demand will rarely decline if supply is reduced, meaning higher prices must eventuate.
And for those who sell do out, it would be entirely rational to use the proceeds to buy shares in Wesfarmers, the owners of Coles, or Woolworths. The dividends will almost certainly offer a higher rate of return on capital than they achieved from farming. And calls for these companies to reduce their profits might not be viewed in the same way, either.