Market Structure and Organization in Agri-Food Value Chains: An Application to the German Dairy Sector

Subproject of the DFG Research Unit SiAg 2010-2013

The German dairy sector is facing a period of significant changes. The number of both farmers as well as dairy processors has drastically declined over the last few decades. The wide range of literature tackling adjustment processes in agricultural sectors often ignores retail activities. As long as the retail sector was highly fragmented and constituted a “transparent” window between suppliers and consumers, this approach was appropriate; however, this has changed dramatically since the retail sector has been subject to a profound consolidation process. Due to the emergence of increasingly dominant agents at all stages of the dairy sector, strategic interactions along the value chain have become more important. In particular, the increasing buyer power of retailers has raised concerns in recent years. Against this background, we aim at analyzing competitive forces along the value chain. So far, there exists no workhorse model that allows for the analysis of interdependencies in a three-layer structure where imperfect competition is assumed at all three stages. We close this gap by developing a general model that allows us to analyze negotiation outcomes between retailers, food processors and farmers. Based on this framework, our research project is divided into two work packages which tackle two different issues of structural change in agricultural value chains:

In the first work package, we focus on merger incentives at the processor level. If products are both conventional and strategic complements, a merger between processors may soften their bargaining position vis-à-vis retailers, while a merged processor has a better bargaining position vis-à-vis farmers. To capture this trade-off, we construct a simple theoretical model that considers the negotiations of processors with both farmers and retailers. When analyzing potential drivers of structural change, we take into account how changing marginal costs at the processors’ level, the processing capacities, as well as a variation of the number of upstream firms change the outcome in terms of endogenous market structure and delivery tariffs negotiated between processors and farmers as well as between processors and retailers. The empirical part of this work package focuses on econometric modeling and estimation of market structure development at the processor level. The empirical model will be developed within an Olley-Pakes framework which, in addition to the determinants of market structure, provides consistent information about productivity differences between processors.

In the second work package, we examine competition between different organizational forms such as cooperatives and for-profit firms at the processors’ level. We endogenize the size of cooperatives in a mixed duopoly equilibrium. We aim to understand how differences in ownership structures and in distribution of market power along the chain affect negotiation outcomes in vertical relations. We further intend to highlight how different ownership structures affect the endogenous quality choice of farmers and processors. The empirical investigation in the second work package focuses on the explanation of market performance and the identification of market power. Within this context, a structural market model will be developed that combines the theoretical findings of both work packages.

DFG research unit SiAg 2010-2013

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