Chapter 6.2

Value-adding in Agricultural Production

Chapter 6.2

Advantages Australia has in value-adding

6.37 During the inquiry a number of advantages Australia possess in relation to adding-value to various sectors of its agricultural production were identified. Wool and cotton were two such industries identified.

Wool industry

6.38 It was argued that Australia has a variety of advantages in value-adding to both the later stage processing of wool (LSP) and the early stage processing of wool (ESP) including:

  • the quality and breadth of its wool clip;
  • proximity to the Asian market;
  • competitive energy and effluent disposal costs;
  • the largest dedicated wool research and development program in the world;
  • political stability;
  • stable economic climate for investment;
  • increasingly competitive labour costs compared to Japan, Taiwan and South Korea;
  • availability of a stable and cooperative textile industry labour force;
  • improvement in productivity and work practices;
  • the vertical nature of Australia's wool industry allowing for;
    • the processing of small lots over short runs;
    • quick response to orders;
    • production of a wide range of products;
    • a reputation for quality and reliability; and
  • a developing value-adding culture with an export orientation. [28]

Cotton industry

6.39 The Australian cotton industry has a number of advantages compared to other cotton producing countries, such:

  • the availability of cotton at a different time of the year from that of most other cotton producing countries. This enables Australian cotton to be offered as “new” crop when most competitors' cottons have been in storage for some time;
  • lower levels of contamination;
  • use of a sophisticated classing system; and
  • proximity to major markets in Asia . [29]

Obstacles to value-adding activities

6.40 Despite the advantages certain industries have in relation to value-adding in the pursuit of adding-value to Australia's agricultural production a wide range of problems have to be faced. General obstacles to value-adding include:

  • the high cost of capital investment;
  • high real interest rates;
  • access to venture capital;
  • high transport and infrastructure costs;
  • high costs of labour;
  • low rates of labour productivity;
  • uncompetitive work practices
  • problems of poor industrial relations in manufacturing industries;
  • geographic dispersion of producer and processing facilities;
  • trade barriers, in particular tariff escalation up the processing chain;
  • poor market intelligence;
  • poor market information provided to producers;
  • costs of promotion and marketing of value-added or “branded” products;
  • government regulations;
  • Commonwealth policies and programs with respect to value-adding being seen as bureaucratically complex;
  • difficulties in guaranteeing quality, continuity, volume and supply of raw materials;
  • lack of export culture amongst producers; and
  • the ease of selling unprocessed products compared to value-added products. [30]

6.41 Two major factors identified during the inquiry as inhibiting the development of value-adding activities in Australia involved the financing of such activities and structural restraints affecting food marketing.

6.42 This section of the report also examines specific problem related to value-adding in;

  • the meat industry;
  • the rice industry; and
  • horticultural industries.

Financing of value-adding

6.43 The unwillingness of individuals and corporations to provide venture capital to support value-adding enterprises in Australia was identified as a major restraint on the establishment and development of value-adding activities in this country.

6.44 In its evidence to the inquiry Mr David Gray, Executive Director of Australian Natural Ingredients Limited, argued that there is no venture capital available in Australia. According to Mr Gray:

    What you have available is known in the industry as development capital, which relates to companies that have already been established and have already got a trading history. So genuine venture capital is not available through institutional financial sources. [31]

6.45 Mr Gray was of the view that fund managers in Australia decline to invest in new value-adding enterprises because they have a conservative approach to investment meant:

    These fund managers have a desire for a risk profile in their investments which is different from that which is in the national interest”. [32]

6.46 The existence of Statutory Marketing Authorities (SMA) was an additional factor Mr Gray saw as restricting the availability of venture capital in Australia for value-adding enterprises. Although recognising the benefits that resulted from the existence and operation of SMAs Mr Gray considered that if they did not exist private sector organisations would have taken up “strategic interest in upstream or downstream investments.” [33] Mr Gray stated:

    To my knowledge, the statutory authorities have virtually never taken strategic investments in value adding. ... This means a potential source of venture capital does not exist which would otherwise exist in the absence of these statutory authorities. [34]

6.47 The view that there are difficulties obtaining venture capital to support value-adding activities in Australia is not accepted by all observers. The Ricegrowers's Co-operative Limited (RCL) told the inquiry:

    There is a good capital market in the country. If there is a good investment opportunity - I do not care if it is in the Warrumbungles - for an agricultural value added product, the money is going to go there. [35]

6.48 Mr James Kennedy, General Manager of the Ricegrowers' Co-operative Limited , told the inquiry that international investment houses were interested in investing in Australian value-adding enterprises but were not sure how to “get part of the action”. [36]According to Mr Kennedy:

    The money is being pushed towards investment houses in Australia to invest, so I do not think the capital is a problem and I do not think the lack of a good opportunity hidden under a rock somewhere in Woop Woop is the problem. I do not subscribe to the capital issue. [37]

Structural factors affecting value-adding

6.49 Professor Samuel in his submission stressed that a proper understanding of constraints to the development of industries involved in adding-value to Australia's agricultural production “requires a perspective extending beyond food processing to an understanding of structural factors within food marketing channels, all the way to the retail level.” [38] Professor Samuel went on to state that industries adding value to agricultural production are “not likely to realise their full potential because of apparent severe structural constraints to their development.” [39]

Power of large retailers and food processors in Australia

6.50 It has been suggested that there has been a concentration of power at the retail level due to a liberal interpretation of the Trade Practices Act. The Trade Practices Commission appears to have adopted a liberal interpretation of the Act as a strategy to lower costs and therefore improve Australia's international competitiveness. [40]The Supermarket Institute of Australia agreed that there is a concentration of retail power when it stated:

    There is no doubt that the industry in Australia, at retail and at wholesale level is very consolidated. Your have major retailers who, by their efforts, command very large sectors of the market. [41]

6.51 This view was confirmed by the Australian Pork Corporation (APC) when it told the inquiry “we have the most centralised retail food trade in the world in Australia.” [42]

6.52 The Australian Supermarket Institute told the inquiry in May 1995 that the four major Australian retail chains are Woolworths, Coles Supermarkets, Franklins and Jewel and the four major wholesaling companies are Queensland Independent Wholesalers, Davids Limited, the Composite Buyers Group and FAL. According to the Institute these companies:

    Between them would either own or supply retail operations numbering in our estimation more than 5 500 throughout Australia. They would supply approximately 95 per cent of the over $30 billion worth of food and grocery products that are retailed in this country. [43]

6.53 This concentration of retail buying power is seen as the single most important factor constraining growth in Australia's food manufacturing sector. Retail buyers, particularly from the large supermarket chains appear capable of forcing down prices paid for processed foods. This strategy particularly affects smaller food processors. The large retail buyers are able to play one supplier off against another. This situation has had a significant impact on the profitability and growth of food manufacturers. [44] Retailers can often influence consumers purchasing decisions by stocking or not stocking particular brands. This gives retailers significant bargaining power, particularly in relation to weaker brands. [45]According to Australian Natural Ingredients Limited, “it is rare for new consumer products, produced and marketed by small companies, to succeed with the mainstream supermarkets as distribution outlets.” [46]

6.54 Professor Janek Ratnatunga stated in 1985 that while the concentration of purchasing power did not necessarily imply market power there was evidence that retailers exercised market power in the form of low prices paid to suppliers. Retailers were prepared to trade off high turnover for low gross profit margins of between two and five per cent. [47]

6.55 Professor Samuel believed that the market power of large retailers' would continue to increase due to their access to “market intelligence about product throughput, consumer prices and manufacturing costs (due to their involvement in house brands and generics) compared to that available to processing firms.” These factors are seen as increasing the control supermarket chains have over the processed food marketing system in Australia. [48]

6.56 It has been alleged that large retailers have used their market power to engage in discretionary purchases of generic products overseas as part of their domestic business strategy. These retailers' control over access to shelf space enables them to import either raw materials or processed products as a means of increasing their bargaining power with Australian suppliers. [49] According to Professor Samuel:

    Imports of processed foods could be used more against smaller, less well established, but efficient suppliers, than against larger, powerful, but less efficient, suppliers - thereby discouraging growth by efficient smaller suppliers, and distorting the signals for economically efficient investment in food processing. [50]

6.57 Like the retail food industry the structure of food processing is also characterised by a high degree of concentration. A few large companies and a large number of small to medium enterprises undertake food processing in Australia. Five firms have a turnover in excess of $1 billion a year. The top 20 companies account for close to 60 per cent of turnover that represents a turnover of $15 billion a year. The next 15 firms have a combined turnover of more than $500 million a year with the remaining 3 700 firms being in the small to medium size range. [51]

6.58 During his evidence to the inquiry Professor Samuel commented “I just wonder, and I raise this as a question, whether in another Western country this level of concentration would have been permitted.” [52]

6.59 In 39 product categories there is one firm that supplied more than half the national market for that category. In 1991-92, Arnotts had a 69 per cent share of biscuit production, CSR had a 69 per cent market share of sugar, Nestle 68 per cent of instant coffee, Uncle Ben's 64 per cent of pet food and Unifoods had a market share of 59 per cent of tea sales. [53] It has been argued that the dominant role some manufacturers hold in Australia allows them to “command unusual cooperation” from retailers in obtaining shelf space, promoting their products and maintaining certain price policies. [54]

6.60 Professor Samuel argued that “the high degree of concentration in food manufacturing suggests that countervailing power to that of retailers is needed for secure access to shelf space.” [55] The view of Professor Samuel was supported by Mr Anthony Botsman, Managing Director of the Professional Resource Group, when he told the Committee:

    I have worked for a company on the supply side trying to get shelf space and having to pay all of the discounts - the warehouse discounts and the gondola end discounts - that get you into those stores. I think it is an unhealthy oligopoly at best. [56]

6.61 According to Professor Samuel market power resulting from concentration at the retail level is likely to have led to the acquisition of greater market power through concentration at the supplier level. This concentration of power is due, in part, to brand recognition and preference by consumers. This brand based power is seen as particularly useful in countering the appeal of lower priced house brands and generics. [57]

6.62 Writing in 1993 Professors Samuel and Janek Ratnatunga expressed the view that the sheer market size and power of retail chains would give rise to informal, but very real integrated relationships with food manufacturers. These two academics supported the argument that the new competition in retailing was no longer between independent business units but between systems of centrally programmed networks. According to Professors Samuel and Ratnatunga this implied that:

    Because of the automatic pressures for vertical integration caused by retailer size, (a) smaller food processing firms with weaker brands are disadvantaged and (b) new entry at the food manufacturing level may need to be negotiated with insider-incumbents within the channel. [58]

6.63 Australia's retail marketing structure and its relationship with large food processing companies presents new entrants to food processing with significant difficulties, such as:

  • high capital costs to successfully launch a new product. These costs being associated with;
    • product development;
    • promotion for brand establishment;
    • achieving an economic scale of production; and
    • meeting government regulations;
  • high costs for negotiating access to shelf space controlled by retailers who have an integrated relationship with larger processors; and
  • obtaining raw materials on favourable terms. [59]

6.64 In evidence to the inquiry the Australian Supermarket Institute confirmed that in many cases manufactures have to pay a fee to supermarkets to obtain shelf space for a new product. [60] These fees were justified by the Institute on the grounds that the introduction of the new product takes up space occupied by other successful products and there are new accounting and bookkeeping fees for the supermarket involved in putting a new product on its shelves. [61]

6.65 In some instances the market in Australia is simply not large enough to allow for an economic scale of production. Careful research is necessary to establish the economic scale of production which has to be achieved to allow for “profitable entry into higher value-added food processing in Australia”. [62]

6.66 It can be difficult and costly to successfully launch a new grocery product in Australia. Between 1981 and 1983 only 10 per cent of new grocery products survived releases onto the market. In 1989 it was estimated that a nation wide launch of a new product cost between $1.5-$2.0 million. [63]In evidence to the inquiry Professor Samuel stated in May 1995 that he suspected that at that time it would cost between $5 million and $10 million to get a new product onto a supermarket shelf. [64]

6.67 The negative effect of vertical integration between large grocery retailers and large food processors can be summarised as:

  • discouraging workable, or effective competition among the larger processors that results in them not benefiting from competitive pressures and therefore not developing best practices in their operations;
  • discouraging investment for innovation and growth by smaller food processing firms;
  • discouraging investment by firms who may wish to enter the food processing industry; [65]and
  • resulting high profitability in the processed food sector by large firms have moderated incentives for them to enter export markets. [66]

6.68 However, not everyone views the concentration of retail power in the hands of a few large food retailers and food processors in a negative light. Mr Graeme Taylor of the then Department of Industry, Science and Technology explained to the Committee:

    Provided the retail structure encourages diversification in terms of a range of products, and it does appear to be doing so, and provided their retail structure is also exercising its influence to improve quality and innovation right back through the food chain to the farm then I cannot say from the point of view of processed food development that it is necessarily a bad thing. [67]

Conclusions

6.69 The Committee accepts that the concentration of retail and wholesale market power in the hands of a few large companies has impacted on value-adding food industries in Australia. However, the Committee accepts that this impact has not always been negative. The Committee is concerned that the negative effect of large food retailers, wholesalers and food processors on value-adding activities is moderated, while not destroying the advantages consumers enjoy from the operation of these large companies

Footnotes

[28] Maximising the Return: Adding Value to Australian Wool: Report of the Wool Processing Task Force, Department of Primary Industries and Energy, Canberra, 1993, p. 19.

[29] Bob Dall' Alba, Positioning Australian Cotton in the World Market, Outlook 94, Vol. 3, Agriculture: collection of papers delivered at the Outlook 94 Conference held in Canberra 1-3 February 1994, organised by ABARE pp. 143, 147

[30] See Evidence, DPIE, p. 883; Peter McKerrow, Value-Adding to Agriculture, Agricultural Science, Vol. 5, No. 2, March 1992, pp. 30-31; Evidence, South Australian Government, p. 548.

[31] Evidence, Australian Natural Ingredients Ltd, p. 736.

[32] Evidence, Australian Natural Ingredients Ltd, p. 735.

[33] Evidence, Australian Natural Ingredients Ltd, p. 738.

[34] Evidence, Australian Natural Ingredients Ltd, p. 738

[35] Evidence, Ricegrowers' Co-operative Ltd, p. 968.

[36] Evidence, Ricegrowers' Co-operative Ltd, p. 968.

[37] Evidence, Ricegrowers' Co-operative Ltd, pp. 968-969.

[38] Evidence, Professor Nicholas Samuel, p. 591.

[39] Evidence, Professor Nicholas Samuel, p. 596.

[40] Evidence, Professor Nicholas Samuel, pp 608-609.

[41] Evidence, Australian Supermarket Institute, p. 352.

[42] Evidence, APC, p. 427; see also Evidence, Australian Natural Ingredients Ltd, p. 737.

[43] Evidence, Australian Supermarket Institute, p. 348.

[44] Evidence, Professor Nicholas Samuel, pp 609-610; see also Nicholas Samuel and Janek Ratnatunga, Structural Constraints to the Development of Food Processing, Australasian Agribusiness Review, Vol. 1, No. 1 May 1993, pp. 64-65.

[45] Nicholas Samuel and Janek Ratnatunga, Structural Constraints to the Development of Food Processing, Australasian Agribusiness Review, Vol. 1, No. 1 May 1993, p. 66.

[46] Evidence, Australian Natural Ingredients Ltd, p. 725

[47] See also Nicholas Samuel and Janek Ratnatunga, Structural Constraints to the Development of Food Processing, Australasian Agribusiness Review, Vol. 1, No. 1 May 1993, p. 65.

[48] Evidence, Professor Nicholas Samuel, p. 609.

[49] Evidence, Professor Nicholas Samuel, p. 612. Nicholas Samuel and Janek Ratnatunga, Structural Constraints to the Development of Food Processing, Australasian Agribusiness Review, Vol. 1, No. 1 May 1993, p. 67.

[50] Evidence, Professor Nicholas Samuel, p. 613.

[51] Evidence, Professor Nicholas Samuel, pp. 609-610.

[52] Evidence, Professor Nicholas Samuel, p. 631.

[53] Evidence, Professor Nicholas Samuel, p. 610.

[54] Nicholas Samuel Ratnatunga, Structural Constraints to the Development of Food Processing, Australasian Agribusiness Review, Vol 1, No. 1 May 1993, p. 66.

[55] Evidence, Professor Nicholas Samuel, p. 610.

[56] Evidence, Professional Resource Group, p. 212.

[57] Evidence, Professor Nicholas Samuel, p. 610.

[58] Nicholas Samuel Ratnatunga, Structural Constraints to the Development of Food Processing, Australasian Agribusiness Review, Vol 1, No. 1 May 1993, p. 67.

[59] Evidence, Professor Nicholas Samuel, p. 611; see also Nicholas Samuel Ratnatunga, Structural Constraints to the Development of Food Processing, Australasian Agribusiness Review, Vol 1, No. 1 May 1993, p. 68; see also Evidence, Australian Natural Ingredients LTD, p.729.

[60] Evidence, Australia Supermarket Institute, p. 350.

[61] Evidence, Australia Supermarket Institute, pp. 350-351; see also Evidence, NFF, p. 1018.

[62] Evidence, Professor Nicholas Samuel, p. 612.

[63] Evidence, Professor Nicholas Samuel, p. 612.

[64] Evidence, Professor Nicholas Samuel, p. 630; see also Evidence, Australian Natural Ingredients LTD, p.725.

[65] Evidence, Professor Nicholas Samuel, p. 615.

[66] Evidence, Professor Nicholas Samuel, p. 611; see also Nicholas Samuel Ratnatunga, Structural Constraints to the Development of Food Processing, Australasian Agribusiness Review, Vol 1, No. 1 May 1993, p. 72; see also Evidence, Professor Nicholas Samuel, pp. 625-627.

[67] Evidence, Agri-Food Council, p. 940