By performing certain functions and services, various marketing organisations and agencies make it possible for commodities, produce and products to move from producers to consumers. However, these functions incur costs, often of considerable magnitude. Discussions on margins and costs usually include the topic of marketing efficiency. An efficient marketing system is one capable of moving goods from producer to customer at the lowest cost consistent with the provision of the services that customers demand. Once the costs involved in marketing have been identified then means can be devised to make the system more efficient. Increases in efficiency can be achieved in a variety of ways: by increasing the volume of business using improved handling methods, investing in modern technology, locating the business in the most appropriate place, implementing better layouts and working practices in production, improving managerial planning and control and/or by making changes in marketing arrangements (e.g. through horizontal or vertical integration).
The chapter is aimed at enabling the reader to:-
Understand what the term marketing efficiency means and the varied forms it can take
Distinguish between marketing efficiency and marketing effectiveness
Identify the factors which influence the level of efficiency and level of effectiveness of a marketing system, and
Determine how marketing costs and margins can be calculated.
The chapter begins with an overview of the twin concepts of marketing efficiency and effectiveness before examining the different forms which marketing efficiency takes, i.e. operational efficiency and pricing efficiency. There then follows a discussion of the reference product concept which allows marketing managers and industrial analysts to compare costs, margin and efficiency levels at different stages of the marketing system. The remainder of the chapter is largely comprised of an explanation, and illustrations of how marketing costs and margins can be measured or estimated whilst taking into account product losses, the production of by-products as well as production, processing, handling, storage, transportation, packaging and capital costs.
It might be thought that the performance of a marketing system could be evaluated in terms of how well the agricultural and food marketing system performs what society and the market participants expect of it. However, it soon becomes apparent that marketing systems have multiple and often conflicting goals. Compromises and trade-offs will be necessary if the various participants in the marketing system are to be satisfied. For example, consider the perspectives of just three parties involved in agricultural marketing systems consumers, farmers, society and government. Consumers are likely to evaluate a marketing system in terms of its performance in avoiding high and fluctuating prices, shortages in supply and consistency in delivering products or produce of acceptable quality. Farmers' concerns could be rather different. Their criteria might include the capacity of intermediaries to exert undue influence on prices, the extent of competition in the sectors supplying farm inputs and accessibility of marketing infrastructure at reasonable cost (e.g. suitable storage and transportation). Society is likely to give consideration to the marketing system's contribution to employment, its impact on the environment and the ethical standards to which it is perceived to adhere. Government's perceptions of a marketing system will also be coloured by its impact on employment. In addition, government will probably take into account the sector's contribution to investment, economic growth and the national treasury through its taxable income. In the case of staple foods, governments will also be greatly interested in a marketing system's ability to avert protests from the electorate against unaffordable food prices. Given these different perspectives there are several contrasting measures which are commonly used in assessing the performance of a marketing system. These are:
the farmer's/grower's share of the retail price paid by the end user or consumer
the gross marketing margin or farm-retail price spread, and
the proportion of a consumer's income which must be spent on food.
Whatever the perspective from which a marketing system's performance is evaluated, the terms most commonly used are efficiency and effectiveness. These are not one and the same thing.
A marketing system can be effective without being efficient. An example of such a system is that created by Indonesia's parastatal Bulog. Indonesia is a country comprised of thousands of islands (not all of which are inhabited). Bulog was charged with the onerous responsibility of physically distributing rice and ensuring that everyone was supplied with their basic food requirement. (Hence the name, Bureau of Logistics, Bulog). Before Indonesia became capable of self-sufficiency in the staple food, the sole criterion of Bulog's success or failure was of its effectiveness in delivering rice to where it was needed. The costs in doing so were a secondary consideration as long as Bulog could keep its costs within whatever budget could be made available to it.
Increased efficiency is in the best interests of farmers, traders, processors, wholesalers, retailers, consumers and society as a whole. The efficiency of a marketing system is measured in terms of the level and/or costs to the system of the inputs, to achieve a given level and/or quality of output. Such inputs are generally in the form of land, finance, time, manpower and materials. Typical outputs include the movement of a given amount of product to markets at specific distances, the supply of a particular level of service to target market segments and the supply of products at a target price. Hence resources are the costs and utilities are the benefits that comprise the marketing efficiency ratio. Efficient marketing optimises the ratio between inputs and outputs.
Improved operational efficiency is evident where marketing costs are reduced but outputs are either maintained or actually increase. Examples of operational efficiency gains would be the introduction of a less expensive method of storing grain or an innovative milk package that reduces energy costs when the product sits in retailers' refrigerators. Technological innovations are not the only avenue leading to higher levels of operational efficiency. An organisation that improves its raw material procurement practices, by say centralising purchases, buying in larger quantities or taking advantage of unit freight rates, is likely to increase operating efficiency. In the same way, an organisation that rearranges sales territories and distributes fewer but larger loads to each delivery point can improve its levels of operational efficiency. Physical losses as commodities, produce or products move through the channels of distribution are another aspect of operational efficiency. The higher the losses, the lower the level of operational efficiency.
In practice, changes in the cost of marketing influence consumers' satisfaction, and efforts to increase the customer's utility often affect marketing costs. A new marketing practice that reduces costs but also reduces consumers' satisfaction may actually reduce the efficiency ratio. For instance, millers might improve efficiency by withdrawing 5 kg bags of meal from the market and sell minimum quantities of 10 kg bags. If a substantial number of consumers prefer to buy the 5 kg bag then the decrease in customer satisfaction could be greater than the gains made in cost reduction to the miller. The compromise which must be made between operational efficiency and customer satisfaction explains the difficulty of improving marketing efficiency. It is not difficult to reduce marketing costs by taking such measures as reducing the number of pack/bag sizes, eliminating packaging or reducing the number of retail outlets supplied but there may be a greater loss in customer satisfaction than is compensated for by the fall in marketing costs and retail prices. When evaluating any marketing change intended to improve marketing efficiency, both cost reductions and customer utility must be considered.
Marketing firms, operating within a competitive environment, are especially well motivated in seeking to increase operational efficiency. Although their goal may be higher profits, often the benefits of improved operations accrue to customers in the form of lower prices. Competition acts as a brake on the extent to which profits increase and limits any tendency for customer service and satisfaction levels to fall.
Figure 12.1 was constructed from data in Pant's1 study of marketing costs and margins for major agricultural commodities in Nepal. It will serve to illustrate price spread analysis. Price spread analysis draws a distinction between the farmer's share of the price to the end user and its reciprocal, the farm-retail price spread. The farm-retail price spread measures the gross percentage of the final retail price which accrues to each category of participant in an agri-marketing system, other than the farmer, in return for the marketing services which they perform.
Figure 12.1 Marketing costs and margins for major agricultural commodities in Nepal
It can be seen that in each case it was the Nepalese farmer who received the greater proportion of the retail price. Whether or not this is a fair proportion depends upon the level of marketing services provided by the farmer. Such services would include some or all of the following: crop drying, grading, sorting into convenient lots, bagging, storage and transporting. In fact, Nepal's farmers provide few of these services. Pant states that due to financial constraints and a lack of storage facilities, most farmers sell their paddy at the earliest opportunity. In practice this means that paddy is sold chiefly between November and January. It is the millers and wholesalers who provide the storage services and so are able to sell rice throughout the year. However, as figure 12.1 shows, the millers and wholesalers receive only a small percentage of the consumer price, as do retailers. There is a prima facie case for concluding that the marketing intermediaries in Nepal are inadequately rewarded relative to the farmers. There are other equally plausible conclusions. Since the farmer's share includes the farmer's costs, production inefficiencies will increase the proportion of the final price which will go to farmers. These inefficiencies can arise for a number of reasons. If the great majority of farmers are very small then the farming sector may be denied access to economies of scale. Where credit cannot be obtained from the formal sector then smallholders may be forced to pay exorbitantly high interest rates to informal lenders. Another cause of inefficient production is the continued use of obsolete technology or husbandry methods.
The data presented in figure 12.1, is not sufficient to allow conclusions as to problem causes but merely suggests areas to which analysts could direct their attention. Indeed, no matter how complete the data it is dangerous to rely only upon quantitative data when assessing the efficiency and fairness of a given marketing system, or the efficiency of particular market participants. Consider the hypothetical data in table 12.1 in which different prices are obtained from growing tomato varieties suitable for canning and those which are best consumed fresh. The table shows the prices paid by consumers, the farm-retail price spread and the percentage of the consumer's dollar that went to the farmer for each type of tomato.
Table 12.1 Margins, shares and costs and marketing efficiency
|Fresh Tomatoes||Canning Tomatoes|
|Retail price (50 kgs)a||$20.00||$40.00|
a. That is, 50 kg fresh equivalent.
The difference in the percentage of the retail price which goes to the farmer is striking. Those farmers who grow fresh tomato varieties receive forty percent of the price to the consumer but farmers' supplying tomatoes for canning only get twenty percent of the consumer's dollar. However, due to the differences in retail prices for these tomatoes, both groups of farmers earn $8. Obviously a smaller percentage of a large number can match or exceed a large percentage of a smaller number. Thus a lower farmer's share of the consumer's dollar does not necessarily mean lower farm prices or returns. The grower will be much more interested in dollars than percentages. If the market for canned tomatoes was to show increasing demand then total aggregate marketing costs of tomatoes would increase and the farmer's share would fall as a percentage. But if with this change in the market consumers could be encouraged to buy more tomatoes at higher prices then actual returns to growers could increase. In these circumstances higher marketing costs could be popular with both consumers and farmers. Kohls and Uhl2 hold the view that:
“It is doubtful that the statistics of the farmer's share merit the attention they receive. The important thing is not the size of the share, but the total return received by agricultural producers from the sale of their products. Higher marketing costs and a more prosperous agriculture are compatible ideas. It is very probable that as the standard of living rises, increased demand for more processing and marketing services will increase marketing costs.”
Moreover, the share of the retail price obtained by the various market participants is not of itself a measure of their relative efficiency. It is much more likely that these shares reflect the amount of value that these parties add as any given commodity passes through the marketing system.
Pricing efficiency is a second form of marketing efficiency and is based on the assumption that competitive markets are efficient. It is concerned with the ability of the marketing system to allocate resources and coordinate the entire agricultural/food production and marketing process in accordance with consumer directives. The evidence of pricing efficiency is efficient resource allocation and maximum economic output. Possibly the best measure of the satisfaction-output of the marketing system is the price that customers will pay in the marketplace for the produce, commodity or product in question. If consumers are willing to pay three cents more per orange for orange juice than for fresh oranges, it can be inferred that the process of juicing adds three cents of form utility to fresh oranges. The pricing mechanism directly affects production, in this instance, by indicating that a certain amount of the available oranges should be processed rather than sold as fruit.
Kriesberg3 says that the usefulness of pricing efficiency measures in evaluating any marketing system depends upon four conditions:
That customers have alternatives from which to choose in the marketplace. In other words, the measure has little relevance to situations where there is an effective monopoly.
The prices of alternatives adequately reflect the costs of providing them. That is, there are no subsidies hidden or otherwise for competitive products.
Organisations must be free to enter or leave the market.
There must be competition between those in the marketplace. For example, cartel-like behaviour should not be in evidence.
Theory suggests that if markets are operating efficiently then prices of a given product will be related over space and time, and between forms. Prices should only differ between geographic areas of a country by transportation costs from one point to another. Similarly, the price of storable products at one point in time should not exceed the price in a previous period in time by more than the cost of storage. And, again, the price of a processed product should not exceed the price of the unprocessed equivalent by more than the cost of processing.
Advocates of the pricing efficiency concept believe that prices which do not reflect the costs of marketing services are clues to functional deficiencies, chief among them being monopolistic power. Competition plays an important role in determining pricing efficiency. Market oriented organisations compete for custom by lowering marketing costs, increasing operational efficiency wherever possible, and at the same time adding more utility to the products in order to gain more market share.
Frequently there are conflicts between the different varieties of efficiency. For example, a new technological development may improve a firm's operational efficiency and permit it to grow very large. However, this growth may reduce the number of firms and thereby affect structure and competition in the industry, and in turn perhaps lower price efficiency.
Marketing costs are incurred when commodities move from the farm to the final market, whether they are moved by farmers, intermediaries, cooperatives, marketing boards, wholesalers, retailers or exporters. With increased urbanisation and industrialisation, marketing costs tend to increase relatively to the farmgate price received by the farmer, i.e. the product moves greater distances, through more intermediaries and is more sophisticated in its packaging. Marketing costs can also reflect the state of a country's development in that as standards of living increase, smaller proportions of income are expended on raw products of the farm and greater proportions are spent on additional and improved marketing services. Increasing the value added means, among other things, that more people in developed countries are involved in marketing agricultural products than in producing them.
Marketing costs include labour, transport, packaging, containers, rent, utilities (water and energy), advertising, selling expenses, depreciation allowances and interest charges. Marketing costs vary from commodity to commodity and product to product. There are several factors that individually or collectively account for these differences. These include:
the more waste the greater the proportion of customers' expenditure which goes on marketing costs
the more perishable the product the greater the marketing costs
the more processing of the commodity the greater the marketing costs
the greater the amount of produce handling and transportation the greater the marketing costs.
From a wide ranging survey of marketing costs in developing countries Kaynak4 reported on wheat, rice, potatoes, eggs and livestock products. Summary data from this survey are presented in figure 12.2.
Figure 12.2 Typical marketing costs and margins for major agricultural products in selected developing countriesb
A marketing margin is the percentage of the final weighted average selling price taken by each stage of the marketing chain. The margin must cover the costs involved in transferring produce from one stage to the next and provide a reasonable return to those doing the marketing. An example of the margin calculation is shown in exhibit 12.1.
Exhibit 12.1 Calculating market margins
|These calculations are based on figures given earlier in the chapter, that is where the buying price from the farmer is $0.50 per kg, the weighted average wholesale selling price is $0.90 per kg and the weighted average retail price is $1.17 per kg.|
|Share to the producer ($0.50/$1.17||= 0.427 or 43%|
|Wholesale margin ($0.90 - $0.50)/$1.17||= 0.342 or 34%|
|Retail margin ($1.17 - $0.90)/$1.17||= 0.230 or 23%|
|Total margin||= 0.572 or 57%|
b. The countries included in the study which gave rise to these figures were: Bangladesh, Bolivia, Chile, Colombia, Cyprus, India, Indonesia, Jamaica, Jordan, Kenya, Korea, Mexico, Nepal, Pakistan, Papua New Guinea, Peru, Philippines, Thailand, Turkey, Zambia.
Looking at margins and changes in margins does not necessarily prove that there is a problem, but rather such examinations suggest that there may be a problem which requires further investigation by studying the marketing costs. For example, in recent years many countries have reduced the role of grain marketing boards and increased private trader involvement in grain marketing. A comparison of margins under the old system with those under the new marketing channels may show that marketing margins are higher under private traders. A little knowledge is a dangerous thing, so on the basis of this margin comparison, people may argue for a return of the marketing board. They may think that traders are making excessive profits, but the marketing board was probably making a loss every year. Its margins were low because its costs were not fully reflected. The government may have had to write off the loss made by the board, something which would not be done for the private sector. Also, changes from government to private marketing have often been part of “Structural Adjustment Programs” which have frequently led to rapid rises in interest rates. The marketing board may have used subsidised low interest loans, the private traders now have to pay the full cost of capital. Moreover, under structural adjustment, currencies have often been devalued heavily. This puts up the cost of capital items, such as trucks, and inevitably leads to higher marketing costs.
“Margins” are often used in the analysis of the efficiency of marketing systems. Often they are misused even if they are correctly calculated. The presentation of a trader's share of the final selling price in percentage terms can give a totally misleading impression unless there is an understanding of the costs involved. Often people who research marketing costs and margins start out with the assumption that traders exploit farmers. When they look at the margins they may think they have found the proof. The calculation in exhibit 12.1 could, for example, be written up as “traders keep more than half the income from tomato sales”, such an analysis could then be used to try to justify government intervention in marketing, whether it be to establish minimum prices or to start a marketing board. Yet it is quite possible to arrive at such margins with reasonable costs and very small net profits for the two traders involved.
Because margins are expressed in percentages they appear to be high. Furthermore, because a “reasonable” marketing margin may have been estimated at some point in time there is a tendency not to accept that such margins can and must change. For example, some governments have, in the past, announced that cash crop farmers will get a certain percentage of the export price. This percentage may have been established when prices for the cash crop were high; it no longer remains useful if prices fall. If the farmer gets 80 percent of the export price for coffee when the on-ship price is $20,000 a ton this permits a marketing margin of $400 a ton. If the world market price then collapses so that the on-ship price is $1,000, an insistence that farmers get 80 percent will mean that the margin will not be enough to cover costs. With the exception of operating capital costs, which will fall as the price goes down, marketing costs will stay more or less constant in money terms. Therefore, marketing margins will rise in percentage terms although staying constant in monetary terms as the price falls.
As explained earlier, increases in marketing margins due to increases is marketing costs may not mean increase in profits made by those doing the marketing. Moreover, where farmers receive only a comparatively small share of the selling price this does not necessarily mean that they are being exploited. Total margins will depend on the length of the marketing chain and the extent to which the product is stored or processed. To know whether margins are reasonable it is necessary to understand the nature and composition of marketing costs.
The calculation of marketing costs and margins is obviously a necessary prelude to determining whether these are reasonable in relation to the value added. This is true whether the perspective is that of a policy maker assessing the performance of the sector or an individual firm evaluating its own performance. There are two possible ways of proceeding. The first is to begin at the farmgate and follow the product through to the end consumer. The second approach is to start with retail prices and calculate backwards to the farmer. The important point is that there must be consistency in the approach adopted. For instance, because of processing and wastage, 1 kg of wheat sold by a farmer will result in, say, only 0.75 kg available for sale to the consumer. Under such circumstances one cannot compare the costs attached to 1 kg of wheat with those of 1 kg of bread because the analyst would not be comparing like with like and could not state that the difference between the two represent the costs of marketing. Similarly, it is important to know whether processing costs are measured as cost-per-unit of bread or cost-per-unit of wheat. Smith6 proposes that the starting point should always be 1 kg of product as sold to the consumer. This he calls the reference product.
In most cases, identifying a reference product's final costs and those attached to the materials from which it was obtained is easily achieved since the prices can usually be ascertained. However, the analyst must be aware that there may be a range of prices simultaneously in operation and seasonality may also affect prices. Nonetheless, allowances can be made for such circumstances. The difference between the sale price and purchase price of 1 kg of the reference product (or its equivalent in raw materials) at any stage in the marketing process is called the gross margin for that stage. The difference between the consumer purchase price and the farmgate price of 1 kg of the reference product (or its equivalent in raw materials) is termed the total gross margin.
It is much more difficult to correctly identify the costs at each stage because this involves obtaining information from marketing agents or making reliable estimates of the likely level of costs. The main problems are:
Agents usually handle more than one product and several items of indirect cost may be shared amongst the various products, e.g. a retail outlet which sells many different types of food would have difficulty in accurately defining the cost associated with selling 1 kg of a particular product.
The costs associated with marketing 1 kg of a reference product may vary considerably, e.g. A cattle dealer may purchase some stock only a few kilometres from the abattoir whereas others may have to be transported several hundred kilometres. It is therefore important to ascertain whether average costs or actual costs are being reported.
There are a variety of ways in which agents can estimate and report costs. A good example is that of depreciation charges where there are three or four equally acceptable approaches but each yielding different amounts. Another example is the variety of ways in which enterprises choose to allocate overheads and other indirect costs. The prudent course of action is to ensure that the method employed is always explained so that correct comparisons can be made.
Government involvement in marketing can make it difficult to identify costs because many government agencies do not publish cost accounts and/or they subsidise or tax market operations in hidden, or indirect, ways.
In some marketing systems the marketing agent hires or purchases the majority of the resources he uses. In other situations, the resources are mainly owned by the agent. The net margin is normally defined as the gross margin minus all costs paid to resource owners other than the marketing agent. From what has just been said it is apparent that two activities performed with similar effectiveness and with similar gross margins may have widely different net margins. It is therefore desirable to identify the services provided by the agent and try to estimate the opportunity costs of resources used. These imputed costs can be taken from a review of the remuneration of others engaged in producing or marketing the product being studied.
When calculating marketing costs and margins there are two phenomena that can confound the estimations: product losses, or shrinkage, and the value of by-products7.
Shrinkage: During the marketing process some of the produce will be lost, stolen, spoilt or otherwise wasted so that more than 1 kg of produce is required at the beginning of a marketing stage to provide a consumer with 1 kg of the reference product. This is termed shrinkage. Sometimes the amount of shrinkage at each stage of the marketing process may seem trivial, or difficult to measure, but if it is ignored it could seriously distort the assessment of the efficiency of the marketing process.
The causes of losses are many and varied: when there is a surplus, either because too much has been grown by the farmer or too much produce has been bought by the trader/retailer, physical losses will be high; poor harvesting techniques and bad handling on the farm (bruising, exposure to the sun) can mean that much damage has been done even before the produce is sold to the trader; when truckers are paid on a ‘per piece’ basis, farmers and traders try to squeeze as much as possible into the package and this can be a false economy as the loss resulting from the damage caused can exceed the savings in transport costs. Produce can be damaged in transit, by the constant shaking on bumpy roads, by exposure to sun on top of a bus, by high temperatures inside a truck or other vehicle (if a truck breaks down and has to sit at the side of the road for two or three days the entire consignment could not be sold). Delays and bad handling at the wholesale market can make things worse. Sometimes, for example, produce which has been well packed by the farmer or the trader is simply thrown onto a heap on the floor of the wholesaler's premises, causing further bruising and damage.
c. Andrew Shepherd has prepared a separate FAO publication, entitled, A Guide To Marketing Costs And How To Calculate Them in which he makes use of Smith's methodology but has added his own explanations and examples. This chapter makes considerable use of Shepherd's publication.
At all stages of the marketing chain some produce will be thrown away. This may be planned, as in the case of cabbage leaves where the outer leaves serve to protect the product and are later removed before offering the vegetable for sale, but in most cases it will be the result of losses caused by bad handling. Sorting should occur at all stages of the marketing chain to separate damaged from good produce. Losses in weight can occur even if produce is not thrown away. Most crops lose weight during transit and storage as the result of moisture loss. This is not necessarily a bad thing. For example, grain stores better when dry but it does mean that a kilogram of produce purchased from a farmer is not equal to a kilogram sold to a consumer by the trader.
This being the case, an estimate of losses must be made. This will not be easy unless the consignments are followed all the way through the marketing chain. Also, losses will vary according to the season: poor quality fruits which are unsaleable during a glut when prices are low may well be saleable when there is a shortage. It is not surprising, therefore, that many of the ambiguities in measuring costs and margins stem from shrinkage. Most Ministries of Agriculture have assessments of losses and these can be used as a starting point for estimates. However, there is often a tendency to exaggerate losses, so official figures should be treated with caution.
Smith6 has proposed a methodology for incorporating wastage or shrinkage rates in calculations of marketing costs and margins. The recommended procedure is to establish how much of the raw material it is necessary to purchase in order to supply the consumer with 1 kg of the reference product. The ratio between these two amounts of product is then used as a conversion factor to express all costs and margins in terms of 1 kg of the final product. Perhaps the methodology will be better understood through an example.
Exhibit 12.2 The effect of shrinkage rates on marketing costs and margins
|A farmer sells tomatoes at $4 per kg. These are then sold by a retailer at $6 per kg but 10 per cent of the quantity purchased is lost in the marketing process. The only identified costs are wages which amount to $1 per kg of product purchased from the farmer.|
|Since 10% (0.1 kg) of the purchased tomatoes is lost, 1 kg of them will produce only 0.9 kg of the reference product. It will thus require;|
|This is then used as the conversion factor for all costs, i.e. $ per kg of reference product.|
|Selling price||= $6.00|
|Labour costs: 1.0 × 1.11||= $1.11|
|Total marketing costs||= $1.11|
|Purchase price: 4.0 × 1.11||= $4.44|
|Gross margin (selling price - purchase price)||= $1.56|
|Net margin (gross margin - all costs paid to outside resource owners)||= $0.45|
Thus the best way to treat losses is to employ a method of calculation such as this one that allows comparisons to be made between the quantity eventually sold and the quantity bought from the farmer. It gives a more accurate estimate and also means that the costs involved in packing, transporting, handling and storing produce which is eventually lost are included. A second example of this calculation is given in exhibit 12.3 together with the a common, but incorrect, method of calculation.
Whilst Smith's methodology was developed in the context of processed products the approach can be used in other situations. If, for instance, a retailer marketing costs and margins must take into account factors which reduce the stock available for sale, such as pilferage Historical records can be used to estimate average losses due to theft and a conversion factor can be established. This then allows the retailer to take pilferage into account when setting prices and thereby recover this marketing cost.
There are quality as well as quantity losses. Quality losses reveal themselves when the trader has to sell part of a consignment at a lower price than the rest. This could be because produce deteriorates over the period it is being sold or because the trader expects that it will deteriorate before he has another opportunity to sell it. In many countries perishable fruits and vegetables are sold at low prices on Saturday evenings because markets are closed on Sundays. Such produce may be unsaleable on the Monday morning because it has to compete with fresh produce.
Exhibit 12.3 Calculating the cost of product losses
|Assume that, at 10 percent loss levels, 1 kg of tomatoes purchased by the trader from the farmer results in 0.9 kg being available for sale to consumers. The trader buys tomatoes from the farmer at $5 per kilogram and marketing costs are $2 per kilogram for the tomatoes originally purchased. The selling price of tomatoes is $8 per kilogram.|
|Then the costs are …|
|1 kg purchased at $5 per kg||=||$5.00|
|1 kg packed and transported at $2 per kg||=||$2.00|
|Sales Revenue or $8 × 0.9 kg||=||$7.20|
|Thus the margin to the trader||=||$0.20|
|Below is an example of the more usual, but incorrect, method of calculation.|
|1 kg purchased at $5 per kg $5.00||=||$5.00|
|1 kg packed and transported at $2 per kg||=||$2.00|
|10 percent losses i.e. $5 × 0.1||=||$0.50|
|Sales revenue $8 × 1 kg||=||$8.00|
|Thus the margin to the trader||=||$0.50|
|The second calculation is clearly wrong because the trader is seen to be obtaining revenue from produce which has already been ‘lost’.|
In estimating the price the trader receives for produce he or she has probably purchased from the farmer at a fixed price per kilogram, therefore taking account of the fact that all of the consignment is unlikely to be sold at one price. Not only will there be price variations due to quality differences but prices will vary according to supply and demand in the market. To calculate the average price the trader receives there is need to calculate a weighted average price. An example of this calculation is shown in exhibit 12.4.
Exhibit 12.4 Calculating weighted average selling price
|Assume an example involving a consignment of 100 kg of tomatoes as follows:-|
|50 kg sold at $2.00||=||$100|
|20 kg sold at $1.40||=||$28|
|20 kg sold at $1.00||=||$20|
|5 kg sold at $0.40||=||$2|
|(5 kg which cannot be sold)||=||-|
|Then the average selling price per kilogram is :-|
Exhibit 12.4 shows a very different picture of trader revenue than if we had followed him/her to the market and recorded the price of his/her first sale, which would probably have been around $2 per kilogram.
Processing and by-products: Products purchased by consumers are often very different in form from the original raw material purchased at the farmgate. Moreover, processing operations may create by-products that have a value of their own. These by-products are not, of course, part of the reference product and therefore have to be excluded from calculations of the marketing costs attached to the reference product. Smith's recommendation is the value of the by-product to record at the point where it is created and to subtract the by-product value associated with 1 kg of the final product at each previous stage in the marketing process back to the farmgate. In this way, the value of the by-products is ‘netted out’ from the calculations, leaving only the costs and margins associated with the reference product. Exhibit 12.5 contains a sample calculation.
Exhibit 12.5 Taking account of by-products when calculating marketing costs and margins
|A miller purchased paddy at 25¢ per kg. The extraction rate is 70% (i.e. 1 kg paddy produces 700 g of edible rice and 300 g of by-products). The by-products sell at 5¢ per kg and the edible rice for 50¢ per kg. The total identified marketing costs (packaging, milling, storage, transport etc.) are 5¢ per kg of paddy. The reference product is 1 kg of edible rice.|
|For each 1 kg of paddy milled, 0.3 kg of by-products is created, so to produce 1 kg of edible rice|
|This is the conversion factor for all costs per kg of reference product.|
|Total marketing costs i.e. 5.0 × 1.429||=||7.15¢|
|Purchase price of paddy, including by-products||=||33.58¢|
|Gross margin, net of by-products (sale price-purchase price of paddy - value of by-products)||=||12.12¢|
|Net margin, net of by-products (gross margin, net of by-products - total marketing costs)||=||4.97¢|
If required, all marketing costs and margins can be shown as a percentage share of the reference product price, for example, the farmer's share of the reference product price is :
33.58/50 × 100 = 67.16%
As in the case of shrinkage calculations, it is important to know whether costs, conversion rates and by-product values are measured in relation to the product as purchased from the previous stage, or as sold to the next stage.
Handling costs are easily overlooked. Each time a product is handled the cost per kilogram will be negligible. But a product can be handled many times before it reaches the consumer. The sum total of all these small handling costs can be considerable, particularly in countries with relatively high labour costs.
In some cases it is possible to get an accurate idea of handling costs. For example, porters at wholesale markets usually charge a fixed rate per box or per cart. In other cases, however, there will not be a fixed charge. Costs per container will then need to be worked out approximately by dividing the wage of the employee by the number of packages handled. Where casual employees are recruited on an hourly basis (for example at a market) this might be fairly easy. Where the person is a full-time employee of the trader the calculation is more difficult. The employee may spend many hours sitting on a truck travelling between the farmer and the market. He will be doing nothing during this time but the trader will still have to pay him if he wants his assistance to load and unload.
Most products and produce need packing. Exceptions are grains and some larger fruits and vegetables such as pumpkins and water melons which may be transported in bulk. Leafy vegetables, such as cabbages, are also often transported in bulk. Here the outer leaves themselves act as a form of packaging by protecting the inner leaves. There is no packaging cost but it should be remembered that the outer leaves are often thrown away before sale and thus there is a cost in terms of product loss.
Packaging serves three basic purposes:-
It provides a convenient way of handling and transporting produce. Costs would certainly be much higher if everything had to be carried and moved without any form of packaging.
It provides protection of the produce. The efforts which are continually being made to improve bulk packaging are designed mainly to improve the protection offered rather than to increase the convenience of the packaging from a handling point of view.
Packaging can be used to divide the produce into convenient units for retail sale and to make the produce more attractive to the consumer, thus increasing the price at which it can be sold.
Quite often the farmer will provide the packaging, such as jute or gunny sacks for maize and paddy, which is used right through the marketing chain. More complex and expensive packaging such as plastic crates will on the other hand, normally be the trader's responsibility.
A fruit or vegetable may be packed and repacked several times on its way between producer and consumer, depending on the length of the marketing chain. The farmer may use one type of packing (for example a sack) to take his produce to market. At the market a trader may transfer the produce to a wooden box or plastic crate for transport to the wholesale market. A retailer buying at the wholesale market may then transfer the produce to his own packaging and then repack it (for example in plastic bags) for convenient sale at his shop. All of these various types of packaging involve costs, and need to be taken into account when working out total marketing costs. The simplest packaging cost calculations are those where the bag, box, crate or basket it used only once. All that needs to be known is how much produce the package contains in order to work out the packaging cost per kilogram.
With the use of more expensive packaging every effort is made to use the packages over and over again. In these circumstances there is need to make an estimate of how many times the container is used to arrive at a cost per journey. Allowance must also be made for transporting empty package back to the beginning of the marketing chain. If a trader owns his own vehicle and all his business is in one direction (i.e. from farm to town) then his cost of returning the containers is negligible. If, however, he has to pay transport costs for the empty containers this can increase his packaging costs significantly. An example of this calculation is shown in exhibit 12.6.
Exhibit 12.6 Calculating packaging costs
Sophisticated packaging will be used more when it significantly reduces losses; non-perishable produce will not require expensive packaging because the benefits of using it will be marginal. The possibility of using improved packaging made with local materials should always be considered.
Transport costs are incurred by farmers when they take their produce to the market and by traders as they move the produce down the marketing chain to the consumer. Sometimes transport costs are very obvious because they involve a direct payment by a farmer or trader to a truck owner or, in some cases, boat owner on a per piece basis. In other cases transport costs are less direct, as when the trader, or even the farmer, owns and operates his own vehicle. Sometimes there is no financial outlay but there is still an opportunity cost. For example, when a farmer uses animal transport, a bicycle or even carries the produce himself to get to an assembly market he could be doing other things with his time. This is a relevant marketing cost if the farmer has the possibility of selling his produce at the farm gate but feels his income will be higher if he takes it to the market. If the farmer has no alternative to going to the market then the time spent can be more properly regarded as part of his costs of production. If he doesn't go to the market he will not be able to sell his produce.
Payment to truck drivers to carry produce to market on a ‘per piece’ basis makes for easy marketing cost calculations but is usually a more expensive way of transporting produce. Truckers have no idea whether they will fill their trucks or not and so calculate their charges ‘per piece’ by assuming an average load over the season or year which is less than the capacity of the vehicle. Thus traders or farmers working in groups can, if they are sure they can fill a vehicle, save on transport costs by joining together to hire the truck, then it becomes cheaper per unit transport costs. Extension officers involved with marketing can play an important role by helping farmers or traders to organise to do this.
When produce is carried on a ‘per piece’ basis it is a simple matter to divide the cost per container by the number of kilograms in the container. When a truck is hired or the trader uses his own, the calculation is more difficult because the vehicle may be used for several different commodities each packed in a different sized container. For most trucks the factor limiting quantities carried is space available, not weight. Thus products which have a low weight-for-volume ratio (for example green peppers) should be costed at a higher per kilogram cost than produce which is heavier in relation to its volume. This requires making a rough estimate of the volume of the containers used for each commodity. The space available in the truck (minus an allowance for space that cannot be filled because of the shape of the containers, etc.) can then be divided by the volume of the containers, so allowing the cost per kilogram to be worked out. An example of this calculation is shown in exhibit 12.7.
The calculation becomes more complicated when a trader owns his/her own vehicle and the traders have to estimate transport costs. There are so many factors to consider in working out the costs per kilogram for one journey that this is best avoided unless there is no alternative information available to allow the cost to be estimated. If, for example, some traders use their own transport while others hire trucks on a ‘per journey’ or ‘per piece’ basis then the costs of the latter can be used as a ‘best guess’ of the costs to a truck-owning trader.
Because traders and truck owners are often accused of overcharging it is important to be aware of the transport costs they face. These include:
wages paid to the driver and, where relevant, his assistant
cost of fuel, maintenance, repairs and the like
cost of licences, road tax, insurance and other necessary payments
costs incurred en route such as tolls or bribes paid at official or unofficial road blocks and charges for entering a market
the capital cost of the vehicle. When working out the yearly costs of the truck's operation there is need to include not only the cost of bank interest paid on a loan but also the annual depreciation (or loss of value) of the truck. When roads are bad trucks may last only a few years and thus depreciation will be a major cost.
Having identified annual transport costs it is then necessary to consider the amount of work the truck will do in one year in order to work out a cost per tonne per km. This will depend on:
the periods in which produce is available to be marketed
the other uses (if any) to which the truck can be put on return journeys or when not being used for agricultural marketing
the days the truck is unavailable due to break-downs, repairs, services and the like
when both produce and the truck are available, the number of journeys and kilometres the truck will be able to do.
Exhibit 12.7 Calculating transport costs
As can be seen, there are numerous individual costs which can combine to make produce transport extremely expensive. In many cases transport will be the most important marketing cost. It is therefore vital that the cost is calculated correctly. Expensive mistakes can be made if, for example, a village cooperative decides to buy a truck to compete with traders. If it under-estimates the costs of operating the truck or over-estimates the amount of produce it will handle it could end up with a large loss.
Storage is carried out in order to extend the period of availability of a crop to a consumer. In the case of staple food crops long-term storage is, of course, essential. The harvest period may be just a few months but the staple has to be consumed throughout the year. Storage can be carried out by the farmer, the trader (or marketing board) or by the consumer. With regard to more perishable crops, storage can be used to extend what is often a very short period of availability. However, this is only viable when the produce can be sold after storage at a price higher than the into-store price, with the difference fully covering the costs of storage, as well as offering an incentive to take the risk that a loss may result.
Storage costs fall into four categories:
costs associated with the physical operation of the stores, that is the actual cost per kilogram which must be paid to place the produce in the warehouse or cool store. Such costs are made up of factors such as depreciation on the building, security, electricity and other utility costs and maintenance
costs associated with the maintenance of the product quality while it is in store, for example, the cost of chemicals
costs associated with loss of quality and quantity while the produce is in store
the financial cost to the owner or the produce while it is in store.
The biggest single factor affecting storage costs is capacity utilisation. Where a store is used frequently full capacity costs per unit will be low. Where it is kept empty for much of the time costs will be high.
Where commercial storage facilities are used it is relatively simple to work out physical storage costs incurred by the trader as he will be charged on a basis such as kilogram/days, box/weeks or tonne/months. The cost per kilogram for the period the produce is in store can then be worked out. Where the trader hires an entire warehouse and moves produce in and out it is necessary to know the average number of containers/kilograms in store during the period for which the store is hired. An example of this calculation is shown in exhibit 12.8.
There will usually be quantity losses while produce is in store. This may be deliberate, for example when grain is dried so that it will store better, or accidental, due to bad storage. With fresh produce some quantity loss is almost inevitable, however efficiently it is stored. Physical losses in storage need to be treated as costs in the way previously outlined. Quality losses are also inevitable and for the trader these are reflected in the prices he or she receives. As stated earlier, it is important to get an accurate estimate of the weighted average price at which stored produce is eventually sold.
Exhibit 12.8 Calculating storage costs
It is easy to ignore the fact that produce while in store incurs a financial cost for the trader. To do so, however, would give a totally inaccurate impression of marketing costs. An example of a realistic calculation of storage costs including additional costs such as bank interest is shown in exhibit 12.8. This example assumes that there is no loss. However, a four-month period of storage will almost certainly lead to some losses and these need to be built into the calculations.
Exhibit 12.9 Calculating storage costs over time
|Assume that a trader buys potatoes at $10 per bag and keeps them in store for 4 months. To do this he has to borrow money at 12 percent per year.|
|Then the cost of bank interest is:|
|$10 × 0.04 (12% p.a. over 4 months) = $0.40 per bag.|
|Thus a realistic calculation of storage costs per bag for the consignment of potatoes is:|
|Storage charge for 120 days at $0.02 per day||=||$2.40|
|Interest charge of $0.40 per bag||=||$0.40|
|Total cost per bag||=||$2.80|
The transformation of a produce from one form to another clearly involves costs associated with the operation of the processing facility. In calculating marketing costs, it is necessary to consider two other important aspects of processing costs. Firstly, as with product losses, one kilogram of product purchased from the farmer cannot be compared with one kilogram of processed product sold to the consumer. There is need to ask. How much will be sold to the consumer if one kilogram is bought from the farmer?' Secondly, there may be a by-product as a result of the processing and this by-product can often be sold. The value of the by-product must therefore be included in the calculations.
The cost of the food in very sophisticated processed food products sold in supermarkets (for example “ready-to-eat” meals) can be a very small proportion of the retail selling price, sometimes less than ten percent Processing, packaging and other marketing costs absorb the rest. However, here only the cost of primary proceedings is considered.
Some examples of primary processing are:
paddy into milled rice (conversion at 65–70 percent, by-product bran)
maize into maize meal (conversion at 65–85 percent depending on quality of meal, by-product bran)
green tea into black tea (conversion rate 28–32 percent, no by-product)
cotton into lint (conversion rate 30–35 percent, by-product cotton seed)
cherry coffee into green bean (conversion rate approximately 18 percent, no by-product)
copra into coconut oil (conversion rate 60–65 percent, by-product copra cake)
soya beans into oil (conversion rate 18 percent, by-product soya meal) and
oil palm into palm oil (conversion rate 18–24 percent, by-products palm kernels and oil palm cake).
In calculating processing costs it is necessary to know the conversion rate, the quantity of by-product, the value of that by-product and the costs of processing. An example of such a calculation is shown in exhibit 12.10.
Exhibit 12.10 Calculating processing costs
|Assume that a rice milling operation converts paddy at the rate of 70% (0.7) and has saleable by-products equal to 25% of the paddy weight. Processing costs per kilogram of paddy have been calculated at $0.20 per kilogram on the basis of the mill's total annual costs divided by the number of kilograms of paddy processed. The buying price of the paddy was $1.50 per kilogram and the by-products have a value of $0.50 per kilogram.|
|Then the processing cost per kilogram of paddy is:|
|One kilogram of paddy purchased||=||$1.50|
|Processing costs i.e. 1 kg × $0.20||=||$0.20|
|Less by-product revenue of 1 kg×0.25×$0.50||=||$0.12|
|Break even selling price per kilogram of paddy||=||$1.58|
|Thus the break even selling price per kilogram of milled rice is:|
Of course, it will not always be possible to obtain reliable information on a miller's costs. These will include not only operating costs such as fuel, maintenance and repair but also labour costs, the cost of the capital investment in the mill and its premises, and the opportunity cost of the owner's time. Calculating total costs from all these individual costs cannot be realistically done by an extension worker. However, he or she can perhaps get information about milling costs. Ministries of Agriculture may have model budgets for mills, according to their size, as may banks which lend money to mill owners. These can be modified according to circumstances and throughput of the particular mill.
Capital costs are a major component of marketing costs. Such costs will vary from country to country depending on the level of interest rates. They include:
the cost of money needed to buy produce and keep it in store. Many small traders buy produce, sell it and use the proceeds to buy more, so their needs for operating capital are limited. Traders who buy produce and store it for lengthy periods will, on the other hand, have sizeable operating capital requirements. In some countries traders buy from farmers in advance of the harvest, that is they buy the “field” or the “tree”. Thus they will have to finance the produce they buy for even longer periods and their marketing costs will, consequently, be higher.
the capital cost of a warehouse or a truck if the trader owns them
the capital cost of other buildings or of equipment, such as office space, weighing scales, grain drying equipment and
the depreciation (or loss of value) of the vehicle, warehouse or equipment owned by the trader, miller, or other party.
The calculation of capital costs for a small consignment of produce is far too complex an operation when the aim of the exercise is simply to work out marketing costs of vegetables from a group of farmers to a nearby urban market. It is best to use commercial rates for the hire of services, such as transport rates, storage rates or contract milling charges, even if the trader is using his own vehicle or other facilities. These commercial rates will already have capital costs built in by the trucker, warehouse owner or others.
However, extension workers may be asked to advise a Cooperative on whether to build a store, construct a maize mill or purchase a truck. Under these circumstances it is necessary to compare the capital and depreciation costs with the expected annual return from the Cooperative's activities after the direct operating costs have been covered. Capital costs are the interest paid to the bank on the loan. Assuming interest rates stay constant, this interest can be estimated in advance on a yearly basis if the proportion of the “principal” (that is, the total amount borrowed) paid back every year is known.
Depreciation can be calculated on a “straight line” basis. Here, the life of the vehicle or building is estimated and its cost, minus its “salvage” or “scrap” value at the end of its working life, is divided by the number of years of its life to get the annual depreciation. An alternative, and more accurate approach, is to assume depreciation at a fixed percentage per year. In this way the value goes down more rapidly in the early years than later. If, for example, a $10,000 truck is depreciated at 10 percent then the depreciation in the first year is $1,000 and in the second year $900 (that is 10% of $10,000 – $1,000).
The measures used in assessing performance of a marketing system tend to vary with the perspective of the individual, group or organisation carrying out the assessment. That is, producers, traders, processors, consumers, government and society at large are likely to look for different things from a marketing system and so the criteria by which they judge it are also likely to differ.
Marketing systems can be effective without being efficient. Effectiveness relates to the achievement of goals without consideration of the cost. Marketing efficiency is the ratio of inputs to outputs. Typical inputs are land, labour, capital and raw materials whilst common outputs are service levels, specific volumes of products delivered to the customer and the provision of a given level of satisfaction. Marketing efficiency is principally comprised of operational efficiency and pricing efficiency. Operational efficiency is increased when marketing costs are reduced whilst outputs are either maintained or expanded. Pricing efficiency is concerned with the efficient allocation of resources by a marketing system. The concept of pricing efficiency is only relevant to competitive markets. The price mechanism directs resources to where there is effective demand and where maximum economic returns can be earned from those resources.
Care has to be taken in drawing conclusions from such measures as the farmer's share of the consumer price and the far-retail price spread. These figures, if considered on their own, are likely to be misleading when used to assess the efficiency or fairness of a marketing system. For example, a given market participant's share of the consumer's dollar may be low because provide few marketing services (or he/she add little value) or may be arithmetically low, as a percentage, but achieve reasonable returns since the retail price of the product is high. What is important is not the percentage of the final price which is received but the total return from the provision of products and marketing services.
The reference product concept is important for purposes of comparing the performance of market participants who may be operating at different stages of the marketing channel from one another. The finished product as delivered to the end user can serve as the reference point. For instance, using the reference product concept allows the market analyst to compare the marketing costs of bread and wheat. Due to wastage and processing methods, 1 kg of wheat will not convert to 1 kg of bread. Taking bread as the reference product and recording its costs and margins, it is possible to establish how much wheat is required in order to supply 1 kg of bread. The costs and margins of raw materials and semi-finished products can then be adjusted so that direct comparisons can be made between these and the finished product. The reference product concept also takes into account product losses, the creation of by-products, transport, storage, handling, packaging and capital costs.
|By-products||Marketing margin||Price spread|
|Conversion rates||Marketing costs||Pricing efficiency|
|Conversion ratios||Marketing margins||Reference product|
|Economic efficiency||Operational efficiency||Shrinkage|
Explain what is meant by the efficiency of a marketing system
Under what circumstances might a reduction in marketing costs actually lower marketing efficiency?
Briefly explain the phrase, the farm-retail price spread.
Name the 3 measurements of marketing performance which are mentioned in this chapter.
What is the alternative name for ‘the marketing margin’?
What are the 4 pre-conditions of the usefulness of pricing efficiency measures?
Briefly discuss the principal mistakes that you believe were made by the Colombian flower growers
Describe the main categories of storage cost.
With reference to case 12.3 outline why you think Kallu found himself working twice as hard for half as much profit.
What functions does Wimalajeewa perform to earn his commission (see case 12.2)?.
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4. Kaynak, E. (1986), “Food Marketing Systems: Less Developed Countries Practices”, Journal of Food Marketing, pp. 21–37.
5. Morgan, C.M. (1984), Airfreighting High Value Perishables: Flowers From Colombia, J. Freivalds (ed). In: Successful Agribusiness Management, Gower Publishing Company, pp. 101–107.
6. Smith, L.D. (1981) “A Methodology For Measuring Marketing Costs And Margins For Foodstuffs In Developing Countries.” In: Post Harvest Operations: Workshop Proceedings, FAO Network And Centre For Agricultural Marketing Training In Eastern And Southern Africa, Harare, Zimbabwe, pp. 37–83.
7. Shepherd, A.W. (1993), A Guide To Marketing Costs And How To Calculate Them, Food And Agriculture Organization Of The United Nations, Rome.
8. Abbott, J.C. (1987), Agricultural Marketing Enterprises For The Developing World, Cambridge University Press. pp 36–38 and pp. 43–45.