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Processed FoodTrade Pressured

by Evolving Global Supply

Chains

Anita Regmi Mark Gehlhararegmi@ers.usda.gov mgehlhar@ers.usda.gov

The last three decades have seen tremendous growth in sales of processed food—sales now total $3.2 trillion, or about

three-fourths of the total world food sales. But, contrary to initial expectations, this phenomenon has not led to significant

growth in global trade—only 6 percent of processed food sales are traded compared with 16 percent of major bulk agricul-

tural commodities. Although consumer demand for processed foods continues to grow globally, growth in trade has gener-

ally stalled since the mid-1990s. Global trade in processed food grew rapidly during the 1970s and 1980s, as consumers in

high-income countries demanded more foreign food products. Through the mid-1990s, these products accounted for a big-

ger share of growth in U.S. agricultural exports, with expanding exports to Japan, Canada, and Mexico. However, since the

mid-1990s, growth in both global and U.S. processed food trade has slowed, and bulk agricultural commodities account for

more of the recent growth in U.S. agricultural exports.

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Anita Regmi, USDA/ERS

Mark Denbaly, USDA/ERS

The slow growth in trade of

processed food products has often been

attributed to existing multilateral trade

rules that favor trade in raw commodities

at the expense of processed products. But

trade policy is not the whole story—many

other factors affect the choice of locations

to produce and sell food products.

Patterns of food trade are strongly influ-

enced by the changing nature of competi-

tion in the global food industry—from

shifting consumer preferences to the

growth in multinational food retailers and

the ways they manage their global supply

chains. Consumer-driven changes are

increasingly pushing food suppliers to

meet consumer demand and preferences

at a local level, even as the food industry

becomes more global. Local processing

allows manufacturers to strategically tailor

both manufacturing and packaging to suit

local tastes, preferences, and retailer

needs. The result of this trend has been an

acceleration of foreign direct investment

(FDI), often at the expense of trade. As a

case in point, U.S. food companies sell five

times ($150 billion) more through FDI

sales than through U.S. export sales ($30

billion).

Shifting Preferences Shape Supply Chains

Food suppliers are increasingly tailor-ing their marketing strategies to theunique characteristics of consumerdemands in each market that they serve,and the choice of strategy can either stim-ulate or discourage trade. At the broadestlevel, there are significant differencesbetween developed- and developing-coun-try markets, and suppliers have developedvery different strategies in serving thesetwo types of markets.

Market sizes, as indicated by retailsales value, are much larger for developedcountries. The United States, theEuropean Union, and Japan togetheraccount for over 60 percent of total retailprocessed food sales in the world.However, market growth has generallybeen faster among developing countries,particularly lower-middle-income coun-tries such as China, Morocco, thePhilippines, and many Eastern Europeancountries. The transitioning EasternEuropean countries, such as Bulgaria,

Romania, and Ukraine, experienced dou-ble-digit growth in retail sales of manyfood and beverage products during thelate 1990s. While sales in these marketshave stabilized, Asian markets have pickedup in the past few years, and processedfood product sales are expected to contin-ue to significantly increase.

Consumer preferences, shaped prima-rily by incomes, changing lifestyles, andevolving cultural preferences, largely deter-mine the items available in grocery storesin different markets. In developing-countrymarkets, higher incomes result in dietupgrades, with increased demand formeats, dairy products, and other highervalue food products. These include pack-aged cereals, pasta, oils, and other itemsused in meal preparations. In the devel-oped-country market, where consumersalready consume sufficient quantities ofthese items, sales growth is noted for labor-saving products, such as prepared meals.Food sales in developed-country marketsare also being influenced by consumer pref-erences for greater product variety and foodproducts possessing specific attributes—for example, products perceived to be saferor more healthful or products produced in

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1970 72 74 76 78 80 82 84 86 88 90 92 94 96 98 2000 020

25

50

75

100

125

150

175

200

225

World trade in processed food slowed in the 1990s

$ U.S. billion

Source: United Nations Commodity Trade Data Base.

Japan

European Union

Rest of world

North America

Source: Euromonitor, 2003. Country classification per the World Bank.

High-income

Upper Lower Low-income

2%

7%

28%

12%

Middle income

Annual retail food sales grow faster in the lower income countries, 1996-2002

ways that are more beneficial to the envi-ronment and take animal welfare and equi-table labor concerns into consideration.

In developed-country markets, wherethe volume of food consumed increaseslargely with population growth, food sup-pliers can increase returns mainly byadding value to their products—either byincreasing the production of ready-to-eatfood products or producing foods withspecial attributes desired by consumers,such as organic foods or foods with specialhealth properties. In contrast, in develop-ing countries, where incomes are risingand lifestyles are rapidly changing withurbanization, retail sales growth results

largely from increased volume and, tosome extent, increased sales value. As thesignals from different markets are trans-mitted up the supply chain, food produc-ers, processors, and traders adapt to meetthe evolving retail demand in each mar-ket. The differing adaptations ultimatelycontribute to changes in food trade pat-terns by influencing the import demandfor processed food products and theinputs used in their manufacture.

Demand Growth Lures FDI to Developing Countries

Recognizing the large potential indeveloping-country markets, food manu-

facturers are expanding their opera-tions in those markets. But they haveseveral options for selling their prod-ucts; exporting is just one option and,in many cases, not the preferred one.Most foreign food sales are generatedby investing abroad and processing inforeign markets. The choice betweenexports and FDI depends on the type ofproducts sold. Products that do notundergo major changes from their basiccommodity forms through processing(known as land-based products), suchas rice, wheat flour, meats, and fruitsand vegetables, are less suited for FDIbecause their production is limited by

specific growing conditions. For these prod-ucts, processing generally takes place closeto the location of primary production.Processed land-based products, such asfresh or frozen meat, frozen and cannedfruit and vegetables, and dry milk powder,can be exported to foreign markets.

Production of manufactured foods isless location specific because technologyand capital are mobile in the world foodeconomy. Through FDI, food manufactur-ing can expand to another country to sat-isfy the demand there. Therefore, land-based products tend to be traded far morethan manufactured packaged products,

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Trade in food and agricultural products can be distinguished by the interna-tional mobility of inputs used in the production process. On the one hand,trade is generally greater among products for which production largelydepends on land and other geo-climatic factors—termed for simplicity inour discussion as land-based products. On the other hand, there tends tobe less trade in consumer-ready manufactured products, which can be pro-duced almost anywhere investments in processing facilities are made.

Land-based food products include bulk agricultural commodities, such aswheat, corn, soybeans, coffee, and tea; horticultural products, such as fruit,nuts, and vegetables; semiprocessed products, such as vegetable oils, grainflours, sugar, and animal products; and some processed food products soldpackaged and consumer-ready in grocery stores, such as fresh and chilledmeats, flour preparations, and processed fruit and vegetables. Manufacturedfoods include other processed foods that use multiple inputs in their for-mulation and undergo significant changes from their raw forms. Examplesare breakfast cereals and various bakery and confectionery goods.As can beexpected, trade among processed food products varies based on their char-

acteristics. Land-based products, identifiable by their basic commodities,such as meats and frozen vegetables, tend to be traded more than manufac-tured products.

Fresh horticultural products–7%

Bulk grains and oilseeds–

Animal products

Manufactured food products

Processed fruitand vegetables

Oils and meals

54%

Total food Processed food

Note. Processed category includes semiprocessed food products. Manufactured food products consist of food preparations, flavorings, breakfast cereals, bakery products, pet food and prepared feeds, confectionery, soft drinks, and malt beverages.

Source: Foreign Agricultural Trade of the United States, 2003, USDA/ERS.

U.S. processed food exports are largely land-based products

39%

Food and Agricultural Product Trade Shaped by Product Characteristics

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and account for over 75 percent ofthe total value of U.S. processed foodtrade (see box, “Food andAgricultural Product Trade Shaped byProduct Characteristics”).

The largest firms, based inWestern Europe and the UnitedStates, are expanding their sales innumerous foreign markets to main-tain growth, while growth in thehome markets stagnate. Some firms,such as Nestlé, Kraft, and Unilever,already operate in over 140 coun-tries. With young, growing popula-tions in Asia and Latin America driv-ing sales in baby foods, milk-basedproducts, bakery products, and con-fectionery, it is no surprise that man-ufacturing firms are expanding tosupply the emerging large-scalesupermarket chains in these regions.

Growth in large-scale retailing inthe developing countries has coincidedwith new investments by foreign foodmanufacturers. In 2002, Heinz expandedits plant capacity by 15 percent in Chinaand opened a new plant in thePhilippines. The Kellogg Company nowhas manufacturing plants in China, India,Japan, South Korea, and Thailand for sup-plying retail chains in Asia. PepsiCo, thesecond-largest U.S.-based food company, iscontinuously extending its geographicalreach with its extensive international mar-

keting arm in snack foods, currently focus-ing on Latin America and Asia-Pacific. TheFrench-based Danone Group is developinga stronger presence in Africa and theMiddle East through investments in freshdairy and bakery products.

Smaller companies with a narrowerfocus are also looking for new marketsacross national boundaries. Italy’s popularconfectionery company, Ferrero, isexpanding operations in Asia-Pacific andEastern Europe. Confectionery manufac-turer, Wrigley Jr. Company, and theFonterra Group of New Zealand, a dairycompany, have also expanded operationsand currently sell their products in over140 countries.

Whether multinationals’ operationsin foreign markets promote or inhibit foodtrade depends on the individual productssold in these markets. Depending ontransportation cost savings and the ease incustomizing to suit consumer needs andprovide quality assurance, consumer-ready food products may be manufacturedin local markets through FDI. This in turn

can generate trade growth in the raw com-modities used to manufacture the finalfood products.

Supermarkets Change Industry Structure inDeveloping Countries

The last decade has witnessed anunprecedented growth in supermarketsamong developing countries, particularly inAsia and Latin America where risingincome levels have increased consumerdemand for many higher valued processedfood products. The trend has led to increas-ing centralization of distribution networksand also closer geographical integration.These developments can have both positiveand negative impacts on trade.

Until 1990, there were only a smallnumber of supermarkets in most Asian andLatin American countries, existing mainlyin major cities and wealthier neighbor-hoods and primarily financed by domesticcapital. By the early 2000s, supermarketshad penetrated the middle-class neighbor-hoods, and even the poorer urban neigh-

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Fred Gale, USDA/ERS

Greg Hamra

borhoods and rural areas, particularly inLatin America. While supermarketsaccounted for 15-30 percent of the nationalfood retail sales before 1990, they currentlyaccount for 50-70 percent of the retail salesin many Latin American countries, register-ing in one decade the level of growth expe-rienced in the United States in fivedecades. The development of the super-market sector in Asia is similar to that ofLatin America, but 5-7 years behind in itsexpansionary process. However, supermar-kets in Asia are growing at a faster rate com-pared with those in Latin America.

The expanding supermarket sector indeveloping countries is increasingly for-eign owned. In Latin America, large multi-national firms (such as Ahold, Carrefour,Wal-Mart, and others) constitute 70-80percent of the top five supermarket chainsper country. These global retail companieshave also invested aggressively in theAsian markets in recent years. The successof these companies in the global retailmarket is largely due to their ability tooffer a wider variety of products year-round and at lower prices. With theirlarge-scale operations and supply chainsreaching into many countries, these com-panies can efficiently handle time-sensi-tive and large volumes, resulting in costsavings. These savings can be passed on toconsumers in the form of lower prices.

The changes in the food retail sectorhave resulted in a trend toward centraliza-tion of procurement, whereby large distri-bution centers have taken over the distri-bution functions of myriads of smaller cen-ters and middlemen. A Carrefour distribu-tion center in São Paulo may serve 50 mil-lion consumers in three different States,and an Ahold wholesaler in Costa Rica mayserve the entire Central American foodretail market for Ahold. The logistics sectorhas also improved the interface betweensuppliers and retail outlets.

The presence of multinational retail-ers is likely to lead to an overall increaserather than decrease in food trade. Thequest for year-round supply of fresh prod-ucts has encouraged joint venture partner-ships and strategic alliances among firmsin the northern and the southern hemi-spheres, increasing trade in these prod-ucts. Similarly, alliances with retail outletscan open export opportunities for bothsmall and large producers and manufac-turers when the alliance is with a largemultinational retail chain. However, thepresence of large multinational retailersmay also encourage food manufacturers toexpand their manufacturing units into theregion by assuring steady markets. In suchcases, the presence of multinational retail-ers may encourage more local processingfrom domestically produced raw products,thus discouraging trade.

Private Brands Ensure Quality but Restrain Trade

In response to changing consumerdemands, retailers have adopted moreproactive marketing strategies, where theytry to achieve customer loyalty not only byimprovements in service, location, andstore layout, but also by more control overthe overall value creation process in thefood chain. One strategy is the adoption ofprivate labels, where retailers seek dualobjectives, lowering retail price andenhancing product value. The use of pri-vate labels, especially when the purpose isto guarantee quality, is often accompaniedby strict control of suppliers of raw mate-rial and can, as a result, inhibit trade.

In the United States and many othercountries, private retail brands have gen-erally been cheaper substitutes of similaror lower quality compared with majormanufacturer brands. This use of privateretailer brands is currently rising in devel-oping countries due to the ongoingreplacement of the traditional informalfood market sector by a more formal sectorcharacterized by the presence and expan-sion of supermarket chains. For example,the retail chain Food World leads in pri-vate retail brand sales in India, sellingstore brand products, such as jams andhoney, at lower prices than major manu-facturer brand products. However, in theaffluent segments of West European,

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Country Past 2001

Percent

United States 5-10 (in 1930) 80 (in 2000)

Latin America

Argentina 17 (in 1985) 57Brazil 30 (in 1990) 75Chile NA 50Guatemala 15 (in 1994) 35Mexico NA 45

Asia

China (urban) 30 (in 1999) 48

Indonesia 20 (in 1999) 25Korea 61 (in 1999) 65Malaysia 27 (in 1999) 31Thailand 35 (in 1999) 43

NA = Not available.

Sources: T. Reardon and J.A. Berdegué, “TheRapid Rise of Supermarkets in Latin America:Challenges and Opportunities forDevelopment,” Development Policy Review,Vol. 20, No. 4, September 2002, pp. 317-334.D. Hu, T. Reardon, S. Rozelle, P. Timmer andH. Wang, “The Emergence of Supermarketswith Chinese Characteristics: Challenges andOpportunities for China’s AgriculturalDevelopment,” Development Policy Review,Vol. 22, No. 5, September 2004, pp. 557-586.

Supermarkets' share of retail salesis growing in many countries

Greg Hamra

Japanese, and U.S. markets, where con-sumers are willing to pay extra for quality-assured food products, private retailerbrands are increasingly designed to pro-vide products with specific attributessought by consumers.

Retailers may seek to add value andprovide higher quality products when theexisting products in the market do notmeet consumer demands for specific prod-uct attributes. For example, the Danishretailer, Dansk Supermarket, operates aseries of different private brands for dairyproducts as higher quality alternatives tomajor manufacturer brands. The Danskbrands are advertised as being of a superiorquality due to the use of local dairy outputproduced under traditional practices withdue consideration given to food safety con-cerns. Similarly, other retailers acrossEurope have introduced retailer brands forother products catering to specific con-sumer demands regarding safety, environ-ment, animal welfare, and other issues.

In implementing a strategy of usingprivate brands, retailers must ensure thattheir brands meet the desired quality

standards. This requires careful selectionof suppliers and the type of product forbranding. A study of 751 retail purchasersin 16 European countries suggests that, inaddition to traditional factors like price,quality, and the ability to supply neededvolumes, retailers select suppliers basedon product traceback ability and willing-ness to engage in long-term relationshipswith the retailer. As the branding func-tion places more responsibility for prod-

uct design, quality control, and productliability on the retailer, traceability andcloser cooperation with manufacturersare necessary.

Increased use of private retail brandscan have negative impacts on food trade.For example, the European consumers’preoccupation with food safety issues haspromoted retail brands, such as Dansk,which use local inputs. If the practice ofprivate labels using local sourcing were tobe expanded to wealthier segments inother developed-country markets, the useof private retail brands could potentiallyreduce the role of imports in the brandedproduct supply chain. Moreover, the certi-fication of quality assurance requiresadhering to national and retail standards,which, if more stringent than those adopt-ed in other countries, can potentiallyrestrict imports.

Trade Rules May Deter Some Processed-Product Trade

Ultimately, however, suppliers’ deci-sions whether to locally source or importproducts is also influenced by the rulesgoverning trade in these products. One ofthe main accomplishments of the 1994World Trade Organization (WTO)Agreement on Agriculture was to subjectagricultural trade to stronger international

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Average tariffs

Processing chain Australia Canada EU Japan U.S.

Percent

Cocoa

Cocoa beans 1 0 0 0 0

Cocoa paste 0 0 10 8 0

Cocoa butter 0 0 8 0 0

Cocoa powder 9 6 27 19 16

Chocolate and products 17 57 18 21 15

Source: Agricultural Market Access Database (AMAD) and International Bilateral Agricultural Trade Database (IBAT).

Tariff escalation in cocoa and products

Maurice R. Landes, USDA/ERS

disciplines, leading to a general reductionin agricultural tariffs. However, tariffs onagricultural products remain relativelyhigh and vary considerably across bothcountries and products. Many countriesimpose low or no duty on many products,but maintain very high tariffs, often inexcess of 100 percent, on import-sensitiveproducts.

Barriers to trade in processed prod-ucts are often more restrictive than on rawcommodities. Tariffs on average aregreater on processed products than ontheir less-processed forms, a phenomenonknown as tariff escalation. Analysis of tar-iff data from 22 countries indicate that theaverage tariffs on fully processed productsexceed those on primary products, withdifferentials ranging from 2 percent forthe United States to over 40 percent forTurkey. Over the entire group, the averagetariffs range from 30 percent on fullyprocessed goods, dropping to 20 percenton horticultural products, 18 percent onsemiprocessed items, to 17 percent on pri-mary products. As an example, most coun-tries have no tariff on raw cocoa beans,with the exception of Australia, which hasan ad valorem tariff equivalent of 1 per-cent. However, as one moves up the pro-cessing chain, ad valorem tariff equiva-lents tend to increase, with tariffs onchocolates and other cocoa products rang-ing between 15 and 57 percent. Similarexamples of tariff escalations exist amongmany other commodity sectors, includingcoffee and oilseeds.

In addition to tariffs, countries havenumerous other instruments at their dis-posal to regulate the flow of imports, suchas the various trade remedy measures. Forexample, imports can be reduced for limit-ed periods through antidumping andcountervailing duties and safeguard meas-ures that allow temporary actions whenimports surge. Available data show that

WTO member use of trade remedy meas-ures on agricultural products has risen,especially on processed food products. Ofthe total 76 antidumping and countervail-ing duties present worldwide on agricul-tural products in 2002, 43 were onprocessed food products and only one wason a basic agricultural commodity, theremaining consisting of semiprocessedand horticultural products. Similarly, safe-guard measures have also been used pre-dominantly on processed food products.

The presence of tariff escalation andincreased use of trade remedy measures onprocessed foods suggest that countries areseeking to capture value-added locally andimplement trade regulations that encour-age imports of relatively less-processedagricultural commodities. While this hasundoubtedly contributed to slower growthin trade of processed food products, tradeflows are also shaped to a growing extentby the changing dimensions of the globalfood industry. More integrated supply

chains that locally customize products tomeet regional consumer preferences mayencourage trade of less-processed agricul-tural commodities over trade in processedfood products. Therefore, even as the foodindustry becomes more global with thesame multinational retailers and manufac-turers operating across the world, fooddemand is being increasingly satisfied atthe local level where food suppliers are bet-ter able to meet specific demands of local consumers.

This article is drawn from . . .

New Directions in Global Food Markets,edited by Anita Regmi and Mark Gehlhar,AIB-794, USDA/ERS, February 2005, avail-able at: www.ers.usda.gov/publications/aib794/

Market Access for High-Value Foods, byAnita Regmi, Mark Gehlhar, John Wainio,Thomas Vollrath, Paul Johnston, and NitinKathuria, AER-840, USDA/ERS, February2005, available at: www.ers.usda.gov/publications/aer840/

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