Journal of the Academy of Marketing Science Summer 1975, Vol. 3, No. 3, 259-264

Food, Food Prices and Price/Earning Ratios

Merritt L. Kastens

Management/mprovement

The market price of all the farm land in the U.S. is roughly four times the value of the annual farm production. If a farmer could net ten per cent of his product sales-which is highly unl ikely-and if he needed no further investment in equipment and stock and working capi tal-which is impos- s ible-farm land would be selling at 40 times earnings. This is an industry that is growing at four or five per cent a year. Any security analyst would know what to do with that kind of an investment.

In 1972 a typical cattle rancher made about four per cent on his invest- ment. If he was really typical that was the first profit he made in ten years. This year he is losing money again.

The present administration says it wants to put agriculture on a "businesslike" basis. Social commentators foretell the advent of big "agribusiness"-not always with enthusiasm, but businesses exist to produce return on investment, and a businesslike investment in agriculture would have to generate a great deal more income than is possible today to be economically justified. Agriculture is undoubtedly the most capital- intensive industry in the U.S. today. The average farm turns over its assets only about once in six years. If it generated 100 per cent net margin before income taxes and interest, that is, if it had zero costs, it would only earn about eight per cent after taxes on assets employed. In a relatively risky business even that return would not attract much investment capital.

Actually, many industrial companies that "diversified" into agriculture have realized this, but, surprisingly, only after they "got into the game." Many are cutting back or pulling out. Except for cattle feeding and a few California produce operations, large-scale corporate fanning ventures are not a major factor and are not likely to be under present circumstances. The monster agribusiness takeover scare is unwarranted.

259

260 KASTENS

But that is not to say that farming is not getting more businesslike. Farmers are better educated; they have more alternative opportunities in which to employ their talents; they are by necessity becoming much more sophisticated in management methods. The average successful farm, one of those that produce 90 per cent of the farm output, commands $200,000 to $300,000 in assets. And surprisingly enough, the more successful farms have a lower asset to sales ratio than the average. More capital is not the key to "modern" farming; the key is more effective use of capital.

However, even with skillful use of capital, farm product prices might have to double the average level of recent years to yield an attractive re- turn. Admittedly, since the farmer only gets about a third of the con- sumer's food dollar, that would only mean about 30 to 40 per cent increase in cost of food on the table; but that is in constant dollars, and therefore five to ten per cent annual inflation has to be added. Moreover, food prices are expected to rise over the next ten years.

The present food price situation can be explained in classical supply and demand terms: bad crop years in Russia, Australia and the Orient: sky- rocketing food demand in an increasingly affluent Japan and Europe; money in the pockets of American shoppers augmented by more than $2 billion worth of additional food stamps pumped into the system; and no quick way to expand the available supply of food.

But in a market economy-in a businesslike atmosphere-supplies will only expand at a price that produces a reasonable return on a business in- vestment. For example, present beef prices are decidedly inadequate to promote expanded herds, and if the beef grower demands a businesslike rate of return, prices will have to go much higher.

Imports will not help. There is a world shortage of beef, and meat prices are higher in Europe than they are here. Worldwide demand for all food products is burgeoning as affluence reaches Japan and Europe and as many developing countries pull themselves beyond the subsistance level. Furthermore, since farming has become a high technology industry, the U.S. production cost for virtually all commodity crops is the lowest in the world. (Labor intensive row crops and certain tropical crops are obvious exceptions). To match our level of technology means not only to make the direct investment but to extract from the total economy the indirect investment cost of fertilizer plants, distribution facilities, experimental farms, and all the rest. Tiffs capitalization will not c o m e quickly. Export demand is likely to remain high and to result in net meat exports rather than imports.

As recently as two years ago $15 billion worth of farm product exports

FOOD, FOOD PRICES AND PRICE 261

sounded like a pipe dream. Now the question is "How far over $20 billion will food exports go?" If the common market slackens off its protectionist barriers against food imports, it will spur our exports even more and they almost certainly wilt relax to some degree to keep their food prices from getting completely out of hand. Those exports are good for our balance of payments, but they have to come out of our domestic supply and conse- quently will keep the pressure on our supply/demand balance.

In addition, removing price supports will not help except in a few special cases. Demand pressure has pushed most farm product prices well above support levels, and as long as the demand holds up there is no reason for the prices to come down. Peanut prices could come down forty or fifty per cent. Sugar prices might some day come down through the sup- port level if cane producers in the tropics increased production and if a stop was put to subsidizing sugar beet production to encourage conversion of beet land to grain production. Some tobacco and cotton land might be recovered if subsidies were removed from these crops which, with some forty million acres released from acreage reserves, would permit a substan- tial increase in food crop production.

There also might be some reduction in the assets charged to agriculture. Some $16.5 billion of the market value of farm land is estimated to arise from the federal crop allocations associated with individual plots. If the price supports, and hence the allocations, were eliminated that value would disappear. $16.5 billion is a large figure, but it is only about five per cent of total farm assets-not enough to alter the ROA equation substantially.

Cannot some relief be expected from applied technology? Perhaps, but farm labor productivity is going up five to six per cent a year, just about enough to cover wage increases. Since most economists only figure in farm proprietor's labor at two or three dollars an hour in calculating farm profitability, these imputed wages have considerable up-side scope.

The improvement in land productivity and pest control should help, but further mechanization may not. Yield per acre has been increasing a few per cent a year. Insect losses, overall, on wheat, are said to be down to three per cent and other major crops are almost as low. More mechani- zation, however, runs up against the capital problem. Book value of farm equipment is now about 70 per cent of total crop value, and a return has to be made on both that machinery investment and the land. Thus further mechanization can cut production costs but only at the expense of still greater capital costs.

Can genetics contribute? Yes, particularly in hogs; in fact, we will probably see the beginnings of battery-raised hogs in this decade. If

262 KASTENS

geneticists can do for pork what they did for chicken that could be one plus value.

What about the much-maligned middleman? He actually gets more of the food dollar than the farmer does, and his percentage of the take has been relatively constant for a long time, but just that constancy is signifi- cant. Grandmother bought dried navy beans and then proceeded to soak them and bake them in a pot for ten hours. Mother bought Heinz's canned pork and beans. "Heat 'em and eat 'em." Today's shopper buys a franks- and-beans TV dinner complete with the oven-ready "plate." thus buying much more than food with the lbod dollar, and today's consumer eats away from home, with increasing frequency, thus buying food plus service, plus a place to eat. Therefore, if the "middleman's" mark-up is essentially what it was twenty or thirty years ago, the consumer is getting more for his money. There are improvements to be made, but if consumers con- tinue to insist on getting more and more convenience and service with food they are going to have to pay for it.

What about the engineered foods-the synthetic proteins? There are possibilities for the future, but probably not in the eighties. If the sugar from 70 million acres, about one and a half times what we had in our land bank, were fermented to yeast and the protein extracted it would provide all of the protein requirements of the present world population. If three per cent of the world's petroleum refinery output, not much more than British Petroleum takes out with their bio-dewaxing process, were con- verted to protein via yeast and bacteria it would produce enough protein for the world population of the year 2000-5 billion people.

But such a process becomes a manufacturing business. It will not happen unless the price structure will justify the investment in the neces- sary chemical processing plants. Petro-protein producers will not be satis- fied with four or five per cent pretax return on their massive investments, although they could become very interested if the price were right.

There is no prospect of running out of food in this century at least. Even with existing technology there is no need for food shortages any- where in the world. The problems are political, economic, and to some extent, sociological. On the present trends the United States can produce all the food it will need plus a substantial exportable surplus through the year 2000 on existing farm land with no new irrigation projects-Bureau of Reclamation please note. It is estimated that our farm output could be increased by almost 50 per cent by 1980 without noticeable strain under proper incentive.

What may be running out is cheap food. Increases in productivity may

FOOD, FOOD PRICES AND PRICE 263

very well compensate for the increases in the cost of the factors of agri- cultural production, it is the capital structure of agriculture that is dis- torted. Admittedly, farm land is ridiculously over-priced in terms of its economic productivity. The farmers themselves have driven the price up by a factor of three in the last twenty years. Maybe as farmers become more financially sophisticated this land fever will subside and land prices will come down. Farmers may no longer be willing to "live poor and die rich." It is questionable though. Until that time, as inherited land be- comes less and less significant in agriculture, farms bought at current prices will have to be financed and will have to yield a competitive return on the funds employed. Ever more expensive equipment will have to justify the investment involved. The U.S. spends less o f its income on food than any other nation in the world. That may have to change. Con- sumers are very much aware that they are being prepared by the opinion makers to accept the fact that energy from now on is going to be a much more costly proposition than they have been accustomed to. It is quite likely that another socio-economic corner in food costs has already been turned and that a new era has been entered in which food will permanently take a bigger slice of the household budget than it has in the past. I f food production is going to be a business and not a way of life then the prices will have to be related to earnings in a manner comparable to that o f other business, and that is not the way it has ever been up to now.

(Arn'cle received June 1974.)

REFERENCES

Ball, A. G. and Heady, F. O. 1973. Size, Structure and Future of Farms, Ames Iowa, Iowa State University Press.

Fischer, R.W. 1974. "Food Supplies and Food Prices," Journal of the American Oil Chemist Society (January) 178A-180A.

Harris, Marshall, 1974, Entrepreneurial Control in Farming. Washington, U.S. De- partment of Agriculture, ERS No. 542.

Lins, David A. 1973. A Simulation Model of Farm Sector Social Accounts with Projections to 1980, Washington, U.S. Department of Agriculture. ERS N. 1486.

Melichar, Emmanuel, 1969. "Farm Capital and Credit Projection to 1980," Ameri- can Journal of Economics, 51 (June) 1172-1177.

Meyer, Herbert E. 1973. "The Baffling Super-Inflation in Meat" Fortune, 88 (July) 116-119,184-186.

Pavelis, George. 1973. Energy, Natural Resources and Research in Agriculture. Washington, U.S. Department of Agriculture.

Penson, John B. Jr. 1972. "Demand for Financial Assets in the Farm Sector, A Port- folio Balance Approach." American Journal of Agricultural Economics, 54 (May) 54--62.

264 KASTENS

Reimund, Donn A. 1974. "Farming Enterprises of Large Multi-Establishment Firms," Marketing and Transportation Situation, MTS-192 (February) 20-23.

Smith, Allen G. and Krause, Kenneth R. 1974. "Equity Financing Looms on the Farm Scene," The Farm Index, (April) 6-7.

U.S. Department of Agriculture, Issued Annually, The Balance Sheet of the Farming Sector, Washington.

- - - . Issued Semiannually, Farm Real Estate Market Developments. - - - . Issued Annually, Agricultural Statistics. - - - . Issued Annually, Farm Cost Situation. USDA 1974. Our Land and Water Resources, Current and Prospective Supplies and

Uses, Washington, Misc. Pub. No. 1290.

ABOUT THE AUTHOR

MERRITT L. KASTENS is the president of his own consulting firm specializing in strategy formulation and the editor of Food Industry Futures, a bi-monthly publication devoted to long-term trends in the food supply system. He was trained as a chemist at Roosevelt University and the University of Chicago. In the past he has served as Manager of the Planning and Analysis Department of Union Carbide International Com- pany, Assistant Director of Stanford Research Institute, and Associate Editor of Applied Publications of the American Chemical Society. He has advised a number of U.S. government agencies in various technical and policy areas and assisted several Universities in developing their long range plans.