Testimony on Pesticide Pricing

                                     Prepared For The U.S. House of Representatives

                                         Committee on Agriculture, Washington, D.C.

                         By Kenneth McEwan, Ridgetown College, University of Guelph

1.0       Introduction

Pesticides are a major farm input with many commercial cash crop operations spending 5% - 15% of cash operating expenses on these products. As global competition in agricultural markets has increased, competitiveness in input pricing has received more attention. The stimulus for the recent study APesticide Price Differentials Between Canada and the U.S.@ was raised out of concerns brought forward by farmers in North Dakota and Minnesota that prices for identical pesticide products were higher in the U.S. than in Canada. This is not a new problem. About ten years ago similar concerns were expressed by Canadian farmers and this potential disadvantage was recognized by the Task Force on Competitiveness in the Agri-Food Industry. This difference in pesticide pricing between Canada and the U.S. for similar products has been reported at other national border crossing points e.g. Ontario vs Great Lake States (McEwan, 1996).

The U.S. is normally ranked 1^st with close to 30% of the global market share for pesticide sales while Canada typically represents 2% to 3% and ranks 8^th or 9^th. The U.S. has many large acreage crops and several with high chemical demands. From a manufacturers perspective, this means the U.S. receives considerable attention and has significant impact when determining new product registrations. U.S. crops normally thought to influence a manufacturer=s decision making are: corn, soybeans, cotton, peanuts, and many of the specialty horticulture crops. The large acreage crops in Canada are wheat, barley and canola and are grown using extensive agricultural practices i.e. low input use. Market size and product demand are important factors when determining product price, since pesticide pricing is not cost based but determined according to what the market will bear.

2.0       Economic Theory

The traditional economic models used to describe competition i.e. pure or perfect, and the derivative models of monopoly, duopoly and oligopoly, do not necessarily work very well when applied to the real world. These models have failed for a variety of reasons and two of these are: the requirement for detailed knowledge about cost structures of firms; and the lack of guidance to define the boundaries of a market or an industry.

Economic models that appear to have more relevance to the pesticide industry are the ones which suggest that competition is a process and that firms compete on more than just price. These models emphasize the importance of barriers to entry into the industry and place little relevancy on the number of firms serving a particular market. Competition is defined as the ability of firms to discover the preferences of their customers, the capabilities of their rivals, the ability to innovate, to differentiate their products, to price cut, ability to advertise, and to develop personal relationships with buyers or sellers to enhance good will and reputation.

Further, there has been some economic work which suggests that farmers are sometimes irrational in their pesticide use decisions and are not necessarily profit maximizers. This piece of theory supports the notion that competition for pesticides is likely to be expressed in several dimensions other than simply price.

There are several theoretical explanations that allow one to understand the reasons why prices may vary from one geographic location to another. The most relevant explanations include:

i)          the case where prices of similar pesticide products differ as a result of differences in the demand (the farmer=s willingness to pay) for the pesticides in the two countries;

ii)         the case where prices of similar pesticide products differ as a result of differences in costs that arise due to the variation in the size of the market and other delivery and sales factors in the two countries;

iii)         the case where prices of similar pesticide products differ as a result of the ability to segment markets due to differences in demand (particularly those related to the availability of substitute formulations) in the two countries; and

iv)        the case where prices of similar pesticide products differ as a result of different patent and/or registration requirements in the two countries.

In conclusion, this theoretical background on competition and why prices are likely to differ between regions provides a framework from which to examine differing pesticide prices. In general, it would appear that manufacturers view the pesticide market as having an inelastic demand curve, thus cutting price is not going to maximize total revenue, rather product differentiation (i.e. what new innovation it brings to the market e.g. crop safety), personal relationship, and service will add to profits.

3.0       An Overview of Pesticide Pricing in Canada

It is the manufacturers that decide on how best to position the pesticide in the market place. The pricing of the product is influenced only marginally on costs of production, rather it is estimating what value the product brings to the target market, what share of the target market can be captured, and assessing the level of riskiness associated with the products that play greater roles of importance. Price determination by the manufacturers involves the use of strengths/weaknesses/opportunities/threats analysis, focus groups, market research and market value assessment to determine the value of the pesticide to the grower. The challenge for the manufacturer is to assess the value and establish an appropriate price relative to similar products being sold. The higher the value the higher the price. The lower the value the lower the price. In minor markets, the pesticide typically assumes the price established in the major markets, unless the pesticide can be differentiated based on formulation or some other difference.

However, there are exceptions to this methodology of establishing price,  with Roundup being an example. With Roundup,  price is established based on a price volume relationship that is established through extensive market research. Volume is set to maximize marginal revenues across all markets. Monsanto uses this pricing strategy even though the patent for Roundup has expired, and even though virtually identical competitive products exist (i.e. Touchdown and Glyfos). Several factors enable Monsanto to use this strategy. First, the market for Roundup is expanding and this expansion is being driven primarily by Monsanto e.g. transgenic crops. Second, Monsanto has strength in the supply chain because of their strategy to expand markets and because of brand loyalty at the grower level. Due to these two factors, distributors and retailers may hesitate to jeopardize their position with Roundup if they were to carry the competing products, Touchdown or Glyfos.

As an industry benchmark, most manufacturers try to achieve about 15% return on investment. The margins (defined as retail selling price minus product expenses divided by retail selling price) received by manufacturers for specific products are confidential but the industry range is normally thought to be between 20% to 50%. It is possible for a product to have a high margin and still not be profitable because of high research and development costs.

 Manufacturers try to influence price at the retail and distributor level by using programs - incentives for performance. On average, the total value of the programs at both the distributor and retailer level is about 15% to 20% of the invoiced price. Typical components of the programs are: sales performance; early order; early take; central service rebates; business planning; and specialty training. Pricing at the distributor level is determined by taking the retail price and subtracting off the retail margin. There are many factors that affect the price manufacturers charge distributors for pesticides and some of these are: ability to warehouse; payment terms; able to supply timely reports and amount of market coverage. Normal margins at the distributor level are 2% to 15%. Distributor margins tend to be higher for new products and for minor products.

Pesticides at the retail level are also on a cost plus margin basis. Retailers are expected to price according to local conditions and the level of competition in the area. Typical factors affecting a dealer=s cost are: cash; volume; time of purchasing; previous performance and nature of the relationship. Increasingly, retailers are trying to differentiate themselves in the market place and increase profitability in handling pesticides by providing more services e.g. custom application.  In general, retailers have a two price system depending on the volume being purchased. Cash discounts and volume discounts are frequently used and are normally valued at about 2% of gross sales.

In 1997 when Western Canadian retailers were asked about the competitiveness at the retail level amongst prairie provinces, the ranking was Alberta, Manitoba, and then Saskatchewan. Reasons given for this were: higher valued crops grown in Alberta and Manitoba thus more likely to invest more in pesticides on a per acre basis; and a significant portion of Saskatchewan is fallow, farmers especially in the dryland regions tend to be very cautious on input purchasing i.e. will only spend $C3 or $C5 per  acre on pesticides as compared to $C15 or $C20 on more intensely cropped lands. Further, another influence on the prices paid for pesticides is farmer buying practices. Increasingly, buying groups are being formed and make the decision to purchase solely on prices, no services, and no credit terms.

This description of how manufacturers set price fits very well with the previous economic theory discussed. It appears that manufacturers view pesticides as having an inelastic demand curve, and that cutting price is not going to maximize total revenue rather product differentiation i.e. what new technology it brings to the market (e.g. less residue), personal relationship, and service will add to profits. Distributor and retail margins can be seen below in Table 1.

Table 1:

Source: A Review of Agricultural Pesticide Pricing and Availability in Canada, 1997

* 2,4-D increased in 1997

4.0       Pesticide Price Comparisons With Other Countries

The following discussion is based on results found by the Prices Surveillance Authority in Australia completed in 1993. This report is relevant to any discussion on different pesticide prices between various jurisdictions for a variety of reasons. It clearly documents similar products having different prices in various countries despite free trade existing. Further, the study  breaks down pesticide costs by component.

The report compared international pesticide pricing and showed substantial differences in prices across countries and products as illustrated in Figure 1. For reasons given in the study individual country markets are in effect largely insulated one from the other even though free trade may exist. As a result the farm chemical industry at a global level is not a competitive industry with respect to prices. The reasons for this include differences in labeling regulations, regulatory requirements, formulations and timing of growing seasons.  While Australian firms do compete, the majority of their products are sufficiently differentiated for

firms to be able to be price makers not price takers. Such differentiation can occur from a natural source (resistance, seasonal factors) or from value-added delivery systems.

Figure 1:  Overseas Price Index Comparison

Source:  Price Surveillance Authority, 1993

The Price Surveillance Authority also undertook the task of surveying manufacturers to analyze costs associated with supplying chemical to farmers. At the manufacturers level it was found that active ingredient accounted for 55.2% of the wholesale price for locally formulated products. Other key items contributing to cost are marketing and sales expenses- 12.9%; packaging - 2.7%; and net profit margin - 6.8%. A complete accounting of costs associated with farm chemicals is depicted in Table 2.

Table 2:  Composition of Costs Associated with the Supply of Farm Chemicals

    Source: Prices Surveillance Authority, 1993           

The Australian report concluded that pesticide pricing is not cost based but determined according to what the market will bear. Farmers in whichever country needing the chemical the most and exhibiting a higher willingness to pay, are charged the highest prices.

5.0       Pesticide Price Comparisons Between Manitoba and North Dakota/Minnesota

Table 3 depicts the % difference in pesticide prices between Manitoba and North Dakota/Minnesota from 1994 to 1999. From this table it is possible to see several products higher priced in North Dakota/Minnesota relative to Manitoba. Notable products with a higher price include: Liberty, Lontrel/Stinger, Roundup Original/Ultra, Avenge, BuctrilM/Bronate, Hoe Grass/Hoelon, Pardner/Buctril, and Puma. There are products lower priced in North Dakota and a couple of examples are Furadan and Malathion. Notice that many of these price differences have existed for some time and in general there has been little change in the size of the price difference over the study period.

Table 3: The Per Cent Difference in Price for Selected Pesticides Between Manitoba and North

Dakota/Minnesota

Source:  The Thomsen Corporation, 1999

When yearly price changes are examined over the 1993-1999 time period, there are some products displaying a price decline, but generally most are up 1 to 5% per year. It is interesting to note that the price of Roundup dropped 10% in 1995 while Malathion jumped 48% in 1999. Most pesticide products have increased in price over the 1993 - 1999 period, however there are some exceptions such as MCPA, Poast, and Trifluralin. As seen in other studies, the Manitoba and North Dakota pesticide price series also shows that individual product prices do not move in harmony with each other.

6.0       Pesticide Price Comparisons Between Ontario and Great Lake States

In 1996, Ontario enjoyed significantly lower prices in 7 out of 16 herbicides surveyed including products such as Bladex 90 DF, Dual, Dual Bulk, Reglone, Roundup, Sencor 75DF and Pardner. Ontario also enjoyed a 15% price advantage over the Great Lake States for Pursuit, the major soybean herbicide used in Ontario in 1996 (McEwan, 1997).  For insecticides, U.S. average prices were at minimum 20% lower than Ontario prices for products such as Furadan 480DF, Malathion 500 EC, and Ambush. Figure 2 depicts pesticide prices between Ontario and Great Lake States for selected products from 1993 to 1997.

Figure 2:  A Comparison of Pesticide Prices Between Ontario and Great Lake States

Source:  McEwan, 1997

7.0       Pesticide Prices Differ Between Prairie Provinces

A comparison of prices between Alberta and Saskatchewan for 2,4-D Amine illustrates pesticide prices vary between prices with a higher cost for Saskatchewan producers. On average, Saskatchewan producers have paid between 2-7% more for 2,4-D amine than their Alberta counterparts. A couple of reasons for differences in pesticide prices between neighbouring provinces include greater spatial differences between dealers in Saskatchewan and products sold in Saskatchewan tend to be low margin, high volume products thus dealers need additional margin to support their outlets.  Table 4 provides the difference in price as a percent value.

Table 4:

         Source:  derived from AFRD and Saskatchewan Agriculture and Food data

8.0       A Changing And Dynamic Pesticide Market

Pesticide options available to growers are constantly changing. In the broadleaf, post-emergent herbicide market for soybeans in Ontario during the 1997 growing year there were 6 herbicides (Pinnacle, Pursuit, Basagran, Blazer, Reflex and Roundup) representing the involvement of 6 manufacturers. In comparison, in 1990, growers had only two postemergent broadleaf weed control options. During the 1997 growing year Pursuit dominated this market, however, with the introduction of Roundup Ready soybeans and Classic, this superiority by Pursuit has been eroded.

9.0       A Comparison of Fuel, Fertilizer and Pesticides Prices, 1993-1996

In order to compare farm input bundles between Ontario and Great Lake States,  price indices were computed using all the inputs surveyed within the Ontario Farm Input Monitoring Project (45 products – Table 5). Relative value weights were assigned to each input. The results from a comparison of average Ontario versus U.S. prices indices (percentage differences, U.S. base) using the final survey done in each of 1993,1994,1995 and 1996, are found below. Relative to U.S. prices, Ontario combined survey prices were higher in the final survey of each year, in all four years. At the end of 1996, the total Ontario input price index was 4.5% higher than the U.S. index. The major advantage to U.S. producers has been in the fuel category, while Ontario producers enjoyed relative advantages in overall pesticide prices. At the end of 1996, U.S. again reported an advantage in overall fertilizer prices.

Table 5:

Caution must be exercised when interpreting these indices because no farm ever buys all the products grouped together to develop the index. However, the index does serve as an indicator of regional price differences.

10.       Summary

There are many reasons why pesticide prices vary between countries and they include: differences in patent expiry dates; differences in market size and costs; differences in pesticide demand (e.g. farmer preferences, willingness to pay); and differences in the number of substitute products available. The restriction in the movement of pesticides across borders (i.e. because of labeling, formulation, name differences, timing of seasons and different regulatory systems) is one of the basic reasons for expecting to see prices for similar pesticides to differ between dealers in the U.S. and those in Canada. From a manufacturer=s perspective, the U.S. and Canada represent two distinct markets for pesticide sales.