Chapter4: Marketing Channels, Costs and Margins for Farm Product

4.1Marketing Channels

• Marketing channels are the chain of intermediaries through whom

the various agricultural products passes from the producers to the
consumers.

• It represents the route through which agricultural products move

from the producers to the consumers.

• It is the set of firms and individuals that take title or assist in

transferring title, to a good or service as it moves from the
producer to the final consumer.
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 Marketing channels…

• Producer or manufacturer Retailer Consumer.

• Producer or manufacturer Consumer.
• Producer or manufacturer Wholesaler Retailer –
Consumer.
• Producer Commission agent.

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4.2Marketing Margin
 A marketing margin (MM) is the percentage of the final weighted

average selling price taken by each stage of the marketing

chain/system(absolute & relative MM)
 The total marketing margin(TMM) is the difference b/n what the

consumer pays & what the producer/farmer receives for his

product. In other words it is the d/c b/n retail price and farm price.
 The margin must cover the cost involved in transporting produce

from one stage to the next and provide reasonable return to those
doing the marketing activities. 3
 Marketing margin continued…….
 A wide margin means usually high prices to consumers and low price to
producers.
 The total marketing margin may be subdivided into different components:
all the costs of marketing services and the profit margins or net returns.
 The marketing margin in an imperfect market is likely to be higher than in a
competitive market because of the expected abnormal profit.
 But market margin can also be high, even in a competitive market due to
high real market cost.
 The common method used in estimating marketing margin is comparison of
prices at different levels of marketing over the same period of time.

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 Marketing margin continued…….
• Total gross marketing margin (TGMM) is always
related to the final price paid by the end buyer and
is expressed as percentage
TGMM = consumer price-producer price x 100
consumer price
TGMM = Pc-Pp x100……………………….1
Pc

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 Example: Calculation of marketing margins
• When 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%

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 Class room exercise
 Assume the following tables for milk in a marketing channel
from a farm to Ambo market indicated. Based on data
concerning the selling and buying prices. One can calculate
the marketing margins by applying the formula:
Price for milk in a marketing channel grown in a farm out of in Ambo
Marketing chain participant selling price (birr per lit)
Producer on farm 3.26
Rural Assembler 4.50
Wholesaler in Ambo 5.00
Retailer in Ambo 6.00
Consumer only buyer 6.00
o From the given data, calculate: GMM for each channel participants,
GMMp and TGMM? Use the formula and check it

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 Net Marketing Margin(NMM)

 The net marketing margin(NMM) is the percentage of the final price

earned by the intermediaries as their net income after their marketing costs
are deducted.
NMM= Gross Margin-marketing costs x100
consumer price
NMM= TGMM-MC x100
Pc
Where
MC= Marketing cost
Pc= final consumer price
Pp= producer price
TGMM= Total Gross Marketing Margin
GMMp= Gross Marketing Margin of the Producer/ share
NMM= Net Marketing Margin
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 4.3 Marketing costs
What is a Marketing Cost?
 Marketing cost is an actual cost incurred by each agency involved in
the marketing channel. It includes:
 Labor, containers, rent, utilities (water and energy), advertising,
selling expenses, depreciation, allowances, weighing, loading,
unloading, losses and spoilages and interest costs.

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 Marketing Costs …
 Handling charges at local point
 Assembling charges
 Transport and storage costs
 Handling by wholesaler and retailer charges to customers
 Expenses on secondary service like financing, risk taking and
market intelligence

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 Marketing cost-----

 Marketing costs vary from commodity to commodity or from product

to product. This is due to;
 The more waste a product has, the greater the marketing costs.
 The more perishable the product, the greater will be the marketing
costs
 The more processing of the commodity, the greater will be the
marketing costs
 The greater the amount of produce handling and transportation, the
greater the marketing costs. 11
 Total cost of marketing of commodity

C = Cf + Cm1 + Cm2 + . . . + Cmi

Where,
C= Total cost of marketing of the commodity
Cf = Cost paid by the producer from the time of the produce leaves till he
sells it
Cmi= Cost incurred by the ith middlemen in the process of buying and
selling the products.

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 4.4. Marketing efficiency and performance

• It is essentially the degree of market performance.

• It is a broad & dynamic concept.
• It refers to the effectiveness or competence with which a market
structure performs its designated function.
• It is the ratio of market output (satisfaction) to marketing input (cost
of resources); an increase in ratio represents improved efficiency &
vice versa.
• This means a reduction in marketing cost without reduction in
consumer satisfaction indicates improvement in efficiency.

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 Marketing Efficiency-----

• A higher level of consumer satisfaction at higher marketing cost may

mean increased efficiency if the additional satisfaction derived by
consumer outweighs the additional cost incurred on the mkting process.
• But a change that reduces cost but also reduces consumer satisfaction
need not indicate increase in marketing efficiency.
• 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.
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 •Assessment of marketing efficiency:
A, Technical or Physical or Operational efficiency
 It pertains to the cost of performing a function; Efficiency is increased
when the cost of performing a function per unit of output is reduced.
 Improved operational efficiency is evident where marketing costs are
reduced but outputs are either maintained or actually increase.
 Eg. 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.
 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.
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 Assessment of marketing efficiency:---------
• 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 5kg
bags of meal from the market & sell minimum quantities of 10kg 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 b/n operational efficiency &
customer satisfaction explains the difficulty of improving marketing
efficiency.

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 B, Pricing / Allocate efficiency :
• Pricing efficiency refers to the structural characteristics of the
marketing system,
 when the sellers are able to get the true value of their produce and
 the consumers receive true worth of their money.
• It is is based on the assumption that competitive markets are
efficient.
• It is concerned with the ability of the marketing system
 to allocate resources
 coordinate the entire agricultural/food production&
 marketing process in accordance with consumer directives.
• The evidence of pricing efficiency is efficient resource allocation17 and
 B, Pricing / Allocate efficiency : --------

 The pricing mechanism directly affects production.

 Frequently there are conflicts b/n the d/t 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 no of firms & there by affect structure

& competition in the industry, & in turn perhaps lower price efficiency.

 The above two types of efficiencies are mutually reinforcing in the long run,

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one without the other is not enough.
 Empirical Assessment of Marketing Efficiency

• A reduction in the cost for the same level of satisfaction or an increase in the
satisfaction at a given cost results in the improvement in efficiency.
E =(O/I )*100
E = level of efficiency
O = value added to the marketing system.
I = real cost of marketing
• Shepherd’s formula of marketing efficiency:
 ME = (V/I-1)*100
 ME = Index of marketing efficiency
 V = Value of the goods sold or price paid by the consumer (Retail price)
 I = Total marketing cost or input of marketing.
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 This method eliminates the problem of measurement of value added.
 4.5 Structure, Conduct and performance in agricultural marketing
 The term structure refers to something that has
 organization
dimension–shape, size and design;
 which is evolved for the purpose of performing a function.
 The term market structure refers to the size and design of the market.
 It also includes the manner of the operation of the market.

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 Some of the expressions describing the market structure are:

1. Market structure refers to those organizational characteristics of a

market which influence the nature of competition, pricing and affect
the conduct of business firms;
2. Market structure refers to those characteristics of the market which
affect the traders‟ behavior and their performances;
3. Market structure is the formal organization of the functional activity of
a marketing institution.
• An understanding and knowledge of the market structure is essential
for identifying the imperfections in the performance of a market.

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 Components of Market Structure:

1. Concentration of Market Power

2. Degree of Product Differentiation

3. Conditions for Entry of Firms in the Market

4. Flow of Market Information

5. Degree of Integration

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 Components of Market Structure:--------
1. Concentration of Market Power:
• It is an important element determining the nature of competition &
consequently of market conduct and performance.
• This is measured by the number & size of firms existing in the market.
• The extent of concentration represents the control of an individual firm
or a group of firms over the buying and selling of the produce.
• A high degree of market concentration restricts the movement of goods
b/n buyers & sellers at fair & competitive prices, & creates an oligopoly
or oligopsony situation in the market.
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 2. Degree of Product Differentiation:
• Whether or not the products are homogeneous affects the market structure.
• If products are homogeneous, the price variations in the market will not be wide.
• When products are heterogeneous, firms have the tendency to charge different
prices for their products.
• Everyone tries to prove that his product is superior to the products of others.
3. Conditions for Entry of Firms in the Market:
 Another dimension of the market structure is the restriction, if any, on the entry of
firms in the market.
 Sometimes, a few big firms do not allow new firms to enter the market or make
their entry difficult by their dominance in the market.
 There may also be some gov’t restrictions on the entry of firms.

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4. Flow of Market Information:
• A well-organized market intelligence information system helps all the buyers and
sellers to freely interact with one another in arriving at prices and striking deals.
5. Degree of Integration:
• The behavior of an integrated mkt will be d/t from that of a mkt where there
is no or less integration either among the firms or of their activities.
• Firms plan their strategies in respect of the methods to be employed in
determining prices, increasing sales, coordinating with competing firms &
adopting predatory practices against rivals or potential entrants.
• The structural characteristics of the market govern the behavior of the firms
in planning strategies for their selling & buying operations.
• The market structure determines the market conduct and performance . 25
 Market Conduct
The term market conduct refers to the patterns of behavior of firms,
especially in relation to pricing and their practices in adapting and
adjusting to the market in which they function.
Specifically, market conduct includes:

A. Market sharing and price setting policies;

B. Policies aimed at coercing (forcing) rivals; and

C. Policies towards setting the quality of products.

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 Market Performance

 The term market performance refers to the economic results that flow
from the industry as each firm pursues its particular line of conduct.
 Some of the criteria for measuring market performance and of the
efficiency of the market structure are:
1. Efficiency in the use of resources, including real cost of performing
various functions;
2. The existence of monopoly or monopoly profits, including the
relationship of margins with the average cost of performing various
functions; 27
 Market Performance------
3. Dynamic progressiveness of the system in adjusting the size &
number of firms in relation to the volume of business, in
adopting technological innovations and in finding&/or inventing
the new form of product to maximize the social welfare.
4. Whether or not the system aggravates the problem of Inequalities
in interpersonal, inter-regional or inter-group incomes. For example,
inequalities increase under the following situations:
a) A market intermediate may pocket a return greater than its real
contribution to the national product;
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 Market Performance------
b) Small farmers are discriminated against when they are offered a lower
return because of the low quantum of surplus;
c) Inter-product price parity is substantially disturbed by new uses for
some products & wide variations and rigidities in the production
pattern between regions.
 The market structure, therefore, has always to keep on adjusting to
changing environment if it has to satisfy the social goals.
 A static market structure soon becomes obsolete b/c of the changes in
the physical, economic, institutional and technological factors.
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For a satisfactory market performance, the market structure should keep
pace with the following changes:

1. Production Pattern

2. Demand Pattern

3. Costs and Patterns of Marketing Functions

4. Technological Change in Industry

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For a satisfactory market performance, the market structure should keep
pace with the following changes:

1. Production Pattern:

• Significant changes occur in the production pattern because of

technological, economic and institutional factors.
• The mkt structure should be re-oriented to keep pace with such changes .
2. Demand Pattern:
• The demand for various products, especially in terms of form &
quality, keeps on changing b/c of change in incomes, the pattern of
distribution among consumers, and changes in their tastes and habits.

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• The market structure should be re-oriented to keep it in harmony
with the changes in demand.
3. Costs and Patterns of Marketing Functions:
• Marketing functions such as transportation, storage, financing and
dissemination of market information, have a great bearing on the
type of market structure.
• Government policies with regard to purchases, sales and subsidies
affect the performance of market functions.
• The market structure should keep on adjusting to the changes in
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4. Technological Change in Industry:
• Technological changes necessitate changes in the market structure
through adjustments
 in the scale of business,
 the number of firms,
 and in their financial requirements.

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 4.6 Market Integration and Product differentiation
Market integration
• Integration shows the relationship of firms in a market.
• The extent of integration influences the market conduct of the
firms and consequently their marketing efficiency.
• Markets differ in the extent of integration and, therefore, there is a
variation in their degree of efficiency.
• Market integration is a process which refers to the expansion of
firms by consolidating additional marketing functions and
activities under a single management.

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Types of market integration
• Types of integration that tie together individual firms are called
horizontal, vertical and conglomerate.
• Theses affect the structure of firms, conduct and hence performance.
Horizontal Integration
 In this type of integration, some marketing agencies (say, sellers)
combine to form a union to reduce their effective number and the
extent of actual competition in the market.
e.g. Primary milk producers can organized as cooperative union.

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Vertical integration
• It is occurs when a firm performs more than one activity in the
sequence of the marketing process.
• It is linking together of two or more functions in the marketing
process within a single firm or under a single ownership.
e.g. if a firm assumes wholesale as well as retailing, it is a vertical
integration or processor under taking retailing.
Conglomeration
•A combination of agencies or activities not directly related to each
other may operate under a unified management.

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 Measures of Concentration
1.Concentration ratio
• It is expressed in the term CRx, which stands for the percentage of the
market sector controlled by the biggest x firms.
• Eg,CR3= 70% would indicate that the top 3 firms control of 70% of a
market.
• CR4 is the most typical concentration ratio for judging what kind of an
oligopoly it is.
• A CR4 of over 50% is generally considered a tight oligopoly;

• CR4 between 25 and 50 is generally considered a loose oligopoly.

• A CR4 of under 25 is no oligopoly at all.

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• We would add that a CR3 of over 90% or a CR2 of over 80% should be
considered a super-tight oligopoly.
• The problem with this measure is that CR4 does not indicate what the
relative size of the four largest companies is.
• It may be that a CR4 of 80 means that one company controls 50% of the
market, while the others have 10% apiece.
• That's a very d/t mkt structure than 1 where every firm has a 20% share.
Advantages– it is easy to construct and easy to understand.
Disadvantages- covers only a portion of total market but small size firms are
not covered.

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 2. Herfindale-Hirschman index(HHI)
• A measure of concentration based on the sum of squares of market shares
of firms, expressed as proportions of total market sales.
• The Herfindahl index, also known as Herfindahl-Hirschman Index or
HHI, is a measure of the size of firms in relationship to the industry and
an indicator of the amount of competition among them.
• It is an economic concept but widely applied in competition law and
antitrust.
• It is defined as the sum of the squares of the market shares of each
individual firm.

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• As such, it can range from 0 to 1 moving from a very large amount of
very small firms to a single monopolistic producer.
• Decreases in the Herfindahl index generally indicate a loss of pricing
power & an increase in competition, whereas increases imply the
opposite.
Example: The major benefit of the Herfindahl index in relationship to such
measures as the concentration ratio is that it gives more weight to larger
firms. Take, for instance, two cases in which the six largest firms produce
90 % of the output: Case 1: All six firms produce15%, &Case 2: One firm
produces 80 % while the five others produce 2 % each.

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• We will assume that the remaining 10% of output is divided among 10
equally sized producers.
• The six-firm concentration ratio would equal 90 % for both case 1 and case
2, but in the first case competition would be promoted where the second
case approaches monopoly.
• The Herfindahl index for these two situations makes the lack of
competition in the second case strikingly clear:
• Case 1: Herfindahl index = 6 * 0.152 + 10 * 0.012 = 0.136
• Case 2: Herfindahl index = 0.82 + 5 * 0.022 + 10 * 0.012 = 0.643
• This behavior rests in the fact that the market shares are squared prior to
being summed, giving additional weight to firms with larger size.

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• Put simply, now two firms control half the market, so serious
competition questions are raised.
Formula
n
H=∑Si2
i=1
• where si is the market share of firm i in the mkt, & n is the no of firms.
• The Herfindahl Index (H) ranges from 1 / N to one, where N is the number
of firms in the market.
• Equivalently, the index can range up to 10,000, if percents are used as
whole numbers, as in 75 instead of 0.75.

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• The maximum in this case is 1002 = 10,000.
• There is also a normalized Herfindahl index.
• Whereas the Herfindahl index ranges from 1/N to one, the normalized
Herfindahl index ranges from 0 to 1.
• It is computed as:
• H=(H-1/N)/(1-1/N)
• where again, N is the number of firms in the market, and H is the usual
Herfindahl Index, as above.
• A small index indicates a competitive industry with no dominant
players.

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• If all firms have an equal share the reciprocal of the index shows
the number of firms in the industry.
• When firms have unequal shares, the reciprocal of the index
indicates the "equivalent" number of firms in the industry.
• Using case 2, we find that the market structure is equivalent to
having 1.55521 firms of the same size.
• An H index below 0.1 (or 1,000) indicates an un concentrated
index. An H index between 0.1 to 0.18 (or 1,000 to 1,800)
indicates moderate concentration.

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• An H index above 0.18 (above 1,800) indicates high concentration.
• Disadvantage: This concentration index is very demanding in terms
of data.
 Lerner index
• Another way to show how the elasticity of demand affects a
monopoly's price relative to its marginal cost is to look at the firm's
Lerner Index (or Price mark-up): the ratio of the difference between
price and marginal cost to the price: (p - MC)/p.
• This measure is zero for a competitive firm because a competitive
firm cannot raise its price above its marginal cost.

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• The greater the difference between price and marginal cost, the larger
the Lerner Index and the greater the monopoly's ability to set prices
above marginal cost.
• If the firm is maximizing its profit, we can express the Lerner Index
in terms of the elasticity of demand by rearranging (p-MC)/P = 1/ε
• Because MC > 0 and p > MC, 0 <p - MC < p, so the Lerner Index
ranges from 0 to 1 for a profit-maximizing firm.
• The above equation confirms that a competitive firm has a Lerner
Index of zero because its demand curve is perfectly elastic.

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• The Lerner Index for a mono increases as the demand becomes less
elastic.
• If e = -5, the monopoly's markup (Lerner Index) is 1/5 = 0.2; if e = -
2, the markup is 1/2 = 0.5; and if e = -1.01, the markup is 0.99.
• Monopolies that face demand curves that are only slightly 'elastic set
prices that are multiples of their marginal cost and have Lerner
Indexes close to 1.

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 Factors of spatial market integration
 Market integration, however measured, is the result of the action of traders, as
well as the operating environment determined by the infrastructure available
for trading & policies affecting the price transmission.
 All the measures of integration considered so far have in common the feature
of being computed using only price information available in a specified
period of time.
• Each market link is summarized by just one number.
 However, markets are complex institutions and their performance as well as
their integration is the result of numerous factors.

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 Factors of integration
 Among these factors, marketing infrastructure, price stabilization
policies, the degree of dissimilarity in production in d/t areas, as well as
supply shocks, are important explanatory factors of market integration.
 To test hypotheses concerning the effect of structural factors on market
integration one needs to specify the explanatory variables mentioned
above.
 Marketing infrastructure includes transportation, communication, and
credit.

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 These variables are expected to influence market integration positively.
Price stabilization policy
 In order to test these hypotheses, it is necessary to get an index of the
degree of price stabilization policy undertaken by a government in
various affected areas.
 One simple way to do this is to consider the correlation between
prices and end-of-period public stocks.
 This correlation is expected to be negative and its absolute value is
taken to be indicative of the degree of price stabilization policy.

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 Production affects market integration through the degree of dissimilarity in
self-sufficiency of various markets.
– If mkt i is a surplus market & market j is a deficit market in the
commodity under consideration, then the likelihood that i and j are
linked by trade is higher than if both mkts were surplus or deficit areas.
– The degree of dissimilarity is usually measured by the absolute value of
the percentage difference in production per capita.
– Another variable related to production is the number ofproduction
shocks affecting various districts.

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• The effect of these shocks on market integration is not clear a
priori.
• When the production shocks are of a tremendous magnitude, one
would expect market integration to be disrupted.
• In the case of normal production shocks, they may even positively
affect market integration, in so far as they add incentives to trade
between affected areas and other areas.

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Thanks for your attention!!

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