ABM 2201: Handout 16/3/2017

Marketing: Introduction
Definition of Marketing
Marketing means different things to different people. To consumers, marketing may refer
to the shopping trip to the market. The farmer may associate marketing with the loading
of produce onto a truck for a trip to the urban centres. On the other hand, middlemen
such as retailers, wholesalers and processors may see marketing as a process of gaining
competitive advantage over their rivals, increasing the quantities sold and satisfying their
customers.

In this module, marketing is defined as the performance of business activities that direct
the flow of goods and services from the producer to the consumer or final user. The
process of marketing begins at the point of production (the farm or ranch) and continues
until a customer buys the final product, or until it is purchased as a raw material for
another production phase.

However, marketing also includes input supply firms that serve the farms and ranches.
Thus, it consists of those efforts that effect transfers of ownership and which create time,
place, and form utility to commodities. By creation of these utilities, marketers are
productive and add value to raw agricultural commodities that consumers want.

Food marketing is the performance of all business activities involved in the flow of food
products and services from the point of initial agricultural production until they are in the
hands of the customers. Marketing is a bridge that connects the producer and the final
consumer.

A marketing system can be defined as a network of channels, middlemen, and marketing

activities that facilitate the production, distribution, and exchange of a nation’s agricultural
product supply. A marketing system performs essential functions such as Exchange
(Buying and selling), Physical functions (Storage, transportation, processing) and
Facilitating functions (Grades/standards, Financing, risk taking, market Information). By
these functions, a marketing system adds form (e.g. changing farm products to food

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products), place (e.g. moving food products from rural production sites to urban
consumption areas), time (timing and availability of a seasonal product is altered by
marketing), and possession utility (created by marketing activities that assist consumers in
acquiring title of products).

Growth and Role of Marketing
The pioneers of our country did not have much concern about marketing. Each family
grew its own food and built its own shelter. Producers and consumers were in one unit. As
development went by, people realized that some had a comparative advantage when
doing certain kinds of activities than others. This encouraged specialization and
consequent increase in output but the breakdown of self-sufficiency in food. Markets then
developed to facilitate exchange of this marketable surplus between rural and urban
areas.

With the development of food marketing, it became unnecessary for people to stay on
land because they could access their basic needs through the market. This encouraged
the development of urban areas and rural-urban migration. Of course, this increasing
urbanization further complicates the task of those engaged in marketing.

Until recently, there has been great interest in improving the economic lot of the
underdeveloped countries through improving production technologies with little concern
about marketing. Technologies such as fertilizers, better seed and cultivating machinery
were used to advance output. However, for farmers to adopt such changes they must be
able to sell their products profitably to someone else. Without better marketing this is not
possible. Hence agricultural production and food marketing must develop hand in hand.

The Agricultural Marketing Process

A marketing process involves:
1) A series of actions and events that take place in some sequence
2) Coordination of this series of events and activities. Coordination is necessary if
goods and services are to move in some orderly fashion from the hands of the
producers into the hands of the consumers.

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Therefore, the marketing process has the production on one extreme and consumer
demand on the other. In between these extremes are the activities and events that make
up the marketing system.
The marketing system is influenced by the production and consumer demand in a two-
way manner. The way production is initially organized has a major influence on the
organization and operation of the marketing process.

Because the goal of marketing is to satisfy the needs of the consumer at a profit,
consumer preferences and behavior dictate to a large extent the activities of the
marketing process.

The people who perform the activities that characterize the marketing system are called
intermediaries. Market intermediaries are those individuals who specialize in performing
the various marketing functions involved in the purchase and sale of goods as they are
moved from producers to consumers. Intermediaries can be classified as follows:
 Collectors
 Assembly traders
 Wholesalers
 Retailers
 Processors/commercial buyers

Collectors are small, mobile traders who buy from village bulking agents and farmers.
They operate over short distances and trade in small volumes at a time. They are most
common in areas where farmers are poorly organized. For example, bicycle vendors may
buy bananas from farmers in places that are less accessible by road and sell them to
assemblers in big collecting centers.
Fermented milk products, also known as cultured dairy foods, cultured dairy products,
or cultured milk products, are dairy foods that have been fermented with lactic acid
bacteria such as Lactobacillus, Lactococcus, and Leuconostoc

Assembly traders: These are traders who normally buy from very many small traders and
sell to large traders who lack time to gather products from many scattered farmers.
Another reason assemblers may be useful to large traders is that the latter often lack
information about the availability of products. They are normally based in rural markets.

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In our example, assemblers sell the bananas to large traders called wholesalers from
Kampala.

Wholesalers: These are larger than assemblers in terms of volume handled and can sell in
bulk to retailers, processors, industries or other wholesalers. They target big markets in
urban areas or big factories.

Retailers: Retailers are the market intermediaries who purchase and merchandise food
products for final consumers. The main role of retailers is distribution of products to
consumers. Some retailers may specialize while others can sell a range of products. Food
retailers may include supermarkets, restaurants, convenience food store and others alike.
Retailers are the most numerous of the marketing institution.

Processors/commercial buyers: These are involved in the transformation of the agricultural

products. These can be small or large. In case of bananas, these could be restaurant
owners who buy “matooke”, cook it and sell it in a form (i.e. meal) different from that in
which it was bought.

A market chain
A market chain refers to the link between the producer and the consumer. The links
between the producer and consumer are described based on the number of transactions
that occur between the farmer and the final consumer (see fig 1). Intermediaries who link
the producer to the consumer are the market chain actors
Figure 1.1. A market chain
Consume

Retailing

Trading

Processing

Trading

Post-harvest handling

Production

Figure 1.1 shows an example of a market chain. Each circle in the figure represents a
point of transaction and a chain in the distribution channel of the product from the

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production point to the consumption point. At each transaction stage or chain, the product
changes hands through chain actors (also referred to as intermediaries) and costs are
incurred.
A market chain is supported by business development services such as:
 Research entities
 Input suppliers
 Communications organizations
 Transporters,
 Local administration
 Market information and
 Financial services

The marketing process depends to a large extent on the transportation, communication

system, institutions that enforce the contractual agreements and monetary system and
social capital. A complex food industry cannot exist without well-developed transport,
communication, and educational systems. A product must be moved from the point of
production to the place where the final consumer can find it at an affordable price. Buyers
need to trust that the product they are buying is reliable in terms of quality and the sellers
will keep their promise to supply. On the other hand, sellers also need the assurance that
the buyer will keep his promise to buy and pay his dues. Rules and values of the society
are equally important in shaping the behavior of the marketing system.

Science and technology are also major influences on the food marketing process. New
technologies in food processing, packing and marketing have given rise to new products.
Technology has become a powerful engine of change. Technology development that affects the
food industry can be in form of agricultural inputs, production procedure or processing aspects.
In Uganda, however, the science and technology is still in its infant stages particularly in the
processing sector and the agricultural input sector. As such the food industry is faced with a
challenge of competition from other countries that also target the Ugandan consumer. Market
research is the key to this challenge.

AGRICULTURAL MARKETS IN DEVELOPING COUNTRIES

Characterization of Agricultural Markets in Developing Countries

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Types of markets
A market is an arena for organizing and facilitating business activities and for answering
the basic economic questions: what to produce, how much to produce, how to produce,
and how to distribute production. A market may be defined by: i) location (e.g. Owino
market), ii) a product (e.g maize market), iii) a time, (December beef market) or a level
(e.g. retail market).

In many developing countries like Uganda, it is uncommon to find a market that

specializes in one product. Many traders combine products and market classification is
basically by: level of distribution and location. In terms of level, markets can typically be
classified into two types: retail and wholesale market.

Classification of markets in terms of level of distribution

Retail markets: The term “retailer” refers to an individual or organization that
predominantly sells goods and services to the final consumers or users. Retail markets are
classified either by their method of operation or by the form of ownership.

Retail Markets Categorized by Method of Operation:

A retail market can be classified according to the method of operation as: 1) full service
retail, 2) supermarkets, and 3) non-shop and non-personal retailers
i)Full service retail market Offers complete retailing services to their customers. Such
retail markets are characterized by in-shop across-the counter retailing organizations
where buyers come to the shop and are waited upon by a shop attendant. The
salesperson asks the potential buyer what he/she wants, walks to the relevant
merchandise shelf, brings the item and asks the buyer to pay a specified amount of
money. The service may also involve weighing, wrapping or packing. Most shops in
developing countries are of this type.
ii) Supermarkets are large-scale retailing institutions with several departments and
operate primarily on self-service basis. Examples of supermarket in Uganda include;
Nakumatt, Game, Capital Shoppers, Tuskys, Shoprite, Quality etc. Super markets are
emerging in developing countries and growing at a fast speed. Nevertheless, there is a
tendency in Uganda to classify full service retail markets as supermarkets based on the

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mode of operation alone, i.e the market has only one department but operates on self-
service basis.
iii) Non-shop personal retail markets are house-to house markets. In their mode of
operation, such retail markets bring goods up to the door, and there is no quality
guarantee for the product. These are also common in Uganda and other developing
countries. The hawkers who sell vegetables, fresh beans, potatoes are included in this
category.

Retail markets categorized by form of ownership

Categorized according to the form of ownership, retailing institution includes 1)
independent stores, 2) corporate chain stores and 3) franchise system.
i) Independent shops: Independent shops are single unit shops owned by one or two
individuals. Independent shops constitute the majority of business organizations in Africa.
The main advantage of these business organizations is their ease of establishment, the
strong internal motivation of their owners and the ease of supervision. They are capital
constrained and lack qualified personnel.
ii) Corporate chain shops: A chain shop system is defined as an organization consisting
of two or more shops centrally owned and managed; and handling generally the same
lines of products on the same level in the distribution structure.
iii) Franchise system: These systems comprise small but independent retailers. The
retailers under this category included: voluntary chain, retailer cooperative chain and
manufacturers-sponsored systems
o Voluntary chain refers to an association of independent retailers
sponsored by a wholesaler for the purpose of assuring himself a group of retailing
outlets for his goods and services. While the wholesaler gains by having a sure chain of
profitable outlets, the retailers gain by having a sure source of supply as well as
obtaining their products at lower prices than they would otherwise do.
o A retailer cooperative chain: This type of retail market is defined as an
organization initiated and sponsored by a group of independent retailers who jointly
buy and operate a wholesale warehouse
o Manufacturers-sponsored systems: Under this system, a manufacturer
sets up a network of retail outlets by contracting with new or established independent

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 operators. For example, the Bata shoe company Ltd. Has made such contracts with the
Bata shoe shops.

Wholesale markets:
Wholesale markets refer to markets that primarily sell to those who buy for resale and for
business use. These can also be classified into: 1) merchant wholesale, 2) Manufacturer’s
sales branch, 3) agents and brokers and 4) assemblers.
i) Merchant wholesalers are the biggest single group of wholesaling organizations
when measured either by the number of firms or by business volume.
ii) Manufacture’s sales branches are a category of manufacturers who establish their
own sales branches and sales offices. An example of this kind of wholesalers is the
manufacturers of safi, Maganjo grain miller, etc. Such wholesale markets distribute goods
to various retailers and also sell to small wholesalers.
iii) Agents and Brokers: In contrast to the merchant middlemen, agents and brokers do
not take title to the merchandise they deal with. They only actively negotiate the purchase
or sale of products on behalf of their principals. The main types of agent middlemen are
the brokers, auctioneer. They are compensated on the basis of a commission.
iv) Assemblers are traders who buy products in small quantities from many producers
and sell in larger quantities to a relatively small number of large customers such as
millers, processors and overseas buyers. Assemblers are common in agricultural
production in most developing countries that are characterized by numerous producers,
each producing a very small proportion of the total industry output. This necessitates
traders who can bulk volumes.

While the distribution of products from the producer to the final consumer involves both
the wholesaler and retailer in most cases, it is not uncommon in Africa to have consumers
buying directly from the farmer or the retailer buying from the farm thereby eliminating
the wholesaler. Figure 2 below shows some different types of distribution channels (also
referred to as distribution systems)

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Different channels of distributing cabbage in Uganda
Farmer Consumer

Consumer
Farmer Shopkeeper

Retailer Consumer
Farmer Wholesaler

Immediately after independence, many African governments controlled the distribution of

agricultural products. Practically all products grown for export moved from the growers to
co-operative societies to marketing boards and then to overseas buyers. However, with
liberalization, there is increasingly less involvement of government in distribution of
agricultural products across Africa. In Uganda, for example, there is virtually no
government intervention in the distribution of agricultural products.

Some distributors have premises in which they carry out their distribution role while others
do not operate a roof. Distributors who do not operate in premises include: market places
and itinerant traders.

Distributors who do not operate in premises

Market Places:
A market place is a specific site where buyers and sellers meet at regular intervals for
purposes of engaging in economic exchange. Market places are characteristic retailing
institutions of the rural countryside all over the African continent. These markets primarily
deal in marketing of livestock, local and imported goods, food crops and craft articles. In
Kampala, for example, special sites have been designated as markets. These include
market places such as Owino, Nakasero, Kalerwe etc. They also provide services such as
cooked food, repair of bicycles, shoes and intercommunity socializing. Some market places
operate daily while others operate on a weekly or monthly basis. This is because supply
and demand varies. In some market places, supply and demand is sufficient to support
daily transactions while in other market places either demand or supply may still be low.
As the market place grows, the frequencies of the transactions in such a market place
demand that the market place also operate frequently.

The growth of market places is influenced by:

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  The agricultural activities in the surrounding area: A market place is more likely to
develop in areas surrounded by high agricultural activities
 Population size and density of the locality: Densely populated areas and fast
growing population suggest high demand and a market place is likely to be
established and grow fast.
 Level of development of communication and infrastructure: With development in
communication and infrastructure, it becomes less costly to trade in the locality and
distributors will want to access the market in such an area. This may cause a
market place to grow
 Degree of specialization in production and marketing: When production and
marketing are highly specialized, it means that other goods and services must be
distributed from outside the community and this may necessitate a market place in
such locality
 General level of economic development of the area. As people’s economic status
improves, their demand increases, which will pull supply that could influence the
establishment of a market place. While market place may increase in importance as
more people are drawn from subsistence to the money economy in Africa, they
diminish in importance with economic development in developed economies.

Itinerant traders:
These sellers ply the town streets on foot, cycle or even vehicles and from village to
village carrying their wares. In Uganda they are commonly known as “ Batembeyi”. They
provide a service that is economically justifiable. However, itinerant traders are usually not
reliable. Typically a sale is finalized when an item is delivered. They offer no after sale
service and return of exchange of items is not allowed. Secondly, most transactions are on
cash basis.

THE ROLE OF MARKETING AND TRADE IN ECONOMIC DEVELOPMENT

Marketing and trade play vital roles in the economic growth and overall development of a
nation. The major roles of marketing and trade in the national economy can be thought of
in terms of:
 Specialization in activities of comparative advantage
 Enhanced resource-use efficiency and trade

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  Advances in marketing with economic growth.

Specialization in activities of comparative advantage

Without market facilities, areas must maintain diversified activities to produce their own
food, shelter, tools and other needed goods. In the presence of a market, however, an
individual can specialize in one activity and sell the surplus in order to purchase other
needed goods. The individual is likely to specialize on the basis of a comparative
advantage in that activity for which he or she has some special resource or ability.

Note: A comparative advantage exists when an individual or region can produce a

commodity more cheaply, relative to the price of other goods, than another individual or
region.

Enhanced resource use efficiency and trade

Through specialization and trade, a community is better able to utilize its limited
resources. Specialization and the resulting efficiency of resource-use is the basis for
economic growth and development. As markets and economies develop, surpluses occur
more frequently in profitable activities, creating new wealth, while products are moved
greater distances than before through trade.

Advances in marketing with economic growth

As economic growth proceeds, several changes in marketing take place. With economic
development, the activities and tasks of marketing increase. Activities such as storage and
processing, packaging and retail distribution become more important. Greater activity
moves away from the site of production and towards marketing. This, in turn, creates
employment opportunities and further specialization (diversification of the community).

EVALUATION OF MARKETING SYSTEMS PERFORMANCE

Market performance is defined as how well the food marketing system performs what
society and the market participants expects of it. E.g. to provide attributes of form, time,
space, information, etc. Examples of poor market performance aspects: Price fluctuations,
hiked prices, deceptive market information (e.g. labels and advertisements, use of wrong
scales to measure commodities; or selling rotten/bad products), hoarding during the time

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of scarcity (black market), expensive practices such as over-packaging, disparity in prices,
below cost (monopoly) pricing.
Regardless of the economic system, a marketing system must meet the needs of the
people. This is important because it influences the level of consumer satisfaction and
profits.
Judgment of market performance can be effected by considering the following factors
i. Competitiveness of marketing system
ii. How fair prices are determined
iii. How well the marketing system serves farmers and consumers
iv. Ability/capacity to improve the marketing system
v. Optimal output available at minimal cost.
vi. Reasonable levels of profits:
vii. Encouragement of innovations:
viii. Reasonable levels of investment.

A marketing system can be measured with two criteria, or yardsticks.

i. Efficiency. How well goods and services flow from business to consumers
ii. Fairness. How the marketing system meets the needs of the consumers.

Market efficiency
Efficiency in the food industry is the most frequently used measure of market
performance. Efficiency commonly refers to minimum cost or least cost of economic
welfare associated with a marketing activity. Improved market efficiency is a common goal
of market participants and the society because higher efficiency means better
performance. Efficiency is measured as the ratio of output to input. Food marketing can
be viewed as an input-output system. Marketing input includes resources (such as labour,
packaging, machinery, energy etc.) necessary to perform the marketing functions.
Marketing output include time, form, place and the possession utilities that provide
satisfaction to consumers. Efficient marketing is the maximization of this input-output
ratio.

The input cost of marketing is simply the sum of all prices of resources used in the
marketing process. However it is less easy to measure the value of the marketing utiilities

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(consumer satisfaction). This makes it difficult to determine when the marketing efficiency
ratio is rising or falling. Satisfaction output of the market process can be assessed using
the price consumers are willing to pay. For example, if consumers are willing to pay
500/=, more for orange juice than for fresh oranges, we may conclude that the
processing of fresh orange into juice adds 500/= of form utility to the fresh oranges.
The marketing efficiency ratio can be increased in 2 ways
i. Reducing the costs of performing the marketing function without changing the
marketing utilities.
ii. Enhancing the utilities/output of the marketing process without increasing
marketing costs

Types of market efficiency

Operational efficiency refers to the situation where the cost of marketing is reduced
without negatively affecting the output side of the efficiency ratio. For example
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. In addition, an
organisation that improves its raw material procurement practices, by say centralising
purchases, or buying in larger quantities, is likely to increase operating efficiency.
Operational efficiency is frequently measured by labour productivity or output per man-
hour. Operational efficiency in wholesaling and retailing has lagged behind that of food
processing and farming because of the difficulties in mechanising and automating food
wholesaling and retailing.

Changes in marketing costs often are accompanied by changes in the output. So the effect
will depend on whether the output changes proportionately more than the costs and vice
versa. Therefore it is important to measure both the numerator and the denominator
when evaluating market efficiency.

Pricing efficiency is concerned with the ability of the market system to efficiently
allocate resources and coordinate the entire food production and marketing process in
accordance with consumer directives. Pricing efficiency is said to have failed if the prices
do not represent the preferences of the consumers, and coordination of buying and selling
activities of farmers, marketing firms and consumers fails.
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It’s important to note that competition plays a key role in fostering marketing efficiency.
However, there may be conflicts between these two types of efficiency. For example,
improvement in operational efficiency through technological development may result into
larger firms and reduction in the number of firms, which reduces pricing efficiency.

To evaluate markets on the basis of efficiency, the ingredients of an efficient market must
be identified. Four of these are:
 Consumer demand is accurately and quickly relayed to the producer and the
resulting information on producer supply is relayed back to the consumer.
 Marketing and distribution services are provided at the minimum cost per unit,
compatible with the kinds and qualities of service required. Normally, the cost of
marketing services will be reflected in the marketing margin.
 Innovation and flexibility exist so that market intermediaries are able to respond to
new opportunities in terms of location or product quality.
 The national objectives of marketing are assisted.

Market fairness
The marketing system is judged fair if it meets the needs of the consumers. Since the
consumers’ needs can be satisfied through different ways such as price, place,
packaging or product itself, then fairness must be maintained in all components that
contribute to the consumer’s satisfaction. Fairness and efficiency go hand in hand.
Without efficiency, it is difficult to satisfy the consumer and hence achieve fairness.
Consumers show how they feel about the marketing system by the choices they make
in the market.

Some commonly used methods of market evaluation include:

 Degree of market efficiency in terms of marketing margin
 Price analysis
 Evaluation of services
 Structure, conduct and performance analysis
 Market information and intelligence.

Marketing margins as a measure of market efficiency

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Marketing margin s measure the difference between retail and farm prices of agricultural
products (the difference between what the consumer pays for agricultural products and
what the farmer receives). Thus a marketing margin is the price of all utility adding
activities and functions performed by agricultural marketing firms. A marketing margin
includes all the expenses of performing marketing functions plus the profits of marketing
firms. The overall marketing margin is simply the difference between the farm-gate price
and the price received on retail sale.

Marketing margins can be calculated for different levels of the market, so that:
Marketing margin = P1 - P2
Where
P1 = the price at one level or stage in the market
P2 = the price at another level

There are several types of marketing margins, based on the market level being
considered. The wholesale margin is the difference between the price paid by the
wholesale trader and the farm-gate or producer price.

The retail margin is the difference between the price the retail trader pays and the retail
price he charges to consumers. When the margin is expressed in monetary terms, it is
called the price spread. Expressed as a percentage, it is known as the percentage
margin.

Calculation of marketing margins

Basic example: A rural dairy producer sells one kg of locally-processed butter to a trader
for 2000/kg Ugandan Shillings. The trader sells the butter to a retailer in an urban area for
2400 Ugshs/kg. The retailer in turn sells the butter to his consumers for 2600Ugshs/kg.
Wholesale margin = trader price - producer price
= 2400UShs - 2000 UShs = 400 UShs/kg
Retail margin = retail price - trader price
= 2600 UShs - 2400 UShs = 200 UShs /kg
Total price spread = wholesale margin + retail margin
= 400 UShs + 200 UShs = 600 UShs
Percentage wholesale margin =wholesale margin/wholesale buying price X 100
= ( 400 UShs / 2000UShs) x 100 = 20%
Retail mark-up = retail margin/retail selling price x 100

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 = ( 200 UShs / 2600UShs) X 100 =7.69%

Exercise
A pastoral herder can sell his cattle to a trader for UShs 700/kg (based on the buyer's
estimate of the weight). The trader treks the animals to an urban area, where he sells
them to a butcher for UShs 1000/kg. The butcher then sells the meat to consumers. Half
of the meat sells for UShs 1300/kg; the rest sells at UShs 1500 /kg.
Question 1. What is the wholesale margin? What is the retail margin, based on an average
retail price for meat? What is the total price spread?
Question 2. What is the percentage retail margin? What percent is the wholesale mark-up?

In an efficiently operating market, the competitive environment should keep the marketing
margin to a minimum. Market prices should then reflect two elements: the actual costs of
marketing plus normal profit margin. A normal profit is one which provides returns to
investment comparable to available rates of interest plus some compensation for the risk
borne by the marketer.

Evaluation of services
Marketing services may be difficult to evaluate directly, although cost comparisons can
provide some indication of availability. The functioning of services can also be seen in the
structure of the market. Large numbers of intermediaries in the market indicate a lack of
capital and risk-avoidance services such as banking and insurance. Without capital, traders
are forced to deal in small quantities at a time. This leads to a dominance of small traders
in the market. Lack of insurance can have the same result. The presence of numerous
traders can thus be seen as an effective adaptation of the market to a situation where
services from external and public source are lacking.

The structure-conduct-performance model

To help with the measuring process, economists have developed a method for measuring
the fairness and efficiency of the marketing system. This model, measures efficiency and
fairness by looking at
 Market structure (how a system is organized)
 The conduct (how decisions are made in a marketing system)

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  Performance (how well the system works)
These three items are said to be related to each other in such a way as to provide a
“picture” of the performance of a market. The way firms are organized in a market
(structure) tells a great deal about how they make decisions (conduct), which in turn
changes the level of efficiency and fairness present in the market (performance).
Market structure (influences) conduct of firms
Conduct of firms (influences) market performance in an industry
Structure
There are certain qualities that a market must have if its structure is to have a high level
of fairness and efficiency. These qualities include the following
a) Number and size of firms in the market
b) Barriers to market entry/exit
c) Degree of product and price competition
The number and size of firms in an industry is important because neither many small
firms, nor few large firms are good for the market. Firms need to be large enough to have
a low operating cost per unit output, but not so large that they can dominate the market.
There should not be barriers or obstacles to entry or exit from the market. E.g. If
someone wants to go into a certain business another firm should not be able to prevent
him or her from doing so. Competition among firms forces individual firms to do a better
job

It is clear from the above points that the number of firms in a market plays an important
role in competition and economic efficiency. When four or fewer of the largest firms in an
industry account for more than 50% of total market sales, the firms in these markets may
behave as oligopolies. This means that they compete on things other than price, spending
large amounts of money on advertising, packaging, etc. Efforts to improve and change
products may not be as important to the firms in this situation. The result is a loss of
economic efficiency. In this case, the government may step in to limit mergers (two firms
agreeing to merge together) and acquisitions (one firm buying another) to prevent further
consolidation or concentration (further shrinking the number of firms in an industry)

Conduct

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The structure of a market alters, or influences the conduct or managerial decision making
of the firms in it. In a market with many firms, conduct is usually limited to increasing
output, and cutting costs as a firm tries to increase its long term profits, which helps
society. However, if there are only a few firms in the market, they may get into an
advertising war or engage in costly promotional campaigns. They may attempt to restrict
output to force prices up. In these cases, society is not helped. There are qualities or
criteria that describe the conduct of firms that help to define the level of economic
efficiency in a market. These qualities or criteria include the following:
a) Enough firms in the market to create a competitive atmosphere
b) Firms trying to sell at lower prices than competitors
c) Firms offering product improvements to stimulate buying interest
d) Firms that emphasize quality and service
e) No unlawful cooperation among different firms on pricing and other matters. In other
words, firms do not get together and agree not to compete
f) Product claims are truthful
g) Product differences or distinctions do exist and are based on meaningful differences
created by clever advertising

The satisfaction of these qualities or criteria should result in “acceptable conduct” on the
part of firms in a market. It will lead to economic efficiency.

Performance
The structure of an industry and the conduct of the firms in it lead directly to the
performance of the industry. If the criteria or factors described earlier for structure and
conduct are met, the market should be fair and efficient, which is the performance desired
by society.
Meeting the two goals of fairness and efficiency in a market should bring a balance
between the needs of consumers for the highest level of satisfaction, and producers for a
deserved level of overall profits.

Market information and intelligence

Market information is crucial to producers, wholesalers and consumers to help them make
decisions on what and whether to buy and sell. In general, information is required on

18
prices, traded or available quantities, forecasts of future supplies and demand, and
general market conditions. Information must be relevant, accurate and timely and reflect
all sectors of the market, especially consumer demand. Such information can be used by
traders to shift to those goods with high consumer demand. An effective market
information system reduces risks to traders, eventually reducing market margins. When
reliable information is not available, traders increase their margins to protect themselves
from risk (e.g. if information on distant cattle markets is not reliable, traders face the risk
of finding low prices at the end of a long trek).

An efficient market information system needs to address information flows in both

directions between consumers and producers. Information should be evaluated in terms of
its accuracy, how promptly it reaches those who need it and its degree of detail. These
can be determined by comparing the results of surveys of traders and agents with known
information about the market.

Price analysis
Price is the value placed on what is exchanged. Decisions made in the agricultural industry
are largely coordinated by prices determined by a market economy. Basically, coordination
requires that each firm and consumer make independent decisions, based on their own
interests and guided by the price signals. If a competitively functioning pricing system is
directing in the market, it has the advantage of being impartial (no decisions are based on
political power etc, to determine ’fair treatment’.
Generally, a competitive price mechanism performs three jobs. Namely;
 They guide and regulate producers’ output and selling decisions
 They guide and regulate consumption decisions
 They guide and regulate marketing decisions over time, form, and space

Market participants occasionally use price information to select among alternatives in

order to undertake profitable production and marketing decisions e.g. substitution
decisions are based on prevailing prices of commodities such as farmers converting corn
to animal use other than for human consumption, dairy producers converting fluid milk to
cheese or yoghurt, consumers substituting poultry meat for beef. Also farmers could plant
more acreage under soya bean and less under corn if prices and profit favour the former

19
rather than the latter, etc. These changing market choices can be explained by price
signals and profit motives of market participants.

A REVIEW OF BASIC ECONOMICS

Consumer Demand and Agribusiness Supply

The Meaning of Consumer Demand

Consumer Demand is defined as the various quantities of a particular commodity that an
individual consumer is willing and able to buy as the price of that commodity varies, with
all the other factors that affect demand held constant.

The demand schedule is a schedule of quantities of a commodity that buyers will buy at
different prices at a given time. It can also be defined as the amount or quantity of a
product that consumers are willing and able to buy at various prices. When consumers are
both willing and able to purchase a product that is referred to as effective demand - the
desire of the consumer for the commodity backed up by the purchasing power.

A hypothetical demand schedule

Price per ton ($) Amount purchased (thousand tons)
4.00 3.0
3.75 3.4
3.50 3.8
3.00 5.0
2.75 5.7
2.50 6.4
2.25 7.2

Plotting the prices and quantities on a graph shows a line sloping to the right. This means
that the higher the price, the lower the quantity sold. This is referred to as a negative
relationship, and it shows the law of demand (“Consumers buy less of a good as the price
rises and more as the price goes down.”)

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Hypothetical demand curve for corn
Price per
ton ($)

4.00 ---------------

3.50 -----------------------------

3.00 --------------------------------------------

2.50 --------------------------------------------------------------
2.0 -------------------------------------------------------------------------

2.0 3.0 4.0 5.0 6.0

Thousands of tons purchased
Speculative demand
Speculative demand is the demand related to anticipated use and prices relative to current
prices. Most agricultural products are produced seasonally but are consumed throughout
the year. Thus the concept of speculative demand is of interest to agribusiness firms.
They anticipate that prices that will rise from harvest through the year, by enough to
provide them with a profit even after adding the costs of storage. Factors that influence
speculative demand include crop prospects for substitutes which tend to increase
speculative demand, expectation of war and the possibility of weather changes. Effects of
speculative demand include the fact that it influences current prices of a commodity as
well as future prices leading to price fluctuations.

Factors that influence demand

Some of the factors that influence the level of consumer demand include: Own price, price
of substitute, price of the complement, income, population, tastes and preferences,
seasonality, expectations about prices, incomes, availability. Taxes, subsides and
regulations also influence demand. Taxes or subsidies can drive a wedge between demand
price that buyers are willing to pay, and the price the seller receives

Change in Demand and change in quantity demanded

21
Another area of consumer demand is the difference between a change in the quantity
demanded by consumers and a shift/change in consumer demand. If a change in the
own-price of an item brings a change in the number of units of the product sold, then
there has been a change in the quantity demanded. However, if price remains the same
and the quantity sold changes, this means a shift/change in demand.

Change in Demand and Change in Quantity Demanded

Price

D C

D2 Do D1
0
Quantity Demanded

Movements along the demand curve points A to C or point B to E occur when buyers
respond to changes in the price of the good itself, while changes in demand that involve a
shift to the right (Do to D1) represent an increase in demand. Do to D2 represent a
decrease in demand.
The factors that cause this movement of the demand curve (change in demand) are called
demand shifters. An increase in demand results when:
 Price of substitute goods increases
 Price of complement goods decreases
 Number of buyers increases (Increase in population)
 Income or price expectation increases
 Expected shortages or expectations of decreased product availability occur
 Government increases subsidies or reduces taxes
 Positive changes in taste and preferences
 Seasonality.

22
Changes in any of these conditions can lead consumers to demand more of a product
even though the price does not change. The reverse of the factors can lead consumers to
demand less. Product sellers must pay attention to changes in these factors so that they
respond accordingly to shifts in any of them. These shifts can have a powerful impact on
the long run level of producer sales and profits.
The meaning of Supply
Supply is the amount which producers/traders are prepared or willing to offer for sale at
different prices at a given time and place. Quantity supplied is the amount of a
commodity that is offered for sale at a particular moment, at each possible price.
Note: Supply is different from output since willingness and ability to sell are necessary for
supply to take place.
The law of supply is the relationship that exists between the prices and quantity offered
to the market. The higher the price, the more will be offered for sale; the lower the price,
the less will be offered for sale.
Supply schedule; is a table which shows the different quantities of a commodity that are
offered for sale, at different prices, at a particular moment in time.

A hypothetical supply schedule for corn

Price per ton ($) Amount offered for sale (thousand tons)
4.00 5.6
3.75 5.5
3.50 5.4
3.00 5.0
2.75 4.7
2.50 4.4
2.25 4.0

Supply curve
This depicts the relationship between price and quantity supplied of a commodity. It is the
graphical representation of the supply schedule. Below is a figure of a supply curve, based
on the above supply schedule.

Supply curve for corn

Price per ton ($)

23
 3.00 -----------------------------

2.50

2.0

0 2 3 4 5 6
Thousands of tons sold

Factors affecting the supply of a commodity

The supply of a commodity depends on many factors. The most important of these include
the following; The price of the commodity, Prices of other commodities, Changes in the
prices of the factors of production, Changes in technology, Changes in the level of price or
yield risks faced by producers, Institutional constraints such as government policies may
increase or decrease production thus shifts the supply curve to the left or right.

Changes in quantity supplied and changes in supply

A change in the quantity supplied of a commodity is caused by a change in the price of
the commodity, and is represented by a movement along the supply curve, with other
factors held constant. The changes in quantity supplied are described as extensions or
contractions of supply.

A change in the supply of a commodity occurs when other factors beside the price of the
commodity such as technology, prices of other commodities, change. A decrease or
increase in supply is represented by a shift in movement of the supply curve to the left or
right.

An increase in quantity supplied due a rise in the price of a commodity

Price P1

Po

0 Qo Q1
Quantity supplied

24
The above figure shows the effect of a change in the price of the product when other
factors do not change. An increase in the price from 0Po to 0P1 will cause the quantity
supplied to increase from 0Qo to 0Q1 (i.e., there will be an extension of supply).
A fall in the price from 0p1 to 0Po will cause the quantity supplied to fall from 0Q1 to 0Qo
(there will be a contraction in supply).
An increase in supply due a shift in technology

S2 So S1
Price
Po

0 Q2 Qo Q1
Quantity supplied
If more of a product is offered for sale at the same price, supply has shifted to the right
(increased). If we assume that So is the original supply curve a movement to S1
represents an increase in supply, because more is now supplied at that price, and a
movement to S2 represents a decrease in supply, because less is now supplied at the
same price.

The principal causes of shifts in the supply curve are;

 Changes in input or factor prices
 Changes in returns from commodities that compete for the same resources
 Changes in technology that influence both yields and costs of production or
efficiency
 Changes in the prices of joint products (i.e., commodities such as wool and mutton)
 Changes in the level of prices and/or yield risks faced by the producer
 Institutional constraints such as government acreage-control program

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Matching supply and demand in agribusiness markets
Prices are the result of supply and demand forces operating within the framework of an
open exchange, freely competitive market place. In this lecture, the interaction of supply
and demand to determine prices is explained.

Price determination
Price determination refers to a situation where the interaction of supply and demand
determines price. A market price is determined when the market demand curve of the
commodity in question intersects the market supply curve. A market demand curve is
derived by summing up individual demand curves for a product. Similarly, the horizontal
summation of individual supply curves leads to a market supply curve. The demand curve
reflects the desires of the consumers while the supply curve indicates the motivations of
producers.

Equilibrium price
Both demand and supply must be considered in the determination of a price.
Demand and supply schedules for corn
Amount purchased (thousand Price per ton Amount offered for sale (thousand
tons) ($) tons)
3.0 4.00 5.6
3.4 3.75 5.5
3.8 3.50 5.4
5.0 3.00 5.0
5.7 2.75 4.7
6.4 2.50 4.4
7.2 2.25 4.0
From the table above, note that at $3.00 per ton of corn, buyers will buy 5.0 thousand
tons. At this same price, sellers will produce and offer for sale, 5.0 thousand tons. At $
3.00, buyers will take all that sellers will offer, and there will be no unused corn; the
market will be cleared. This will be the price that will be established if the forces of
competition are allowed to function. The point where demand and supply are equal is the
equilibrium price.

26
Equilibrium price
D S
Price per unit
Po -------------- Equilibrium price and quantity

0 Qo Quantity per unit of time

At Po (equilibrium price), the quantity demanded Qo, equals the quantity supplied Qo
(equilibrium quantity). At this point, all buyers of the product who are willing to pay price
Po for the commodity could buy the amount they wanted, and all the producers who
supplied quantity Qo could sell their product at Po, the price they need to receive in order
to produce quantity Qo; there are no surpluses or shortages in the market.
Market disequilibrium occurs when imbalances in supply and demand exist, as shown
in the figure below:

A market Disequilibrium

D Surplus S
P1 ----------------------

Price per unit Po ---------------------- Equilibrium price and quantity

P2 ---------------------
Shortage
0 Q1 Qo Q2 Quantity per unit of time
A price such as P1 is not an equilibrium price and will cause a surplus to exist. At P1,
producers will wish to sell Q2, but consumers are willing to buy only Q1, leaving surplus
(Q2-Q1) in the market at this price. Producers who want to sell this surplus must yield to
the down ward pressure on their asking price. Only when the price falls to the equilibrium
price Po, will consumers purchase all that suppliers want to sell.

27
On the other hand, if the price is initially established below equilibrium, at price P2 as in
the figure above, suppliers will only supply quantity Q1, but consumers want quantity Q2
as shown by the demand curve. Therefore, there is a market shortage equal to Q1-Q2. In
order for consumers to purchase the short quantity supplied, they must bid the price up to
Po. Only at the equilibrium price Po is the amount producers supply equal to the amount
that consumers demand.

MARKET STRUCTURES, PRICE DETERMINATION AND

COMPETITION

Prices are determined under different market structures

The term market structure refers to the set of industry characteristics that affect the
extent of rivalry in the market, and ultimately affects market performance related to
pricing and output. Elements of market structure include:

 Number and size of existing and potential entrant sellers, and number and size of
existing and potential entrant buyers and their distribution
 The extent of entry/exit costs and other difficulties associated with market entry (or
exit)
 The extent to which products are similar or different across firms (the degree of
product differentiation)
 The extent of economies of scale in production
 The extent to which costs are similar or different across firms
 The extent of transaction costs, and the extent of travel or information costs on the
part of buyers

Four major market structures exist and these are mainly based on the forms of
competition within the market. These include: pure (perfect) competition, monopolistic
competition, oligopoly and monopoly.

Perfect competition refers to an idealized state in which;

 There are many buyers and sellers, each of whom is small in size relative to the
overall market
 There are no entry/exit costs or other difficulties associated with entry/exit

28
  Products made by different sellers are effectively identical
 Economies of scale in production are exhausted at low output levels, which explains
in part why there are many relatively small sellers
 Costs are identical across firms
 There are no transaction, travel or information costs

A consequence of this market structure is that there is vigorous competitive rivalry

amongst the sellers, and buyers are unable to collude. Because sellers are so small
relative to the overall market, no one seller can significantly affect market price by way of
its output-setting behaviour. Therefore sellers are price takers who maximize their profits
by taking the market price as a parameter unaffected by their own behaviour. The pure
competition also requires perfect knowledge on current and future market conditions.

Price Determination under Perfect Competition

In a perfectly competitive setting, there are many sellers and buyers. Together, all buyers
make up a market demand curve. Together, all sellers make up the market supply curve.
The demand curve reflects the desires of the consumers while the supply curve indicates
the motivations of producers. An equilibrium price is established at the intersection of the
market demand, and the market supply curves. Once the equilibrium price has been
established, a single perfectly competitive firm faces horizontal (perfectly elastic) demand
curve at the equilibrium price.

Market demand curve and firm demand curve in perfect competition

Supply
Price($) (Market) DD curve taking a single perfectly
Competitive firm

5 ------------------------------------------------ 5 ----------------------------------

Market Demand Single Firm

0 50,000 Quantity 0 100 Quantity

Effects of perfect competition on farmers

29
 1. Because the individual farmers cannot affect their prices, there is a strong incentive
for them to increase their profits by lowering their costs and improving operational
efficiency in agriculture.
2. Individual farmers are price takers. They receive whatever price is dictated by the
total market demand and supply curves. Consequently, they do not price their
products as other firms do.
3. Farmers are subjected to a perpetual cost-price squeeze. Any short run increase in
profit will stimulate long run increase in production, which then forces market
prices back to normal profit levels (Zero profit)

Pure monopoly: refers to a market structure in which;

 There is one seller, and any number of buyers.
 There are high market entry/exit costs or other barriers to potential entrants,
though these may recede over time
 Products made by other sellers are sufficiently differentiated as to be in different
markets, and thus do not provide any competitive pressure on the monopolist
 Economies of scale in production often occur at relatively high output levels, though
this is not necessary; The monopolist's cost structure m ay or may not be any
different from that of other sellers
 High transaction, travel, or information costs can lead to or sustain a monopoly
structure, though they also be small or non-existent

As a consequence of this market structure, in the short run monopolists are price makers
who recognize that their sales output has a direct impact on market price. Therefore
monopolists set Price (P) and market-clearing quantity (Q) simultaneously.

Monopsony vs. Monopoly

Monopsony occurs when there is a single buyer. A monopsonist would like to buy at a
price no higher than the seller's marginal cost, which is the lowest price the seller will
voluntarily sell at. Monopsony can occur when there are one or two big employers in a
remote area -- the old company town. When monopoly meets monopsony (as when there
is a company town with a unionised workforce), the wage and total employment are
subject to negotiation.

30
Oligopoly: An oligopoly is a market dominated by a few large suppliers. The degree of
market concentration is very high (i.e. a large % of the market is taken up by the leading
firms).

Key features of oligopoly

 A few firms selling similar product
 Each firm produces branded products 
 Likely to be significant entry barriers into the market in the long run, which allows
firms to make supernormal profits.
 Interdependence between competing firms.  Businesses have to take into account
likely reactions of rivals to any change in price and output

Firms within an oligopoly produce branded products (advertising and marketing is an

important feature of competition within such markets) and there are also barriers to entry.
Another important characteristic of an oligopoly is interdependence between firms. This
means that each firm must take into account the likely reactions of other firms in the
market when making pricing and investment decisions. This creates uncertainty in such
markets.

Factors that Influence the Extent of Competition

The extent to which firms compete against one another and hence the market structure
depends directly upon the number and relative size of sellers (and buyers)

The number and relative size of sellers depends on:

 Product characteristics: Product characteristics such as perishability can limit the
number of sellers competing in a given regional market.
 Production and cost characteristics: Products that feature very high fixed costs will
also feature large economies of scale, which will naturally tend to restrict the
number of sellers in a particular market. High fixed cost products include equipment
such milk cans etc).
 Entry/Exit conditions: If there are large sunk costs (unrecoverable past
expenditures) associated with entry into a market (e.g. Image advertising
campaigns, development of specialized expertise, investment in specialized
equipment, etc.), and if there is a probability that the entrant will have to exit

31
 because market conditions failed to live up to the forecasts, then there is an exit
cost that reflects the sunk-cost investment. In addition, patents, copyrights, and
trademarks are legal barriers to entry. Regulations limiting plant closures or that
require substantial regulatory approval can limit entry.

 Number of buyers: the number of buyers also affects the degree of competition. If
there is only one buyer, or if buyers can act collusively like a single entity, then we
have a condition called monopsony. Very large firms can sometimes act as
monopsony buyers of labor and other inputs, and big retailers like supermarkets
can sometimes use their size to negotiate more favourable wholesale prices of the
goods they retail.
 Products differentiation: The extent to which products are identical or differentiated
also has an impact on the extent of competition. In fact, we define a product
market by the set of goods/services that are sufficiently similar as to be considered
close substitutes by buyers. If products are highly differentiated, then there are
fewer products in a given market, which leads to less 'competitive pressure'. Thus it
is usually (though not always) in a firm's best interest to differentiate its product(s)
from those of its rivals.

 Production concentration: High travel costs and geographically dispersed sellers can
reduce the number of sellers in a given geographical market, thus lessening
competition.

Costing of Marketing Activities

Defining “costs”
There are many different types of costs and many different meanings given to costs. A
cost as we use it in most conversations has a rather general meaning. It is determined by
what we have to give up to acquire goods and services. For example, when someone says
that a loaf of bread costs 2000, it is clear that 2000 shillings was given up to obtain the
loaf of bread.

In the world of business, the meaning of the term cost depends on the context in which it
is used. For an economist, the relevant concept of cost is captured by market alternatives.
Many inputs are purchased in the market place and used immediately in the firm’s

32
production or distribution process. Since these inputs are offered for sale on the market,
the alternative cost of any specific use is equal to the market price of the input.

Opportunity Costs
The opportunity cost of an agricultural product (or, more generally, of a choice) is the
highest valued opportunity that must be passed up to allow current use. Thus the monthly
opportunity cost of a tractor owned by Isabel may be, for example, the monthly income
the tractor could have generated if Isabel had rented the tractor to someone else to use.
Costs can be explicit or implicit; controllable or uncontrollable; fixed or variable

Explicit and implicit costs

Explicit costs are expenses for which one must pay with cash or equivalent. Because a
cash transaction is involved, they are relatively easily accounted for in analysis.
Implicit costs do not involve a cash transaction, and so we use the opportunity cost
concept to measure them. This analysis requires detailed knowledge of alternatives that
were not selected at various decision points. Relevant here are the opportunity cost of the
firm's assets and cash, and of the owner's time invested in the firm.

Controllable and Non-controllable costs

A controllable cost is one that can be regulated totally by the responsible manager. If
most of the costs incurred by a marketing department or unit are controllable by the
manager involved, he/she is in a good position to exercise expertise and to influence the
actual cost of the product being produced. Non-controllable costs, on the other hand, are
costs a manager has no influence on. For example, if you are producing a product and
most of the costs are either implicit or when a labour contract states that employees can
make just x number of 5 units per hour, no more no less, you have very limited cost
control.

Fixed and variable costs

Costs vary according to two circumstances: 1) passage of time and 2) level of activity.
Costs that stay the same over a time period regardless of the level of output are called

33
fixed costs. Examples include insurance costs, property tax, rent etc. Costs that change
with the level of activity or business volume are called variable costs.
By definition, fixed costs do not vary with the volume of goods or services produced as
output. Fixed costs are the costs associated with the fixed inputs that define the economic
short run. Thus fixed costs are only relevant in the economic short run. Even if the firm
temporarily shuts down, it still continues to incur the fixed cost expense. This is typical of
capital loans or rent agreements. In a juice extraction enterprise, for example fixed costs
are taken as the costs associated with the purchase of machinery (extractor), machinery
depreciation, taxes, trading license, rental charges, payment for land purchases, payments
for buildings, and interest on loans.

Fixed Costs Vs Output

Costs

Total fixed costs

Output
Variable costs, in contrast, vary (usually directly) with the volume of good or services
produced as output, and thus can be avoided by a temporary shutdown. These are costs
for items such as raw materials ingredients, packaging materials, fuel and electricity which
are related directly to production, casual labor, water that goes into the process directly,
and distribution. In the juice extraction enterprise for example, variable costs are the costs
associated with purchase of fruits, sugar, spices, water, Packaging/canning/bottling, and
others.

Variable Costs Vs Output

Total variable costs

Costs

Output

34
As production increases fixed costs are spread over a larger number of units and so
average fixed costs fall. Average variable costs also fall, over a certain range of production
levels, as the organization benefits from economies of scale. However, at some point
average variable costs will start to rise again as diseconomies of scale take effect. Since
average variable costs tend to rise faster than average fixed costs fall, the average total
cost rises too.

The Total Cost-Output Relationship

Cost (Ug. Shs)

Output

From the graph above, it can be seen that under ordinary business circumstances, total
costs of operating a business tend to be high in the beginning because the entrepreneur
must invest in the business incurring fixed costs, then as output increases, costs start to
decline as the fixed costs are spread over more units of output. It is always best to
operate at the lowest level of costs, and after this lowest level, costs begin rising.
In order to track all the costs and benefits accumulating from a value addition enterprise
over time, a good manager must be able to keep records, thus the need for record
keeping skills.

Attempting to receive the highest possible profit is one of the most common pricing
objectives. The most profitable level of output can be determined on a unit basis. To do
this, one requires building a formula for pricing that permits covering the fixed costs of
production and variable costs of production and includes some provision for profit.
Selling price per unit = Total cost per unit + Profit per unit
Where Total cost per unit = [fixed cost/unit] + [variable cost/unit]

End of handout: 16/3/2017

35
 ABM 2207: Handout 23/3/2017

STRATEGIC MARKET PLANNING

Marketing planning
Planning involves setting objectives, designing and implementing a program to
achieve the organization's objectives and having a monitoring and control mechanism
to ascertain whether the planned program is on track or has achieved its desired
objectives. A marketing plan is a part of the firm’s total business plan which also
includes an organizational plan, a production plan, and a financial plan.

The planning process should include a report on existing lines of business. It should
also point out which businesses and products should be dropped and which
businesses should be started. This type of planning is called strategic planning.
Strategic planning begins with an assessment of an organization's internal and
external environments.
It's important for a strategic marketing planning process to look at the company from
the customer's point of view by asking questions that have a long time horizon, such
as: What needs or problems cause customers to consider buying from our company?
What improvements in the customer's personal or business life can we enable or
improve? Which customer market segments are attracted to our company or
products? Which customer motivations or values lead people to decide to purchase
our products? What changes or trends in our customer base are affecting their
general interest or attraction to products like ours?

Benefits of strategic market planning

 It focuses management's attention on external events, especially those
representing threats and/or opportunities.
 It leads management into taking a long term perspective. Strategic market
management usually has a well-defined time-cycle when managers have to
submit short, medium and long term plans. Such cycles instil a discipline that
forces managers to devote an amount of time giving thought to future
developments.

36
  It changes the basis on which resource allocation decisions are made. Strategic
planning seeks to match resources to opportunities (and/or threats).
 It provides a strategic management control system. Monitoring and control are
an integral part of strategic management. This enables management to deal
with problems as these emerge rather than allowing problems to become
crises.
 It helps enterprises operating in rapidly changing and unpredictable
environments to cope.

Thus, strategic market management is proactive in that it prepares managers not

merely to expect change but to anticipate it. Moreover it serves as an instrument for
making management more externally orientated.
Note: Before a firm writes a marketing plan, it should decide on the overall business
plan.

Developing of a Marketing Plan

CONTENTS OF THE MARKETING PLAN

The following describes the contents of the marketing plan which includes the
executive summary, corporate purpose, situation analysis (SWOT), objectives,
strategies, action plan, monitoring evaluation and control and the marketing
intelligence system.

Executive summary
The planning document should start with a short summary of the main goals and
recommendations to be found in the main body of the plan. A summary permits
management to quickly grasp the major directions of the plan.

Corporate purpose
This tells of the specific customer needs that are going to be filled. This must be
widely explained so that the employees, lenders, shareholders, and even customers
can know and understand it. There are two elements to the corporate purpose, one is

37
to prepare the organization's basic mission statement, and the other specifies the
basic management goals.
Basic mission: This answers the question what business the enterprise is in and what
business should the enterprise be in? Periodically the basic mission of an organization
has to be reconsidered since the environment of enterprises is constantly changing.
For example, in the wake of market liberalization many marketing parastatals were
being forced to revise their mission statements. Those that formerly had exclusive
rights to market staple foods such as grains, and under market liberalization have had
this exclusive function taken away from them, are wrestling with the question of what
their role should be now. Another reason for reviewing an organization's mission from
time to time is that larger enterprises can find themselves gravitating away from their
core business. The process can be imperceptible. Investments can be made here and
there, none of which amounts to a substantial drain on corporate resources but
collectively they can sap those resources and divert the organization from its core
business and core customers.

The firm’s basic management goal: This shows how the firm is going to fulfil its
purpose. It describes what the firm will do better, cheaper, and faster than the
competition and will cause the consumers to buy this company’s products rather than
someone else’s. Examples include; to have lowest prices, the highest quality, largest
selection, fastest service. The goal is what separates this firm from all the other firms.

Situation Analysis (the strategic marketing audit)

This is carried out by constantly monitoring and reviewing the organization’s
strengths, weaknesses, threats and opportunities (SWOT). This is an extremely
important part of the Marketing Plan. The purpose of a situation analysis is to
investigate the company's own strengths and weaknesses (internal analysis) and
discover the threats and opportunities in the environment (external analysis) so it can
avoid the threats and take advantage of the opportunities.
The situation analysis helps identify the answer to four basic questions: where is the
organization now? How did it get there? What conditions is it heading into? What
strategy should it adopt for the future?

38
Figure 1 SWOT analysis

Figure 1 reveals that strengths and weaknesses arise from within the organization and
therefore are in large measure controllable. Threats and opportunities, however, have
their origins in the external environment and are, for the most part, outside the direct
control of the organization. Nonetheless, an organization that is carefully monitoring
changes in the external environment is in a position to anticipate events (i.e. to act
before the event takes place).

Figure 2 suggests some of the questions that might be used in assessing strengths,
weaknesses, opportunities and threats. The meanings of these elements of SWOT
analysis are:

Figure 2: Indicators of strengths, weaknesses, opportunities and threats

39
Objectives
Having discovered the issues with which it is faced, management must then make
some decisions about objectives which will then guide the subsequent search for
promotional strategies and action programs. Objectives should be quantifiable,
measurable, achievable, communicable and consistent. Objectives may be stated in
economic or subjective terms.

Organizations pursue non-economic as well as economic goals. Those goals which do

not relate to profitability, such as employee relations and those related to social
responsibility, are social rather than economic. Economic objectives have to be
translated into marketing goals. For example if a company wants to earn $1.8m profit,
that is, its target profit margin is over 10 percent on sales, then it must set a goal of
$18m in turnover. A company has to set certain targets for consumer awareness,
distribution coverage and so on, if it expects to maintain or improve its market share.
Objectives are usually set in a hierarchical way. Each objective can be achieved in a
number of ways and so the marketing manager is faced with making choices.

Marketing Strategy
Core strategy
The core strategy is a statement of what an organization is offering to create a
preference for its products and services in the marketplace. Through a careful
examination of the customer and his/her needs and wants, the organization can
determine what is required to create a differential advantage.

The marketing mix

The marketing mix is a concept that comprises the product, price, place (distribution)
and promotion decisions and is often called the 4 P's. The mix is the right combination
of marketing activities to ensure customer satisfaction.

Product: The product offering can be manipulated to create different market effects at
three levels: the core product, the tangible product and the augmented product. At its
core, a product is not a physical entity but the benefits that it offers customers. Those
benefits may be physical or psychological in nature. For example, the consumption of

40
imported foods, in a developing country, sometimes has as much to do with the
status of being seen to buy sophisticated, and perhaps expensive, products as it has
with any superior physical qualities compared to domestic equivalents. The tangible
product refers to its features, quality, styling, packaging, branding and labelling. A
third level is that of the augmented product, that is, additional service elements which
are attached to the product. Examples include after-sales service, extended
guarantees, credit facilities, technical advice and product trials.

Price: Prices should be set in relation to specific pricing objectives. Pricing decisions
include payment terms, discounts, contract and pricing structures. Non-price
competition may come through packaging, labelling and advertising. Prices have to
reflect the costs of production and marketing and target profit margins. A variety of
approaches may be taken to pricing including cost based, demand based, competitor
based and market based.

Promotion: Promotion includes advertising, public relations, selling, exhibitions,

brochures, free gifts, etc. Possibly the most important decision about promotion is the
message to be communicated. The message(s) has to differentiate the products
and/or its supplier. To this end, an organization will seek to convey a unique selling
proposition (USP), that is, to find some aspect of the product, service or organization
which others cannot, or simply do not promote to customers and which is perceived
to be important or attractive to those consumers.

Place: Produce distribution elements include physical distribution like storage

handling, transportation and warehousing, both on and off firm, and functional
distribution e.g. wholesaling and retailing. The decision as to which distribution
channel the organization should seek to use falls into the realm of strategic marketing
but actions within the chosen channels are operational in nature. Growers, processors
and manufacturers have to market their products to, and not through, channel
members. To the extent that channel members see themselves as anyone's agent,
they are more likely to see themselves as agents of their customers rather than
agents of product suppliers.

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Action plan
Implementing a marketing program involves deciding on long, medium and short term
activities for all marketing functions. Decisions have to be made on budgets, staffing
levels, how to communicate the elements of the plan, coordination of activities and
motivating people to carry out the plan. All of this has to ensure marketing efficiency.
Whilst too much planning can stifle flexibility and creativity, no planning is a recipe for
disaster. It leads to ill-conceived product and marketing strategies, enhancing the
possibility of waste and inefficiency in a vital industry: the production and marketing
of food.

Monitoring, evaluating and controlling the marketing planning

It is the task of management to ensure that the marketing plan is carefully monitored,
evaluated and controlled. Typical controls involve setting standards of performance,
evaluating actual performance against standards and, if the deviations are intolerable,
taking corrective action. Marketing planning can be seen as a cycle, which begins with
clear objectives that set out what the marketer intends to achieve, and ending with a
feedback mechanism in order that the objectives can be evaluated, a course of
corrective action can be taken (if there are deviations from plans) and the
organization can monitor its usage of resources.

Note:
• Each business venture is different; therefore, each marketing plan is unique. An
entrepreneur should not feel it necessary to develop a cloned version of a plan
created by someone else/some other business. Nevertheless, most marketing
plans should cover market analysis, the competition, and marketing strategy.

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 MARKETING MANAGEMENT
Marketing management seeks to attract and retain customers by offering them
desirable products. This way the organisation obtains the resources to meet the
expectations of its own stakeholders – shareholders, employees and the community.

Marketing management can be defined as the process of identifying target markets,

researching the needs of customers in these markets and then developing the product,
price, promotion and distribution to create exchanges that satisfy the objectives of the
organization’s stakeholders. Implicit in this definition is competitiveness. Customers
have choices – normally there will be several competitors seeking to attract them – so
the organization’s ability to meet its objectives requires it to offer superior value to
competition
Marketing management consists of five tasks:
1. Identifying target markets. Management has to identify those customers it
desires to make exchanges with. Choice of target markets will be governed by
the wealth they possess and the organisation’s capability to serve them.
2. Marketing research. Management has to collect information on the current and
potential needs of customers in the markets chosen, how they buy and what
competitors are offering.
3. Product development. The business must develop products (and/or services)
which will meet needs and wants sufficiently to attract target customers to buy.
4. Marketing mix. Management will then have to determine the price, promotion
and distribution for the product. This marketing mix is tailored to offer value to
customers, to communicate the offer and to make it accessible and convenient.
5. Monitoring. Since management will wish to build relationships which retain
customers, it needs to obtain feedback on customer satisfaction with the
exchange and to modify the product and marketing mix as needs and
competitive environments change.

A key decision every company must make is to determine how homogeneously to treat
the market. Companies that produce one product or service for the entire market
practice mass marketing. Companies that produce products or services for one or
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more specific market segments rather than the whole market practice target
marketing. Finally, companies that produce products or services for each individual
customer practice customer level marketing.

Mass marketing:
Mass marketers produce the same product for the entire market. The main advantage
of mass marketing is the low cost of these products, which their manufacturers achieve
by realizing economies of scale (average per unit cost declines with the volume of
production). This is a common characteristic of industries where there is a high fixed
cost associated with production or marketing. In order for its product to be attractive
to consumers, a company that produces un-differentiated product for a mass market
must price it sufficiently lower than the differentiated products offered by its
competitors. By doing so, the company hopes to achieve a volume that is high enough
so that the margin between the product’s price and its cost will yield the company an
attractive profit.
The importance of mass marketing has diminished over time as marketers have
developed a cost –effective appeal to smaller consumer segments with distinct tastes.

Target marketing:
Target marketing has become the referred approach for most products because of its
effectiveness in identifying new marketing opportunities. Because consumers have so
many different needs, it is difficult for one product to satisfy all. By grouping
consumers with similar needs into market segments, it is possible to target a product
to consumers in the chosen market segment.
A market segment is defined as a group of consumers with similar needs. Many
markets can be broken down into a number of broad segments using various
approaches.

Criteria for selecting Market Segments

Measurable: A segment should be measurable. It means you should be able to tell
how many potential customers and how many businesses are out there in the
segment.

44
Accessible: A segment should be accessible through channels of communication and
distribution like: sales force, transportation, distributors, telecom, or internet.
Durable: Segment should not have frequent changes attribute in it.
Substantial: Make sure that size of your segment is large enough to warrant as a
segment and large enough to be profitable
Unique Needs: Segments should be different in their response to different marketing
efforts (Marketing Mix)

Consumer and business markets cannot be segmented on the bases of same variables
because of their inherent differences.

Bases for Consumer Market Segmentation

There are number of variables involved in consumer market segmentation, alone
and in combination. These variables are:
 Geographic variables
 Demographic variables
 Psychographic variables
 Behavioural variables

Geographic Segmentation
In geographical segmentation, market is divided into different geographical units like:
i. Regions (by country, nation, state, neighbourhood)
ii. Population Density (Urban, suburban, rural)
iii. City size (Size of area, population size and growth rate)
iv. Climate (Regions having similar climate pattern)
A company, either serving a few or all geographic segments, needs to put attention
on variability of geographic needs and wants. After segmenting consumer market on
geographic bases, companies localize their marketing efforts (product, advertising,
promotion and sales efforts).

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Demographic Segmentation
In demographic segmentation, market is divided into small segments based on
demographic variables like:
 Age
 Gender
 Income
 Occupation
 Education
 Social Class
 Generation
 Family size
 Family life cycle
 Home Ownership
 Religion
 Ethnic group/Race
 Nationality
Demographic factors are most important factors for segmenting the customers
groups. Consumer needs, wants, usage rate these all depend upon demographic
variables. So, considering demographic factors, while defining marketing strategy, is
crucial.

Psychographic Segmentation
In Psychographic Segmentation, segments are defined on the basis of social class,
lifestyle and personality characteristics.
Psychographic variables include:
i. Interests
ii. Opinions
iii. Personality
iv. Self-Image
v. Activities
vi. Values
vii. Attitudes

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A segment having demographically grouped consumers may have different
psychographic characteristics.

Behavioural Segmentation
In this segmentation market is divided into segments based on consumer knowledge,
attitude, use or response to product.
Behavioural variables include:
i. Usage Rate
ii. Product benefits
iii. Brand Loyalty
iv. Price Consciousness
v. Occasions (holidays like mother’s day, New Year and Eid)
vi. User Status (First Time, Regular or Potential)
Behavioural segmentation is considered most favourable segmentation tool as it
uses those variables that are closely related to the product itself.

Bases for Business Market Segmentation

Business market might be segmented on the bases of following variables:
i. Company Size: what company sizes should we serve?
ii. Industry: Which industry to serve?
iii. Purchasing approaches: Purchasing-function organization, Nature of existing
relationships, purchase policies and criteria.
iv. Product usage
v. Situational factors: seasonal trend, urgency: should serve companies needing
quick order deliver, Order: focus on large orders or small.
vi. Geographic: Regional industrial growth rate, Customer concentration, and
international macroeconomic factors.

The segments designed by the company must include consumers with similar product
needs. Then the company will market differentiated products designed to meet the
well-defined needs of the market segments it has identified. However, developing
different products for each group is achieved at a cost. The measure of success for a

47
company practicing target marketing is whether it can attract a sufficient number of
customers who are willing to pay the price for its differentiated products that are
designed to meet the needs of each distinct customer group. This is in contrast to
mass marketers who produce a relatively undifferentiated product that are designed
to meet, at a low cost, the common needs of consumers across all market segments.

Another key decision facing the agribusiness is the number of market segments to
pursue. A company running a single segment runs the risk that the segment will
decrease in size or attract too many competitors. Focusing on multiple segments
reduces these risks and often offers an opportunity to lower costs because of the
opportunity to share facilities and personnel in the production and marketing of the
various products. The major disadvantage in marketing to multiple segments is that
the firm might lose market share to more focused competitors.

Niches. Describe smaller consumer segments that have more narrowly defined
needs or unique combinations of needs. Examples of product serving niche markets
include specialty teas, gourmet coffees, organic products, and exotic fruits and
vegetables. Focusing on serving customers in a niche has several advantages
including a better knowledge of the customer group and the potentialisation to earn a
greater profit, which results from the ability to meet the niche customers’ needs more
effectively than more broadly, focused competitors. However, niche marketers face
the same risks as single segment marketers should the niche decline. Pursuing a multi
niche strategy offers advantages and disadvantages similar to those of pursuing a
multi segment strategy.

Customer-Level marketing:
Companies may want to identify even smaller groups of customers who share some
characteristics that provide a market opportunity. Today, many companies build
customer data bases containing information about their customers’ demographics,
past purchases, and other characteristics. The intersection of computers, customer
data bases, and manufacturing flexibility gives companies the possibility of offering
customized products and personalized services. Customized marketing takes place

48
when the manufacturer produces a new product from scratch for the customer, for
example, when an equipment manufacturer builds a piece of specialized equipment
for a food processor. Mass customization occurs when the company has established
basic modules that can be combined in different ways for the customer, for example,
when an equipment manufacturer includes optional equipment to meet the customer’s
needs.

Product positioning:
Once the food or agribusiness firm has determined which market segment it will
pursue, it must decide how its products will be positioned within those segments. The
goal of product positioning is to utilize the company’s strengths so that its products
will have a competitive advantage relative to competitors’ products. Food products are
often positioned based on product quality as defined by taste, nutrition, price, or the
image associated with consumption of the product. A key factor in successfully
positioning a product is to ensure that consumers know the product’s key benefits and
that they are able to differentiate the firm’s product from its competitors’ offerings.
After positioning a product, the company then establishes a marketing mix that will
support the product’s positioning. The marketing mix, also known as the four Ps
includes various decisions regarding the product, price, place and promotion.

At this point, read Chapter 8 (The Markeing Mix) in: Kohls, R. L. and J. N. Uhl (2002). 
Marketing of Agricultural Products (9th Edition), Prentice Hall. 

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ANALYSIS OF THE MARKET
Market analysis is the task of finding and measuring business possibilities. It builds on
customer and competitor analysis to make some strategic judgments about a market
and its dynamics. The goal of a market analysis is to determine the attractiveness
of a market and to understand its evolving opportunities and threats as they relate to
the strengths and weaknesses of the firm.
Objectives of a market analysis
 To determine the attractiveness of a market to current and potential
participants.
 To understand the dynamics of the market; The need to identify emerging sub-
markets, key success factors, trends, threats, opportunities and strategic
uncertainties that can guide information gathering and analysis

Dimensions of a market analysis

The nature and context of an analysis of a market and its relevant product markets
will depend on the situation, but will often include the following dimensions;
1. Emerging sub-markets
2. Actual and potential market and sub-market size
3. Market and Sub-market growth
4. Market and sub-market profitability
5. Distribution systems
6. Trends and developments
7. Key success factors

1. Emerging sub markets

The challenge is to detect and understand emerging sub markets, identify those that
are attractive to the firm given its assets and competencies, and then adjust offerings
in order to increase their relevance to the chosen sub-markets. The opportunity is to
influence these emerging submarkets so that the competitors become less relevant.
Sub-markets can be created in the following ways;

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  Where the product/service can be boosted/expanded to include a new
dimension e.g. creation of a new product in the line
 The market can be broken into niches. E.g. Making a line of cakes, and
designing some for women, others high protein, others low calories. The niches
can represent an area for which the original product was not relevant.
 The application scale/capacity can be expanded, say to be able to solve more
problems that were existing in the market, or to make operations of the
business easier such that a new group of consumers to whom the changes
appeal can be another sub-market
 The emergence of a new and distinct application can define relevant brand
options. (Baby aspirin)
 A product can be re-positioned (Create a new image).
 A customer trend can be a driver of a sub-market. For example, the trends
towards customers sensitivity to the health implications of what they consume
has resulted in herbal and natural supplements which have led to several sub
markets.
 A new technology can drive the perception of a sub market. The new
technology can lead to the production of a product(s) that represents new sub
markets.
 A whole market can simply be invented. E.g. online auction invented by e-Bay.

2. Actual and potential market size

The size of the market can be evaluated based on present and potential sales if the
use of the product were expanded. Some information sources for determining market
size include government data, trade associations, financial data from major players,
customer surveys. Total market size can be known by surveying the product users. In
addition to the size of the current relevant market, the potential market also has to be
considered. A new use, a new user group, or more frequent usage could change the
size and prospects for the market.

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3. Market and sub-market growth
If all else remains constant, market growth means more sales and profits even
without increasing market share. The analysis of the market and sub-market growth
involves identification of the driving forces behind market dynamics; Forecasting
growth using historical data (say, can identify a prior market with similar
characteristics), or leading indicators such as demographic data, and sales of related
equipment; and detecting maturity and decline. Some leading indicators of the decline
phase include price pressure caused by competition, a decrease in brand loyalty, and
the emergence of substitute products, market saturation, and the lack of growth
drivers.
4. Market and sub market profitability analysis
In order to evaluate the investment value of an industry or market, an estimate of
how profitable an average firm will be needs to be conducted. While different firms in
a market will have different levels of profitability, the average profit potential for a
market can be used as a guideline for knowing how difficult it is to make money in the
market. Michael Porter devised a useful framework for evaluating the attractiveness of
an industry or market.
Porter’s approach
This approach can be applied to an industry, a market, or a sub-market. The basic
idea is that the attractiveness of an industry or market as measured by the long term
return on investment of the average firm depends largely on five factors that
influence profitability;
 The intensity of competition among existing competitors
 The existence of potential competitors who will enter if profits are high
 Substitute products that will attract customers if prices become high
 The bargaining power of customers
 The bargaining power of suppliers

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Each factor plays a role in explaining why some industries are historically more
profitable than others. An understanding of this structure can also suggest which key
success factors are necessary to cope with key success factors are necessary to cope
with the competitive forces.
The intensity of competition from existing competitors will depend on the several
factors including:

 The number of competitors, their size, and their commitment

 Whether their product offerings and strategies are similar
 The existence of high fixed costs

 The size of exit barriers

Competition among existing

firms

Threat of potential Threat of substitute products

Industry (Market)
entrants
Profitability

Bargaining power of suppliers Bargaining power of customers

The potential competitors are the potential market entrants and include firms that
might engage in;

 Market expansion; Say into another geographical area.

 Product expansion; Can cover the range of accessories needed for the business
e.g. in skiing, clothing, tennis equipment, etc
 Backward integration; Customers are another source of competition; they can
integrate backwards and make their own product
 Forward integration; Suppliers attracted by margins are also potential
competitors, e.g., they can open a retail store.

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  The export of assets or competencies; A current small competitor with critical
strategic weaknesses can turn into a major entrant if it is purchased by a firm
that can reduce or eliminate those weaknesses.
 Retaliatory or defensive strategies; Firms that are threatened by a potential or
actual move into the market might retaliate to protect their (dominant) position

Whether potential competitors, identified or not, actually do enter depends on

large part on the size and nature of barriers to entry. Thus an analysis of barriers
to entry is important is important in projecting likely competitive intensity and
profitability levels in the future. Various barriers to entry include required capital
investment, exclusive ownership of the necessary resource, Legal barriers e.g.
public franchises (Given by gov’t), economies of scale, distribution channels, and
product differentiation.

Substitute products can influence the profitability of the market and can be
a major threat. Substitutes that show a steady improvement in relative
price/performance and for which the customer’s cost of switching is minimal
are of particular interest.
Customer power; when customers have relatively more power than sellers,
they can force prices down or demand more services thus affecting
profitability. A customer’s power will be greater when its purchase size is a
large proportion of the sellers business, when alternative sellers are available,
and when the customer can integrate backward and make all or part of the
product (e.g. tyres and car sellers, packaging can makers; food manufacturer
can integrate backwards).
Supplier power; when the supplier industry is concentrated and sells to a
variety of customers in diverse markets; it will have relative power that can be
used to influence prices. Power will also be enhanced when the costs to
customers of switching suppliers are high.
Cost structure

An understanding of the cost structure of a market can provide insights into present
and future key success factors. More likely, competitors will aim at to be the lowest

54
cost competitor especially in high value added stages of the value chain. The cost
structure also is helpful for formulating strategies to develop a competitive advantage.

5. Distribution systems
The following aspects of the distribution system are useful in a market analysis:

 Existing distribution channels - can be described by how direct they are to the
customer.

 Trends and emerging channels - new channels can offer the opportunity to
develop a competitive advantage.

 Channel power structure - for example, in the case of a product having little
brand equity, retailers have negotiating power over manufacturers and can
capture more margin.

An analysis of likely or emerging changes within distribution channels can be

important in understanding a market and its key success factors. E.g. emergence of
convenience stores at fuel stations.

6. Market trends

Changes in the market are important because they often are the source of new
opportunities and threats. Knowing the market trends is important because it can
serve as a useful summary of customer, competitor, and market analyses. Some
examples include changes in price sensitivity, demand for variety, and level of
emphasis on service and support.

7. Key Success Factors

The key success factors are those elements that are necessary in order for the firm to
achieve its marketing objectives. A few examples of such factors include; Access to
essential unique resources, ability to achieve economies of scale, access to
distribution channels, technological progress

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It is important to consider that key success factors may change over time, especially
as the product progresses through its life cycle.

MANAGEMENT OF MARKET RISK

There are two general types of risk that are faced by any business: Financial risk, and
business risk. Financial risk is the possibility that the firm will be unable to meet its
financial obligations. A firm can reduce its financial risk by keeping the amount of debt
in its capital structure within acceptable limits. Business risk is the change in net
income that arises from normal fluctuations in business activity.

Types of business risk

Some of the more common types of risk faced by agribusiness firms include;
i. Production risk: Because of the biological nature of production processes in
agriculture, the expected level of output cannot be precisely forecast because of
the uncontrollable conditions under agricultural production. Weather, disease and
pest infestations are the most common sources of production risk.
ii. Casualty risk: This means the loss of life resulting from unforeseen occurrences
and also loss of property. Some of the unforeseen occurrences include fire, flood,
theft, and vandalism.
iii. Technological risk: The use or non-use of new technology, equipment breakdowns,
and discovery that equipment or even products have become obsolete all create
technological risk.
iv. Personnel risk: The illness, injury or death of one of the principals or major people
in a firm can affect the business. There is also the risk that a key employee will
quit and go to work for a competitor.
v. Risk because of the action of others: The people in a business can cause problems
of risk and loss.
vi. Market risk: Occurrences such as change in consumer tastes, import restrictions in
the market can cause adverse price movement and negatively impact on the firm’s
profits.

56
In contrast to business risk, financial risk results from the method of financing the
firm, for example, the use of borrowed funds, where a share of the operating profit
must be allocated to meeting the interest charge on debt capital, before the owners of
the equity capital can take their reward. This is called financial risk due to leverage.
Only if the firm is 100% owner financed is there no financial risk due to leverage.
In addition to this financial risk due to leverage, there are financial risks in using
credit. For example, unexpected rises in interest rates on borrowed funds, or the
possible lack of availability of loan finance when required.

Ways to reduce and manage business risks

Reduction and management of market risk involves reduction of risk experienced
because of bad price movements. There is the inflexible nature of demand and supply
for raw agricultural commodities, which means that small shifts in supply can lead to
large changes in market prices. To reduce the amount of market risk that participants
face because of price fluctuations, the following methods or instruments can be
employed;

i. Maintaining a financial cushion. This can be in the form of a cash reserve, a large
balance in the bank accounts, or by maintaining a reserve of borrowing capacity (A
manager might borrow only a portion of the approved amount of a line of credit.
In times of difficulty, the manager can use the rest of the line of credit.
ii. Insurance. Some of the risks that can be insured include casualty risk (e.g.fire
insurance), Personnel risk (e.g life insurance), and production risk (E.g. hail
insurance). An insurance company assumes the risk of loss and charges each of
the insured, at a premium. If, and when a loss occurs, the company uses the
proceeds from the premiums to pay off the loss.
iii. Using business strategies: Three business strategies that an agribusiness can use
to reduce business risk are diversification, vertical integration, and rapid use of
technology.
Diversification is doing business in more that one industry. By making different
products, even getting into different businesses, a firm can reduce the risk that a

57
 down turn for one product or business will hurt the firm’s future. For example, one
firm can go into both the seed and feed businesses in order to diversify risks.
Vertical integration occurs when one firm enters a business at two or more levels
in a marketing channel by either buying a firm, or through contractual
arrangement. E.g. a large farmer purchases a local elevator to handle his grain or
a vegetable canner arranges with farmers in the area to grow vegetables under
contract. Firms integrate to assure themselves of a supply of raw material, to
guarantee output for products, to protect themselves from the actions of others in
the marketing channel, to reduce the cost of buying or selling raw materials or
products, or to gain more market power. Vertical integration reduces the risk for
the integrating firms.
Rapid use of new technology can by itself be risky. Selecting less risky
technologies can reduce this. In addition, some firm managers or owners are slow
to try new technology until they have seen it work. However if everything works
properly, new technology can reduce risk. E.g. a drought resistant variety (reduces
production risk), a fully automated computerized food processing plant (can
reduce the firm’s reliance on key personnel). Also, if the new technology reduces
per unit costs for a firm, it can reduce the risk of loss from a decline in the price of
the commodity or products.
iv. Flexibility: This refers to the ease and economy with which the farming business
can adjust to changed circumstances. This can be in the form of asset flexibility,
product flexibility, market flexibility, cost flexibility, and time flexibility.
Asset flexibility means investing in assets that have more than one use e.g.
multiple use buildings, land, and maintaining an adequate level of liquidity.
Product flexibility exists when an enterprise produces a product which has more
than one end use, or when the enterprise yields more than one product.
Market flexibility is related to product flexibility, where a product can be sold in
different markets that may not be subject to the same risks.
Cost flexibility is about organizing production while keeping fixed costs low and
incurring higher variable costs as necessary e.g., land and machinery may be
leased rather than purchased, labor can be hired on a contract or casual basis.

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 Time flexibility relates to the speed with which adjustments to the farming
operations can be made. E.g. tree crops whose production cycle is several decades
compared with short-term seasonal crops which may be planted, grown, harvested
and sold in about six months.
v. General government programs such as general disaster-relief programs in the form
of low interest loans in the case of disasters (flood, earth quake, etc)
vi. Share contracts e.g. farmer and land lord share all including risks
vii. Contract marketing e.g. cooperative marketing (price pooling e.g. where farmers
collectively buy inputs or sell output)
viii.Forward contracting/pricing: This is the setting of the exchange price of a
commodity or product before the physical transfer to the new owner. If the
supplier of the commodity being purchased raises price after the agreement has
been signed this does not affect the buyer who signed the agreement before.
However, if the supplier decided to offer discounts the day after the agreement is
signed, then the buyer would not be eligible for them either. It works for both the
seller and the buyer. The seller is assured of a selling price before delivery is
made. The buyer knows in advance the price of a raw commodity or product
purchased for use in processing or for re-sale.

Hedging on futures markets

Futures Markets
The futures price is today’s price for products to be delivered in the future. The two
events of pricing and products delivery occur separately in the futures markets, and
simultaneously in the cash markets.
The futures market is therefore a mechanism for trading promises of future
commodity deliveries among traders. As such, it is a unique risk management and
profit tool for farmers and food marketing firms. In the futures market for any
commodity, only the price of the contract is left open for discussion. All the other
factors are standardized and are already written into the contract. They include
specification of quantity, quality, date of delivery, as well as the place of delivery.

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Price of the contract by law is discovered through public auction in a specified trading
area as specified by law. The seller of the commodity promises to deliver the
commodity as specified in the contract at the time set in the contract. The buyer of
that commodity agrees to accept delivery of the commodity and to pay the seller the
price agreed on.

In the futures contracts, neither the buyer, nor the seller generally intend to fulfill the
promises they made in the agreement. This is because the contract’s major purpose is
to shift the risk of price movements to someone else temporarily. The promise of the
seller to deliver the commodity can be cancelled by buying back the contract.
Likewise, the buyer of a futures contract can cancel his or her obligation by selling
another contract. Thus, by asking equal but opposite transactions in the futures
market any time before the due date of the contract, traders can cancel their
contractual obligation to deliver or receive the commodity specified, while still getting
the price protection offered by the futures contract.

Functions of futures markets

 They are a major price discovery mechanism and they provide an opportunity for
producers and users of commodities to shift the risk of adverse price movements
and to forward price commodities by hedging
 Commodity futures markets also offer an opportunity to speculate and perhaps
thereby to gain from changes in prices
Hedging
The process of shifting price risk by forward contracting using the futures market is
called hedging. Hedging can be defined as the taking at the same time of equal but
opposite positions in both the cash and futures markets. There are two basic types of
hedges; the selling hedge, and the buying hedge.

1. The selling hedge is used by persons who own a commodity and want to shift the
risk of a down ward movement in price to someone else.

2. The buying hedge. Here, the person wishing to purchase the commodity buys
futures contracts to protect his/her cash market ownership position against an

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upward movement in price. The firms that use this method agree to sell
commodities or products at an agreed-on price often before they have purchased
the commodities needed to fulfil the agreements.

End of Handout 23/3/2017

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