Saturday, May 24, 2008

Organised retail and food price inflation — Opening the ‘Black Box’

Organised retail can be an ally in promoting food security for the urban poor and dampening food price inflation.

Ashok Gulati
Thomas Reardon

With overall inflation hovering above 7 per cent, food prices have become a political hot potato. The Government is desperately looking for policy options to contain food inflation. Exports of certain agricultural products (rice, wheat, select pulses) have been banned, and several commodities have been suspended from trading in the futures market.

Many traders have been raided for “hoarding”, and so on. What is being missed is a more in-depth understanding of the price formation in the food market and the various effective points of entry for the government to tame food inflation.
Price formation

In agricultural commodities, much of the price formation takes place between the farmer and the consumer, which for many is a “black box” composed of wholesale, processor, and retail segments.

We call it “black box” because its workings are not well known to the public or policymakers, and is not typically under the analytical microscope of researchers in India, but in public debate, various opinions are held on its functioning (assumptions that it is speculative, for example, abound).

Yet, that “black box” is important in India as, typically, cereals account for 40 per cent of the consumer food price with fruits, vegetables, dairy and fish/chicken making up the balance. Very roughly, and depending on the product, the shares of the “black box” are about a third to wholesalers, processors, and retailers.

Little is known about how that “black box” contributes to inflation. Research under the International Food Policy Research Institute/Michigan State University (IFPRI/MSU) programme, however, shows that the “black box”, can be made more efficient and competitive by compressing the value chain, investing in the missing infrastructure and institutions, and by creating greater transparency and competition among the stakeholders in the value chain from wholesalers, processors, to retailers.

A brief survey was made of prices in the organised and traditional retail in Delhi.
We first visited traditional retailers (handcarts, weekly markets, make-shift retail stalls, and kirana stores) and then five organised retail chain stores, both in north Delhi. Organised versus traditional retail

We bought the same unit size and form, and a “medium quality” of each product that was sure to be in both traditional and organised retail shops — to ensure strict comparability per item over retail outlets. We examined 20 basic food items (11 vegetables, 6 fruits, wheat atta, parboiled rice, mustard oil, sunflower oil, and channa dal).

It was found that for vegetables, organised retailers were, with no product exception — 33 per cent cheaper than traditional retailers; for fruits, organised retail was 15 per cent cheaper; for parboiled rice, 14 per cent cheaper; for atta, 5 per cent cheaper; for mustard oil, 6 per cent cheaper; for sunflower oil, 17 per cent cheaper; and for channa dal, 1 per cent cheaper.

The finding that organised retail sells food more cheaply than traditional retailers in the urban areas broadly matches evidence from a number of developing countries.
In other developing countries, supermarkets drove down consumer prices (relative to traditional retail) as an essential to their take-off in early- to mid-1990s and beyond. This appears to be the case in India today.

Price advantage

The main reason organised retail can charge lower prices is because they combine: (1) economies of scale in procurement (mass buying from suppliers) with (2) economies of scale in handling and logistics such as via modernised distribution centres. The supermarket chains are known to build regional and global food procurement networks to reduce costs, de-seasonaliseofferings, and increase product diversity.

Indian supermarket chains are also improving the back endof fresh produce procurement quite early in their development stage leading to greater efficiency and price advantage that one usually observes in more advancedorganised retail of countries such as Mexico, Brazil, S Korea, and Thailand.

What do these findings signal to the policy makers in India looking for ways to contain food price inflation? Organised retail can be an ally in promoting food security for the urban poor and dampening food price inflation.

Supermarkets can be key players in making food markets more efficient and serving consumers by reducing the size of the margin going to the “black box” between the farm gate and the consumer.

Price competition combined with cost-cutting by large retailers in the US was even responsible for a well-documented dampening of inflation — the leaders in organised retail in the US were supposed to have been responsible for reducing the inflation rate by one-third! (The authors are co-directors of International Food Policy Research Institute/Michigan State University programme on “Markets in Asia”.)

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