John Bovay is one of those up-and-coming young academics. He was with us when he was at the University of Connecticut, delivering riveting talks such as this one:
Now he is at Virginia Tech and brought along Virginia Tech as the newest member of our University Interchange Program where professors share their latest research– thus helping to disseminate knowledge– and students get a chance to be mentored, get access to educational activities, start to build industry relationships, seek out internships and jobs.
He also brought some new research on the interrelationship between organic and conventional produce sales. We asked Matt Ogg to find out more:
Agricultural and Applied Economics
Q: You have provided valuable insight at previous editions of The New York Produce Show and Conference (NYPS) into hot topics ranging from food waste and food safety impacts, to GMO and non-GMO food labels.
This year, you’re back to analyze another significant subject when it comes to consumer habits and purchasing decisions – in the form of the implications of rising demand for organic fruit and vegetables in the US. Can you expand on what your subject matter will entail?
A: I’m going to start the presentation with the general motivation for why we’re interested in this research topic, which is that fruits and vegetables (FV) are healthy, so it’s important from a public policy perspective to encourage people to consume more. There have been policies discussed that would create more incentives for people to consume healthier foods. These include subsidies on healthy foods and taxes on unhealthy foods.
The specific research question that we are considering is: ‘What are the implications of rising organic FV demand on prices for organic FV and conventional FV, and what are the implications of those changes in prices on the consumption of FV?’
Another reason why we’re interested in this question is the relationship between income and healthy diets. It’s not just a health issue; it’s also a social issue in a broader sense. Obviously, because organic FV are more expensive than conventional FV, higher-income people who already have healthier diets tend to be larger volume purchasers of organics. Those are just the basic facts about the way organic and conventional products are consumed by different groups of people.
But we realized there was probably a gap in economics literature in terms of studying demand for FV using econometric techniques, which are the specialized methods that economists use to analyze data. That gap is that sometimes, but certainly not all the time, demand is considered to be this one equation or set of relationships that characterize the preferences of every consumer in the market.
We know that different people have different sets of preferences. So, this study really illustrates the differences in the conclusions that one might draw when analyzing the effects of some kind of policy change.
Another way of thinking about the key question paper is: Could an increase in organic FV demand that only affects demand for organics by a small group of consumers result in price shifts that, in turn, allow people to buy more conventional FV at a better price, and actually increase consumption of conventional FV? That’s something we investigated in the research using some of the sets of parameters, some of the ways of quantitatively characterizing the market. We see that result. We see that increases in demand for organic FV may result in price changes for conventional FV that, in turn, increase the consumption of conventional FV among certain groups of consumers.
Q: That’s certainly fascinating food for thought, and we’ll come back to the results later. Firstly, now we have a comprehensive overview of your session topic, could you guide us step by step through the structure of your presentation in terms of the points you’ll discuss?
A: I’ll start with the motivation for our paper; talking about Americans’ dietary quality and the shortcomings in terms of fruit and vegetable intake compared with dietary guidelines, and the connection between diet and income, and the implications of dietary quality for health. These are all issues with which the audience will be very familiar.
Then, before I start talking about demand as an economic concept, I want to carefully describe what economists mean by demand. So, a shift in demand doesn’t just mean an increase in quantity demanded. It means that at any given price, consumers in aggregate are willing to buy more of a product. So, if I said that consumption of apples increased from 100 million tons to 105 million tons over a certain period of time, that would not necessarily mean that demand increased in an economic sense. It might be that prices were lower, and therefore people consumed more. Rather, a demand increase means that when holding prices constant, people were willing to buy more.
One thing I’m looking forward to hearing from the audience is the ways in which they anticipate the demand for organic FV might shift besides a couple of possible reasons that I mentioned earlier; such as effective marketing, or health scares, or positive health information that affects demand for one type of produce or another. Or, there might be government-supported information campaigns. The US Department of Agriculture (USDA) has some support for organic producers. Other than these avenues, I wonder whether there are any other important drivers of demand that I should include in the paper.
The next thing I’ll do, after talking about demand in general terms, is to talk about a specific type of economic modelling, called an equilibrium displacement model or a multi-market model. It’s an analysis of what happens to quantities consumed, and prices paid, when distinct products are linked in either consumption or production. Obviously, in the case of organic FV and conventional FV there are all kinds of interlinkages. That’s the mechanism by which increased demand for, say, organic bananas might have an effect on conventional bananas.
People have budget constraints, and they only want so many bananas in a week. So, if I buy 15 total bananas, I’d have to choose how many organic and how many conventional. If I increase my demand for organics, I’m probably not going to increase my demand for conventional also, but maybe at some times of the year I like to eat more bananas. These are all kinds of considerations that need to be made when doing analysis of demand for FV. It’s really an empirical question, so we have to analyze the data to see what it’s telling us about the relationships between different types of products. The key is whether they are substitutes or complements. That is: ‘Do I consume more of A and B at the same time?’, or ‘When I consume more of A, does that mean I consume less of B?’.
Then I’ll get into the details of the simulation exercise that we did, and the results.
Q: How recent is this research? How long did you work on the paper, and with whom did you collaborate?
A: My co-authors are Brandon R. McFadden, who is an assistant professor in the Applied Economics and Statistics Department at the University of Delaware; and Conner Mullally, an assistant professor in the Food and Resource Economics Department at the University of Florida. We’ve been working on it for about two years, and it has not been published yet as we’re seeking comments that could help improve the paper.
Q: You’ve explained about the motivation for this research. Could you elaborate on how the questions and answers raised in the paper are significant for the fresh produce industry?
A: That’s a really great question. A lot of producers, wholesalers and others attending the NYPS are going to be marketing organic FV and conventional FV. Although I mentioned that not every economics paper adequately characterizes consumers as having heterogeneous preferences (as having different sets of preferences or different ways of making decisions about how they consume), that’s really intuitive. Because the implications from using different sets of assumptions about the way people make decisions are so different, it’s important to consider the possibilities that are outlined in these research results. That is, that there is a possibility that an organic FV promotion campaign could increase consumption of conventional FV.
I think attendees will be interested in seeing what I think are unexpected results in terms of demand for one thing affecting total quantity consumed of the produce in aggregate. By seeing these results, it will certainly generate interest because I’m not sure that the results are intuitive. But the results will also have a bearing on how people think about marketing their products, and marketing organic FV versus conventional FV, or other quality dimensions.
I have to say it with a little cautionary note, however, which is what we have here is an illustration, and based on the data, the implications are going to be very different. It’s something that needs to be considered, but it’s not possible for me to make a prescriptive recommendation. It’s more the concept of substitution between organic FV and conventional FV, and the effects of demand for one set of products on consumption of another group of products.
Q: Did you set out to prove or disprove anything with this research? Did you have any hypotheses?
A: It wasn’t really a hypothesis we wanted to prove or disprove. It was more that we were interested in showing how something like an organic FV promotion campaign could have very different effects on those consumers who often buy organics, versus those consumers who never buy organics. It was just to see what those different effects might be.
Q: What theory and simulations did you undertake to gather the evidence that you will be presenting? Can you enlighten us more about the multi-market equilibrium displacement model, and how it helps to examine the impact?
A: The equilibrium displacement model is a very typical model for analyzing impacts of a policy change or shock to markets, especially in agricultural economics. But what we did that, I think, was innovative was to add this concept of heterogeneous demand functions, or heterogeneous consumer preferences to that standard equilibrium displacement model. That’s the theory part.
For the simulation, what we’ve done, so far, is to use evidence from existing literature on the relationships between prices of some products, and demand for those products and other products; these are called elasticities.
So, we use those parameters from the literature in an equilibrium displacement model with heterogeneous demand to illustrate the implications of two different demand shocks. In one scenario, we simply simulate a 5% increase in demand for organic FV. In the other scenario, we simulate a 5% increase in demand for organic FV and a 5% decrease in demand for conventional FV, and we show the effects of these two different scenarios on the consumption of organic FV and conventional FV by consumers in aggregate, and by two different groups of consumers for the purpose of illustration.
Q: What were the interesting results for Scenario 1 and Scenario 2?
A: In the first scenario — where we simulate a 5% increase in demand for organic FV — we show that for Segment 1 consumers (who are consuming the majority of organic FV) a 5% increase in demand for organic FV would cause them to buy a little bit more organic, as they would substitute away from conventional to buy a little more organic, and overall their consumption of FV would rise by 0.1%.
In the second scenario — where we simulated a 5% increase in demand for organic FV, and also a 5% decrease in demand for conventional FV — we see the total consumption decreasing among Segment 1 consumers. That result is driven by the really large market share for conventional FV. So, even though they’re consuming a lot of organic FV, the majority of their FV is probably still conventional.
When they’re shifting a lot of their consumption from the less expensive conventional FV to the more expensive organic FV, their overall consumption of FV is going to decrease. To make it clear, what I’ve simulated shows a 7% increase in organic FV consumption, and about a 5% decrease in conventional FV. But because they’re spending more on conventional FV, that 5% decrease in conventional FV consumption outweighs the 7% in organic FV consumption.
Then, those consumers who are consuming most of the conventional FV (Segment 2), they would be consuming even more conventional FV after such a shift in demand, and fewer organic FV because the shift in demand for organic FV would cause a rise in the price for organic FV, so those people who don’t have strong preferences for organic FV would consume a little bit less organic FV, and shift towards even more conventional FV, and, according to our simulation, their overall consumption of FV would rise also.
Q: And can you clarify exactly why the overall consumption of FV rises in your study?
A: In our simulation, it’s because a demand shift in terms of increasing demand for organic FV is going to increase the price of organic FV, and it’s going to decrease the price of conventional FV, at least relative to organic FV. So, people are going to be able to buy more, and get more for their money in terms of conventional FV. Since conventional FV still makes up such a large share of total produce, the net effect is to increase total sales.
Q: And can you expand on why the increase in the price of organic FV causes the price of conventional FV to decrease?
A: This is a result of organic FV and conventional FV being substitutes in consumption. What that means in specific economic terms is, for example, when the price for organic apples rises, consumers, in general, are going to buy more conventional apples. So, that’s the mechanism for increasing demand for organic FV to trigger increased consumption of conventional FV.
Q: Does this present a dilemma for organic FV producer-suppliers? Since if organic FV is promoted, their traditional organic FV consumers could end up buying less, but at the same time they could have a positive impact on overall FV consumption…
A: I think that’s really good insight, but I think it’s a win-win because those people who have strong preferences for organic FV… if they are motivated to buy more organic FV, and they feel happy doing that, then organic companies will benefit. At the same time, if there is some hypothetical event that triggers a demand shift, and if that allows the prices of conventional FV to fall, it will benefit the mass of consumers who are not generally purchasing organic FV. That would certainly be a win for those consumers also.
In terms of consumers, it’s a win-win. I don’t see necessarily a scenario where an organic FV promotion campaign benefits sellers of conventional FV, but we do expect to see perhaps an increase in quantity demanded of conventional FV through these substitution effects, but in terms of revenues and profits I’m not sure that that’s the story the simulation is showing.
Q: Is it safe to say then that the rise in demand for organic FV is a good thing overall for fresh produce sales and consumption?
A: I think it probably is, yes, because organic FV are seen as a higher quality product. They always command a higher price in retail, so I would think that rising demand for organic FV would certainly be a good thing for the produce industry in general.
Q: What was the overall conclusion of your paper in a few standout points?
A: I’ve got three takeaway messages. The first is that, as we’ve been discussing, the increasing demand for organic FV can affect the market prices for both organic FV and conventional FV, and it can lead to increased consumption of conventional FV through the substitution effect. In particular, non-organic buyers (who we call Segment 2) may especially benefit from lower prices for conventional FV that come about as a result in the increase in demand for organic FV.
The third conclusion is what I’ve shared; naturally we see that organic FV buyers decrease their consumption of FV when something happens that motivates them to shift their demand to buying even more organic FV because they are more expensive than conventional FV, so they can afford to buy fewer.
Q: Once your paper is published, what will happen next in terms of it being able to influence policy agenda in the US?
A: Well, that’s a great question. I used to work at the USDA, and I have collaborators there with whom I still work. This paper is preliminary work, and I hope it will help to inform future research that will, in turn, be able to provide more specific policy guidance, eventually.
Q: Will there be a follow-up paper?
A: I do think so, yes. Probably, we’ll try to follow this research with some more detailed analysis of the effects that I’ve talked about. I feel there’s a need to do more careful analysis of the substitution between organic FV and conventional FV because it’s been about 15 years since the organic regulations came into force in the US, and a lot has changed in the market since then. Organic demand continues to grow stronger, and there are more products out there labelled organic. The existing research needs to be updated to reflect the modern realities of the produce market.
Q: Given your research and findings, what actions do you recommend that fresh produce executives should take?
A: I hesitate to be prescriptive, but it’s important for executives to recognize that marketing activities and promotions may not only have effects on the product line that’s being promoted but also on demand for other products. Also, it’s important to use data analytics (the tools that economists use) and statistical analysis that we refer to as ‘econometrics’ (or market analytics) to be able to better anticipate what the overall effects might be of promoting one line on the overall company bottom line, and the industry-level implications also.
Q: Overall, what do you hope attendees will learn from your presentation this year?
A: In terms of inspiration, I hope that I will be able to continue the conversation I’ve been having over the past few years at the New York Produce Show about the importance of the produce industry for health, and to continue the conversation about social issues associated with diets in general.
The research is intriguing, and we are looking forward to digging deeper at the show.
We have a few preliminary thoughts:
- Although it may be true that an individual can substitute organic for conventional or vice versa, at any given moment, that is not true for the populous as a whole. In other words, if this season there are a nine million cartons of conventional pears and one million cartons of organic pears – that is it. No matter how high demand might be for organic pears, there is no substitutability because there are no more organic pears. Obviously, if people come to believe pears can cure cancer or improve one’s sex life than, like tulip bulbs in Holland of yore, the price of organic pears can skyrocket. But whether pears sell for a nickel or $50 – at the end of the year, in our example, 10% of the pears sold will be organic, 90% conventional. There are no other pears in the world and, as such, no increase in love for organic pears can lead to an increase in consumption of conventional pears at any given moment in time.
- It is important to recognize the role of produce retailers as the gatekeepers in what consumers have the option to buy. On a low volume item, a retailer can decide it does not wish to take up two slots — one for organic and one for conventional. Whereas the typical conventional consumer will eat either organic or conventional, since the passionate organic consumer is only willing to buy and consume organic, many a retailer will decide to only sell organic leeks, herbs or some other low volume item. So, the sales statistics for organic do not directly give much of a picture of consumer demand for organics. Think of the fact that Coca-Cola is certified Kosher. Because Coke does not have pork, shellfish, mix milk and meat, etc., it is easy to certify Kosher. So, Coke does this. But it would be foolish to point to the enormous amount of Coke consumed and say look at how big the demand is for Kosher food.
- Attention must be paid to the impact promotions may have on the remaining, non-promoted, product. The research seems to suggest that higher prices for organic (driven by the economist’s perception of demand, meaning a willingness to pay a higher price) could lead consumers to buy more conventual. First, I refer to Point One above — there is no “more” conventional at any given point in time. So, this is impossible. Second – even if there was more, the reason why consumer demand (in an economist’s sense) increases is likely to be very relevant. If the organic demand increased because it came to be believed that eating organic will make you rich, because of some positive element non-disparaging to conventional produce, this might have no impact on conventional produce sales. But if the reason the demand for organic produce increases is disparaging to conventional — say that people are told that conventional produce is bad due to pesticides and organic is good — then the same forces that cause an increase in demand for organics could well cause a decrease in demand for conventional.
- It is important to remember that produce is not a closed-loop system. That is to say that if one enjoys an organic piece of fresh fruit for dessert each day and the price goes up, one could switch to conventional – but one could also buy frozen, canned, dried or decide to eat ice cream instead. Many people have decided to give up a daily Starbucks to pay off a credit card debt or save for a vacation. So, the relative value consumers place on things makes it difficult to know where their money will go if the price of an item rises. It strikes me that this makes this kind of calculation exceedingly difficult.
Of course, the best research always leads to more things to research!
Understanding the role that rising demand for organics may play in the future of the industry is very important, so please join us and join in this meaningful discussion with Professor Bovay.
You can see the website here.
Let us know if you need a hotel room here.
Please register right here!
Looking forward to seeing you in New York!