Multilayer of Suppliers Fixed Costs and Spatial Competition in the Upstream Market as a Source of Retailers Buying Power

Abstract

The present study is in the context of the new Model Agricultural Produce Market Committee (APMC) Act 2003, which aims at freedom of farmers to sell their products to the large private firms and bringing reforms in the wholesale ‘cash and carry’ and retail markets in India. The most important suggestions have remarked in the Economic survey 2014–2015 and outlined that state governments should be specially persuaded by the central government to provide policy support for alternative or special markets in the large private sector. Many states, including West Bengal, accepted the proposal and had opened the market for agricultural commodities for the large private sector. In this paper, we study a model of vertical restraints in the case of small farmers in West Bengal, India considering multilayer of fixed costs and monopoly power of the small as well as large traders in the vertical structure.

JEL: D8, D43, L13

Keywords

Buyer market power vertical competition agricultural market small farmers large traders consolidators

Introduction

The paper considers a vertical model in a broad scene of two set of differentiated downstream retailers, one who acts as an oligopolistic (i.e., organized) sell only high quality products and other as the competitive fringe (i.e., unorganized) sell average quality products. The upstream firms are one monopoly consolidator and a set of small farmers who are acting as a competitive fringe. Primarily, we consider a good example of a vertical competition where, downstream firms organized retailers (viz., retailers, ‘cash and carry’ traders) purchase agricultural food products from the consolidators and the consolidators buy their saleable commodities from the small farmers. In this paper, we study a model of vertical restraints in the case of India considering multilayer of fixed costs in the vertical chain from the small farmer to the retailers. We show how the presence of fixed costs in the vertical chain from the small farmer to the retailers creates a wholesale market for the agricultural food products imperfectly competitive.

Here we consider two types of foxed costs, namely, transportation cost and grading cost. Transportation cost needs to incur to carry to the local wholesale market and to the large traders (LT). Grading cost (using labour) in the collection centre includes managerial efficiency in the production process, training and fixed cost to certify as quality.

The present study is in the context of the new ‘Model Agricultural Produce Market Committee (APMC) Act, 2003’ that aims at the freedom of farmers to sell their products to the large private firms. Moreover, we also consider the reforms in the wholesale ‘cash and carry’ and retail markets in India. The regulations of hundred per cent foreign direct investments (FDIs) in cash and carry markets were enforced in 2006 with an automatic route and FDI in the single-brand retail market in 2012. In India, large retailers as well as large cash and carry (wholesaler) traders are either involved in single- or multi-brand trade. These traders exist in organized as well as unorganized sectors. Here, we denote organized single and multi-brand retailers and cash and carry wholesale traders as ‘large traders’ (i.e., LTs). There are different intermediaries present in the rural wholesale market such as primary producers, transportation cost, village-level trader, aggregator, sub wholesaler, retailer. These intermediaries are the examples of ‘small traders’ (STs) in the rural wholesale market. A section of these STs are acting as consolidators. Here, we explain an actual vertical model used by the LT to collect the agricultural food products in India. Therefore, now in the rural wholesale market, we have three types of agents; one, STs who deal with the average-quality products and act as a wholesaler, two, LTs (retailers, cash and carry traders) who collect only high-quality products and three, consolidator. Chambolle and Villas-Boas (2007) find that retailers may choose to offer products differentiated in quality to consumers, not to relax downstream competition, but to improve their buyer power in the negotiation with their supplier.

Literature Review

Countervailing buyer power claims that greater retail concentration also increases retailers’ bargaining power as buyers of input and thus induces the price of this input to fall. According to this concept, this decrease in the input price is further passed through to consumers and compensates for the price hike due to heightened market power at the retail level (Gaudin, 2015). Here, we consider fixed costs that are the driving force of the countervailing buyer power. As small farmers are not able to bear these and consolidators are so, large firms will reduce the collection price of the high-quality output. The other cost is the innovation cost. It is fixed to produce substitute goods. The existing product and the new product are horizontally differentiated (Allain & Waelbroeck, 2006). Difference between the margins charged by producers and retailers depends on the difference of the differentiations between upstream and downstream firms, which in fact indicates the relative degrees of competition at each level of the market (Allain, 2002). If the good is produced by a perfectly competitive industry with infinitely elastic supply, then a dominant buyer cannot influence the good’s price. But if industry supply is upward sloping, the dominant buyer can induce a lower price by reducing its demands (Mills, 2010). The buying power at the retail level can lead to a rise in wholesale price. As a result, retailers without buying power may increase their retail price (Erutku, 2005). Wal-Mart prefers to serve quality products at the lowest possible prices (Walton, 2005). More price leadership events are price reductions than price increases, consistently led by the smaller firm (Seaton & Waterson, 2013). Transforming individual listing decisions into a joint listing decision makes delisting less harmful for a group member; this, in turn, enhances the group members’ bargaining position at the expense of the upstream leader (Caprice & Rey, 2015). In our case, STs make a group and act as a consolidator. Social welfare is decreasing in the retailers. Strategic use of their quality requirements. While thew quality requirements set by the high-quality retailer exceed the corresponding socially optimal quality level, those set by the low-quality retailer undercut the welfare-optimal low quality (Schlippenbach & Teichmann, 2011). In Austria, the market concentration in food retailing is rather high, which might imply the exercise of market power and a price setting, which departs from marginal cost pricing. The stronger found evidence of market power towards input suppliers than towards consumers (Salhofer, Tribl, & Sinabell, 2012). Rapid consolidation among firms in all sectors of food marketing has heightened concerns that these marketing firms are exercising market power to the detriment of producers and consumers (Sexton & Zhang, 2001). Modern food consumers increasingly value a diverse portfolio of product attributes, making quality, in its many dimensions and product differentiation critical aspects of modern food markets. This revolution in food product quality and differentiation presents many important research questions that cannot be studied with a model of perfect competition because the axiom of the homogeneous product is violated, as in many cases is the axiom of perfect information (Saitone & Sexton, 2010). High buyer concentration, costly product transport and non-competitive buyer conduct may interact to produce large farm-retail price spreads (Rogers & Sexton, 1994). Strong evidence was found in a relationship between market power as well as an increasing trend in the effect of market power on retail margins (Irz & Liu, 2016). The cooperative membership has a positive impact on selling to wholesalers and a negative impact on selling to small dealers (Haoa et al., 2018). This is important in our case as consolidators are acting as a cooperative member. Retailers using specific marketing strategies may accelerate or slow down the inflation trend (Castellaria, Moroa, Platonib, & Sckokaia, 2018).

Model of Vertical Restraints

To understand the interaction between small farmers and the LTs, first it is required to understand the preferences of the LT and the ST. The LT always tries to maintain collecting high-quality products from the farmer and pays a higher price for that. On the other hand, the ST does not maintain any such quality constraints in the rural wholesale markets. Hence, we assume that the LT is more risk taker than the ST is, as LT is able to determine the qualitative and technological constraints in the time of purchase from the small farmers. We need to understand the original lineages of the need for the quality attributes. The components which influence the qualities are: (a) a farm-to-retail marketing margin. This is the difference between the implicit values of an agricultural commodity when sold at the retail level in processed form versus the explicit value of the unprocessed commodity at the farm level. Actually, the degree of product differentiation is a determination of the size of the marketing margin. The idea is that a processed firm or LT that sell a more differentiated product will have more market power and so will enjoy a higher marketing margin (Azzam, 1999; Dixit & Stiglitz, 1977; Keller, 1976; Tomek & Robinson, 2003; Wohlgenant, 1999, 2001). (b) ‘The Agreement on the Application of Sanitary and Phytosanitary Measures’ also known as the ‘SPS Agreement’ and ‘Traceability’ in an international treaty of the ‘World Trade Organization’. (c) The US–India knowledge initiative on agriculture education, research, services and commercial linkages (KIA) and after the three-year ‘work plan’ of the KIA ended in 2009 the US–India engagement now goes by the name of ‘agriculture dialogue’. Both in terms of their motives as well as their design, the KIA and the ‘agriculture dialogue’ threaten to undermine Indian food security and national sovereignty. It has been proposed to train Indians in the drafting of contracts and even suggested that Indian cultivators on a contract would need to shift to crops that were suitable for processing (Sridhar, 2014). The food quality and Sanitary and Phytosanitary (SPS) requirements can impede trade, particularly in the case of developing countries (Henson & Loader, 2001). It is widely acknowledged that the SPS measures can act to impede trade in agricultural and food products (Digges, Gordon, & Marter, 1997; Hillman, 1997; Jaffee, 1999; National Research Council, 1995; Ndayisenga & Kinsey, 1994; Petrey & Johnson, 1993; Sykes, 1995; Thilmany & Barrett, 1997; Unnevehr, 1999). The food safety issues are gradually becoming more important in international trade (WHO, 1998). The fresh products are shipped and consumed in the fresh form. Therefore, handling at all points of the food chain can influence food safety and quality (Zepp, Kuchler, & Lucier, 1998). These fresh commodities are subject to increasing scrutiny and regulation in developed countries (DCs) as food safety hazards are best understood and most often traced to their sources. Unnevehr (2000) explains how SPS agreement and traceability conditions are creating a barrier of fresh agricultural food products export from the LDCs to the DCs. Now food safety regulations, labelling requirements and quality, compositional standards play the important role besides tariff and non-tariff restrictions. Traceability could also reassure food quality and safety and at the same time be used as a tool to control the production process (Chryssochoidis, Kehagia, & Chrysochou, 2006). According to Chryssochoidis et al. (2006), Bernues, Olaizola, and Corcoran (2003) and Hobbs, Bailey, Dickinson, and Haghiri (2005), the quality of a product cannot be guaranteed through traceability, but when bundled with such quality guarantees, it seems to add more value. There are relevant literature on some important discussion papers of the Department of Industrial Policy and Promotion, Government of India (DIPP, 2010) and others on FDI in retail (Shelthi Research Group, 2008). The challenge faced by the small-scale producers engaged in ‘high value agricultural crops’ is the evaluation of supermarkets and retailers as the major buying force, as a result side-lining small-scale producers and traders (Temu & Temu, 2005). The participation of small producers in global fruit and vegetable trade is also affected by the increasing attention that food quality and safety are receiving in food trade. Weinberger and Lumpkin (2005) find that ‘traceability’, ‘phytosanitary’, infrastructure and productivity issues will continue to be a barrier for participation in the fruit and vegetable trade for most of the developing world. Wahida, Tobiba, Umberger, and Minot (2013) find in a study in Indonesia that for all high value agricultural (HVA) products, almost 50 per cent of consumers are willing to pay at least 10 per cent more for organic products. Gulati, Minot, Delgado, and Bora (2005) explain in their paper ‘growth in high-value agriculture in Asia and the emergence of vertical links with farmers’ that changes in income and consumption patterns along with urbanization affect the consumption of food consumption. The change of food preference towards HVA is related to the greater variety of food available and perhaps the higher opportunity cost of time for the household members. In practice, supermarkets rarely buy directly from small farmers, with or without contracts, but rather procure goods through commissioned agents or assemblers. Thus, modern retail chains have started relying on the consolidator. This new form of vertical linkages, especially in Southeast Asia is allowing small holders to participate in the supply chain.

We find that the mechanism of direct collection from the small farmers often fails due to higher transaction cost (including extra transportation cost) for both the small farmers and the LT. Now the question is how the LT is collecting high-quality products from the small farmers. We explain in particular how the LT collects and try to resolve the question whether it is possible to collect agricultural food products at lower prices or not. At this moment, we are proceeding to explicate the issue in detail.

LT depends on two other modes of collection: (a) collection through the local agent or ST. ST also participates in the rural wholesale market. ST denotes here consolidator. (b) Participation in the rural wholesale market (or, mandi). The LT depends heavily on the consolidator. A consolidator collects at a lowest possible transaction cost from the small farmers. Moreover, consolidator does the first-level grading at the lowest cost. By using consolidator, LT can diversify their risk of not having high-quality products and reduce extra transaction costs. Consolidator also reduces the transaction cost of small farmers. Now we need to understand that why the ST is acting as a consolidator. Having collected from the F, ST first segregates the products according to different gradation. Thenceforth, it sells the high-quality portion to the LT at a price congruent with the high quality and sells the rest combining with their old-quality stock at a lower monetary value in the rural wholesale market (Das, 2016a, 2016b). We sketch the theoretical framework first, thereafter substantiating our claims with evidentiary support.

Here, we see a model of vertical competition where, downstream firms (viz., retailers, cash and carry traders) purchase agricultural food products from the consolidators (i.e., STs) where the consolidators buy their saleable commodities from the small farmers. Consolidators are divided into two classes’, namely, ‘principal consolidator’ and ‘sub-consolidator’.

If small competitive farmers would able to bear grading costs, then it would be variable. On the other hand, when traders bear these costs, it is fixed. We show this with the help of complete the vertical model below.

In Figure 1, we identify different types of fixed costs that small farmers are not able to bear. These fixed costs create the supply side imperfect.

Figure 1.

The Model of Vertical Restraints in India: A Case of Small Competitive Fringe of Farmers

Source: Field survey in North 24 Parganas district, West Bengal, in the year 2016.

Consider a set of perfectly competitive upstream small producers (farmers), which produce a homogeneous good and denote as industry and two sets of differentiated retailers. One set of retailers sell only high-quality products and another set of retailers sell average-quality products (i.e., LTs). Here, first set of the retail industry is oligopolistic in their intra-brand competition. The second set of the retail industry is a competitive fringe (CF). Upstream small producers produce at a constant marginal cost C. $\geq 0$ They use a fixed transportation cost to sell the produce. They are not able to bear extra transportation cost. Here, we consider two types of the fixed costs; one transportation cost (TC) and another is the grading cost (GC). If production actually takes place, then these fixed costs are to be incurred, that is, TC $\geq 0$ and GC $\geq 0$ .These fixed costs are not scaled dependent but retailer specific. Here, we also consider two types of consolidators’, namely, ‘sub consolidators’ and ‘principal consolidator’. Sub consolidators are small in sized and linked with the principal consolidator. Principal consolidator is a monopolist.

We consider a five-stage game. In the first stage, farms make a simultaneous contract offer to the sub consolidators and the ST in the rural wholesale market (local wholesale market), where they are allowed to discriminate between the sub consolidators and the ST. In this stage, farms incur fixed transportation cost to sell to the ST only, that is, TF. Sub consolidators have to bear transportation cost, that is, TSCF to collect from the farms. In the second stage, sub consolidator and the ST observe all the contract offers and decide from which farms they will exclusively buy. Third, sub consolidator sells to the principal consolidator with a margin (contract should be specified). Therefore, sub consolidator has to incur three types of transportation costs, namely, TSCF, TSCPC, TSCST and grading costs, that is, GSC. In the fourth stage, the principal consolidator sells the high-quality products to the collection centre and low-quality products (almost average, because first-level grading has been gone by the sub consolidator) to the ST in the rural wholesale market. Principal consolidator has to incur two types of transportation costs, namely, TPC and TPCST and one type of grading cost, that is, GPC. In the fifth stage, LT grades the collected products again using fixed grading cost, that is, GC and sells in the retail market to the ultimate consumer. The ST in the rural wholesale market collects average-quality products by incurring three types of transportation costs, namely, TF, TSCST, TPCST which ST could have got only incurring one type of TC. This means the presence of these extra TCs will create the rural wholesale market price stickiness. We explain the wholesale price behaviour later on in this paper. Moreover, the presence of three types of fixed costs for the sub consolidator, two types of fixed costs for principal consolidator and one type of fixed cost at the collection centres has created the market for the high-quality products imperfect. Therefore, small farmers are not able to extract any extra earning from the high-quality products because small farmers are not able to bear extra TC to sell the average- and high-quality products. Caprice, Schlippen-bach, and Wey (2014) find that fixed costs affect both input market contracting and final goods prices. Moreover, fixed costs help to monopolize an imperfectly competitive downstream market and thus translate into higher consumer prices (Caprice et al., 2014).

Theoretical Analysis

We construct a theoretical model based on the identified field data and the vertical model that we explain in Figure 1. The two important ant costs, namely, grading cost and consolidator’s margin with higher transaction cost, carrying a cost, warehousing costs and possible losses, etc., divide the market for agriculture food products in the rural wholesale market into two divisions. The first part is market for high-quality products and the second part is market for average-quality products. The marketplace for low-graded products is lacking (due to field information). This means that the presence of the LTs divides the retail markets into two parts one of the average-quality products and second for the high-quality products. LTs are collecting and selling only high-quality products. This means they are applying ‘blue ocean strategy’. They want to create new demand in an uncontested market space, or a ‘blue ocean’, rather than compete head-to-head with other small retailers in an existing industry (Maubargne & Kim, 1999, 2005). As a result, the collection cost for high-quality products is high (Das, 2015a, 2015b, 2015c, 2015d, 2016). Therefore, there are two sets of traders attending the two sets of consumers. There are two types of retailers. They are STs for average-quality products and LTs for high-quality products. All the traders under the ST are same preference group and all the traders under the LT are the same preference group. The cost–quality bundles are different for the two sets of traders’, namely, the ST and the LT. At present, the research question is whether with the bearing of the LT in the food retail market, the ST will be pushed out from the markets or not. To resolve this inquiry, we need to seek for the strategy adopted by the LT to enter into the marketplace. We know the Michael Porter’s ‘three generic strategies’ where he identified the strategies that are used to enter into the marketplace. These are, ‘cost leadership strategy’, ‘differentiation strategy’, ‘focus strategies’ (Porter, 1980). Michael Treacy and Fred Wiersema (1995) have modified Porter’s three strategies to identify three basic ‘value disciplines’ in their book The Discipline of Market Leaders that can create customer value and provide a competitive advantage. They are operational excellence, product leadership and customer intimacy. Renée Mauborgne and W. Chan Kim (1999) introduce a popular Post-Porter model in their Harvard Business Review article ‘creating new market space’. In their article, they report a ‘value innovation’ model in which companies must see outside their present paradigms to discover new value propositions. Their approach complements most of Porter’s thinking, particularly the concept of specialization. They later introduce their ideas in the book Blue Ocean Strategy (Maubargne & Kim, 2005). Therefore, it is hard, but not impossible to topple a house that has built a predominant criterion. From the market observations and studying data, we have found that, the LT has adopted blue ocean strategy. They are really attempting to differentiate products from the existing ST. They usually do not desire to argue with the ST and setting different price–quality combinations. Maintaining a high-quality product is costly and needed some skill. That is difficult to maintain by the ST.

Model

The conditional indirect utility of a consumer with a marginal willingness to pay ϴ for quality k and income y is given by Y + ϴk–P if one unit of the product of quality k is purchased at price p, and by y if the product is not purchased. Consumers’ valuation of quality is given by ϴ. It is assumed, a range of consumers with a total mass of one distributed uniformly over a unit interval i.e. ϴ $\in$ U[0,1]. If a consumer purchases one unit of a product of quality k at a price P then, the conditional utility is Y + ϴ k–P and y if the product is not purchased. Let θ_L denote the consumer who is indifferent between buying the low-quality product and not buying at all, where the subscript L denotes low-quality product. Thus, θ_L is the value of θ that solves y + ϴk_L. P_L = y. Similarly, θ_H is the consumer that is indifferent between buying the low- or high-quality product, i.e. θ_H , is the value of θ that solves $y + θ k_{H} - p_{H} = y + θ k_{L} - p_{L}$ , where the subscript H denotes the high-quality product. Thus, consumers with $θ \in [θ_{L}, θ_{H}]$ will not buy the product, those with $θ \in [0, θ_{L})$ will buy the low quality product and the others $θ \in (θ_{H}, 1]$ will buy the high-quality product. Accordingly, the demand for each quality is the length of the consumer interval buying the given quality multiplied by the density of consumers along that interval times the total number of consumers, N = 1, for illustrative convenience. As a result, the demands for the high and low-quality products are:

D_{H} (p_{H}, p_{L}, k_{H}, k_{L}) = 1 - θ_{H} = 1 - \frac{p_{H} - p_{L}}{(k_{H} - k_{L})}

(1)

D_{L} (p_{H}, p_{L}, k_{H}, k_{L}) = θ_{H} - θ_{L} = \frac{p_{H} k_{L} - p_{L} k_{H}}{k_{L} (k_{H} - k_{L})}

(2)

There are two sets of retailers; the LT and the CF, we denote them $i = H, L$ , each retailer i faces a demand function $D_{i} (P, k_{}),$ where, $P = (P_{H}, P_{L})$ indicates the vector of retail prices and k_H , k_L are the vector of exogenous quality. Here we have derived two types of demand functions. $D_{i} (P, k_{}),$ Where,is the i_th type of demand function with exogenous quality k. We may write demand for i_th type as $D_{i} (P)$ . This type of demand is twice differentiable and downward sloping with $\partial_{P_{i}} D_{i} (P) < 0 < \partial_{P_{j}} D_{i} (P) .$ Let $R_{i} (P) = (P_{i} - W_{i}) D_{i} (P)$ be the retailer i’s flow profit when it sells at a price P_i and rival retailer $j \neq 1$ sells at P_j . We consider linear vertical contracts: i.e. a contract only consisting of a linear wholesale price W_i . Moreover, here we consider two important fixed costs that differentiate the products, viz. Transportation Cost and Grading Cost (or quality improvement cost). The fixed costs entailing with the W_i , for average quality products are, TF, TSCST, TPCST. In addition, the fixed costs entailing with the W_i , for high quality products are, TSCF, TSCPC, GSC, TPC, GPC, GCCC. Where, F_i = fixed cost for i_th product type. TF, TSCST, TPCST are the fixed costs for average quality products or denoted as F_L and TSCF, TSCPC, GSC, TPC, GPC, GCCC are the fixed costs for high quality products or denoted as F_H . Moreover, F_H > F_L. The condition i.e. F_H > F_L ensure the product differentiation.

Calculation of retailer i’s total profit function is

π_{i} (P) = (P_{i} - W_{i}) D_{i} (P) - F_{i}

(3)

Where W_i is the wholesale price faces by the i_th type of retailer. We may write the two profit functions for the two types of retailers’ LT & CF as below:

π_{i} (P) = (P_{H} - W_{H}) D_{H} (P) - F_{H}

(3A)

π_{i} (P) = (P_{L} - W_{L}) D_{L} (P) - F_{L}

(3B)

In the last stage both types of retailers set their prices so as to maximize their profits.

The corresponding first order conditions are given by:

$\partial_{P_{i}} π_{i} (P) = (P_{i} - W_{i}) \partial_{P_{i}} D_{i} (P) + D_{i} (P) = 0$

The solution yields the equilibrium prices for i = 1,2,…j,..,n. (here n = countable few numbers of firms including a competitive fringe.)

$P^{*} (W_{1}, . W_{2} ., W_{j}, .. W_{n}) = (P_{1}^{*} (W_{1}, . W_{2} ., W_{j}, .. W_{n}), ... P_{j}^{*} (W_{1}, . W_{2} ., W_{j}, .. W_{n}), ... P_{m}^{*} (W_{1}, . W_{i} ., W_{j}, .. W_{n}), ... P_{n}^{*} (W_{1}, . W_{i} ., W_{j}, .. W_{n}))$

Whose solution yields the equilibrium prices for

P^{*} (W_{H}, W_{L}) = (P_{H}^{*} (W_{H}, W_{L}), P_{L}^{*} (W_{H}, W_{L}))

(4)

We use the simplified notation $P_{i}^{*} = P_{i}^{*} (W_{H}, W_{L}), a n d, P^{*} = P_{}^{*} (W_{H}, W_{L})$ for $i = H & L$

The collusive outcome is defined by the maximization of the aggregate profits. Here the principal consolidator creates a cartel with the market for high quality products and the market of average quality products. Data also support the fact that the principal consolidator has been able to bear the fixed costs therefore, has some monopoly power.

Using the equilibrium retail prices $P_{}^{*} (W_{H}, W_{L})$ , and the marginal cost of production C we derive the wholesale prices that maximize the industry profit. The reduced form of gross industry profit is given by:

π (W_{H}, W_{L}) = (P_{H}^{*} - C) D_{H} (P^{*}) + (P_{L}^{*} - C) D_{L} (P^{*})

(5)

Maximize equation (5) with respect to , we obtain:

\begin{array}{l} \frac{\partial π (W_{H}, W_{L})}{\partial W_{i}} = [(P_{i}^{*} - C) \partial_{P_{i}} D_{i} (P^{*}) + D_{i} (P^{*}) + (P_{j}^{*} - C) \partial_{P_{i}} D_{j} (P^{*})] \partial_{W_{i}} P_{i}^{*} \\ + [(P_{i}^{*} - C) \partial_{P_{j}} D_{i} (P^{*}) + (P_{j}^{*} - C) \partial_{P_{j}} D_{j} (P^{*}) + D_{j} (P^{*})] \partial_{W_{i}} P_{j}^{*} = 0 \end{array}

(6)

This simplifies to:

\begin{array}{l} \frac{\partial p (W_{H}, W_{L})}{\partial W_{i}} = (W_{i} - C) \partial_{P_{i}} D_{i} (P^{*}) \partial_{W i} P_{i}^{*} + (P_{i}^{*} - C) \partial_{P_{j}} D_{i} (P^{*}) \partial_{W_{i}} P_{j}^{*} + \\ (W_{i} - C) \partial_{P_{j}} D_{j} (P^{*}) \partial_{W i} P_{j}^{*} + (P_{j}^{*} - C) \partial_{P_{j}} D_{j} (P^{*}) \partial_{W_{i}} P_{i}^{*} = 0 \end{array}

(7)

Solving for the respective equation system for , we get the equilibrium wholesale prices , which maximize the overall industry profit. The optimal wholesale prices are such that the final product prices $W^{M} = (W_{H}^{M}, W_{L}^{M})$ are raised to the level a fully integrated monopolist would choose.

Now $W^{M}$ will be used as a benchmark.

The principal consolidator sets wholesale prices to solve the following maximization problem:

$\begin{array}{l} \max_{W_{H}, W_{L}} \sum_{i = 1}^{n} (P_{i}^{*} (W_{1}, .. W_{j}, ... W_{n}) - W_{i}) D_{i} (P^{*} (W_{1}, .. W_{j}, ... W_{n})) \\ S . t . \sum_{i = 1}^{n} (W_{i} - C) D_{i} (P^{*} (W_{1}, .. W_{j}, ... W_{n})) - F_{i} \geq 0 \end{array}$

When $i = H & L$

\begin{array}{l} \max_{W_{H}, W_{L}} \sum_{i = 1}^{2} (P_{i}^{*} (W_{H}, W_{L}) - W_{i}) D_{i} (P^{*} (W_{H}, W_{L})) \\ S . t . \sum_{i = 1}^{2} (W_{i} - C) D_{i} (P^{*} (W_{H}, W_{L})) - F_{i} \geq 0 \end{array}

(8A)

Where, $F_{i} =$ the Fixed cost for the i_th type of product.

For $i = H & L$ , we get,

\begin{array}{l} \max_{W_{H}, W_{L}} [{(P_{H}^{*} (W_{H}, W_{L}) - W_{H}) D_{H} (P^{*} (W_{H}, W_{L})} + {(P_{L}^{*} (W_{H}, W_{L}) - W_{L}) D_{L} (P^{*} (W_{H}, W_{L})}] \\ S . t . [{(W_{H} - C) D_{H} (P^{*} (W_{H}, W_{L}))} + {(W_{L} - C) D_{L} (P^{*} (W_{H}, W_{L}))} - F_{H} - F_{L}] \geq 0 \end{array}

(8B)

As retail profits decrease in wholesale prices, the constraint of the common supplier (i.e. the principal consolidator) to earn non-negative profits is binding. Using symmetric retailers, the equilibrium wholesale prices are, thus, implicitly given by:

$W_{H} = W_{L} = W^{N} = C + \frac{F_{H} + F_{L}}{D_{H} (P^{*} (W^{N}, W^{N}) + D_{L} (P^{*} (W^{N}, W^{N})}$

The equilibrium wholesale price is equal to the marginal cost of production plus a margin which increases linearly with the level of the fixed cost F. The margin corresponds to the fixed cost F divided by the total sales. An increase of the fixed cost F leads to raising wholesale prices for fulfilling the manufacturer’s zero-profit condition. In the absence of any fixed costs, the wholesale prices are set equal to marginal cost. As other couples of wholesale prices fulfill the manufacturer’s zero-profit condition, there also exists asymmetric equilibrium with $W_{H}^{N} \neq W_{L}^{N}$ .

Empirical Evidence of the Impact on the Wholesale Prices of Agricultural Food Products

The entire study has been done based on the experiences in the state of West Bengal and experiences in other states in India, where farmers are small sized in nature, in terms of land use. Based on the theoretical overview, we analyse the matter empirically here. To show the empirical evidence and the impact of the fixed costs on the price behaviour, we have taken the vegetable price data. LTs mainly collect vegetables. In West Bengal, the LTs collect mainly potato throughout the year from the consolidator. West Bengal is the second largest potato producing state in India. We surveyed in the districts of North 24 Parganas and Nadia, West Bengal, India. Corporate firms are operating in these two districts. We study the wholesale price behaviour of potato in these two districts and compare with the other districts in West Bengal. There are special characteristics of potato. It is used as a regular diet and also as an input from the food processing firms. In the market of agricultural food grains, the government intervention is there through the presence of minimum support prices. Therefore, we have not considered other food grains here. Regarding field surveys, we surveyed Hooghly district and North-24 Parganas district, West Bengal, India for getting farm-level information and evidence. Our work is based on the in-depth study and information on North 24 Parganas district where three corporate firms, including 100 per cent FDI in cash and carry trade are operating. These are Reliance Fresh, Metro cash and carry, Keventer Agro, Aditya Birla Group. Metro cash and carry is the only hundred per cent FDI in West Bengal in the wholesale market and others are domestic and working in partnership with foreign firms through indirect control. As par information from Metro cash and carry, they are operating only through their collection centre at North 24 Parganas districts. For other districts they dependent on the intermediaries. Metro cash and carry collects directly from the farmers and also intervene in the local wholesale markets. The same thing is true for the other two companies, though Keventer Agro also collects from the farmer cooperatives from Nadia and Murshidabad districts and buys from there (Nadia and Murshidabad districts) wholesale markets. Corporate farming in the name of participatory farming was reported recently from the districts of Nadia and Purulia in West Bengal (Shelthi Research Group, 2008). Contract farming was not considered here as during the study period it was not allowed in West Bengal. To show the empirical evidence of price behaviour and riskiness, we have taken the data of vegetables as large capital or corporate firms are collecting vegetables throughout the year and a few food grains directly from the farmer and in the market of food grains, the government intervention is there through the presence of minimum support prices. It was difficult to get price data of all the vegetables, which are produced and trading every week and/or month in all the 19 districts of West Bengal. So under vegetables, we have used the data on the wholesale price of potato of weekly basis of all the (based on data availability) markets of 18 districts (except district Darjeeling as data were not available) of West Bengal then derived the average of wholesale price according to the district and then applied the methodologies. To investigate district wise, we have chosen vegetable, potato, as potato is a regular diet and used as an input by the food processing firms. These data on the weekly wholesale price of potato have been collected from the website of ‘Agricultural Marketing Information Network-AGMARKNET’ (www.agmarknet.nic.in). The Indian market also reformed for domestic large capital or corporate traders, including retailers, wholesalers, exporters and importers, food processing firms, etc… 100% FDI in cash and carry has been opened in 2006 with an automatic route and in the single-brand retail market by 2012. Reforms for multi-brand retail not yet been taken. To understand the impact of the presence of the LTs, database has been collected of the weekly wholesale price of potato from January 2006 to October 2013.

We use Kernel density functions to explain the rural wholesale market price behaviour of potato. We use Kernel density functions because it is non-parametric and we can easily compare with the normal and t distributions. Figure 2(a) considers the change of wholesale price behaviour in North 24 Parganas. Price stickiness is present in figure. This is absent in case of West Bengal average in Figure 2(b).

Figure 2 (a).

Source: Author’s own calculation in North 24 Parganas district, West Bengal, in the year 2016.

Figure 2 (b).

Source: Author’s own calculation in North 24 Parganas district, West Bengal, in the year 2016.

Therefore, wholesale prices for the high- and the average-quality products are almost equal. The LTs have high buying power and they are able to maintain product discrimination in buying high quality and the small retailers have low buying power so they are buying average-quality products. Moreover, price stickiness in there in these two wholesale prices. This stickiness helps the STs to collect average-quality products at a lower price when the demand from the consumer is high.

Conclusions

Here we find that, fixed costs are present and required for high-quality products transaction in the rural wholesale market. The presence of fixed costs creates the market imperfect and dominated by the intermediaries. Small farmers are not able to bear these fixed costs. Therefore, our analysis shows that the fixed costs that are not related to the average-quality products also create a market for average-quality products imperfect and a cartel is there between the agents who are trading with the average-quality products and the agents who are trading with the high-quality products. This is happening because the industry is dominating by the few intermediaries who are trading in both of the markets.

Declaration of Conflicting Interests

The author declared no potential conflicts of interest with respect to the research, authorship and/or publication of this paper.

Funding

The author received no financial support for the research, authorship and/or publication of this paper.

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