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California Almond Industry: An Economic Analysis

Industry Structure Almonds are Californias number one tree nut crop, number one export, and the nations top specialty crop export. The production value of almonds now totals more than $2.4 billion a crop year (as of 2009), with an export value of more than $1.9 billion, representing over 80% of the worlds total supply of almonds (Almond Board of California). Though the numbers are impressive, Californias almond industry faces numerous challenges and opportunities resulting from various economic forces. An understanding of the economics behind the almond industry, and the economic landscape in which it operates, is useful not only for the decision making of individual firms in the industry, but also for understanding the agribusiness landscape of the almond industry as a whole. The almond industry operates in a pure competition or price taker market, as defined in Economics: Private and Public Choice. All of the firms in the industry produce and/or sell an essentially identical product, a large number of firms exist in the market (currently more than 6,000 growers, over 100 handlers, and a large number of brokers and traders), each firm supplies only a small fraction of the total supply, and barriers to entry and exit are relatively low. Though at one time the large growers cooperative, Blue Diamond, controlled a large enough portion of total crop production to be able to influence the market, as growers leave the cooperative and new growers and handlers enter the industry, this influence has declined. The almond industry has seen an increase in rivalry, or competition, over the years, a trend that continues today. The intensity of competition in an industry is often a result of how or whether demand for product produced is growing. In the case of the almond industry, much of the growth in recent years may be attributed to new customers and markets. For example, over three years (2007 to 2010) Spains yearly

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volume of almond imports has remained constant; by contrast China, over the same period, increased imports from 47 million pounds in 2007 to 168 million pounds in 2010, surpassing Spain as the number one export market for California almonds. As illustrated by this example, demand is growing in large part due to new customers, and firms are therefore able to seek out and find new customers, supporting an expansion of production. The graph in appendix A illustrates this production expansion in acreage. If demand were stagnant or declining, firms would have to compete more on price and nonprice factors such as quality and varieties to capture new customers. An excellent example of this scenario is Japan: Declining demand in Japan has led firms to focus on quality over any other consideration. In this market, unlike many other almond markets, brand differentiation is essential as brands become linked to quality and customer loyalty. In addition to competition and rivalry within the industry, Californias almond industry faces a threat of potential entrants both at home and abroad, with a greater threat from the latter. Domestically entrants are limited to California by necessary growing conditions and infrastructure coupled with high costs to purchase land and equipment. In addition, established firms have achieved economies of scale, meaning they have achieved minimum average costs, enabling these firms to maximize profits, or grower returns (see Appendix B) (Gwartney, Stroup and Sobel). Abroad, particularly in Australia where similar growing conditions have seen the establishment of a small but growing almond industry, entrants aface similar barriers to entry, in addition to a certain brand loyalty: The marketing efforts of the Almond Board, as well as the quality of California almonds, have led many markets to prefer California origin over others. Entrants in other countries, however, may benefit over their U.S. counterparts from advantageous trade agreements with various markets.

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In addition to competition within the industry, it is important to consider the threat of possible almond substitutes. Luckily, this threat is relatively low, depending on the end usage. In the case of the snack industry, particular producers of substitutes (other tree nuts) compete vigorously through various advertising campaigns to win and/or keep customers. In fact, one measure of success of marketing efforts by the Almond Board of California is tracking the introduction of new products by nut type. The threat of substitutes is perhaps most clearly seen in the competition for development of and inclusion in new products. However, no substitute product exists for many almond products like marzipan, many Middle Eastern delicacies, or the Spanish Turon. The relative price stability of almonds over the past few years as compare to pistachios or walnuts has also made almonds a more attractive option when companies plan ingredient ratios or buying decisions, as the downside risk is less when compared to other nuts. As discussed above, demand for almonds continues to grow, much of it from new markets and buyers. As the number of markets and buyers has continued to grow over the years, the power of buyers has declined. With the rise of new markets in Asia and the Middle East, if Europe or the United States is not willing to accept a pricing level, firms are able to easily ship their products to other markets. Certain markets for the almond industry, however, do continue to have more bargaining power than others. For example, large industrial buyers in Europe who utilize relatively undifferentiated input product, or for whom the product constitutes a major portion of the buyers total costs, still tend to have more bargaining power than a buyer in a market like Japan where quality takes precedence over price. Suppliers to the almond industry, on the other hand, tend to have significant bargaining power due to several factors: (1) Suppliers, such as bee or tree suppliers, tend to be more concentrated than their buyers (almond growers), (2) many suppliers do not receive a high percentage of their revenue from one

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industry, but rather from a variety of industries (as is the case with bee suppliers), and (3) mergers of suppliers for products such as pesticides and fungicides has increased the suppliers bargaining power. Finally, it is important to note the elasticities of demand and supply for the almond industry, as illustrated by the graph in Appendix C. Demand for almonds is relatively inelastic, as there are few close substitutes, almonds represent a relatively small percentage of a consumers income, and almonds are increasingly considered a staple part of diets or even cultures. Over the long run, the elasticity of demand for almonds increases the longer a price change holds as consumers seek out alternatives or reduce their consumption. On the supply side, in the short run supply is also relatively inelastic. The length of the production process (four years until a tree bears significant fruit), and the cost and difficulties of switching to another product both contribute to the relative inelasticity of supply in the short run. Over the long run, as for demand, supply is relatively elastic as over time producers can scale production up or down as necessary. Macroeconomics Macroeconomic forces with the biggest impact on the California almond industry are those impacting income and relative prices. GDP and exchange rates, as determinants of income and cost, have major impacts on quantity of goods produced and consumed, as well as on international trade patterns. (Peters, Shane and Torgerson). Gross Domestic Product, the most widely used indicator of economic performance, measures total expenditure (expenditure method), or total income (income approach). GDP as an indicator provides a way of measuring the growth (or contraction) of an economy, as well as measuring how much a country has to spend. As income (GDP) grows, consumers will devote a share of that increased income to food expenditures. We can also look at GDP as determined by the Aggregate Demand curve. When the

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economy contracts, as in a recession, the AD curve shifts to the left, with a corresponding reduction in quantity demanded at all price levels. In a period of expansion, the opposite holds true. Not all GDP change is equal, however, in the eyes of the almond industry. The degree to which changes affect the industry depend on countries affected. In developed economies such as Europe or the United States, the income elasticity of demand for agricultural products is relatively low (.1 or less), and responds weakly to changes in income. Developing countries such as China and India, however, have relatively high elasticities of demand (.25 to .5), which implies much larger impacts on agricultural consumption with changing incomes (Shane, Torgerson and Sundell). This difference has important implications for the almond industry, whose demand in recent years has been largely driven by a rise in to developing countries. The exchange rate is the price at which one currency converts to another, and is determined by several factors on the money demand and supply side. On the demand side, demand for money is determined by demand for U.S. exports, U.S. financial assets, and for the dollar as a reserve currency. On the supply side, supply of money is determined by U.S. imports, demand for the other countrys financial assets, and demand for the other currency as a reserve. Understanding the exchange rate is fundamental to an understanding of international trade, and therefore vital to understanding the almond industry and its functioning in the international economy. If the U.S. dollar depreciates against the currency of a trading partner, U.S. exports (in this case almonds) become cheaper in local currency terms. This increases demand for U.S. exports in general, almonds included. The exchange rate also affects the prices of domestic foodstuffs. If the U.S. dollar depreciates relative to other currency, imports become more expensive. This can have the effect of increasing domestic demand for domestically produced goods. Since the U.S. market for almonds is almost entirely supplied by California, this effect may be negligible for almond demand, but may be important for consumers who may see almonds as a THE CALIFORNIA ALMOND INDUSTRY 5

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substitute for other nuts that may be imported from abroad (such as cashews). Exporting is vitally important to the almond industry, as 70% of the crop is exported (Almond Board of California), thus a weak dollar is generally in the best interests of the industry. When considering exchange rates, however, it is important to consider real exchange rates, or those adjusted for inflation. For example, if the dollar depreciates against another currency, but the rate of U.S. inflation is equal to or greater than the rate of depreciation, in real dollars there is no advantage for U.S. exporters or importers of U.S. goods. When GDP contracts, as in the recent recession, the government can take steps, known as fiscal policy, to try to increase Aggregate Demand and thus GDP either through an increase in government spending, reduction in taxes, or through transfer payments (Chase, Session #7: 2/20/2012). Fiscal policy increases GDP in the short term through government spending, and in the long term (hopefully) through increased individual. An expansionary fiscal policy will most greatly benefit agriculture when economic output is below its potential. At these times, the positive impacts on demand and output will outweigh the potentially negative effects on inflation and real interest rates. Fiscal policy specifically targeting the agriculture sector, such as higher investment tax credits for agricultural capital goods, will be especially beneficial to the industry. The graph in Appendix D illustrates the effects of fiscal policy on an underperforming economy. Finally, monetary policy can have a large impact on the almond industry, both directly and indirectly. An expansionary monetary policy, where the central bank increases the money supply through the purchase of securities or other bonds, reduces the cost of credit as well as increases credit availability by lowering the interest rate. Commercial banks are therefore, in theory, more willing to make agricultural loans under an expansionary policy, making it possible for firms to increase production, purchase

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equipment, additional land, etc. More indirectly, lower real interest rates tend to raise U.S. and world economic growth, or in other words income and aggregate demand. In addition, when expected returns (interest rates) on U.S. assets are lower relative to those available outside the U.S. there tends to be downward pressure on the U.S. dollar. The almond industry therefore benefits from increased international demand for their product, as the dollar depreciates relative to other currencies making almonds cheaper. Conversely, a restrictive monetary policy restricts the money supply and raises interest rates, generally causing the U.S. dollar to appreciate relative to other currencies. Although this policy can decrease the inflation rate, it may make U.S. exports unattractive to other countries, thereby decreasing export demand for the almond industry. Quantitative easing, or the easy monetary policy, and expansionary fiscal policy can also negatively impact the industry through impacts on inflation rates and expectation. According to the demand-pull theory, when aggregate demand is increased beyond the economys ability to produce, either through the helicopter effect of an easy monetary policy or an expansionary fiscal policy, interest rates can rise. In the current economy, inflation is currently held in check by large bank reserves, meaning a part of the money supply is not in circulation. If banks suddenly flood the economy with credit, however, inflation could increase, and rapidly. Inflationary expectation alone can raise nominal interest rates, increasing the cost of credit and ultimately slowing economic growth, and hence demand. High inflation also raises the costs of inputs, as well as the cost of credit, and reduces real wealth or a consumers spending power. Conclusion As we emerge from the economic crisis, the almond industry should continue to pay close attention to the growth of consumption in developing countries where the almond industry has the greatest

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opportunity for growth, the alignment of exchange rates, and the macroeconomic policies both of the U.S. government and those of governments abroad. As economic growth remains positive in emerging markets, we can generally expect an accompanying shift toward consumption of higher value commodities such as almonds and other nuts; when accompanied by a favorable exchange rate, consumption in export markets will continue to grow. Although the almond industry will increasingly face scarce resources in the form of land and other raw materials, the fundamentals of the industry remain strong, with a strong outlook for continued growth.

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Bibliography
Almond Board of California. "2008 Almanac." Almond Board of California, 2008. Almond Board of California. "2011 Almanac." Almond Board of California, 2011. "California almonds turn in another good year." 10 November 2010. Western Farm Press. Western Farm Press. 28 February 2012 <http://westernfarmpress.com/tree-nuts/california-almonds-turn-another-goodyear>. Cline, Harry. "Almonds defy ag economics." 19 November 2004. Western Farm Press. 20 January 2012 <http://westernfarmpress.com/almonds-defy-ag-economics>. Gwartney, James D., et al. Economics: Private and Public Choice. 13th. South Western College Pub, 2010. Klonsky, Karen. What's the Real Price of Almonds? Cost and Return Study. UC Davis. Modesto, 2010. Onunkwo, I.M. and J.E. Epperson. "Export Demand for U.S. Almonds: Impact of U.S. Export Promotion Programs." Journal of Food Distribution Research (2001): 140-151. Peters, May, Mathew Shane and David Torgerson. "What the 2008/2009 World Economic Crisis Means for Global Agricultural Trade." August 2009. Economic Research Service, USDA. 3 March 2012 <http://www.ers.usda.gov/publications/wrs0905/>. Porter, Michael E. "The Five Competitive Forces that Shape Strategy." Harvard Business Review (2008): 7993. Session #7: 2/20/2012. Perf. Dr. Kristine Chase. St. Mary's College of California, Moraga. 2 February 2012. Session #8. By Dr. Kristine Chase. St. Mary's College of California, Moraga. 28 February 2012. Shane, Mathew, David Torgerson and Paul Sundell. "Macroeconomics and Agriculture: Questions and Answers." 12 June 2009. Economic Research Servic, USDA. 3 March 2012 <http://www.ers.usda.gov/Briefing/Macroeconomics/questions.htm>.

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Appendix A

Source: 2011 Almanac, Almond Board of California

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Appendix B

Source: Wikipedia, http://en.wikipedia.org/wiki/File:Costcurve_-_Long-Run_Av_Cost.PNG Long Run Average Cost Curve: Established firms in the almond industry are at an advantage vis--vis new entrants, as established firms are producing at Q2, where new entrants would be producing at Q1.

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Appendix C

Elasticity of Demand and Supply for Almonds Price Supplyalmonds

Demandalmonds Quantity
Both demand and supply are relatively inelastic for

the California almond industry.

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Appendix D

Fiscal Policy effect on Aggregate Demand

Source: Freeeconhelp.com, http://www.freeeconhelp.com/2011/10/notes-for-fiscal-policy-andcrowding.html

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