Playing chicken : the players, rules and future of South African broiler production

Abstract

The South African broiler industry is the greatest contributor to the South African agricultural sector, while at the same time providing the cheapest form of protein to the South African consumer. In light of a recent application for increased tariffs due to the industry’s inability to compete with the price of imported products, the need for a tool that is able to quantify the benefit of increased tariff protection to producers, while at the same time considering the cost of increased tariffs on South African consumers became apparent. The integrated nature of the industry however raised the concern that the assumptions associated with traditional quantitative modelling techniques, particularly that of a perfectly competitive market, would not allow the current broiler model within the BFAP sector modelling framework to represent the industry accurately. The primary objective of the study was to determine the true method of price discovery within the South African broiler market, in order to specify a price equation that is able to capture the dynamics surrounding price formation with improved accuracy. This price formation mechanism was then integrated into a simulation model that represents the industry accurately. Due to its ability to represent reality within the market with greater accuracy, the New Institutional Economic (NIE) framework was used to analyse the structure of the South African broiler industry as action domain. The actors and activities in the value chain were evaluated, followed by an analysis of the institutions that govern exchange within the market, highlighting the implications of these institutions for price formation within this coordinated market structure. Upon evaluation of compensation structures used within broiler production contracts, it became evident that the market for live broilers produced by contract growers could be considered as a market for grower services, as opposed to a market for live broilers. Compensation based on a broiler production tournament offers significant incentives for greater efficiency, effectively ensuring that production efficiency increases on a continuous basis. Despite the contractual obligation of integrated producers to pay their contracted growers based on a formula including the cost of production, the broiler producer price is negotiated between integrators and retailer, within a concentrated market structure. The cost of production is used as bargaining tool in price negotiations, yet the availability of imported products at extremely competitive prices limits the extent to which increased production costs can be passed up through the value chain. This was confirmed by the fact that the response of the domestic broiler producer price was much more elastic to changes in the international price than to changes in feed costs. The theoretical factors that drive broiler producer prices in South Africa were confirmed econometrically through the use of an error correction model, estimated empirically using secondary monthly data from 2007 to 2012. The estimated equations were integrated into a partial equilibrium framework using an import identity to establish equilibrium in the market, rather than a price equilibrator. The inelastic response from the domestic broiler producer price to changes in broiler feed prices raised questions regarding South African producers’ ability to compete with imported products and produce sustainably in the long run. Given the higher costs of production domestically, as well as the relative size and importance of the broiler industry within the South African agricultural sector, the need to evaluate the tariff application objectively was clear. Policy decisions should weigh the benefit of increased producer prices on broiler producers against the cost of protective policy to consumers, while also considering the specific consumers that would be required to bear the cost of increased tariffs. Integration of the partial equilibrium model of the broiler industry into the BFAP sector modelling framework enabled the simulation of various tariff scenarios, quantifying the effect on the agricultural sector, as well as chicken consumption. At the same time, the successful simulation of different scenarios and policy shocks validated the model. Simulation of the tariffs applied for by SAPA resulted in a producer price increase of 6%, which would be a significant margin on the bottom line for domestic producers. The cost to consumers of a 3.3% increase in retail prices also seems digestible; however the underlying factors that drive competitiveness should also be addressed in order to ensure long run sustainability for the industry.