European F&A needs to reposition itself in the global arena
- The European food and agricultural value chain is relatively diverse and stable
- The European chain is principally low risk, but the risk profile will worsen
- Main challenges are: geopolitical risks, increasing influence of global developments on the European F&A sector, relatively weak competitive position, fragmented supply chain structure, changing consumer behaviour
This study was written by Harry Smit.
The European food and agricultural value chain, including primary agriculture is relatively diverse and stable, benefitting from being close to a large consumer base with a relatively high purchasing power. As a result, the European food and agricultural value chain is principally low risk. An increasing influence of global developments on the European F&A sector and some internal challenges will have a negative impact on the risk profile and bring it more in line with that of other regions. The sector will have to cope with and find answers to the following challenges:
- Europe is subject to geopolitical risks caused by (1) a high dependency on a few countries for some key inputs such as phosphates and natural gas and (2) export flows to less stable neighbouring regions such as Eastern Europe, North Africa and the Middle East.
- Although Europe is not a big player in global agri commodity markets from a trade perspective, global developments increasingly impact the European F&A sector. The reform of the Common Agricultural Policy (CAP) following the 1994 WTO agreement on agriculture is an example of this. Today’s dynamics in BRICs countries are another example. These countries have an increasing impact on world markets that leads to an overhaul of traditional trade patterns (i.e. Brazil developing into an agricultural powerhouse for exports, China becoming a growing importer).
- The competitive position of European primary agriculture on world agri commodity markets is not strong due to its fragmented farming structure and high costs of production. The competitive position is coming under further pressure due to high legislative demands while the sector lacks certain tools in the toolbox that competitors do have (e.g. genetic modification (GM) technology).
- The EU is a price taker in most international markets. Its traditional and fragmented supply chain structure makes it difficult to adapt fast to changing global dynamics to benefit from opportunities and to tackle threats. European food companies on average have a small scale. As a result, in most cases European companies are the targets for consolidation rather than consolidators themselves.
- Food companies have to become more flexible because European consumer behaviour is changing rapidly too. Preferences for food, channels through which food is bought etc. are changing. Some food companies will win, others will not. As a whole food consumption is relatively stable, but dynamics per company will vary a lot.
- Europe is increasingly vulnerable to internal turbulence. For example, the potential risk of a break-up of the internal market following a Brexit or the suspension of the Schengen treaty for free travel of people might hamper the necessary consolidation in the European food industry. Also the ‘stop-and-go’ nature of trade with Russia causes volatility in trade flows and brings along significant risks.
Key characteristics of the European agricultural sector and food value chain
Diversity in European agricultural production contributes to overall stability
European agriculture and the European food chain are highly diversified. European farmers typically grow various crops in rotation and/or have several livestock species on their farm. On average, due to scarcity of land, European farmers work with a high input high output production system. Average input use (e.g. fertiliser, crop protection) in European agriculture is higher than for example in the US. Similarly, yields in Europe are high in a global context. The rich history of Europe also brings along a wide diversity of high value food products of which Parma ham, Rioja wine, Roquefort cheese, extra virgin olive oil are just examples. Horticulture has a relatively high share in European agriculture, facilitated by a relative abundance of labour compared to land. European agriculture overall is a relatively stable (almost boring) business. The relatively stable climate creates relatively stable yields. Swings in crop areas and input use are relatively small from year to year as farmers take a longer term view on crop rotation instead of responding immediately to price signals with area expansions/reductions.
Europe: a fragmented farming structure and food value chain
The European food value chain can be characterised as rather fragmented. The average European farm in Europe is 33 ha, which is small compared to countries like US, Brazil, Australia and Russia, though it is big compared to countries in Asia and Africa where smallholder farming dominates agriculture. Also the food chain in Europe is dominated by small to medium sized players with most of them having a national presence. Only few food companies are active in multiple European countries (e.g. Arla Foods, Vion, Danish Crown) and the number of European food companies that have a global spread is even smaller (e.g. Unilever, Nestle, Heineken). The same goes for food retail. This fragmentation is the result of the long European history of independent states with their own eating cultures, their own food legislation and languages. The EU internal market is relatively new (1992) and harmonisation of legislation is still ongoing.
Furthermore, in most of the EU except for the UK and the new member states, cooperatives play an important role in distribution of farm inputs to the farm as well as in processing and/or marketing of agricultural products coming from the farm. Many of these cooperatives hold strong local positions and several are also active globally, e.g. Friesland Campina, InVivo, Tereos, DLG, Lantmännen, Südzucker, Baywa. The market share of cooperatives in processing primary products exceeds 50% in most countries and sectors which is an illustration of their strong position.
European population almost stable
Population growth in Europe is almost absent. Demand growth in the food market has to come from consumers trading up towards higher value products. Furthermore, economic growth prospects for Europe are modest as well.
European consumers are changing their habits
European consumers are undergoing changes, creating opportunities on the one hand but at the same time resulting in threats elsewhere. An important trend of this moment is that of the hybrid consumer, whereby consumers are moving away from the middle ground in favour of ‘value’ (good enough) and ‘premium’ (indulgence). Another important trend is the move towards convenience, resulting in among others an increasing number of eating occasions and locations. Furthermore, the growing attention to health and sustainability, and the emergence of the informed consumer is pressuring food companies to respond and adapt, who in turn pass on the additional demands to farmers. For the longer term, the changing demographics will have a significant impact on food consumption, for example resulting in changing preferences for food and channels through which food is bought.
Innovation creating dynamics in the supply chain
The emergence of e-retailing in food has the potential to transform the value chain. So far, the bigger retailers and food companies are investing heavily to grasp the opportunities created by e-retailing and the big data that are created by this new way of selling products. At the same time, newcomers are entering the competitive arena launching disruptive new business models, resulting in margin pressure for the existing players that are less agile and need to carry large legacy assets.
At farm level, we expect a slower development and less impact from 'big data', as the numbers involved are much smaller, product life cycles of products farmers use are much longer and the farming universe including its needs is much more diverse than that of consumers and fast moving consumer goods. Furthermore, the fragmented European farming structure has a negative impact on cost prices and adoption of modern technology.
Typical for Western Europe is its negative consumer attitude towards modern technology in relation to food. Consumer concerns in relation to, for example, genetic modification (GM) and animal welfare issues have resulted in strict regulations, again negatively impacting the competitive position of European farmers on world markets.
International trade position of the European Food and Agri sector
The EU is a modest trader in global F&A markets
Overall, volume wise the EU is not a big player on global agri commodity markets compared to the major exporters (US, Brazil, Oceania) and importers (China, Japan, the Middle East). The European region is more-or-less self-sufficient for food with a relatively small trade surplus of agri-food products of EUR 16 billion. The only agri commodity where Europe is competitive is wheat. The other most important export products are high value products that benefit from climatic circumstances, high processing and quality standards and a strong (brand) reputation. In these specific sectors Europe can be a significant player. Exports in 2015 reached EUR 129 billion and imports EUR 113 billion. The most important export destinations are the US, China, Switzerland, Russia and Japan. The most important exports products are wine & spirits, food preparations, infant food, wheat, chocolate products, pasta & pastry, dairy products and pork meat. Europe imports predominantly tropical products and protein crops because both cannot be grown competitively in Europe. The most important import origins are Brazil, the US, Argentina, China and Turkey. The most important import products are (tropical) fruits, soybeans & oil meals, coffee, tea & cocoa and vegetable oils.
World market dynamics have made their way into the European internal market
The European food and agricultural supply chain is becoming more dynamic due to policy reforms. European farmers still benefit from the Common Agricultural Policy (CAP) due to import tariffs on agricultural products that shield them to an important degree from lower cost imported products. Furthermore, the CAP provides direct income support to farmers through a system of direct payments per hectare. Export subsidies have been abolished and supply management through production quota is coming to an end with the abolishment of sugar quota in 2017, while market intervention through stock taking has been reduced. As a result, European farmers and food companies are experiencing much more price volatility, with prices of agricultural products in the domestic European market that move in line with world market prices. Whereas, in the past (prior to 2007) European prices were almost stable and much higher than on the world market.
European farm inputs industry losing ground internationally
The European farm inputs industry does not benefit from any government support. This sector is under pressure, slightly losing ground to foreign players due to a bleak market outlook and a disadvantaged competitive position in most sectors. The middle segment is traditionally strong, but subject to consolidation by American and Asian companies that enter the European market.
Europe pursues its own policies for quality and environment
Where in price policies Europe is conforming to world market dynamics, in quality policies Europe is still taking a deviating course from what is common practise in most parts of the world. Europe does not allow GM technology for cultivating crops (with a few exceptions), whereas elsewhere in the major producing regions this technology already has an adoption rate of around 90%. Furthermore, several countries have adopted rather strict legislation for animal welfare, banning for example cages for poultry and individual housing for pigs. Typically, some of these measures are taken at the European level and some at national level.
In the global context, Europe is leading in environmental policies, for example with legislation to prevent water pollution, air pollution and preserving biodiversity. European directives are implemented in national law. As a result, regulations can differ from country to country depending on local environmental pressure and other specific national circumstances. For the agricultural sector the more stringent and restrictive quality and environmental policies increase costs of production and make it challenging for European suppliers to compete on the world market.
Over time, income policies are increasingly linked to quality, environmental and social policies. Income support for competitive farmers has declined and has been redirected to farmers that face natural handicaps and/or contribute to maintaining high natural values such as biodiversity. Farmers that do not develop in the direction of a more sustainable European agriculture model are faced with a decline in income support.
Developments in the external environment
Only very slow progress in global trade agreements
Global trade liberalisation has stalled ever since the Uruguay Round Agreement on Agriculture in 1994. This agreement has enforced the reform of the CAP as illustrated in the previous section. Because the global multilateral trade process is not making any progress, focus in trade negotiations is shifting towards bilateral trade agreements, such as the TTIP. Such agreements with a much smaller scope, usually result in lowering import tariffs agricultural products in exchange for market access for non-agricultural products. The impact is increased competition on the European F&A market. The most impacted sectors usually are pork and beef, next to poultry and dairy to a lesser degree. The complication with increased market access for foreign competitors is the import of foreign production methods. Foreign production methods are not always allowed in the EU, for example use of growth hormones, animal welfare standards and hygiene rules in slaughter houses. Imports of products produced with these methods cannot be stopped if these are allowed in the foreign country. As a result, European producers don’t always compete on a level playing field. Only private sector standards can prevent these imports, for example the Global GAP standard of European food retailers that assures certain production methods are applied.
Negative impact from recent global economic turbulence
Various events, many of them linked, such as depreciation of emerging market currencies, the slowdown of the Chinese economy and the fall of the oil price, have negatively impacted the European F&A value chain. The lower oil price has a negative impact on the purchasing power of several important food importing countries in the Middle East and Africa putting pressure on for example milk prices. The depreciation of several currencies has the same effect on imports of foods by emerging economies. The weakening of the Euro vis-à-vis the US-dollar has also positively supported the competitive position of Europe vs. the US. The slowdown of the Chinese economy has a negative effect on agri commodity prices worldwide, especially for dairy and meat products. On the other hand, there are also beneficial effects from lower energy prices and lower economic activity in the form of lower fuel costs at the farm, in transport and processing and lower costs of fertilisers. Nevertheless, for the F&A value chain as a whole these cannot outweigh the negative effects.
Price outlook relatively stable
In a general context of lower energy and commodity prices, EU cereals prices are expected to range on average between EUR 150/t and EUR 190/t. Steady growing world demand in a context of affordable feed prices should favour the livestock sector. Therefore, despite the difficulties faced currently on the milk market, the EU dairy sector could grasp these opportunities to further expand, driven also by growing EU domestic demand. After a strong recovery which took place in 2014 and 2015, EU per capita meat consumption is expected to decline slightly except for poultry meat gaining minor market shares over the other meats. Small pigmeat production increases will be driven by export demand, while beef production is expected to decline.
Brexit, start of the European disintegration?
The European institutions and the internal market increasingly are coming under pressure. Scepticism about the “European project” is growing and support among citizens is falling. Also policy making in agriculture is susceptible to this pressure, already visible in the legislation in relation to GMO that is being renationalised, giving member states the authority to either allow or forbid this technology once its safety is established by the European Food Safety Authority (EFSA). A potential Brexit will put further pressure on the internal market and harmonisation of legislation. A scenario in which policy makers are no longer aiming for a level playing field but go back to nationalising quality, environmental and social policies entails significant risks for the internal market. The smaller member states will be most impacted in such a case, because they by definition lack a large domestic market. A potential Brexit will also mean going into unchartered territory. What will happen to trade flows from the European continent towards the UK and vice versa? Will there be tariffs on either side? Also food companies will feel the brunt as shipping goods (either raw materials, intermediates or end products) from one country to another will become subject to more red tape and potentially to levying tariffs.
Western Europe: mixed outlook for production growth in mature and saturated market
Western Europe is a saturated food market as result of demographics and the economic outlook. As a result, growth prospects in most F&A value chains are limited. For food production, the outlook is mixed. Production and exports of dairy products is expected to grow, based on strong competitive position due to beneficial natural circumstances. Animal protein production is expected to decline because, with its high costs of production due to its small scale and legislative pressure to reduce environmental pressure, Western Europe is not a competitive supplier to international markets. Production in other sectors is expected to remain relatively stable. As the Western European food market is still rather fragmented, cross-border consolidation will increase, but cultural differences will have a negative impact on the success of consolidation. Some big European players will look further afield for growth, for example sugar companies shifting their focus to Africa.
Central Europe: closing the yield gap will raise production, while consumers trade up
Central Europe (i.e. the new member states of the EU) will see growth of primary production due to intensification of agricultural production, i.e. closing the yield gap with Western Europe, facilitated by the umbrella of the European Union’s institutions and common agricultural policy (CAP). The growing volumes of locally produced agri commodities will require investments in logistics and also provide opportunities for local processing and growth in livestock farming, among others, to meet the needs of consumers that trade up as the economy grows. The processing sector benefits from low labour costs compared to Western Europe. Since Central Europe consists of many countries we should not consider it as one uniform production region but as a group of smaller fragmented markets. As a result, it is unlikely that this region will produce its own global F&A champions. A more likely scenario is that foreign companies will seek expansion opportunities there and operate alongside smaller domestic players. The farming structure in Central Europe is dichotomous, with half of the land held by smallholder farmers and the other half by large-scale corporate farms. The food market might benefit from economic growth as these countries are catching up with their Western counterparts. The food market is split into a high value modern food market in cities/for the rich and a low value market for the majority of poorer people.
Eastern Europe: highly unpredictable and today's export ban has significant impact on imports
The future of Eastern European agriculture (Russia, Ukraine, Kazakhstan, etc) is difficult to predict. It has natural resources in abundance and significant potential to increase production. However, the political unrest that currently characterises the region is leading to declining investments in agricultural production and value chains. The typical farm model in the region is large vertically integrated agro-holdings that bring together production of agri commodities, livestock operations and processing activities under one umbrella in order to reduce dependency on the highly unpredictable and volatile spot markets for intermediate products.
Eastern European countries produce mostly unprocessed agri commodities such as grains and oilseeds, which are sold both domestically and exported. The Black Sea region is an important supplier to the world market of grains & oilseeds. Global traders have established themselves in the region to assure access to agri commodities. The processing industry in this region is underdeveloped which results in import dependency for further processed products such as meat and dairy products and fruits & vegetables. However, due to the import ban this import has come to a halt. If the import ban will be lifted imports might start flowing again to meet demand in the more prosperous parts of this region (mostly around bigger cities).
Furthermore, this region exports fertilisers and energy to Western Europe and other parts of the world. This industry has benefitted a lot from the weakening of the rouble, which has strengthened its export position. So far these industries have not been affected by political conflicts.