CONTENTS

Have Expenditures to Advertise Almonds Been Effective

Director’s Corner

Next Meeting

NEC-63 Spring 2001 March 22-23, 2001 Washington, DC Policy and Distribution Issues in Agricultural Commodity Promotion Programs

Have Expenditures to Advertise Almonds Been Effective

by John M. Crespi and Richard J. Sexton

The Almond Board of California was established in 1950 by a federal marketing order. The almond order provides the industry with various tools to influence the demand and supply of almonds with the goal of increasing grower returns. Among its provisions, the order authorizes the industry to undertake advertising and promotion. Funds for this purpose are collected through an assessment on almond handlers. The exact provisions of the industry’s advertising and promotion program have varied over time, but the order allows for and programs have generally included provision for handlers to receive full or partial credit on their assessment for advertising their own products. The industry has also conducted a generic advertising program. The entire advertising program was suspended for crop years 1994/95 – 1996/97 due to litigation.

We evaluated the economic impacts of advertising and promotion expenditures funded under the almond marketing order and provide an estimate of the cost to the industry of suspending its program for the indicated years. Has the advertising program been effective in increasing demand for almonds in the United States, and, if this effect on demand is affirmed, have the expenditures been cost effective in the sense of yielding benefits to growers in excess of the costs borne by them?

ACCOUNTING FOR CHANGES IN U.S. ALMOND CONSUMPTION

Our study focused on the U.S. market for almonds, where most almond promotion expenditures have been directed. However, because about two thirds of each year’s crop is exported nowadays, our simulation model takes account of the export market in determining price impacts due to almond promotion. We specified a model wherein per-capita quantities of almonds consumed annually in the United States is a function of the real (deflated) farm price of almonds, real consumer income, and the real annual expenditure on almond promotion.

An increase in the price of almonds should cause a decrease in almond consumption, while an increase in total money income should lead to an increase in almond consumption. Successful promotions will increase demand, but unsuccessful promotions will have little or no effect on demand.

Data for the model consisted of 36 annual observations for crop years 1962/63 through 1997/98. Our measure of promotion expenditures consisted of the sum of the amounts spent on advertising by the Almond Board of California (ABC) and Blue Diamond Growers (BDG), the leading marketer and dominant advertiser of almonds in the industry. For most of the time period we studied, almond handlers like BDG were allowed to satisfy at least a portion of their promotional assessment by advertising their own products. Thus, promotion funded under the auspices of the almond order appropriately includes the amount of assessments credited to BDG and other handlers for the purposes of advertising their own products

The estimated model explained about 85% of the variation in almond consumption from 1962/63 – 1997/98. The price elasticity of demand evaluated at the means of the full sample was estimated to be approximately –0.7. This elasticity implies that a one percent increase in the price of almonds results in a 0.7 percent decrease in almond consumption. The estimated promotion elasticity was 0.13, indicating that a ten percent increase in annual promotion expenditures results on average in a 1.3 percent increase in almond consumption. The elasticity with respect to income was about 0.7, in the range of what is considered a “normal” good in that consumption increases with an increase in income, but the increase is less than proportional.

SIMULATION MODEL AND BENEFIT-COST ANALYSIS

Next the estimated model of U.S. demand was used to measure the gross and net benefits to the California almond industry from its expenditures on promotion. The demand model provides estimates of how quantities of almonds sold increase in response to a given increase in promotional expenditures, holding prices and other variables constant. However, price cannot be assumed to remain constant. Indeed, the increase in price following a promotion-induced shift in demand is an important source of the benefits from almond advertising. To properly evaluate the effects of almond promotion, we must combine the estimated demand model with a model of the supply of almonds to the U.S. market.

The diagram in figure 1 illustrates the conceptual supply and demand relationships for a typical year t. The curve labeled represents the residual supply curve for almonds to the domestic (U.S.) market. It shows the quantities available to domestic consumers at various prices; at higher prices, more almonds are available domestically, while at lower prices, larger quantities of almonds are diverted to other uses, such as to the export market, or may be left unharvested or stored across crop years. The curve labeled represents the farm-level demand curve—at higher prices, consumers purchase a smaller quantity of almonds than at lower prices, holding promotion expenditures and other factors constant. The market equilibrium occurs at point E. The market price adjusts until the quantity demanded and the quantity supplied are equated at price .

The effect of an increase in successful promotion is illustrated by the outward shift in the demand curve to . The econometric model allows us to estimate the horizontal distance of the demand shift in the U.S. market, identified by D in the diagram. Suppose the actual annual promotion expenditure is $1 million (in 1998 dollars). Based on our estimated demand model, a $0.1 million (i.e., ten percent) increase in total promotional expenditures would lead to an increase in U.S. per-capita almond consumption of
0.051*( ) = 0.0025 pounds per year, if there is no change in price. Multiplying this amount by the population (267.9 million in 1997/98) yields the total horizontal demand shift in the U.S. from a ten-percent increase in promotional expenditures, about a half percent increase in average consumption, at constant prices.

However, this is greater than the actual increase in consumption that would result for two reasons. First, an increase in price is needed to bring forth the additional almonds to satisfy the increased demand, as the residual supply curve, , indicates. Second, an increase in assessments is needed to pay for the additional promotion expenditures. This cost has the effect of shifting farm-level demand down by the amount of the additional per-unit assessment—the curve in Figure 1. The new equilibrium is represented by the point E’, where intersects . Price and quantity both increase to ’ and '.

To generate a model of the supply of almonds to the U.S. market, we begin by noting that newly planted almond trees do not bear for three to four years. Harvest is, thus, determined primarily by yield, which is a function of weather conditions and alternate bearing patterns and is largely unaffected by the current year’s price. In other words, in the short run (a time window of about four years for almonds) price has essentially no effect on total supply. We chose to examine the promotion program over a recent four-year period so that we could treat bearing acreage as fixed and total harvest as unaffected by the current market price.

The increase in producer profits due to almond promotions under this model formulation is simply the change in the producer price as a result of the promotion multiplied by the amount of the harvest. Further, because supplies are fixed, producers bear the full incidence of the increase in the promotional expenditure. That is, the assessment on handlers will be shifted entirely to growers under this market scenario. The residual supply of almonds to the U.S. market in a given year consists of total supply (harvest + carry in) minus the amount that would be exported at various prices. We calibrated residual supply curves to the U.S. market using estimates of the export demand for almonds provided in an earlier study of the industry (Alston et al. “Optimal Reserve and Export Policies for the California Almond Industry: Theory, Econometrics and Simulations.” Giannini Foundation Monograph No. 42, February 1995). We used a range of choices for this elasticity (0.86, 1.50, and 2.56) to examine the extent to which our results are sensitive to choices of this parameter, where, admittedly, our knowledge is imprecise.

By equating the equations for supply and demand and solving for market equilibrium, we obtained values of actual prices and predicted quantities, given the actual values for the explanatory variables and . We then simulated counterfactual scenarios using a hypothetical, marginal increase in the amount of promotion in each year for 1990/91 to 1993/94 of 1.10 times the actual amount of promotion. We also increased the assessments to pay for that promotion by 1.10 times the actual assessment rate, where we define the “actual” assessment rate as the ratio of total promotional expenditure to the total value of production. Because the program was suspended due to litigation from 1994/95 through 1996/97, the 1990/91 – 1993/94 period represented the most recent four years of promotion activity that were in some sense “normal” from the industry’s perspective.

The differences between the actual and counterfactual scenarios were then used to calculate measures of the marginal net benefits to producers from the joint increase in promotion expenditures and assessments. A real discount rate of three percent per annum was used to compound the costs and benefits. All monetary calculations were deflated and expressed in 1998 dollars.

For the lower bound residual supply elasticity of 0.86, the marginal benefit-cost ratio for a ten-percent increase in promotional expenditure was estimated to be 6.88, i.e., a marginal dollar expended on promotion yields a return to growers of $6.88. As the supply elasticity rises, producers receive progressively smaller benefits from a given demand increase because price rises less for a given demand shift. Hence, the benefit-cost ratio falls from 6.88 to 4.51 and then to 2.87 when the intermediate value of 1.5 and the upper bound value of 2.56 for the residual supply elasticity are used.

To evaluate the precision of our measures of benefits and costs, we conducted simulations. These simulations yield confidence intervals on our benefit measures, permitting us to make probability statements such as that a 95% confidence interval for the benefit-cost ratio is formed by the interval from a:1 to b:1, where a is a lower confidence bound on benefits per dollar expended and b is an upper confidence bound.

Table 1 provides the mean and lower and upper bounds of 95% confidence intervals for producer benefit-cost ratios from the simulation for each of the residual supply elasticities. For example, the column for the residual supply elasticity of 1.50 shows that the mean from the simulation was 4.56 (which compares closely with the point estimate of 4.51) and that a 95% confidence interval for the producer marginal benefit-cost ratio is given by 2.08 – 10.47.

FINANCIAL IMPACTS FROM THE PROMOTION PROGRAM’S SUSPENSION

The average promotion expenditure by the industry in the three years preceding the suspension expressed in 1998 dollars was $10.5 million per year compared with only $3.9 million per year during the suspension. Suspension of the industry’s promotion program from 1994/95 through 1996/97 provides a natural experiment for assessing the impact of the absence of advertising on the almond industry. Blue Diamond’s promotional expenditures also dropped significantly during this period.

For the three years prior to the suspension period, the average, effective assessment was $0.02091 per pound (kernel weight). Using this assessment rate with the harvests for the 1994/95 through 1996/97 period would have resulted in the following levels of promotion: $15.3 million in 1994/95, $7.7 million in 1995/96, and $10.6 million in 1996/97. Actual promotion levels were $5.3 million, $4.2 million, and $2.2 million for 1994/95, 1995/96 and 1996/97, respectively. Using these counterfactual estimates of promotion and the corresponding assessment rate for the years 1994/95 through 1996/97 in the market equilibrium model allows us to compare estimates of growers’ profit obtained using the actual promotion levels and assessments with those obtained under the counterfactual levels.

Table 2 summarizes the results. The accumulated loss from the suspension of the promotion program is estimated to be between $89.62 and $234.21 million dollars, depending upon the value chosen for the residual supply elasticity. These estimates are reduction in profit (not just revenue), since the costs of the increased promotion are already accounted for in the model.

CONCLUSION

The results of the analysis indicate that almond promotion has been a highly effective tool in stimulating almond demand and increasing producer profits. A best guess is that marginal dollars expended promoting almonds have yielded a return to producers in the range of 3:1 to 7:1. Of course, these rates of return are very favorable when compared to returns available to other investments.

AUTHOR'S ACKNOWLEDGEMENTS

John Crespi is an assistant professor in the Department of Agricultural Economics, Kansas State University. Richard Sexton is a professor in the Department of Agricultural and Resource Economics, University of California-Davis.

The authors are grateful to the staff of the Almond Board of California for contributing data to the study. Blue Diamond Growers also contributed key data to the study, and the cooperation of Blue Diamond’s Director of International Sales, Rex Lake, is much appreciated.