Researchability of modern agricultural input markets and growing concentration.

Aggregate measures of concentration suggest that pesticide markets are less concentrated than seed markets. From 1972-89, the estimated CR4 ratio for pesticides averaged 45% in the United States, falling from 50% in 1972 to a low of 37% in 1982 and then rising through the rest of the 1980s to 48% in 1989. However, the pesticide industry is more concentrated than aggregate numbers suggest because herbicides, insecticides, fungicides, and fumigants do not compete with one another, and the markets for many individual pesticide uses (e.g., pre-emergent grass control on soybeans, post-emergent broad leaf weed control on corn, etc.) involve only two or three major pesticides. For example, not all soybean herbicides are close substitutes as are all soybean seeds. As of 2001, the EPA's top 25 pesticides included only three fungicides, two insecticides, and four fumigants (EPA 2004). Also, some top herbicides have specialized uses (e.g., Roundup has no close substitutes other than generic glyphosate).

During this time, foreign firms' market share has increased from 18% to 43% (Ollinger and Fernandez-Cornejo 1995). While some foreign penetration primarily involved generic sales as a competitive fringe for off-patent products (e.g., the Israeli firm Makhteshim-Agan), other foreign activity represents a dominating share in an individual pesticide. For example, the Danish firm Cheminova dominated the malathion market, by far the leading insecticide, for many years after patent expiration.

Other aspects of pesticide distribution, manufacturing, and regulation raise market power issues. Because only five firms handle most U.S. pesticide distribution, each seeking to offer a full line of products in the regions they serve, several major manufacturers have attempted to require distributors to supply 90% of needs for a particular pesticide with their individual product under the threat of withdrawing the rest of the manufacturer's product line (including patented products). Also, because of specific chemical process requirements, concentration in an upstream input market can have important implications, as in one case where the dominant manufacturer bought and dismantled the only other facility that produced a necessary pesticide ingredient.

Pesticide market concentration is further influenced by provisions of the Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA). A generic firm can typically offer timely competition only by making a binding offer to pay compensation for test data held by the original registrant. Original registrants usually demand a per capita share of costs plus add-ons representing what could have been earned in alternative investments. This can exceed the total profit potential of generic firms in limited-life post-patent markets at more competitive prices and typical generic market shares. While FIFRA requires binding arbitration for these cases, it sets no cost-sharing standard. This subjects generic firms to high risk, which apparently explains why generic entry has been delayed far past patent expiration in a number of successful pesticide markets. For example, generic entry lagged patent expiration by seven years for both linuron, a leading domestic herbicide at the time, and chorothalonil, the leading U.S. fungicide (EPA 2004; Just 2006).

Another adverse impact of FIFRA occurs when a pesticide producer patents a new production process or a slightly modified product that requires a new EPA registration just before an original patent expires and then cancels its original registration. This prevents generic firms from relying on previous test data to compete with the original product while the new patent prevents competition with the new product (Just 2006). Current public data do not permit analysis of such inefficiency.

Concentration and R&D

Market concentration can also be usefully measured by innovation competition (Fulton and Giannakas 2002). For crop biotechnology, the CR4 ratio for USDA approvals of field releases of genetically engineered field crop varieties from 1990-2000 in table 2 evidence both concentration and potential barriers to entry in biotech R&D. Based on approvals, corn seed is less concentrated than soybeans and cotton. Corn seed R&D concentration has remained relatively constant at 65-80% since 1990. Soybean and cottonseed R&D fell some during the mid-1990s, but by 2000 increased to 85 and 96%, respectively. Pesticide innovation can be measured by EPA registrations of new active ingredients. From 1997-2006, the CR4 ratio was 59%. After the top five, most firms obtained only one registration and no firm obtained more than two (EPA 2004).

Soybean production cost data also suggest that genetically modified seed causes interaction between seed and pesticide markets. While data for a careful analysis are lacking, Monsanto's Roundup-Ready soybean seed appears to be responsible for both the 33 to 15% decline in pesticide cost (as one pesticide replaced several) and 25 to 36% increase in seed cost as a share of soybean operating expenses from 1996-2005.

Modeling the Effects of Concentration

The increase in industry concentration raises concerns about its potential economic impact, in particular, the trade-off between greater market efficiency and farmer and consumer benefits from increased competition versus R&D economies of scale from increased concentration. A recent study has shown that concentration in post-patent pesticide markets explains 30-50% of pesticide prices and that the benefits from competition for farmers and consumers combined are 30-90% of competitive market revenue. These effects occur largely as a transfer from individual pesticide firms to farmers and consumers as generic entry tends to lead to more competitive pricing (Just 2006). If R&D cost efficiency outweighs market power effects, then concentration may be more beneficial to society. However, the decline in EPA registrations of new active pesticide ingredients from an average of 26.6 per year in 1993-97 to 7.4 per year in 2002-6 (EPA 2004) following a period of numerous mergers calls into question the concentration effect on innovative activity for the pesticide industry over this period. Yet another effect is that concentration may lead to political economies of scale, whereby large companies are more able to influence government regulations, possibly in ways that could discourage generic entry (see papers in Just, Alston, and Zilberman 2006).

Models designed to measure oligopoly power in an industry have been proposed by Iwata (1974); Gollop and Roberts (1979); and Appelbaum (1982). Assuming firm behavior is interdependent, these studies estimate conjectural variations in production choices following the "New Empirical Industrial Organization" (NEIO), now the cornerstone of industry conduct analysis (Wann and Sexton 1992). Recent studies extend NEIO approaches to simultaneous estimation of price-taking behavior where firms have market power in both input and output markets (Just and Chern 1980; Schroeter 1988; Wann and Sexton 1992). The conjectural variation approach has been extended to distinguish market power and cost-efficiency effects of industry concentration (Azzam and Schroeter 1995). However, this analysis is limited by absence of firm-level panel data. Analysis at the industry level requires extensive time-series data on firm market shares, R&D investment, output quantities, and input and output prices, which are also lacking for the seed and pesticide industries. While the accuracy of the NEIO approach has been questioned, several remedies have been proposed, including non-parametric and Solow residual market power tests, which require somewhat less data than structural market power tests (Raper, Love, and Shumway 2007).

The specialized competition among pesticides by use rather than by crop presents further challenges for modeling the effects of regulations. When a generic firm applies for a registration, it usually must wait most of a year for the EPA approval process. With a carefully timed petition by the original entrant claiming impurities, which the EPA is bound to consider, the additional delay can easily cause the generic firm to miss an entire marketing season, which is typically only a month or two in the spring. Thus, the incentive to extend a monopoly on an individual product can delay the consequent welfare effects on farmers and consumers for a full year. Such issues of delay and penetration of generic competition can be understood only on a product-by-product basis.

Data Availability

The main limitation to effective economic analysis of the effects of industry concentration is the availability of public data for research. The absence of firm-level panel data has forced researchers to develop models at the industry level, using aggregate and undifferentiated public data. Absence of data on product markets limits discovery of concentration and its effects at the level that determines prices. Reliable analysis requires time-series data on firm market shares, R&D investment, output quantities, and prices. While conventional thinking is that such data are private and confidential, concerns about market power in regulated markets should make public observation appropriate.