Incentives to reduce crop trait durability.

In Europe and North America, property rights in the seed sector are based on the Plant Breeder's Rights (PBRs), which grant the plant breeder exclusive rights to a new variety of seed. However, PBRs also allow farmers to use the harvest of one production cycle to self-produce seed for the next. A farmer who buys seed with valuable genetic traits (e.g., productivity, resistance to pests, fitness to a specific climate) has the opportunity to produce crops with the same traits during the next production cycle. Therefore, by self-producing, farmers directly compete with seed dealers. In this sense, crop traits can be considered as durable goods.

In practice, two types of mechanisms can moderate the competition from farmers. The first mechanism is based on technology. To avoid competition from farmers who self-produce, seed dealers can reduce the durability of crop traits. If the quality of the trait decreases dramatically from one generation to the next, self-production becomes economically uninteresting. This can be achieved by developing hybrid seed (as opposed to inbred line seed or "variety"). (1) This strategy has been followed for corn since the 1950s, sunflowers during the 1970s, and more recently, for canola and wheat. Table 1 exhibits the importance of self-produced seed and hybrid seed for major crops in France. Although hybrid seeds dominate the markets for corn and sunflowers, the picture is more contrasted for canola, wheat and barley. Hybrid canola has been developed since the 1990s, but it represents only one-third of the market. Most of the seed companies have research programs on both types of seed and regularly introduce new hybrid and inbred line canola. Hybrid wheat has been developed and sold in France during the last ten years and now represents 100,000 ha. (2,3) For barley, although inbred line seeds still dominate the market, hybrid technology is also available. (4) From a technological viewpoint, developing hybrids for self-pollinated crops (barley and wheat) is feasible, but entails higher production costs. Yet research in genetics with recent advances in biotechnology can lead to more efficient hybridization techniques (5) or to alternative techniques; e.g., Genetic Use Restriction Technology makes harvested seeds sterile (Goeschl and Swanson 2003).

The second mechanism is institutional and relies on intellectual property rights (IPRs) in the seed sector. In Europe, the EU directive 2100/94 (article 14) indicates that a farmer who self-produces seed should pay a license fee. This directive has been applied in France for wheat since 2001, and leads self-producing farmers to pay 4-5 Euros per ha. (6) A large portion of the collected fees is assigned to the innovator who created the seed varieties. (7)

Therefore, although seed producers cannot legally prevent self-production, they can technologically discourage it by selling nondurable seed. In this context, we analyze the pricing strategies of an inbred line monopolist when farmers can self-produce, and her decision to reduce crop durability by switching to hybrid seed. We also investigate the impact of the introduction of a self-producing fee and its welfare implication.

In our setting, farmers can only self-produce inbred line seed (with heterogenous self-production costs). We assume that the seed is produced by a monopolist who is more efficient in producing seed than farmers. Self-production is thus suboptimal, but it appears to compete with powerful (monopolistic) seed dealers. We also assume that hybrid seeds are more costly to produce (by the seed producer), but that once planted they are more productive (for farmers) than inbred line seed. Therefore, we impose no a priori technological domination of one type of seed over the other, as this will become a main parameter of our analysis.

We first consider the case of a monopolist who only produces inbred line seed. In this context, we show that the monopolist sells seed as a durable good to farmers who inefficiently self-produce. The introduction of a fee increases efficiency by making self-production less attractive. It therefore renders the nondurable good strategy more profitable, and assigns efficiency gains to the monopolist. Second, if the monopolist can produce hybrid seed instead of inbred line seed, we show that she has an incentive to introduce technologically dominated hybrid seed (i.e., hybrid seed is less productive than the inbred) in order to extract more surplus from farmers. The monopolist, indeed, decides to inefficiently shorten the durability of the crop. The introduction of a self-production fee reduces the incentive to switch to inefficient hybrid seed.

Finally, two remarks should be made concerning our modeling framework. First, our focus is to study pricing strategies in the seed industry in the presence of IPRs. Seed companies generally invest more than 10% of their sales in research, driven by the prospect of expected market power provided by innovation. This is why we assume that the seed is supplied by a monopoly rather than a competitive industry, even if a competitive industry would, ex post, be more efficient. Second, we adopt a very simplified representation of the decision to switch from inbred line seed to hybrid seed. In reality, it is a long-term decision, as developing hybrid seed requires the launching of different plant breeding programs and the development of different production techniques. There is a complex transition process that is not accounted for here. However, a seed company will commit to such a transition only if she anticipates higher profits in the future. Hence, our analysis is restricted to a necessary condition that the seed producer decides to switch from an inbred line to hybrid seed.

Related Literature

Our contribution is related to the literature on durable goods. The Coase conjecture states that monopoly pricing of durable goods leads to exhaustion of the monopoly rent. This is due to the fact that the monopolist cannot commit to not reducing prices in the future. She would like to commit to high prices (e.g., the monopoly price) but later is tempted to cut prices to attract the residual demand. Expecting this behavior, consumers will buy at marginal cost at most (see Coase 1972; Bulow 1982; Gul, Sonnenschein, and Wilson 1986; Waldman 2003). Here the problem is different, because the good can be sold during each period as a nondurable good to be used by farmers for only one period. This is indeed what the monopolist would like to do: sell seed in each period at the per-period monopoly price. However, PBRs introduce an outside option to farmers to produce their own seed. Future seed prices are thus bounded by self-production costs. When the costs are low enough, the monopolist prefers to sell seed as a durable good (used during several periods) at a price equal to the multiperiod benefit, net of the farmer's self-production cost. Doing so, she can indirectly appropriate part of the revenue from self-produced seed.

In a different context, Liebowitz (1985) provides evidence of the indirect appropriation of revenue from consumers who do not directly purchase journals, but rather copy them. Allowing for product reproduction entails a loss of property rights. It is similar to the loss due to seed self-production, with the difference that the user of the "copied" seed is the farmer who purchased it, and seeds are nondurable when not "copied." Related, Takeyama (1997) shows that copying is harmful for the monopolist if she can commit on future prices (like in the present article), but might help her to mitigate Coase's commitment problem.

The self-production cost is the price paid by users for extending the benefit of the durable good to the next period. It is, thus, similar to maintenance expenditures for deteriorated durable goods. Schmalensee (1974) shows that consumers tend to over-maintain their used units of goods when maintenance is priced at marginal cost (e.g., due to perfect competition in the maintenance industry), while new units are priced above marginal cost. Similarly here, farmers inefficiently self-produce because the monopolist sets the price above the self-production cost. A competitive seed market would restore efficiency by pricing seed below self-production costs. One way to avoid self-production inefficiency (as well as the time inconsistency problem pointed out by Coase 1972; Bulow 1982; and others) is to monopolize the maintenance market (Morita and Waldman 2004). In our case this means to monopolize seed production, but this violates PBRs.

The literature on product durability was influenced by Swan's independence result (Swan 1970, 1971) that states that a monopolist provides socially optimal durability. It requires that the good does not depreciate over time. In our framework, an interpretation of the relative inefficiency of self-production is a loss of return due to gene contamination or lower germination. In this case, the return provided by the seed depreciates when self-produced. Waldman (1996a) shows that with quality deterioration and heterogeneous consumers, durability is underprovided. Hendel and Lizzeri (1999) generalize and extend this result when there exists a secondary market for used goods. Similarly here, the seed dealer introduces less efficient nondurable hybrid seed, although perfect competition would restore efficiency.