Markets are said to be concentrated if a few firms hold a relatively large share of the market, and high concentration is one of the criteria used by federal antitrust authorities when they evaluate the competitive conditions of a particular market. Firms in a highly concentrated market may be able to exert market power and raise prices above a competitive level, to the detriment of buyers. However, high concentration does not necessarily imply the exertion of market power. Economic theory predicts that prices may be kept at or near competitive levels under the threat of entry by new suppliers, even in industries that are highly concentrated. Also, the market may be contestable and remain relatively competitive if potential entrants do not face costs that existing firms can avoid, there are no inherent legal barriers to entry, and entry and exit are relatively costless (i.e., there are no sunk costs).
Several economists have noted that firm entry in the U.S. seed industry may be limited by large entry costs due to high research and development investments and regulatory compliance costs as well as by the complexity of intellectual property rights. These circumstances could limit market contestability and increase the likelihood that firms exert their market power.
At the same time, other authors have noted that the presence of some market power in the U.S. seed industry may not be completely undesirable. Seed firms engaged in the development of new genetics and biotech traits are expected to charge prices above marginal costs in order to recoup the fixed costs of R&D. Without the existence or the prospect of earning prices above marginal costs due to market power, the seed firms would have no incentive to use more efficient technologies, improve product quality, or introduce new seed varieties and biotech traits. Therefore, some authors have proposed that the key question to be addressed is whether concentration and potential presence of market power in the seed industry permits firms to make profits well above those necessary to recoup their R&D investments.
In this study, we report empirical measures of price mark-ups attributable to market power in the U.S. seed industry between 1997 and 2008 — a period characterized by the vertical integration of leading multinational biotechnology firms in this industry. We then calculate the revenues from the estimated mark-ups, compare them with approximate measures of aggregate R&D expenditures in the industry, and draw conclusions about their proportionality over the period of analysis. These results provide insight on the dynamic efficiency of the industry.
Structural Evolution
Understanding the structural evolution of the U.S. seed industry can help put in context the current considerations of concentration and market power. Since the emergence of a commercial seed industry in the United States over 150 years ago, assets have changed hands frequently and most of today's leading seed companies are the products of mergers and acquisitions. Until the late 1960s, assets in the seed industry were primarily traded among seed companies. Starting in the 1970s, however, petrochemical and pharmaceutical multinational companies became primary acquirers. Much of this activity has been traced to the introduction of the Plant Variety Protection Act of 1970, which promised to increase returns from plant research and attracted R&D-minded multinationals. However, this wave of mergers and acquisitions had little subsequent discernible impact on the structure of the seed industry because the petrochemical and pharmaceutical multinationals mainly acquired and merged small and medium-size regional seed companies, which lost market share over time. Both independent market leaders (e.g., Pioneer, Dekalb) and smaller regional and local seed companies maintained their market positions despite the significant capital resources of the new multinational entrants.
Significant consolidation in the U.S. seed industry did not occur because the cost advantages of operating at higher production levels (i.e., economies of scale) were limited and barriers to entry were rather low. In principle, large investments in breeding research and specialized know-how implied that potential scale economies could be significant. Indeed, only a few large seed companies maintained extensive breeding efforts and developed proprietary varieties. Further, substantial time lags between genetic research and commercialization of improved varieties created potential entry barriers. Yet the need for geographic adaptation of all new seed varieties placed bounds on R&D scale economies. Importantly, it also created commercial opportunities for specialized breeding (foundation seed) companies, which minimized entry barriers. They developed and broadly licensed proprietary varieties to a large number of small regional and local seed companies, which in turn adapted them to their local conditions.
The potential economies of scale in distribution and marketing of seeds were even more limited. With crop yields being the primary differentiating factor among seed brands, smaller regional companies could effectively compete against much larger national and multinational firms with extensive marketing and distribution networks. The regional seed companies produced and distributed a small number of varieties within limited geographic regions where they demonstrated competitive yield performance. The regional firms were often relatively more profitable as they were able to avoid the excessive inventory costs that frequently hampered the national firms.
By the early 1990s, many of the multinational firms that led the mergers and acquisitions activity in the previous two decades had divested their seed assets. A handful of multinationals with significant investments in biotechnology, however, maintained or expanded their presence in the U.S. seed industry.
The 1990s | Since the advent of agricultural biotechnology research in the mid-1970s, superior seed genetics (germplasm) were recognized as an essential complementary asset for delivering new biotechnologies. For the commercial introduction of a new biotech product to be successful, the intellectual property, the biotechnology know-how, and the seed germplasm base had to be coordinated. This need for coordination led to a wave of strategic mergers and acquisitions.
Strategies to vertically integrate seed and biotechnology assets are as old as the agricultural biotechnology industry itself. For example, biotechnology pioneers like David Padwa (founder of the early biotechnology start-up Agrigenetics) began to acquire regional seed companies in 1975 in order to finance biotechnology research and deliver its products to the market. Other leading biotechnology start-ups (e.g., Calgene, Biotechnica International, and Mycogen) had similar strategies and acquired a number of firms in the seed industry in the 1980s and 1990s. Multinationals Monsanto and DuPont, which acquired the two largest independent seed firms, were latecomers in the seed industry. In the late 1990s, both of those companies reversed their longstanding strategies to become technology providers in favor of becoming more vertically integrated firms.
Vertical integration into the seed business and ownership of germplasm became a primary strategy of agricultural biotechnology firms for profiting from their innovation.
One reason that vertical integration became a dominant strategy among biotech companies was that the first agricultural biotech products to reach the market demonstrated a low degree of appropriability. That is, biotech companies were unable to secure appropriate returns on their R&D investments through relationships with seed companies governed only by contract. Intellectual property rights overlapped and were heavily contested. A number of multiparty intellectual property disputes for key technologies (e.g., insect and herbicide resistance) reached the courts and amply demonstrated the lack of definitive intellectual property rights among biotechnology leaders. Similarly, a relatively large number of biotechnology companies pursuing similar commercial biotech products provided evidence of significant imitation.
High-quality proprietary seed germplasm was therefore in a relatively strong position. Given short supplies and significant development lags, germplasm could command a significant share of the innovation profits forthcoming from weakly appropriable agricultural biotechnologies. Under such conditions, vertical integration into the seed business and ownership of germplasm became a primary strategy of agricultural biotechnology firms for profiting from their innovation. Of course, some of the prospective profits from biotechnology were transferred to seed assets and capitalized in the lofty prices paid for firms in relevant mergers and acquisitions.
The low appropriability position of agricultural biotechnology relative to complementary germplasm assets was one economic factor arguing for biotechnology firms vertically integrating into the seed business. Another factor was the relatively high transaction cost for coordinating biotechnology and germplasm through contracts. Early in the innovation cycle, there were significant impediments to structuring complete contracts that would distribute value appropriately among contracting parties and motivate appropriate behavior. Because of significant time lags in the development of high-yielding germplasm with desirable traits, contracts that coordinated biotechnology and seed assets had to be constructed years before reaching the market. Such contracts were necessarily incomplete, as it was impossible to predict all relevant technological and commercial possibilities being created. Accurate valuations of the individual contributions of the interdependent biotechnologies and germplasm to the final technological advance (e.g., higher yields) were also difficult to assess. Incomplete contracts would predictably lead to costly renegotiations, disputes, and delays. On the other hand, ownership of both technological and seed assets allowed firms to bypass such costs, providing additional economic reasoning for vertical integration of such assets.
Structural change and concentration | Motives aside, the vertical integration of the biotechnology firms substantially changed the ownership structure of the U.S. seed industry. A number of medium and large independent seed firms (e.g., Pioneer, DeKalb, Northup King, and Golden Harvest) became part of integrated multinational firms (e.g., DuPont, Monsanto, and Syngenta) with assets in biotechnology and other markets.
While the changes in the ownership structure were drastic, the changes in the level of concentration of the U.S. seed industry were quite moderate. Since the early 1990s, the four-firm concentration ratio and the eight-firm concentration ratio have been fairly stable. Other measures of industry concentration also indicate similar patterns in the U.S. seed industry. The Herfindahl-Hirschman Index, which is the sum of squared market shares for all firms in an industry, takes values between zero and 10,000, and higher values indicate increasing market concentration. As shown in Figure 1, the index values for the U.S. seed industry over the period 1992–2008 have stayed close to 1800, which is typically assumed to separate moderate and high levels of concentration in industries. This threshold level for HHI was reached or exceeded in 1992, 1994, 1996, 1999, 2000, 2007, and 2008.
Under the moderate to high levels of industry concentration depicted in Figure 1, two key questions emerge: Do firms in the U.S. seed industry have significant market power? If so, to what extent do they exercise that power? To answer those questions, we first review the existing literature on this topic in the next section. Then, we present our own estimates of market power and the level it is exercised in the U.S. seed industry.
Empirical Estimates of Market Power
There is limited empirical evidence on the presence of market power in the U.S. seed industry. A handful of recent studies have examined the pricing decisions of seed firms based on new empirical industrial organization–type models of the firm's profit function. In a 2002 paper, Fernandez-Cornejo and Spielman constructed a profit function for a representative seed firm and used the profit-maximizing conditions to derive a model of the firm's price-cost margin as a function of the industry HHI statistic, cost indices, the responsiveness of buyers to changes in seed prices (i.e., the elasticity of demand), and the responsiveness of seed firms to the prices charged by other seed firms (i.e., the conjectural elasticity). Based on industry-level data, the authors found that the direct market power effect on the price-cost margin was positive but not significantly different from zero. Also, an increase in market power tended to reduce the processing costs and R&D costs, but the latter effect was not significantly different from zero. Thus, the authors concluded that the primary effect of increasing market power on seed margins is the improved processing cost efficiency.
In a 2008 paper, Shi, Chavas, and Stiegert used farm-level observations on seed price, quantity, and location from 2000 to 2007 to estimate a model of the implicit value associated with individual traits in hybrid seed corn. The model incorporates a generalized form of the HHI statistic to account for the local pricing effects associated with differentiated (i.e., multiple trait) products in the corn seed market. The authors found that three of the four main biotech traits (corn borer and rootworm resistance and two forms of herbicide tolerance) attract significant price premiums and that roughly 8 percent of the price of seed corn is associated with market power held by the seed companies.