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Retail View: Research indicates drought will cause retail price increases

A business school professor at Arizona State University has finalized some research about price elasticity in the produce department that indicates specific commodities could see a significant retail price increase this year because of the drought.

Using scan data provided by the Nielsen Perishables Group, a well-known consulting firm that operates in the fresh produce sector, Professor Timothy Richards, chairman at the Morrison School of Agribusiness within ASU’s W.P. Carey School of Business, showed that some fresh produce tends to rack up steady sales regardless of price increases.

He reasoned that these items are most likely to increase in price at retail as the drought reduces supplies yet consumers continue to create demand for the item.

“You’re probably going to see the biggest produce price increases on avocados, berries, broccoli, grapes, lettuce, melons, peppers, tomatoes and packaged salads,” he said. “We can expect to see the biggest percentage jumps in prices for avocados and lettuce, 28 percent and 34 percent, respectively. People are the least price-sensitive when it comes to those items, and they’re more willing to pay what it takes to get them.”

He predicted that avocados would likely go up 17 to 35 cents at retail to as much as $1.60 each.  He said lettuce would be selling at retail for as much as $2.44 per head. For berries, he estimated a rise of 21 cents to 43 cents to $3.46 for presumably a one-pound clamshell offering. He predicted broccoli would rise 10-20 percent to as much $2.18 per pound. Richards said fresh grapes could climb to close to $3 per pound, which would represent more than a 15 percent hike.

Packaged salads, peppers and tomatoes also could see a double-digit increase, according to this university professor, if the drought cuts supplies by as much as 20 percent.

Richards’ calculations were based on analysis of the scan data showing that the demand for fresh produce items varies greatly as price increases. And price increases also vary when supplies drop.

With avocados, for example, Richards’ research showed that a 1 percent increase in price resulted in far less than a 1 percent decrease in volume. Conversely, for packaged salads a 1 percent increase in price resulted in far greater than a 1 percent decrease in volume.

Consequently, a 1 percent drop in supplies for avocados results in a price increase far greater statistically than 1 percent. For packaged salads, a 1 percent drop in supply resulted in a price increase of far less than 1 percent.

Extrapolating those numbers, for avocados a 10 percent decrease in volume will result in an increase in price closer to 20 percent as consumers continue to buy the product, driving up demand and increasing the price.

Avocados are price-inelastic, meaning price increases lower volume to a lesser degree. For packaged salads, the reverse occurs. An increase in price affects sales to a greater degree. Consequently, a 10 percent increase in price will result in a loss of sales greater than 15 percent. And a 10 percent decrease in volume will only result in a 6.2 percent price increase, according to Richards’ research, which received widespread play in the mainstream media.

In the commodities that were in his report — lettuce, avocados, broccoli and grapes — all were price-inelastic, with price increases greater than the drop in volume.

Tomatoes, melons, peppers, berries, sweet corn and packaged salads all registered price increases of less than 10 percent with a 10 percent decrease in volume. Each of these are price-elastic.

Although this part of his report was based on research, some of Richards’ conclusions about individual commodities were suppositions that did not take all factors into account.

For example, using industry estimates, Richards reported that from 500,000 to 1 million acres of cropland in California will be fallowed this year because of the drought. He said California has about 4.9 million acres of crop production, including field crops, fruits and vegetables.  

Consequently, depending upon how much is fallowed, he reasoned that a 500,000 to 1 million acreage reduction would result in a 10-20 percent across the board reduction in volume.  

Of course, in reality, the reduction in acreage is not happening across the board. There is far more land being fallowed in the San Joaquin Valley than in Coastal California. The San Joaquin Valley is heavily weighted to field crops and permanent crops. In only rare circumstances are growers letting their permanent crops go without water.

A vast majority of land being fallowed is for field crops. Though there is certainly some reduction in vegetable crops, it is nowhere near even the 10 percent lower end of his projections.

In addition, certain crops he discussed, such as avocados, are far more dependent on Mother Nature than the drought in determining annual volume.

Typically avocado trees are alternate-bearing. In 2013, California producers sent close to 500 million pounds of avocados to market. This year’s crop is somewhere around 40 percent less because of the alternate-bearing nature of the crop — not because of the drought.

While lack of water and labor, as Richards cites, may have an effect on volume to a limited degree, that effect pales in comparison to what influence Mother Nature is inflicting.

Long term, of course, the cost and availability of water for avocado production is a huge concern, but on a short-term basis growers will do everything they can to irrigate the trees in the ground.

Richards also cited lettuce as being not very price-sensitive, meaning a drop in volume could result in a significant increase in price.

But for the most part, the production area for lettuce is not where the effects from the drought are being most severely felt. No industry representatives are anticipating a 10-20 percent drop in lettuce supplies this year.

In the same general arena are packaged salads.  Richards found that packaged salad prices do not fluctuate as much as volume does at retail. That no doubt is a function of the contract pricing model that is in place for much of the packaged salad production. With an annual pricing contracts, price just doesn’t fluctuate.

Richards’ main premise is accurate: The drought across the western half of the United States is causing supplies of some fresh produce — mostly vegetables — to be less than normal, which will and does affect retail prices across the country.  

How it will affect individual crops is a very complex situation with each crop having a different set of factors playing into the equation.