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CONTENTS
Optimal Advertising and Free-Riding Under
a Voluntary Beef Checkoff Program
Tables 1 - 4
Next Meeting
NEC-63
Fall 2004
Sept. 30-Oct. 1, 2004
Mr Archie MacDonald
Ms. Nancy Dahab
Dairy Farmers of Canada
Ottawa, Ontario K1P 5E7
Optimal Advertising Investments: Size, Sourcing and Scope
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Optimal Advertising and Free-Riding Under a
Voluntary Beef Checkoff Program
Chanjin Chung, Shida R. Henneberry and Emilio Tostao
Oklahoma State University
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The beef checkoff program began in 1987 and has collected $1 for each
head of cattle marketed in the U.S. and a $1 per head equivalent fee for
imported beef. The mandatory beef checkoff program has recently faced
constitutional challenges. Since the mandatory checkoff fees are used
for collective advertising and promotion efforts, some have argued this
violates individual’s right to free speech. There have been many
lower court legal rulings on this issue and the U.S. Supreme Court is
expected to rule soon on the fate of this mandatory checkoff program.
Despite these lawsuits against the beef checkoff program, almost two-thirds
of beef cattle and dairy cattle producers support the current program
according to a recent survey by the Cattlemen’s Beef Promotion and
Research Board. The survey results indicate that some type of voluntary
program could emerge if the court eliminates the mandatory program. Immediate
questions surrounding the possible voluntary program include: If the program
changes from mandatory to voluntary participation, can the collected checkoff
funds be large enough to finance the ongoing advertising and promotion
programs? Will this spending on advertising and promotion be optimal in
markets where retail and processing sectors are imperfectly competitive?
What would be the extent of the expected free-rider problem? To our knowledge,
no study has addressed these questions for the beef industry.
The objective of this study is to examine optimal advertising and free-rider
problems in the U.S. beef industry under a possible voluntary checkoff
program. The study analyzes whether the collected checkoff funds will
be sufficient enough to reach the optimal advertising expenditure in markets
where retailers and processors exercise oligopoly and oligopsony power.
If the collected funds from the voluntary checkoff program will not be
sufficient to cover the optimal level of advertising expenditures, the
producer loss (caused by the reduced advertising expenditures from the
current level) will be estimated. Furthermore, the study estimates the
extent of free-ridership gained by domestic producers and importers. There
will be a free-rider problem when some domestic producers benefit from
generic advertising programs without paying checkoff dollars, and a similar
problem will occur when importers do not pay checkoff fees voluntarily.
Data from the past five years (1998-2002) demonstrate that U.S. imports
averaged over $2 billion annually for beef (fresh, chilled, frozen) from
various sources mainly Canada and Australia. The imports account for about
ten percent of total domestic consumption.
Optimal Advertising and Free-Riding
Several studies in the literature have examined optimal investment in
advertising. Although results of these studies vary under alternative
market structures, a basic concept of analytical derivations has been
that the optimality of advertising investment is a function of total sales,
elasticities of demand, supply, and advertising, and opportunity cost
of alternative investments. We develop an optimal advertising model with
consideration of trade and imperfectly competitive market structure in
processing and retailing sectors. In this framework, retailers' and processors'
market power are allowed in both procuring raw materials and selling products
(a complete derivation of the model is available upon request).
The newly derived optimal rule is consistent with those in the literature
when an integrated retail and processing sector is assumed and international
trade is restricted to zero. The optimal advertising rule indicates that
as retailers’ oligopoly power increases the optimal advertising intensity
decreases. Retailers’ oligopsony power as well as processors’
market power are not relevant to the determination of optimal advertising
intensity. The optimal advertising rule also suggests that as import supply
elasticity becomes more elastic, the optimal intensity decreases. Consistent
with previous studies, as demand becomes more elastic, the optimal advertising
intensity decreases while the advertising intensity increases as the advertising
effectiveness increases.
The free-rider effect is measured as the amount of farm price decrease
due to the increased production from nonparticipating producers. The extent
of the free-rider problem is estimated via numeric simulations in the
next section.
Application to a Voluntary Beef Checkoff Program
The optimal advertising rule derived in this study is applied to a possible
voluntary checkoff program for the U.S. beef industry. We first examine
if advertising expenditures under the voluntary checkoff program would
be optimal. If advertising expenditures under the proposed voluntary checkoff
program are sub-optimal, the potential producer loss would be estimated.
Finally, the free-riding problem is also numerically estimated.
Advertising intensities derived from a range of parameters
are reported in Table 1. Parameter values are
obtained from previous studies. In Table 1,  ,
 , 
and  are
the advertising elasticity, the price elasticity of demand; the import
elasticity, and the conjectural elasticity reflecting retailers’
oligopoly power, respectively. Simulation results indicate that the U.S.
beef industry would be under-invested under the voluntary programs. The
simulated optimal advertising intensities are much greater than the current
advertising intensity, 0.0005. Case 1 assumes competitive retail and processing
sectors without consideration of trade. Results show that the optimal
advertising intensity increases as advertising effectiveness increases
while it decreases as demand is more elastic. Case 2 considers imperfectly
competitive retail and processing sectors. Since retailers' oligopsony
power and processors’ market power are not relevant to the estimation
of advertising intensity, only retailers’ oligopoly power is considered.
As the retail market becomes more imperfectly competitive, the optimal
advertising intensity becomes smaller. Case 3 considers both market power
and trade parameters. The optimal advertising intensity decreases as import
supply elasticity becomes more elastic. In most cases results show that
estimated optimal advertising intensities are higher than current advertising-sales
ratio except a few cases where advertising is extremely ineffective and
import supply elasticity is highly elastic under the assumption of a highly
imperfectly competitive retail market.
To conduct numeric simulations on impacts of the voluntary checkoff program
on producer benefit, we assume linear functional forms for retail demand
and farm supply functions while assuming a perfectly elastic supply function
for the processing sector. Producer benefit from advertising is measured
as a change in producer surplus. We estimate change
in producer benefits for three different levels of voluntary participation
rates, 55%, 70%, and 85%, and results are reported in Table
2 and Table 3. Table 2 presents changes
in producer benefits ( PS)
with no consideration of trade and market power in retailing and processing
sectors. Results indicate that producers may lose 27 to 72 percent of
current advertising benefit, and the extent of loss increases as the advertising
effectiveness increases. Table 3 shows that when market power and trade
parameters are incorporated in the model, the expected producer loss increases
as the retailing and processing market power increases. Here  ,
 , and
τ represent the conjectural elasticity reflecting the processors'
oligopsony power, the farm-level supply elasticity, and the import share
from total consumption, respectively. When retailing
and processing sectors are imperfectly competitive, the expected producer
loss tends to increase, ranging from 27 to 86 percent of current benefit.
Finally, Table 4 reports the amount of farm
price decrease due to the increased production from non-participating
producers. The free-riding problem diminishes as market power in retailing
and processing sectors increases. Results show that the free-riding from
non-participating producers would lower the market price by 5 to 20 percent.
Discussions and Conclusions
This study develops a framework for the analysis of optimal advertising
and the free-rider problem. Previous studies in the literature were extended
in two ways. First, the new framework allows retailers’ oligopsony
power separately from processor’s market power. Second, to examine
the free-rider problem, we introduce the trade component to the model
and divide domestic producers into two groups: participating producers
and non-participating producers in the possible voluntary program. Then,
the free-rider problem was measured as the amount of domestic price decrease
due to the increased production from importers and non-participating producers.
Simulation results for the U.S. beef industry indicate that the industry
has under-invested in advertising and promotion programs except for a
few cases where advertising effectiveness is extremely low (0.0005), the
degree of imperfect competition is exceptionally high (0.3), and import
supply elasticity is highly elastic (higher than 5). The possible voluntary
program is expected to further under-invest in advertising and promotion
programs, and as a result, producers are likely to lose 27 to 86 percent
of current promotion benefits. The free-riding from non-participating
producers would lower market price by 5 to 20 percent.
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