A publication of the Agricultural & Applied The magazine of food, , and resource issues Economics Association 1st Quarter 2015 • 30(1)

U.S. Implications of the Smithfield Acquisition by Shuanghui Tian Xia JEL Classification: Q13, Q17, L13 Keywords: Agricultural Exports, , Food Safety, Market Competition,

The purchase of , the world’s largest hog U.S. pork exports to mainland China have increased from producer and pork processor, by China’s top pork products 2.33 million pounds in 1996 to 496.59 million pounds company, Shuanghui International Holdings Ltd., stirred in 2013, and the average annual growth rate is 34.7% concerns about domestic pork supplies and food safety in (USDA, 2014b). Chinese pork production and consump- the United States. The Smithfield acquisition will cause im- tion increased from 50.71 and 50.8 million metric tons in portant changes in U.S. pork exports to China, consumer 2010 to 55.6 and 56.1 million metric tons, respectively, concerns about food safety of pork products, and competi- in 2013. Imports accounted for only 0.8-1.4% of Chinese tion in Chinese and U.S. pork markets. pork consumption during the 2010-2013 period (USDA, 2014c). So China has been satisfying its increased demand U.S. Exports to China primarily through increased domestic production. How- Chinese demand for meat products including pork has ever, it will be difficult for China to maintain this tradition continued to increase as the per capita disposable income of self-sufficiency in pork as feed costs rise, and land for in China has kept rising over the past several decades (Fig- additional pork production becomes scarce and expensive ure 1a and 1b). In 2012, the per capita pork consump- (Gale, Marti, and Hu, 2012). China will increase its reli- tion of Chinese urban residents (21.23 kilograms or 46.8 ance on imports to satisfy its increasing demand for pork pounds) was similar to U.S. per capita consumption (45.9 in the future. pounds) while Chinese rural residents’ per capita pork The United States exported 638.8 million pounds of consumption (14.4 kilograms or 31.75 pounds) was sig- pork to China in 2012, which accounted for 39.7% of Chi- nificantly lower than the U.S. consumption level (National nese pork imports and 0.54% of Chinese pork consump- Bureau of Statistics of China (NBSC), 2014); U.S. Depart- tion (USDA, 2014b and 2014c). Smithfield’s pork produc- ment of (USDA), 2014a). In addition, Chi- tion accounted for 27.9% of total U.S. production, and nese consumers have a stronger taste preference towards about 4.5% of Smithfield’s pork products were exported pork than meat products from other origins. Pork to China in 2012. Smithfield’s pork exports to China ac- accounted for 59% of meat consumption by Chinese ur- counted for 18.2% of total Chinese imports and 0.25% of ban residents and 69% for rural residents in 2012 (NBSC, Chinese pork consumption (Smithfield Foods, 2012; Mat- 2014). Because the income of Chinese residents will con- tioli, Cimilluca, and Kesmodel, 2013; and USDA, 2014c). tinue to increase and pork is their preferred meat, Chinese Most of Smithfield’s exports to China have been offal; one demand for pork has significant growth potential. To meet objective of the merger is to boost exports of muscle meat. the rising demand, Chinese producers have expanded their China bans the use of a feed additive known as ractopa- production and China has imported more pork from other mine in pork production. -free pork prod- countries, especially the United States. Figure 2 shows that ucts account for about 40% of Smithfield’s production

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1 CHOICES 1st Quarter 2015 • 30(1) AAEA-0115-172 (Hayes, 2013). One import regula- Figure 1a: Per Capita Disposable Income of Chinese Urban and Rural tion is China’s restriction on the use Residents (Chinese Yuan, 1978-2012). of Codex-approved veterinary drugs in hog production (Stuart and Fritz, 2013). In August 2014, China an- nounced a ban on pork imports from six U.S. processing plants and six cold storage facilities due to the presence of ractopamine in their pork prod- ucts (Waters and Davis, 2014). Due to high domestic production costs and import protections, hog and pork prices in Chinese markets are usually much higher than in U.S. markets. For example, the hog price in China Source: National Bureau of Statistics of China, 2014. was 40% to 100% higher than that in the United States during the time Figure 1b: Per Capita Disposable Income of Chinese Urban and Rural period from January 2010 to July Residents (U.S. Dollar, 1978-2012). 2013 (U.S. Meat Export Federation, 2014). The acquisition of Smithfield by Shuanghui can lead to more U.S. pork exports to China through four channels. First, the acquisition can give an incentive to the Chinese government to allow more pork imports from the United States. After Smithfield became a subsidiary of a Chinese company, future pork imports from the United States will be treated as Source: National Bureau of Statistics of China, 2014; Fxtop Company, 2014. less threatening to the policy goal of Figure 2: U.S. Pork Exports to China (million pounds, 1996-2013). Chinese food self-sufficiency and the protection of its domestic producers. Thus, the Chinese government may gradually relax some restrictions and lower import duties on pork imports from the United States. Second, the major purpose of the acquisition was to bring more U.S. meat products to China. Shuanghui chairman Wan Long indicated this purpose clearly in the announcement Source: U.S. Department of Agriculture, 2014b. of the Smithfield deal (Gara, 2013). Chinese consumers’ preferences for (Bloomberg News, 2013). If Smith- exports to China. taste and freshness of meat products field exports all its ractopamine-free To protect domestic pork produc- are different from those of U.S. con- pork products to China, its exports ers and maintain food self-sufficiency, sumers (Anderson et al., 2011; and to China will increase by 788% and the Chinese government has used Oh and See, 2012). However, mostly account for 2.2% of Chinese pork various measures including import due to various safety issues and scan- consumption. Collectively, these tariffs, regulations as potential techni- dals surrounding some Chinese food numbers indicate there is significant cal barriers to trade, and subsidies to products, imported food products potential for Smithfield and other support production and limit imports from developed countries, such as U.S. pork companies to increase their

2 CHOICES 4th Quarter 2015 • 30(1) U.S. pork products, are viewed as increase Smithfield’s exports of pork supply of imported products from the higher quality products and receive byproducts to China. Shuanghui United States will reduce the prices positive receptions in Chinese mar- will help Smithfield design the pork of U.S. pork products in Chinese kets (Ortega, Wang, and Wu, 2009; byproducts better suited for Chinese markets while more demand due to Wang, 2012; and Jin and Zhang, consumers so that more of Smith- income growth and the new, coordi- 2014). Because Chinese consumers field’s byproducts will be exported to nated selling strategy of the merged have become increasingly conscious China. company will raise the prices so that about the safety and quality of food More U.S. exports to China has the net price effect will depend on the products, the merged company has an implications for U.S. producers and relative magnitudes of these two op- incentive to increase the volume and consumers. Pork prices in U.S. mar- posite effects. However, the prices of share of the exports of Smithfield’s kets will increase. A potentially in- U.S. pork products in Chinese mar- pork products to China and reduce teresting aspect is that, when U.S. kets will continue to be higher than the share of Shuanghui’s lower-qual- firms obtain additional revenue from the prices in U.S. markets. Larger to- ity Chinese products in the merged increased sales of pork byproducts tal volume of U.S pork products sold company’s total sales in Chinese mar- to China, they may be more willing in U.S. and Chinese markets—and kets. The coordination of these deci- to accept lower prices of pork meat higher pork prices in U.S. markets— sions did not exist before the merger. products in U.S. markets, compared will lead to more demand and higher Third, Shuanghui’s distribution with the pre-acquisition price levels. prices of hogs in U.S. markets. U.S. network and market information in However, this negative price effect consumers will be affected by changes China will significantly help increase will be outweighed by the positive in pork prices. More exports of U.S. the sales of Smithfield’s pork products effect on U.S. pork meat prices of pork products to China will reduce in China. Shuanghui is the largest more exports of U.S. pork products the pork supply in U.S. markets. pork producer in China and slaugh- to China. The prices of U.S. pork However, hog and pork producers in ters more than 15 million a products in Chinese markets will be the United States will also respond by year. Shuanghui has meat processing affected by more supply of imported expanding their production, which plants in 18 of 34 province-level ad- products from the United States; will increase the market supply. So ministrative divisions and more than more demand due to income growth the pork prices in U.S. markets will 300 distribution and marketing cen- in China; and the new, coordinated rise due to more exports to China, ters in 31 province-level divisions of selling strategy of the merged com- but the increase will be limited. China. Shuanghui was set up in 1958 pany for two types of differentiated and has accumulated tremendous products—higher-quality, imported Food Safety information and knowledge about products from Smithfield and lower- U.S. consumers may have more Chinese consumers (Shuanghui De- quality, domestic products from Sh- food safety concerns about pork prod- velopment, 2014). Smithfield’s pork uanghui’s plants in China. The larger ucts, especially Smithfield’s products, exports to China will benefit from Sh- uanghui’s network and information. Table 1. Four-Firm Concentration of U.S. Pork-Packing Industry and Number of U.S. Hog Fourth, more byproducts from SlaughterTable 1. Plants Four-Firm Concentration of U.S. Pork-Packing Industry and Number of U.S. Hog Slaughter Plan pork production will be exported to Year Four-Firm Concentration (%) Number of Slaughter Plants China after the acquisition. There are 1980 34 huge taste differences of pork byprod- 1995 46 ucts between U.S. and Chinese con- 2000 56 sumers. Various byproducts such as 2001 57 feet, ears, stomachs, livers, and intes- 2002 55 175 tines are widely used in Chinese cui- 2003 64 154 sine. The market values of these by- 2004 64 166 products are much higher in Chinese 2005 64 163 markets than in U.S. markets. After 2006 61 159 the acquisition, the coordination be- 2007 65 165 tween the decision on Smithfield’s 2008 65 126 exports to China and the decision 2009 63 134 on Shuanghui’s supply of Chinese 2010 65 129 products in Chinese markets will 2011 64 136 also cause the merged company to Source: USDA USDA Grain Grain Inspection Inspection Packers andPackers Stockyards and Administration,Stockyards Administration, 2012 and 2013. 2012 and 2013.

3 CHOICES 4th Quarter 2015 • 30(1) after the acquisition by Shuanghui. fluctuations in prices and sales in U.S. coordination of selling strategies The concerns come from the nega- pork markets. of lower-quality Chinese products tive impression of U.S. consumers from Shuanghui and higher-quality about China’s food industry overall Market Competition imports from Smithfield in Chi- rather than Shuanghui itself. Many The four-firm concentration ra- nese markets in order to compete food safety incidents have occurred in tio of the U.S. pork-packing indus- with other companies. At the same China since its economic reforms in try has increased from 34% in 1980 time, Smithfield’s selling strategies in the late 1970s, and especially in the to 64% in 2012, and the number U.S. markets will be affected by this recent decade. The one receiving the of hog slaughter plants has declined merged company’s new within-com- most media attention was the case of (Table 1) (USDA, 2012 and 2013). pany coordination of selling strategies contaminated baby formula in 2008. In addition, alternative marketing in Chinese markets. In response to Baby formula produced by a major arrangements including various con- the new selling strategies, other U.S. milk supplier, Sanlu Group, was con- tracts have been increasingly used to and Chinese pork companies will taminated by melamine. As a result, procure live hogs. These trends have adjust their selling strategies accord- six children died and about 294,000 raised concerns about the anticom- ingly, changing the nature of compe- children were sick. Other food safety petitive effects of potential buyer tition in the markets. incidents include poisonous power in hog procurements and seller Given the possible increasing con- treated with the pesticide Dichlorvos power in pork markets (Zheng and centration in Chinese pork markets, in 2003, counterfeit alcoholic drinks Vukina, 2009). The acquisition of the more interdependence between U.S. in 2009, clenbuterol-tainted pork in United States’ largest pork producer and Chinese markets, and the coordi- 2011, and dead pigs drifting in the by the top Chinese pork company has nation of selling strategies, the acqui- Huangpu River after a crack-down only heightened concerns about mar- sition will likely lessen competition on illicit trade of dead meat in 2013. ket concentration. among companies in Chinese and Shuanghui itself was implicated as Initially, the acquisition of Smith- U.S. pork markets. A major ques- one of the companies involved in the tion for the future will be how this clenbuterol-tainted pork incident al- field by Shuanghui will not change the structure or concentration of reduced competition will play out for though Shuanghui’s responsibility is U.S. consumers in pork markets. limited and indirect because the scan- either the U.S. or Chinese hog and pork markets. However, over time, dal was at the hog-production rather For More Information than processing level (Gara, 2013). the U.S. and Chinese pork markets The negative perception of U.S. con- will become more interdependent. Anderson S., C. Bieroth, G. Tucker, sumers is expected to continue as long The Smithfield acquisition by Shuan- and T. Schroeder. 2011. “Chi- as food safety in China is perceived ghui and future increased Smithfield nese Beef Consumption Trends: not to be significantly improved. exports to China will lead to a higher Implications for Future Trading concentration in Chinese pork mar- Partners.” Department of Agricul- Food safety concerns of U.S. kets. Pork prices in China will not tural Economics MF-3000, Kan- consumers about Smithfield’s pork necessarily be higher because more sas State University. Available on- products after the acquisition could imports from a low-price country (the line: http://www.agmanager.info/ adversely affect the sales and prices United States) can lower the price in /marketing/bulletins_2/ of Smithfield’s products, although the importing country (China) and industry/demand/MF3000.pdf. the impact is expected to be small this price reduction due to the ben- and its exact magnitude is a topic for Bloomberg News, 2013, October 9 efit of trade can offset the price effect “Smithfield to Cut Hog-Feed Ad- future studies. The negative effect of of higher concentration. However, food safety concerns on the sales and ditive to Boost Exports to China.” when pork markets in the two coun- Available online: http://www. prices of the entire U.S. pork indus- tries become more interdependent try will be even smaller because some bloomberg.com/news/2013-10- and major companies are selling in 10/smithfield-to-cut-hog-feed- U.S. consumers will switch to other both countries, more concentrated companies’ pork products if they are additive-to-boost-exports-to-chi- and less competitive Chinese pork na.html. concerned about the safety of Smith- markets provide an alternative out- field’s products. In addition, if there let for U.S. pork products and, thus, Fxtop Company. 2014. Historical Of- are any food safety incidents related reduce the competition in U.S. pork ficial Exchange Rates. Available on- to the Chinese and markets. line: http://fxtop.com/en/histori- Shuanghui in the future, the inci- cal-exchange-rates.php?MA=1. dents will remind U.S. consumers of The merged company will the safety concerns and cause some implement its within-company

4 CHOICES 4th Quarter 2015 • 30(1) Gale, F., D. Marti, and D. Hu. 2012. Oh, S.H., and M.T. See. 2012. “Pork U.S. Department of Agriculture. China’s Volatile Pork Industry. Preference for Consumers in 2014b. Livestock & Meat Inter- Washington, D.C.: U.S. Depart- China, Japan and South Korea.” national Trade Data. Economic ment of Agriculture, Economic Asian-Australasian Journal of Ani- Research Service, Washington, Research Service, Outlook No. mal Sciences 25: 143–150. D.C., December. Available on- (LDPM-21101), February. Avail- Ortega, D.L., H. Wang, and L. Wu. line: http://www.ers.usda.gov/da- able online: http://www.ers.usda. 2009. “Food Safety and Demand: ta-products/livestock-meat-inter- gov/publications/ldpm-livestock,- Consumer Preferences for Im- national-trade-data.aspx#26019. dairy,-and-poultry-outlook/ ported Pork in Urban China.” U.S. Department of Agriculture. ldpm211-01.aspx. Journal of Food Distribution Re- 2014c. Livestock and Poultry: Gara, T. 2013, May 29 “The Smith- search 40(3): 52–63. World Markets and Trade. Foreign field Deal: China Bringing Home Shuanghui Development. 2014. Agricultural Service, Washington, the American .” The Wall “About Shuanghui.” Available on- D.C., October. Available online: Street Journal. Available online: line: http://www.shuanghui.net/ http://www.fas.usda.gov/data/ http://blogs.wsj.com/corporate- html/category/about/qyjs. livestock-and-poultry-world-mar- intelligence/2013/05/29/the- kets-and-trade. Smithfield Foods. 2012. Smithfield smithfield-deal-china-bringing- U.S. Meat Export Federation. 2014. home-the-american-bacon/. Integrated Report, 2012. Available online: http://www.smithfield- “China’s Hog, Pork Prices Still Hayes, D. 2013. “Prospects for US- foods.com/media/12902/smith- Climbing.” Available online: China Trade in Meat Products field-integrated-report-2012.pdf. https://www.usmef.org/chinas- and Associated Investment Op- hog-pork-prices-still-climbing/. portunities.” Paulson Papers on Stuart, B.W., and R.G. Fritz. 2013. “China’s Impact on U.S. Poultry Wang, H. 2012, August 22 “Con- Investment: Series, sumers turn toward imported The Paulson Institute, July. Avail- and Livestock Sectors.” Choices 28(1): 1–5. food.” China Daily. Available on- able online: http://www.paul- line: http://www.chinadaily.com. soninstitute.org/media/103128/ U.S. Department of Agriculture. cn/business/2012-08/22/con- us-china_trade_and_investment_ 2012. 2011 Annual Report: Pack- tent_15694718.htm. in_meat_hayes_english.pdf. ers and Stockyards Program. Grain Inspection Packers and Stock- Waters, T., and M. Davis. 2014, Jin, S., and Y.Y. Zhang. 2014. “The August 12 “China halts some Value of “Made in USA”: Impact yards Administration, Washing- ton, D.C., March. U.S. pork imports over feed ad- of Chinese Acquisition of a U.S. ditive use.” Reuters. Available Company on Consumer Will- U.S. Department of Agriculture. online: http://www.reuters.com/ ingness to Pay.” Paper presented 2013. 2012 Annual Report: Pack- article/2014/08/12/us-china- at Agricultural and Applied Eco- ers and Stockyards Program. Grain pork-additive-idUSKBN0G- nomics Association annual meet- Inspection Packers and Stock- C20Y20140812. ing, Minneapolis, Minn., July. yards Administration, Washing- Mattioli, D., D. Cimilluca, and D. ton, D.C., March. Zheng, X., and T. Vukina. 2009. “Do Kesmodel. 2013, May 30 “China U.S. Department of Agriculture. Alternative Marketing Arrangements Makes Biggest U.S. Play.” The 2014a. USDA Agricultural Projec- Increase Pork Packers’ Market Power?” Wall Street Journal. Available on- tions to 2023. Economic Research American Journal of Agricultural Eco- line: http://online.wsj.com/news/ Service Long-term Projections Re- nomics 91: 250–263. articles/SB10001424127887324 port OCE-2014-1, Washington, 412604578512722044165756. D.C., February. Available online: Tian Xia ([email protected]) is Associ- National Bureau of Statistics of Chi- http://www.usda.gov/oce/com- ate Professor, Department of Agricul- na. 2014. China Statistical Year- modity/projections/USDA_Ag- tural Economics, Kansas State Univer- book, 2013. Beijing. Available on- ricultural_Projections_to_2023. sity, Manhattan, Kansas. line: http://www.stats.gov.cn/tjsj/ pdf. ndsj/2013/indexeh.htm.

5 CHOICES 4th Quarter 2015 • 30(1)