4 ORGANIC FOOD MARKETS by xbz20178

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									4         ORGANIC FOOD MARKETS

4.1       The EU Organic Food Market

A review of the current trends in the international market for organic food suggests that the
global organic market has yet to stabilise, with new markets opening continuously. The
International Trade Centre (ITC) has estimated that retail sales of organic produce will reach
$23-25 billion in 2003, rising by a further 24 per cent by 2005, to reach $29-31 billion.
However, is this demand surge and the organic price premium sustainable? A review of the
literature relating to consumer attitudes to organic food indicates that the recent demand surge
is based on higher income levels, as well as health, food safety and ethical concerns. We find
that there is potential for growth in all product categories, but the trend is away from generic
goods towards processed products, which is consistent with the findings of Produce Studies
(1998) and Michelsen et al. (1999). Moreover, the range of products needs to be expanded in
all countries in order to ensure future growth in the organic market (Michelsen et al., 1999).

In the European market for organic food, Italy is the largest producer; Germany is the largest
consumer, with a sales value of approximately 2.5 billion Euro, although Denmark and
Switzerland have by far the highest per capita expenditure. To illustrate the fragility of the
organic market, MLC (2003) report that sales fell by 24 per cent in Germany, during 2002,
following a food scandal involving organic feed that had been contaminated by the pesticide
Nitrofen. Organic poultry sales were most affected, while beef and pork sales fell as well.
There was little impact on the lamb sector and some consumer confidence has been regained
in 2003.

However, Smith and Marsden (2003) view that the emergence of this large and seemingly
vibrant market for organic foods across the EU has been facilitated by four main factors:

      •   Substantial public funding for organic production under EC Regulation 2078/92
          (Lampkin et al., 1997);
      •   The introduction of a common statutory framework (EC 2092/91) to preserve the
          integrity of the organic claim within the EU;
      •   A decade of economic prosperity across the region which has enhanced consumer
          demand for authentic and more specialised value-added goods;
      •   Growing consumer distrust of the quality of conventionally produced foods following
          a steady stream of food scares.

The MLC (2003) warn that although organic sales across the EU have grown considerably in
recent years, a general slowdown may be expected. The MLC also express concern over the
accession of ten Central and Eastern European countries to the EU in 2004, as these countries
may flood the market with organic products at relatively low prices, due to lower operating
costs. “As many of these countries currently use traditional, extensive methods, even in
conventional farming, the conversion to organic production is less of an upheaval in many
cases. Hence they are able to enjoy the benefits of higher returns with often little additional
outlay.”

Indeed, despite a significant body of literature arguing that both organic land and the retail
value of organic foods have been showing double-digit annual growth rates throughout the
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past decade (see, for instance, Lampkin et al., 1997; Offermann and Nieberg, 2000; Miele,
2001), as a basis for optimism in retail markets, the data presented in Tables 7 and 8, seem, on
the whole, to be less supportive. Table 7 shows that, in relation to overall food sales, only
marginal percentage growth in the EU market for organics has been taking place.

Table 7 - Organic foods as a percentage of overall food sales in selected European
Countries: 1997 to 2000.
                  1997*      1997*     1997*          1997/8     1998#     1999#     2000#
Austria            2.0        2.5       1.25            2.5        5.0      3.0
Denmark            2.5        <3.0                     <3.0        3.0      4.0
France             0.5                   0.6                     0.5-1.0             3.0-5.0
Germany                       1.5        0.5           1.5         2.5
Italy              0.6                   1.0                       1.0
Netherlands        1.0        1.5      2.5-3.0          1.5       <1.0
Sweden             0.6        <3.0                     <3.0
                                                      1.0-1.5
Switzerland        2.0                                           1.5       2.0
UK                 0.4       2.0                       2.0       1.0                   1.0
* Denotes figures from different researchers.             Source: Miele and Renting (2002).
# Denotes estimates.

Thus, with the exception of the hugely optimistic forecasts that were made for 1998-2000, the
retail value of organic foods as a percentage of total food sales has essentially been flat. In
the UK, retail sales of organic foods failed to exceed 2.0 per cent of the total value of the food
market to 1998 and were 1.0 per cent of total food sales in 2001/02 (Soil Association, 2002).

Table 8 - Retail Value of UK Production.
                                               1997             1998   1999   2000   2001
Organic Land (‘000 ha)                          40               60    103    240    459
Organic Retail Sales (£m)                       279              390    605    802    920
Retail Value of UK-produced Organics (£m)        84             117     151    241    322
% UK-produced share of organic retail sales    30%              30%    25%    30%    35%
Sources: Soil Association (1999, 2000, 2001 and 2002).

From Table 8 we may note that while certified organic land in the UK increased over
11-fold between 1997 and 2001, the retail value of indigenously-produced organic foods
increased only four-fold. This partly reflects the conversion of significant areas of extensively
managed land (cattle and sheep farms) but also continued reliance on imports. Latterly, there
is evidence that, like conventional farmers, UK organic producers are becoming caught in a
farm-gate price-squeeze (Van der Ploeg, 2000).

4.2    The Organic Food Price Premium in the EU

The organic food price premium is the additional percentage amount received for organic
products when compared with the price for the comparable conventional product. In a recent
study, by Hamm et al. (2002), considerable price differences across European countries were
found, even between neighbouring countries, suggesting that the organic market transparency
is particularly poor. Also, one cannot exclude the possibility that buyers in some countries
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had more trust in products, especially in the case of animal products, originating from their
own countries or special preferences for regional products. Another important aspect is that
in some markets large volumes of organic products could not be sold as organic. In such
cases, we might expect relatively low price premiums as organic product buyers could act to
push prices down. Thus, the price differences (and differences in organic price premiums) did
not reflect neo-classical economic theory.

Hamm et al. (2002) found that farm-gate, or producer, price premiums for cereals and animal
products tended to be low in countries with low farm-gate prices for the equivalent
conventional product, and vice versa. The EU average producer price premium for organic
cereals was 102 per cent in 2000, although this varied from 30 per cent in Greece up to 281
per cent in Luxembourg. Potatoes gained an extremely high average EU producer premium
of 257 per cent, which varied from 40 per cent in Greece to 300 per cent in Germany. For
Beef, the lowest price premium was recorded in Spain with 10 per cent. This is not surprising
if one takes into account that in Spain only 10 per cent of organic beef was sold as organic,
which enabled buyers greater choice in deciding where to buy. The price premium for beef in
the UK was extraordinarily high at 173 per cent and may be related to a very low degree of
self-sufficiency in organic beef of only 20 per cent.

The EU average for consumer price premiums in 2000 varied from 31 per cent for organic red
table wine up to 113 per cent for organic chicken. Also, in countries where general food
shops were very active in the marketing of organic food, consumer price premiums were
usually lower than in countries where organic food shops or direct sales provided the main
sales channels.

Nucifora and Peri (2001) suggest that organic fruit and vegetables present a mark-up of
between 40 and 80 per cent with respect to conventionally produced products in the EU.
Although La Via and Nucifora’s (2002) study of large food retailers in France, Germany,
Spain and the UK suggest somewhat lower levels of mark-up. The mean price mark-up was
found to be 51 per cent. Interestingly, although the difference between the highest (77 per
cent) and the lowest (15 per cent) levels of price mark-up in individual products across all
stores is 62 per cent, the difference between the highest and lowest levels of mark-up by
product within each store is only 14 per cent on average.

Furthermore, La Via and Nucifora show that organic fruit and vegetable products have a basic
level of price mark-up of about 36 per cent above that of conventional products. This fixed
component can be explained not only by the inherent superior quality/higher production cost
of organic over conventional products, but also reflects a higher level of marketing and
packaging associated with organic goods. Beyond this constant, the price mark-up can
change by as much as a further 40 per cent. This additional mark-up is explained by physical
store characteristics such as size and location, in addition to the amount of additional service
and information provided in different stores. Country location within the EU does not appear
to significantly affect the mark-up level.
Finally, La Via and Nucifora conclude that the level of organic product prices can be expected
to fall in the future, as the fixed component of the difference in information between organic
and conventional products becomes less important. To some extent, this differential is due to
the still limited consumer knowledge of basic characteristics of organic products, such as the
absence of chemicals in organic food production, the refusal to use genetically modified
stock, and the health and environmental benefits associated with organic produce. As these
general notions about organic foods become more widely known to the consumer, the
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“constant” mark-up component can be expected to fall, with the reduced need for store-level
information provision and marketing. Nucifora and Peri indicate that, in the opinion of buyers
for the large retail chains and other agents trading in both organic and conventional fruit and
vegetable products, a much smaller mark-up of between 20 and 30 per cent would be justified
to reflect the higher costs incurred.

4.3     The Market Potential for Organic Food

Michelsen et al. (1999) find that the level of market shares for organic produce varies widely
across EU countries, product groups and product categories from zero (particularly for pork)
to 10 to 14 per cent (e.g., milk products in Austria and Denmark). Michelsen et al. suggest
that this indicates that the market is still developing, and across countries no absolute limit to
demand for organic products has yet been identified. Conditions for developing the markets
are, however, very different between EU countries, not least because consumer preferences
vary. Thus, absolute limits to demands for organic products must exist and they should be
expected to be found at different levels in different countries - but as yet they seem far from
being reached. The potential demand for organic foods is evaluated by examining the most
important factors influencing consumer choice, while concentrating mainly on which
consumers buy organic foods, their motives, market growth, and the barriers to continuing
expansion of the organic market.

4.3.1 Consumer Demographic Characteristics

Wier and Calverley (2002) review a number of studies that suggest that European consumers
of organic products are mainly younger people (<45 years). A few studies, however, point to
two particular groups who buy organic food frequently: first, young people who buy for
environmental as well as health reasons, and second, older people, who primarily buy because
of health concerns.

The Soil Association (2002) reports that three life stage groups, in the UK, are found to be
significant purchasers of organic food:

      Young families (those children aged between 0-4)
      Older dependants
      Empty nesters (older parents whose children have left home).

The food safety image of organic food has allowed significant development of market share in
baby food but shrinking disposable income of families with older children seems to constrain
organic food consumption, together with the lack of convenience options and children’s
ranges.

Many studies have found that willingness-to-pay for food risk reduction increases with
income and further studies find that higher earning individuals are most likely to pay a
premium for certified organic produce. The UK’s real household disposable income per
capita had increased in 2000 by 25, 65 and 112 per cent since 1990, 1980 and 1971,
respectively (National Statistics). Although, according to Engel’s Law, the share of
expenditure on food decreases with income, total (absolute) expenditure per capita on food
does rise with income per capita as people trade up to higher value products.


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The fact that the proportion of income spent on food falls as income rises implies that the
income elasticity of demand for food is less than one or inelastic. Tiffin and Tiffin (1999)
estimate that the average elasticity of all food demand with respect to all expenditure was
0.524 in Great Britain between 1972 and 1994. This implies that a one per cent increase in
income would lead to a 0.524 per cent rise in food demand. However, as incomes rise, people
become less price sensitive and the own-price demand elasticity of particular commodities
falls towards zero.

Consequently, although the income and price elasticities of demand for food may be lower in
wealthier countries; the elasticities with respect to value-adding activities associated with food
are much higher. In other words, consumers are willing to pay more for more
environmentally conscious and ethically produced food, as well as additional packaging,
processing and service elements of food consumption as they get wealthier.

4.3.2 Motives for buying Organic Food

Even though some studies point out that there is significant motivation to buy organic food on
environmental or ethical grounds (Hack, 1995; Irish and Ries, 1987), most studies show that
consumers primarily buy organic food because of health considerations (Harper and
Makatouni, 2002; Wier and Calverley, 2002; Latacz-Lohmann and Foster, 1997). With
consumers taking a more active role in managing their health due to ageing and increased
medical costs, many people are turning to organic foods to avoid pesticides or post-harvest
chemicals. This trend signals continued growth in the organics market (Promar, 1999).

Wow (2003) state that, unfortunately, there is no conclusive evidence that organic food is
healthier than non-organic food because little private or public money is available to support
such research. However, the US Environmental Protection Agency estimates that 60% of all
herbicides, 90% of all fungicides, and 30% of all insecticides are likely cause cancer. The
Consumer Union's Toxicity Index, a measure of the levels of chemical residues in produce
and the potential health risks of those chemicals, raises concerns about the health and safety of
non-organic produce. For instance, a TI score above 100 is considered alarming. Non-organic
apples have a TI score of 550 while non-organic peaches have a TI score above 5,000. In
addition, a study conducted by researchers in Chicago indicates that organic food can have a
nutrient content as much as 90% higher than non-organic produce. The reason is that greater
soil fertility produces healthier plants that absorb the nutrients from the organic matter in the
soil.

Wier and Calverley’s (2002) research suggests that motivation to buy organic food varies
between different consumer segments. The more “idealistic” consumers, having the highest
buying frequency, are driven by environmental concerns and political motives, but amount to
only a minor proportion of the consumers. In contrast, those groups that are driven mainly by
health concerns have a lower buying frequency, but represent a major proportion of
consumers. It is in these “health concerned” segments where there is an increasing demand
for organic food, including organic convenience food and other easily prepared meals.




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4.3.3 Willingness-to-Pay for Organic Food

Table 9 presents estimates from studies of European consumers’ willingness-to-pay for
organic food at varying levels of price premium.

The findings of Beharrell and MacFie (1991), Coopers and Lybrand Deloitte (1992), Bjerke
(1992), and to some extent Scan-Ad (1998), Grunert and Kristensen (1995), Bugge and
Wandel (1995), and Drake and Holm (1989) are generally in agreement and find that between
5-20 per cent of consumers will buy organic foods when price premiums are higher than 30
per cent. Price premiums between 10 per cent and 30 per cent attract 10-50 per cent of all
consumers to buy organic foods, whereas price premiums between 5-10 per cent induce
between 45-80 per cent of consumers to buy organic foods.

Table 9 - The proportion of consumers that will buy organic foods (%).
 Country            Survey Year          Price Premium for Organic Foods (%)
                                    5-10 10-20 20-30 30-40 40-50 50-60
 Sweden               19871          45       n.a.    n.a.  n.a.    n.a.    n.a.
 UK                   19892        50-80 25-50 15-20 18-20 16-18 15-16
                      19893        50-65 25-50 20-25 15-20 13-15 11-13
                            4
 Norway               1993           70       40      10    n.a.    3-5     n.a.
 Denmark              19905                   n.a.    n.a.  n.a.     15     n.a.
                            6
                      1991          n.a.           54         5     n.a.    n.a.
                      19987          65       20      11    n.a.    n.a.    n.a.
 The Netherlands      19918          95       90      85         80          60
 Germany               n.a.9                  31                 52           9
                           10
                      1994           30       26                 25           4
                           11
                      1996           29       28             30               3
 Source: Wier and Calverley (1999).

 Notes on studies undertaken:
 [1] Drake and Holm (1989)
 [2] Beharrell and MacFie (1991)
 [3] Coopers and Lybrand Deloitte (1992)
 [4] Bugge and Wandel (1995)
 [5] Bjerke (1992)
 [6] Grunert and Kristensen (1995)
 [7] Scan-Ad (1998)
 [8] Hack (1995)
 [9] Kramer et al. (1998)
 [10] Fricke (1996)
 [11] CMA (1996)

On the contrary, Hack (1995), Kramer et al. (1998), Fricke (1996) and CMA (1996) come to
different conclusions in the sense that price premiums of more than 30 per cent will attract
more than 20 per cent of all consumers. Thus, Dutch and German studies are the most
optimistic in their evaluation of the tendency to buy at premiums over 30 per cent. The
Scandinavian and British studies are more pessimistic, expecting only 5-15 per cent of all
consumers to buy at these premiums. Weir and Calverley (2002) suggest that such divergent
                                            26
results may be explained by differences in the sales channels. Most German organic products
are sold in speciality shops, where goods in general are relatively more expensive. Most
Scandinavian and British consumers buy organic food in supermarkets, where price is one of
the most apparent competition parameters. This hypothesis is supported by Fricke (1996),
who finds that the willingness of German consumers to pay is higher in health-food shops,
than in supermarkets.

4.3.4 Price Elasticity of Organic Food Demand

In this section, we attempt to measure the responsiveness of demand for key organic food
products to changes in market prices. The measure used is the price elasticity of demand
which is the percentage change in the quantity of a commodity demanded in response to a
given percentage change in price. While a number of studies have measured attitudes,
motives and willingness-to-pay for organic products, there have been very few attempts to
estimate own-price, cross-price and income demand elasticities. As high retail price
premiums for organic foods persist, elasticity estimates appear to be critically important for
gauging how the UK market for organic food might grow in the future. Demographic
variables such as age, marital status, number and age of children, and educational attainment
have been found to be important variables in explaining and predicting consumer demand for
organic products. Estimates of habit persistence linked to age and household composition, as
well as accounting for where foods are purchased, might also be important for measuring the
price sensitivity of organic food demand.

We have been unable to find demand elasticity estimates for the UK organic market.
However, Wier and Smed (2000) use Danish data for more than 2,000 households for the
period 1997-1998 to estimate a demand model. The results suggest that the demand for
organic foods is more sensitive to price changes than the demand for conventional foods.
Moreover, the demand for livestock products, particularly dairy products, is more price-
sensitive than the demand for crop products. Wier and Smed estimate that if the price
premium for organic dairy products decreases by 20 per cent, then consumption increases
from a market share of 10 to 15 per cent. The consumption of bread and cereals is somewhat
less price-sensitive as a 20 per cent decrease in the price premium only increases the organic
market share from 5 to 7 per cent. Meat consumption has approximately the same price
sensitivity as dairy products, but initially it has a much lower market share. In this case, the
market share increases from 1 to 2 per cent when price premiums decrease by 20 per cent.

Wier, Hansen and Smed (2001) estimate own- and cross-price uncompensated demand
elasticities for organic and conventionally produced dairy products in the Danish market:

                                                         Price
 Quantity                               Organic                     Conventional
 Organic                                 -2.27                         1.27
 Conventional                             0.13                         -1.13


Dairy products in this study include milk, eggs, butter, yoghurt and cheese. The high
own-price demand elasticity estimates can be explained by the fact that conventional and
organic dairy products are very close substitutes in the Danish market. The consumption of
conventional dairy products shows only a low sensitivity to changes in prices of organic dairy
products. This is due to the large budget share of conventional dairy products in Denmark,
                                              27
although organic dairy products have higher market shares than any other food type in the
Danish market of 10 per cent. In comparison, organic bread and cereals, and fruit and
vegetables occupies around 4 per cent only, while organic meat products occupy a marginal
position with a share of approximately 1 per cent.

A further study of the US organic milk market (Glaser and Thompson, 2000) suggests the
following uncompensated (Marshallian) own-price demand elasticity estimates:

                               Branded             Private Label          Organic
 Whole Milk                      -0.726                -0.659             -3.637*
 Skimmed Milk                    -0.808                -0.728              -3.668
* Not statistically different from zero at the 10 per cent level.

Glaser and Thompson note that although the own-price demand elasticities for organic milk
appear quite large, their absolute values were declining rapidly over the sample period
between 1996 and 1999. By contrast, own-price elasticities for branded and private-label
milk were quite stable throughout the sample period. Thus, as organic milk of various fat
content attains larger market shares, consumer response to own-price changes diminishes.
The organic market volume share rose from zero in 1996 to 0.011 and 0.026 per cent, in 1999,
for whole and skimmed milk, respectively.

Similar trends were found for US own-price demand elasticities of organic frozen vegetables
as market shares increase (Glaser and Thompson, 1998). The market volume shares of
organic frozen broccoli, sweet corn, green peas, and green beans rose from approximately
zero in 1991 to 0.087, 0.110, 0.335, and 0.098 per cent in 1996, respectively. The estimated
demand elasticities for these frozen vegetables are:

                                                                Price
                    Quantity               Organic         Conventional   Expenditure
 Broccoli           Organic                 -2.268            0.636*         1.131
                    Conventional             0.535             -1.043       0.857*
 Sweet Corn         Organic                 -1.630             2.437         0.778
                    Conventional             0.002            -0.102*        1.158
 Green Peas         Organic                 -1.906            0.446*         1.489
                    Conventional            0.001*            -0.299*        0.892
 Green Beans        Organic                 -2.181            0.836*         1.123
                    Conventional            0.001*             -0.596        1.113
* Not statistically different from zero at the 10 per cent level.

The own-price response of demand for specific organic frozen vegetables is much larger than
for their conventional counterparts. This is consistent with a newly emerging product with a
thin market share. When elasticities were evaluated at average values for the last 12 months
of the sample (1996), own-price elasticities for organic frozen vegetables uniformly declined
in absolute value while the own-price elasticities for conventional vegetables remained nearly
identical. This trend is probably due to the increased familiarity of consumers to the products
and a decline in nominal prices in 1995 and 1996.

There appears to be a tendency toward asymmetry in cross-price responses: with larger
changes in organic quantities associated with conventional price changes, than vice versa.
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One interpretation of this asymmetry would be that consumers currently buying conventional
vegetables would cross over to organic products if relative prices change whereas consumers
currently buying organic produce are much less likely to “revert” to conventional
counterparts. It therefore appears, from the studies referred to in this section, that lower price
premiums induce a considerable proportion of consumers to buy organic products.

Demand elasticities are now derived for the UK organic market. For this analysis we employ
Tiffin and Tiffin’s (1999) conventional products’ demand elasticity estimates which are
scaled where possible for the UK organic market using estimates from the Danish and US
organic markets. For example, Tiffin and Tiffin estimate the uncompensated demand
elasticity for staple foods (which includes milk, cheese, bread and eggs) as –0.567. Wier,
Hansen and Smed estimates for dairy products (including milk, eggs, butter, yoghurt and
cheese) as –1.13 for the conventional market and –2.27 for the organic market. We can obtain
a scaling factor (-0.567/-1.13=0.502) and use it to scale downwards the organic dairy product
demand elasticity estimate from –2.27 for the Danish market to a more likely value of –1.139
for the UK market. This estimate is likely to be a lower bound of the range of possible
elasticity estimates for the UK organic dairy market.

Furthermore, we can scale individual elasticity estimates by using a factor (-1.139/-
0.567=2.01) to scale-up conventional product price elasticity estimates. As Smith and
Marsden (2003) suggest, the organic production increases witnessed over recent years,
particularly in the milk, lamb and vegetable sectors, implies that the organic food sector may
be starting to experience similar levels of inelasticities in demand as those operating in the
conventional sector. The following outlines the results of such an analysis:

                                UK Conventional Mkt.             UK Organic Mkt.
 Dairy                                -0.567                         -1.139
 Milk                                 -0.765                         -1.537
 Eggs                                 -0.260                         -0.522
 Cheese                               -0.336                         -0.675
 Meat                                 -0.951                         -1.902
 Beef                                 -1.642                         -3.284
 Lamb                                 -0.525                         -1.050
 Pork                                 -1.870                         -3.740
 Chicken                              -1.374                         -2.748
 Vegetables                           -0.311                         -0.622
 Processed Vegetables                 -0.670                         -1.340
 Potatoes                             -0.215                         -0.430
 Green Vegetables                     -0.471                         -0.942
 Fruit                                -0.213                         -0.426
 Bananas                              -1.309                         -2.618
 Apples                               -0.487                         -0.974
 Citrus Fruit                         -0.462                         -0.924

Given the greater market shares of organic produce in Denmark (as described above)
compared to that in the UK (of 2, 1, 2 and 1 per cent in the dairy, bread and cereals, fruit and
vegetables, and meat sectors, respectively) these calibrated elasticity estimates are likely to be
lower bounds of their actual values. Although this method of estimating organic food demand


                                               29
elasticity estimates is far from ideal, it affords a rough guide as to the responsiveness of
demand to any potential squeezing of price premiums in various key sectors.

4.3.5 Distribution and Sales Channels

The high price premiums for organic goods, which research suggests are limiting demand, are
in part due to the many links between producers, importers, wholesalers, distributors and
retailers (Produce Studies, 1998). A more direct link between producer and retailer could
reduce prices. Sylvander’s (1995) study of the marketing costs on the French market refers to
costs at the wholesale level as being important for explaining the higher prices of organic
produce, because organic goods require higher transport, processing and packaging costs than
conventional goods. This is because organic products are only handled and turned over in
small volumes. Sylvander’s results indicate that when organic sales grow to volumes
comparable to conventional sales, price premiums would fall substantially, due to reduced
costs in the marketing and transport stage.

These findings are supported by the conclusions of Coopers and Lybrand Deloitte (1992),
who focus on the UK market. Results from Michelsen et al. (1999) suggest that increasing
volumes and sales through supermarkets reduces the average price premium. Moreover, the
Soil Association (2002) suggests that UK processing facilities are currently constrained by the
relatively small size of the market. For dedicated organic processors it is difficult to achieve
the economies of scale needed to be competitive. For large non-organic processors, the
relatively modest returns available in the short term can be a deterrent against investment in
processing organic products and finding markets.

The distribution of organic products in the EU is, to an increasing extent, being taken over by
conventional supply channels (Produce Studies, 1998). Supermarkets are very dominant sales
channels for organic produce in the UK, as well as in Scandinavia and Austria. Michelsen et
al. find that the conditions for consolidating organic food markets seem to be strongly related
to a high level of supermarket sales. However, sales through supermarkets pose major
challenges to a small sector like organic farming. On the one hand, supermarkets demand
large quantities at homogeneous qualities, delivered precisely and supported by professional
promotion – conditions which are found difficult to fulfil for an emerging organic agriculture
sector. On the other hand, supermarkets are the only possibility for reaching the mass market
that include large consumer segments which it is impossible to contact either through direct
trade from farmer to consumer or via specialised shops. The experience of countries that have
large supermarket sales suggests that major new consumer segments have in fact been
reached. Furthermore, supermarket sales appear the most important means to counter the
main problem of bottlenecks in the distribution network. The problem of small scale hampers
market development as it increases costs in all links from farmer to consumer.

Research by Organic Monitor (2002) shows that British consumers have access to the most
comprehensive range of organic foods in the world. Tesco is the market leader in the organic
food industry and it has over 1200 items in its organic food range. It reported that sales of
organic foods had reached £200 million in 2001. The two other leading supermarkets in the
British organic food industry are Sainsburys and Waitrose and they have a similar number of
products in their organic food ranges. Although their organic food sales are lower than Tesco,
the market share of organic foods of conventional foods in their stores is much higher.
Waitrose stated that organic food sales had exceeded 12 percent of all food sales in its stores
in 2001. In Sainsburys, fruit like organic kiwis had exceeded 20 percent of kiwi sales.
                                              30
European retailers are far behind British supermarkets in the organic food industry. Only
Denmark comes close with FDB, the flagship of the Danish retail sector, offering over 800
items in its organic food range. However the second largest retailer, Dansk Supermarked, has
less than half this number.

It is interesting to note that in The Netherlands and Germany health food stores have
dominated the distribution of organic products for many years and are still powerful, even
though their growth is stagnating compared to the growth of organic products in supermarket
chains (Produce Studies). Although the range of organic products in supermarkets remains
limited due to the organic distributors’ reluctance to co-operate with the conventional food
distributors. By contrast, in Denmark, Sweden and the UK, supermarket chains have built-up
partnerships with organic producers and have thereby encouraged suppliers to produce and
import organic goods.

There is a potential for prepared organic products, such as frozen and convenience food, to
attract younger and busy consumers. The potential for these products will increase as
conventional supermarkets seriously begin to market organic products (Produce Studies).
Expanding the availability and range of organic products in supermarkets will make it
possible to reach all consumers who are potentially interested in organic food (Wier and
Calverley, 2002).

Indeed, evidence suggests that as the organic food market matures the percentage share of
organic processed food increases at the expense of organic fruit and vegetables, traditionally
the dominant part of the sector. In Germany organic baby food accounts for more than 60 per
cent of the market. Other signs of market maturation are the development of supermarket
own-label organic foods, which include chilled ready meals, dairy products and soups (UK)
and high quality chocolate and biscuits (France). The entry of major processors such as Heinz
and Nestle into the organic arena has also brought about some major changes to supply-side
dynamics. The net effect of these changes is that for many parts of the organic market the
rate-limiting factor to growth is sourcing organic ingredients of the correct quality, price,
specification and certification.

4.4    Economies of Scale

Evidence presented to the Agriculture Committee in the House of Commons (2001) suggests
that the scale of production currently limits economies of scale in UK organic agriculture.
Indeed, Mr Finney of Eastbrook Farm Organic Meats suggested that at the moment "we have
virtually no effective economies of scale to play with in a business of this size, in terms of
transport, feed, packaging". As the market grows and supplies grow, such economies of scale
will be possible throughout the industry. This might not affect farmers directly: Dr Lampkin
was not convinced that "there will be a significant reduction in prices to farmers in the short to
medium term", i.e. three years, because increased production was likely to replace imports
rather than add to the total supply, the market was continuing to expand and "there is a lot of
potential for significant economies of scale in the processing and distribution system".

Currently, because of their size (of on average 101 ha in England), organic producers face
additional distribution costs over their conventional counterparts. Although there often are
not the economies of scale in the processing of organic produce compared to conventional
produce. “The shelf life of many organic ingredients is different than for conventionally
                                               31
grown ingredients because preservatives aren’t added. This means a manufacturer handling
organic products may have to run smaller batches because less is available at a time,” said
Phil Margolis of Neshaminy Valley Natural Foods Distributor, Ltd.

4.5    Review of key Food Sectors

This section summarises the market position for each of eleven key organic food sectors,
which have been nominated in order to demonstrate the impact of expansion of organic
supply. This has been based on a desk review of the supply and demand trends of these
sectors, the associated cost of production, the level of UK share of supply and the main
market drivers.

Detailed data and analysis at Annex B support the overview presented in this section.

4.5.1 Production and consumption

The current balance of UK production and consumption for the key sectors is summarised in
Table 10 below, alongside Defra estimates presented in the Organic Action Plan. The data is
based on published figures from the Soil Association Food and Farming Report (2002), the
HRDA report on the UK Vegetable Market (2003) and the Defra Organic Action Plan.

Table 10 -UK Production and Consumption of Organic Produce (2001/02)
 Sector                UK             UK      Production as         % UK share of supply
                   Consumption     Production     % of
                                   (marketed) consumption            SA         BRC survey
                                                                   HDRA        (supermarket
                                                                    OAP         own label)
 Beef (no.)            15,000          9,000          60%           60%        57%
 Lamb (no.)           115,000        109,000          95%           95%        85%
 Pig meat (no.)       104,000         52,000          50%           50%        46% pork
 Poultry (no.)      3,818,000      2,100,000          55%           55%        100%
 Eggs (million)           209            220         105%          100%        100%
 Milk (m litres)          137            218         159%          100%        100% milk
 Apples                22,500          2,250          10%           10%        6%
 (tonnes)
 Strawberries             900             450        50%            50%        44% soft fruit
 (tonnes)
 Potatoes              39,535         29,463         75%            62%        58%
 (tonnes)
 Calabrese               1,600            750        47%            47%        30%
 (tonnes)
 Cereals              143,000         58,000         40%        20% milling
 (tonnes)                                                        60% feed


This data raises a question over the low market share of organic supply in some sectors. As
discussed in Annex B, there are particular constraints on UK production of some commodities
based on climate, standards, costs etc. In other sectors, there is 100% UK share of supply and
                                                32
production exceeds total consumption. Since 2001/02, lamb production has also overtaken
consumption significantly.

The relevance of this to the analysis is that it would not be appropriate to incentivise
production of organic produce for which there is no accessible market. Thus for land
producing organic milk and lamb, the environmental outputs purchased with the conversion
grant have been delivered but there is a question mark over sustainability in view of the
impact of oversupply on prices, which put returns to organic farmers under severe financial
pressure. It is important to consider how this can be avoided in future and to question the
appropriateness of untargeted grants as a mechanism to deliver policy objectives.

For other commodities, the availability of volume imports at competitive prices makes it
difficult for British farmers to compete. This impacts on the market for pig meat and potatoes
in particular but also cereals and other fruit and vegetables. Increasing market share for
apples is a particular problem, given the climatic conditions in the UK (which favour disease)
and the problems of storage. The OFS does not address these issues through conversion
grants or maintenance payments and highlights the need to ensure a package of support
measures, where this can be justified.

4.5.2 Market Growth

Market growth (consumption growth) for each of the key sectors is shown in Table 11. This
data is taken from the Soil Association Annual Report (2002) and a number of other sources.
It highlights a wide range of opportunity for organic producers and reflects in many instances,
the limitations on market growth due to price premia. Thus for example, organic eggs have to
compete with an established free range market and organic bread competes with a wide range
of innovative and specialist breads. Growth in the vegetable sector is also modest although
demand for organic fruit remains strong. The fastest growing organic grocery sectors are
processed foods, dairy products and meat (Organic & Natural Business, 2003).

Table 11 – Market Growth by Sector by Volume (2001/02)
                               2001/02             2002/03
Beef (head)                     140%                 64%
Lamb (head)                     180%                 70%
Pig Meat (head)                  36%                 17%
Poultry Meat (head)              19%                 32%
Eggs                              0%                  0%
Milk (m litres)                  47%                 20%
Top Fruit (tonnes)               50%                 30%
Strawberries (tonnes)            11%                 10%
Potatoes (tonnes)                -5%                  5%
Calabrese (tonnes)               10%                 10%
Cereals milling (t)              14%                  6%

Production growth relative to market growth is summarised in Figure 5, which looks at the
most recent data. This highlights some anomalies in growth of consumption and production
e.g. strawberries, poultry and pig meat. These are sectors that have seen a step change in
production in the period in response to an existing market. For other sectors, production does
not match growth in consumption and imports are drawn in e.g. beef. Much also depends on
                                              33
the ability of UK supply to compete in a growing market – this is particularly relevant to
potatoes, pig meat and top fruit.

Fig 5 - Consumption Growth and Production Growth in 2001/02 (by volume)

      Cereals milling (t)

        Calabri (tonnes)

       Potatoes (tonnes)

   Strawberries (tonnes)

      Top Fruit (tonnes)

          Milk (m litres)

                   Eggs

    Poultry Meat (head)

        Pig Meat (head)

           Lamb (head)

             Beef (head)

  -100%                     0%      100%            200%               300%    400%   500%

                                     Consumption growth    Production growth




4.5.3 Price premium

Price premium for each of the key sectors is shown in Table 12. This data is based on
published data and ADAS Specialists knowledge of the market. The range in farm gate prices
realised by producers varies considerably between individuals (by market, outlet, volume,
quality etc) and over the season (supply/demand balance and availability and price of
imports). The averages presented below therefore need to be treated with some caution.

Table 12 - Farm Gate Price Premium for Key Sectors of Organic Produce (2002/03)
 Sector                          Organic price   Conventional       % premium
                                                     price
 Beef (p/kg dwt)                  230                 185               24%
 Lamb (p/kg dwt)                  240                 210               14%
 Pig meat* (p/kg dwt)             191                  93              105%
 Poultry* (p/kg dwt)              350                 160              119%
 Eggs (p/dozen)                   105                  66               59%
 Milk** (ppl)                      20                  18               11%
 Apples (£/t)                     760                 460               65%
 Strawberries (£/t)             3,300               2,200               50%
 Potatoes (£/t)                   180                  75              140%
 Calabrese (£/t)                1000                  600               67%
 Cereals (£/t)                    150                  75              100%
* Conventional prices are based on free range or outdoor systems
** Represents the pool price received for organic milk sold into organic and conventional
  markets
                                                     34
It is clear that all sectors rely on a price premium but that this varies considerably. Where the
premium is particularly high, there is a risk of downward price pressure as supplies increase
and imports become more available. Maintenance payments would help offset price pressures
in some sectors but would be of limited value to those sectors with more intensive land use
e.g. poultry, top fruit. These sectors invariably rely less on non-market support for
conventional production and tend to operate in more integrated supply chains.

Lower premiums do not necessarily reflect marginal returns – much relies on the additional
cost of organic production. For example, this is relatively modest for hill lamb production but
high for dairying. For the latter, the price premium is diluted by the price pooling mechanism
operated by most of the co-ops buying organic milk. The actual farm gate price for organic
milk is around 23 ppl (allowing for transport costs), which represents a premium of over 28%
over conventional.

4.5.4 Cost of production

Total cost of production1 for each of the key sectors is detailed in Annex F and summarised in
Table 13. This data is based on published costings and ADAS Specialist knowledge of sector
economics. The data is an estimate of the industry average over the 2002 production year but
in practice, actual cost of production will vary considerably between producers and over time.
This is compared with an estimate of cost for conventional production (on a similar basis) and
the difference calculated to give an estimate of ‘additional cost’ on a per hectare basis.

Table 13 – Total Cost of Production for Key Sectors of Organic Produce (2001/02)
    Sector                     Cost of Production –                      Cost of Production –                  Additional cost
                                 Organic (£/ha)                          Conventional (£/ha)                       (£/ha)
    Milk                                1,982                                     2,016                               -34
    Beef                                  377                                       403                               -25
    Sheep                                 541                                       643                              -102
    Pigs                               16,933                                    17,247                              -314
    Poultry meat                       13,123                                    16,998                            -3,875
    Eggs                                6,012                                    15,995                            -9,983
    Cereals                               609                                       595                                14
    Potatoes                            3,563                                     3,229                               334
    Calabrese                           6,148                                     5,358                               791
    Strawberries                       19,515                                    22,265                            -2,750
    Apples                              5,606                                     6,856                            -1,250

The very high additional cost of production per hectare for poultry, eggs and strawberries
reflects the intensive land use for these enterprises.




1
    Cost of production is based on the direct and indirect (variable and fixed) costs of production. It assumes that all labour is paid
and that land is rented. A cost is included for tenants capital (7%). The cost is adjusted to account for the net value of
secondary produce and income e.g. livestock sales associated with milk production, livestock subsidies and area payments or
crops.


                                                                   35
4.5.5 Market Infrastructure

Additional costs are also borne by the UK organic industry compared to the conventional
production (availability of inputs e.g. organic seed, handling/storing small lots, need for
specialist storage, waste) and distribution (length of supply chain, use of second quality
produce). These costs have not been quantified beyond the farm gate but are passed down the
supply chain to producers and are reflected in the market prices quoted above. To this extent
they are fully accounted for in the analysis. Looking forward, it would be helpful to quantify
the potential economies of scale available in distribution costs since these might be offset
against falling producer prices in more mature organic markets. In practice, there is little
evidence that any such savings are passed back to producers – instead, consumers are the
main beneficiary through lower prices for organic food. This means that farmers and growers
need to secure their own efficiency gains and economies of scale – possibly through uptake of
technology (R&D) and co-operation – in order to maintain or improve returns.

The relevance to farmers of low processing and distribution costs lies in the capacity of
reduced costs to offset commodity price pressures by allowing downstream actors to compete
in the market place and through market growth based on more competitive prices to
consumers.

4.6    Telephone survey of suppliers

This section reports the findings of a telephone survey of suppliers and packers to assess the
impact of increased UK supply on demand and prices - to address research objective b)

Structured interviews were conducted with targeted individuals within the organic sector. All
interviews were carried out by telephone and lasted approximately 15-20 minutes. The
questionnaires used comprised both pre-coded and open-ended responses. A sample of 12
organic suppliers, food processors and specialist retailers were selected from a sample of
contacts provided by specialist consultants within ADAS. Full quantitative and qualitative
responses are reported in Annex C.

4.6.1 Sample

The sample was chosen to cover the key sectors studied in this research. There was also a
range in market outlet used, with the most common being multiple/major/independent
retailers (6 of 12 of respondents). This does not necessarily reflect the wider UK supply
position or their attitudes. In particular, the sample is biased in terms of UK supply base; for
the majority of products, suppliers used 100% UK supply – the exception was fruit and
vegetables, due to lack of availability in all seasons.

Over four fifths (10/12) of respondents stated that the UK volume and percentage share of
total supply has changed over the last few years. The main reasons given for the change in UK
volume and percentage share were:
  • Changes in growing conditions
  • Cost of production
  • Increase in demand
  • Increase in sales


                                              36
 •   Increase in the availability of UK products
 •   Increase in the number of farmers who have converted

4.6.2 Constraints on market share

One quarter (3/12) of respondents claimed that the availability of UK production is a
constraint on market share.

All respondents (12/12) were asked to rate the significance of seasonality, quality and price,
as a constraint on market production, on a scale of 1-5, where 1 = not a very significant
constraint and 5 = a very significant constraint.

Table 14 - Constraints on UK Market Share of Organic Supply
                                       No. of responses             Mean rating
                                 1      2       3     4       5
 Seasonality of production       8      0       2     1       1         1.92
 Quality of product              5      0       2     2       3         2.83
 Product price                   1      1       3     2       5         3.75

The data in the above table indicates that product price is the factor that is of most constraint
to market production with a mean rating towards the positive of 3.75. The factor of least
constraint is seasonality of production.

Consumer awareness, legislation and UK weather all received a rating of 5 indicating that
these factors are a significant constraint on market production. It must be noted, however, that
only one respondent mentioned each of these factors.

4.6.3 Organic Farming Scheme (OFS)

Approximately half (5/12) of respondents state that, in their view, the availability of
conversion grants, under the Organic Farming Scheme, is helpful in terms of meeting demand
While the other half take the opposing view. The reasons given in support of these views are
summarised below.

 OFS conversion grants helpful in meeting OFS conversion grants not helpful in
 demand                                        meeting demand
    Conversion grants have got to exist in        Grants are/were not related to market
    order to help farmers                        demand thus resulting in the market being
    They are needed to help make changes         over supplied
    They are helpful in the first instance but    Grants should be directed at marketing
    then     farmers    need      maintenance    rather than production
    payments to help them in case they come       Market demand is there anyway
    under pressure financially                    The OFS is not relevant to all types of
    They encourage people to convert             farmer e.g. poultry
    Without them farms would struggle to          The right sort of farmers are not always
    make their enterprise viable.                attracted into conversion
                                                  They have not encouraged enough people
                                                 to convert therefore there is not enough
                                                 product to meet demand.
                                               37
The above comments reflect differing views as to whether demand is being met and whether
the organic market is currently being over or under supplied. More fundamentally, they
reflect supply-led and market-led approaches. On the one hand there are those who believe
that conversion grants are instrumental in encouraging and assisting farmers to convert to
organic. On the other hand there are some who feel that conversion grants have failed to
encourage sufficient people to take up organic farming, not always encouraged the right sort
of people to take up organic farming, or that they have led to over supply in the market place.

One should bear in mind that there are often differences of opinion with regards to the success
of government schemes and that perhaps those who are not direct beneficiaries are likely to be
somewhat more sceptical. The diverse response also highlights the fact that the market supply
and balance varies considerably between commodities and market outlets.

4.6.4 Future growth

Respondents were asked what level of volume growth (total and UK percentage) they
forecasted, within their business, over the next 12 months.

Responses indicate that the majority of organic products supplied/ manufactured by
respondents will experience an increase in volume growth over the next 12 months. The
volume growth forecasted ranges from 5 to 3,000%.

The mean score for the volume growth forecasted, amongst those who forecast a growth and
provided a response, is 79.9%. Where a range was given the midway point was used to
calculate the mean score (for example, 5-10% range = 7.5%).

Both the mode and median are 10% volume growth.

Two products have been identified as ones that will not experience an increase in volume
growth, one will experience a decrease, one may experience a decrease and the expected
volume growth for one product is not known.

The forecasted volume growth, for the majority of organic products supplied/ manufactured
by respondents, will be 100% UK share. (This does not make sense – M.T. – relates to
sentences below too)

Fruit and vegetables produce are those where the increase in volume growth does not always
comprise 100% UK share. The proportion, as a percentage, of forecasted UK volume growth
for these products ranges from 12.5% to 100%.

The mean score for the percentage of the UK share of volume growth, amongst those who
forecast a growth and provided a response, is 79.7%.

Respondents who identified an increase in the UK share of volume growth, for all/some of the
organic products they supply/manufacture, were asked to specify why they thought the UK
share would change.

Reasons given include:
   An increase in the number of people in conversion and/or having completed conversion
   Better growing conditions
                                              38
   Better marketing and looking for new ways of selling
   Better varieties of produce
   Derogation
   Increase in the amount of land allocated to certain crops
   Market demand
   More raw material available at a lower price
   Potential growth in the market
   The growing interest of the general public in organic produce and what they eat.


4.6.5 UK sourcing

Respondents were asked what their company’s policy is on UK sourcing - two thirds (8/12) of
respondents say that their policy is to source 100% UK. One third (4/12) of respondents state
that, although not always able to source UK, they always try to where they can.

All respondents (12/12) were asked to specify the strategies they have in place for achieving
their UK sourcing policy. By far the main strategy identified is buying from/dealing with UK
farmers and growers. Other strategies identified include:
       Company culture is to source locally and UK
       Develop product lines with existing growers
       Direct marketing
       Fulfilling customer requirements
       Put pressure on suppliers to source UK.


4.6.6 Suppliers

All respondents (12/12) were asked to specify the type of information that they share with
suppliers. The majority (11/12) of respondents state that they do share some information. The
type(s) of information shared include:
    Customer information
    Demand requirements
    Future developments
    Market information
    Product information
    Quality information
    Sales information.

One respondent claims that they don’t share any information.

4.6.7 UK share of supply of primary produce

4.6.7.1   Action by government
All respondents (12/12) were asked what else could be done to maximise UK share of supply
of primary produce by the government. Responses given relate primarily to positive actions
that the government could undertake and include:
   Facilitate, rather than complicate, the introduction of EU legislation
   Help for organic farmers to put their produce on the market
   Help with marketing the industry
                                             39
   Lead by example e.g. support the industry from within government departments such as
   schools
   Level the playing field with Europe
   Raise consumer awareness with regards to how organic products have been produced
   The provision of realistic OFS payments.

In addition, one respondent suggested that the government could help to maximise UK share
of primary produce by ‘not intervening and letting the market work itself out’, thus suggesting
that perhaps a small minority believe that the government should not be actively involved in
this sector.

4.6.7.2    Action by retailers
Respondents were asked what else could be done by retailers, to maximise UK share of
supply of primary produce. Responses given include:
     Better marketing
     Brand organic produce
     Ensure organic produce is available on the shelves
     Have an awareness of the production process
     Payment of realistic prices to farmers/growers
     Promote better labelling of organic produce
     Put pressure on suppliers to supply British produce, possibly at more competitive
     prices
     Raise awareness of organic amongst consumers.


4.6.7.3     Action by suppliers
Respondents, who are not suppliers, were asked what else could be done by suppliers, to
maximise UK share of supply of primary produce. The one response given was that suppliers
need to work together and be co-operative.

4.6.7.4 Action by farmers/growers
Respondents, who are not farmers/growers, were asked what else could be done, by
farmers/growers, to maximise UK share of supply of primary produce. Responses given
include:
    Look at ways to reduce costs
    Look for ways to link up with other co-ops
    Be realistic and grow when the conditions are right

4.7       Retailer attitudes

The UK multiple retailers have played a crucial part in the recent development of the organic
food sector with 82% of organic produce sold through these outlets (Soil Association, 2002).
This has been delivered through a combination of support and commitment to producers and a
high level of in-store profile and promotion of product ranges. While it can reasonably be
argued that much of this is driven by self-interest, it also reflects increased consumer demand
anticipated by the capture of detailed customer buying patterns. Despite the role that the
multiples have played in developing consumption and production, there is concern over the


                                              40
level of their commitment to UK sourcing. The retailers vehemently deny any such lack of
commitment.

When the Organic Action Plan was conceived, government was keen to tie the retailers into
the process, both to get ownership of the plan across the whole supply chain but also to ensure
a sufficient balance of supply-push and demand-pull actions. As part of this process, the
retailers were asked to provide data on the levels of UK supply across a range of commodities
through a BRC survey. The analysis of key sectors is presented in Table 15 below:

Table 15 - UK share of organic & conventional sales as a proportion of total own-label
           products (2001)

 Category          Product        %UK share of       %UK share of
                                  organic sales      conventional sales
 DAIRY        Cheese                   76%                84%
              Milk                    100%               100%
              Yoghurt                 100%                91%
 MEAT         Bacon/ham                20%                34%
              Beef                     57%                91%
              Lamb                     85%                87%
              Pork                     46%                97%
              Chicken                 100%                92%
 VEGETABLES Broccoli                   30%                38%
              Potatoes                 58%                92%
 FRUIT        Apples                     6%               19%
              Soft fruit               44%                26%
Source: Defra

This data is consistent with the wider analysis in this report and highlights the fact that for
many categories of produce, organic market share is similar or better than conventional.
There are key exceptions, notably pig meat, vegetables and top fruit for which technical and
economic issues are limiting.

Following this exercise, retailers were asked to comment on which sectors they felt offered
the best opportunity for increased UK market share and what strategy they were adopting to
achieve OAP targets. Responses on sectors offering opportunity to increase % UK market
share of included soft fruit, apples and pears, fresh produce, milk, bread and cereal products,
fresh meat and fresh fruit and vegetables. However, most made the point that they were led
by consumer demand and did not feel that targets set by government, retailers or others were
helpful to development of the industry.

In terms of commitment to UK sourcing, most felt that they had made substantial
commitments and that suppliers were asked to source British where quantity and quality were
available. This is consistent with the findings of the supplier survey in this study.




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