Lessons from the LIPGENE Project: Economic Issues in Producing and Supplying Special Lipid- Modified Foods

Lessons from the LIPGENE Project: Economic Issues in Producing and Supplying Special Lipid- Modified Foods Presentation for Munich Conference December 2005 By Dr James Fry and Dr Willa Finley LMC International, Oxford, UK

Outline of the Presentation Brief summary of the incidence and economic costs of obesity in the EU. The costs of devising separate identitypreserved (IP) output and processing chains to supply foods with an improved lipid content to help to combat the metabolic syndrome in particular and obesity in general. The willingness of consumers to pay a premium for healthy foods, and the case for subsidies to lower the prices of such food and lower the incidence of obesity.

The Incidence and Direct and Indirect Costs of Obesity in the EU-15 (Applying growth rates from OECD time series some of which are biased downwards by self-reporting to International Obesity Task Force estimates, and UK National Audit Office obesity cost data for 1998)

Increase in Obesity Among EU Adult Males % Obesity in Adult Males (BMI > 30) 30 25 20 15 10 5 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 Finland Austria Belgium Denmark France Germany Ireland Italy Netherlands Spain Sweden United Kingdom

Increase in Obesity Among Adult Females % Obesity in Adult Females (BMI > 30) 30 25 20 15 10 5 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 Finland Austria Belgium Denmark France Germany Ireland Italy Netherlands Spain Sweden United Kingdom

2002 Total EU-15 Direct and Indirect Costs of Obesity (Attributed Pro Rata to 1998 UK Data) 1,989 863 887 916 3,216 10,436 Total = 32,813 million 4,324 4,748 5,435 Germany Italy UK France Spain Austria Netherlands Greece Others

Overall Costs and Incidence of Obesity in 2002 in the EU-15 The full annual direct and indirect costs of obesity in the EU-15 in 2002 were estimated to be nearly 33 billion. The UK, Germany, Italy and France together accounted for over 75% of the total. For both men and women, at least half the member states have more than 20% of their adults with BMIs of over 30.

The Costs of Improving Plant, Dairy and Meat Nutrient Profiles and of Applying Identity Preservation (IP) Systems Throughout Their Supply Chain

The Costs of Separate Supply Chains Identity preservation (IP) systems are needed to keep special foods, commanding premium prices, separate and segregated from cheaper commodity products. In addition to the costs of devising special IP systems for special plant and animal products, the creation of low volume supply chains imposes extra costs on suppliers via the inability to exploit economies of scale.

Identity Preservation (IP) Costs Along the Production Chain with Oilseed and Grain Products

Production and Marketing Costs of IP from a Farm in the US to an Export Market in the EU IP costs, $/tonne, excluding processing 200 160 120 80 40 0 Food Grade Soybeans Herbicide-tolerant Non-GMO Soybeans General Non-GMO Soybeans Non-GMO Maize 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 Quantity (million tonnes)

Indexes of Soybean Crushing Costs, Illustrating the Cost Penalty if IP Requires Smaller Processing Plants Costs as % of a 2,000 tpd Crushing Costs 400% 350% 300% 250% 200% 150% 100% 50% 0% 2,000 tpd solvent 500 tpd solvent 50 tpd expeller

Supply Chain Costs for Healthy Nutrient Profiles in Animal Products

Examples of Existing Lipid-Modified Livestock Products With Enhanced Conjugated Linoleic Acid (CLA) or High Ω-3 Content

Omega-3 Content, grams/100 grams Ω-3 3 Fatty Acid Levels in Conventional 1.5 1.2 0.9 0.6 0.3 0.0 and Enhanced Livestock Products Beef Milk Poultry Eggs Omega-3-enhanced Conventional

1.6 Levels of CLA in Conventional and Enhanced Milk and Beef CLA Content, grams/100 grams 1.4 1.2 1 0.8 0.6 0.4 0.2 0 Beef CLA-enhanced Conventional Milk

Production Costs of Food Products with Healthy Nutrient Profiles Total supply costs for milk, meat or eggs with healthy nutrient profiles are 10-60% more than for conventional alternatives. This is due to The extra costs of feed, such as flax (linseed) or fish oil, needed to enhance the CLA/ Ω-3 levels, The costs associated with reduced rate of gain (high CLA beef) or reduced productivity (Ω-3 eggs). IP costs, including transportation and testing. Higher unit costs due to inability to exploit scale.

Example of the Fresh Milk Supply Chain

Economies of Scale in Conjugated Linoleic 0.70 Acid (CLA) Fresh Milk Production Production Costs, US$ per litre of milk 0.60 0.50 0.40 0.30 0.20 0.10 0.00 Small (<50 head) Medium (50-199) Large (200-499) Industrial (>500) Herd Size (Number of Head) All Other Costs IP Costs Non-IP CLA Costs

Economies of Scale in Processing 0.80 CLA Fresh Milk Milk Processing Costs, $/litre 0.70 0.60 0.50 0.40 0.30 0.20 0.10 0.00 0.365 13.6 54.5 Million Litres per Annum Capacity Non-IP Costs IP Costs

Economies of Scale in the CLA Fresh Milk Production & Processing-to to-retail Chain 2.00 Overall Costs, US$ per litre of milk 1.80 1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 Small Medium Large Herd Size Production Processing Retail

Example of the Free Range Broiler Chicken Supply Chain

Economies of Scale in Free-Range Full Production Costs ($ per bird) 8 7 6 5 4 3 2 1 0 Broiler Production on Farm 6,000 18,000 54,000 Number of Birds Produced Annually Natural Free-range Organic Natural Free-range + Omega-3/CLA

Economies of Scale in Broiler Processing 3.50 Processing Cost per Bird ($) 3.00 2.50 2.00 1.50 1.00 0.50 0.00 0 50,000 100,000 150,000 200,000 250,000 300,000 Processing (Birds/day)

Costs to the Processing Stage for High Ω-3/CLA Free Range Broilers $/bird 9 8 7 6 5 4 3 2 1 0 6,000 18,000 54,000 Flock Size (number of birds) All Other Costs Total IP Costs Total Cost Due to Healthy Trait

Example of Hormone-free and Grass-fed (High CLA) Beef

Production Costs for Beef with Healthy Nutritional Attributes 1,800 1,600 1,400 1,200 $/head 1,000 800 600 400 200 0 Hormone Free Grass-fed (Enhanced CLA) Conventional Basic Costs Penalty from Lack of Scale Cost of Slower Growth IP Costs

Grass-Fed Hormone-Free & Conventional Beef Production Costs (Excl. Calf Cost) 350 300 250 $/head 200 150 100 50 0 Grassfed Conventional Feeding Operations Processing Retail

Example of the Organic, High Ω-3 Egg Supply Chain

Production Costs for Organic and Egg Production Costs ($/dozen) 1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 High Ω-3 3 Eggs Conventional Organic-Omega-3 All Other Costs Costs due to IP Costs due to Omega-3

Overall Extra IP and Input Costs for Healthy Foods, From Farm to Retail IP costs are 2-5% of costs across all products. Extra costs due to the healthy trait typically account for 7-14% of total costs. Combined IP and special input costs represent 10-16% of total costs throughout the chain. It is noteworthy that combined IP and extra input costs in animal food products, as a share of total costs, are broadly similar to the IP costs of oilseeds with speciality fatty acid profiles.

Economies of Scale Have the Biggest Impact Upon Overall Costs Economies of scale in agriculture, processing, distribution and retailing have a bigger effect upon total costs than IP and higher input costs. The cost penalty for niche products (with 2-3% of the market) vis-à-vis conventional products (with over 90%) varies from 35% to 85% for the products considered in the LIPGENE project. Also, retailers expect higher margins on slowmoving niche products than on basic foods.

Implications for LIPGENE Using these results, one can link the extra cost of supplying fat-modified foods to (a) the nature of the product (plant oils, meat or eggs) and (b) the output scale of the healthy product. The scale of output, in turn, depends upon (a) consumers willingness to pay price premia for health and (b) subsidies, if any, offered to encourage consumption. Therefore, we now turn to consider the evidence about consumers willingness to pay.

The Willingness of Consumers to Pay Premia for Perceived Health Benefits: The Trade-off Between Price Premia and Sales

Premia that US Consumers Say They are Willing to Pay for High CLA Milk Products 16% 14% 12% 10% 8% 6% 4% 2% 0% Milk Butter Yoghurt Average Premium That Customers Were Willing to Pay Premium That Customers Were Willing to Pay Who Consistently Choose Low-Fat Brands

Recent US Retail Prices for Nutritionally $/dozen 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 Enhanced or Speciality Eggs 0.00 Omega-3 + Organic Organic Free-Range Natural Conventional

Examples of the Trade-offs Between Price Premia and Market Shares

Premium vs. Market Share for Healthy Foods Phytosterol Spreads (UK Data) 350% 300% Price Premium 250% 200% 150% 100% 50% 0% 0% 20% 40% 60% 80% 100% Market Share

Premium vs. Market Share for Healthy 200% 180% 160% Foods Eggs (US Data) Price Premium 140% 120% 100% 80% 60% 40% 20% 0% 0% 20% 40% 60% 80% 100% Market Share

Premium vs. Market Share for Healthy 70% 60% Foods Beef (US Data) Price Premium 50% 40% 30% 20% 10% 0% 0% 20% 40% 60% 80% 100% Market Share

Premium vs. Market Share for Healthy Foods Broiler Chickens (US Data) 120% 100% Price Premium 80% 60% 40% 20% 0% 0% 20% 40% 60% 80% 100% Market Share

Present Market Share of Healthy Foods Phytosterol spreads have 7% of the market in the UK, and 2%-3% in the US, with buyers paying a near 300% premium at retailers. Healthy eggs and chickens have 3%-4% of the US market, with premia of close to 200% for eggs, but of only 40% for fresh chickens. Healthy beef, milk and cheese hold less than 1% of the US market and command price premia of 25%, 60% and 115%, respectively.

The Policy Dilemma Balancing Subsidies for Healthy Food Consumption against Potential Savings in Obesity-Related Health Costs

Policy Dilemma Only a few consumers will pay a significant premium for special food attributes. The challenge is to balance a. The cost of measures to boost demand for healthy foods, thus expanding the scale of output (and lowering production and IP costs at the same time) against a. The benefits from reductions in obesity and the consequent savings in health costs.

Policy Options 1. One option would be to subsidise the costs of inputs to healthy foodstuffs to make them attractive to consumers on cost grounds. 2. Another option is to mandate the use of healthy inputs in foodstuffs and thereby force consumers to meet the extra cost. 3. A third option is to target subsidies to specific users, e.g., via vouchers, much like medical prescriptions.

Problems of These Options Problems of These Options Subsidising inputs across the board ensures take-up, but it is indiscriminate in scope and wasteful in failing to target beneficiaries. Mandating input use (as with vitamin A in sugar in some countries) is indiscriminate, too, but spares governments subsidy costs, instead passing them on to consumers. Targeting subsidies via vouchers avoids such waste, but (a) entails additional administrative costs, (b) incurs cost penalties from lack of scale, while (c) risking failing to reach many of the beneficiaries from such intervention.

Problems of These Options Problems of These Options Subsidising inputs across the board ensures take-up, but it is indiscriminate in scope and wasteful in failing to target beneficiaries. Mandating input use (as with vitamin A in sugar in some countries) is indiscriminate, too, but spares governments subsidy costs, instead passing them on to consumers. Targeting subsidies via vouchers avoids such waste, but (a) entails additional administrative costs, (b) incurs cost penalties from lack of scale, while (c) risking failing to reach many of the beneficiaries from such intervention.

Problems of These Options Problems of These Options Subsidising inputs across the board ensures take-up, but it is indiscriminate in scope and wasteful in failing to target beneficiaries. Mandating input use (as with vitamin A in sugar in some countries) is indiscriminate, too, but spares governments subsidy costs, instead passing them on to consumers. Targeting subsidies via vouchers avoids such waste, but (a) entails additional administrative costs, (b) incurs cost penalties from lack of scale, while (c) risking failing to reach many of the beneficiaries from such intervention.

Cost-Benefit Analysis: Options 1 and 2 We have computed the cost of subsidies on inputs such as phytosterols and linseed and fish oils for all EU soft spread, poultry and beef output, so as to bring retail prices of healthy foods just below those for conventional foods. (N.B. This would cut out the costs of separate supply chains and IP, since healthy products would become the commodity products.) These costs are contrasted with the costs of obesity to reveal their relative magnitudes.

Costs of Subsidising Inputs on All Output vs. the Direct and Indirect Costs of Obesity 35 30 Annual Costs, billion 25 20 15 10 5 0 Special Inputs Obesity Costs Eggs Broilers Beef Spreads Costs of Obesity

Evidence of the Benefits from Lipid-Modified Diets Indications of benefits from a more general approach to altering the balance of lipids are provided by Vessby at al, 2001. Changing diets to monounsaturated from saturated fats improved insulin action by more than 20% and led to a better lipid profile, as long as individual s overall fat intake was less than 37% of their total calorie intake. Beyond that percentage, dietary changes had no effect.

The Trade-off Options 1 & 2 In these two options (full subsidisation or mandating), everyone receives lipid-modified animal products, regardless of their health. Our costings assume big increases are possible in the use of key inputs without bidding up their prices. However, against this, these options have the benefit of avoiding all IP costs and ensuring the attainment of economies of scale. The result is that the costs of an EU-wide system to promote a healthier lipid profile in leading animal-derived foods would amount to 30% of the direct and indirect costs of obesity.

Costs of Targeting Input Subsidies on 5%, 20% and 100% of the EU Population Extra Costs, billion/year 12 10 8 6 4 2 0 5% 20% 100% Share of Product Market Targeted for Subsidies or Mandating IP and Lack of Scale Special Inputs

The Trade-off Option 3 Here we consider the effect of targeting subsidies on 5% and 20% of the population, rather than 100%, in terms of the associated IP costs and lack of economies of scale, setting these against the savings on special input costs. By chance, the combined additional costs of lack of scale and IP systems are similar for both the 5% and 20% cases, at roughly 4 billion. Extra costs of special inputs bring the net costs to around 5 billion for the 5% case and 6 billion for 20%, vs. 10 billion for 100% scope.

Implications for Public and Private Sector Responses

Implications for Policy Without some form of intervention, it seems inevitable that the combination of high input costs, IP systems and lack of scale, alongside consumers unwillingness to pay much of a premium for healthy products, would condemn healthy lipid-modified foods to a series of mostly small niches in the overall market. If governments intervene, they must decide whether a targeted approach towards subsidies offers a better cost-benefit trade-off than universal subsidisation or mandating.

Targeting or Global Intervention? Targeting subsidies proves to be cheaper than an across-the-board subsidy, as long as the administrative costs are kept in check. A further factor favouring a targeted approach is that it runs less risk of bidding up the prices of special ingredients for lipid-modified food products than a comprehensive approach. We must await results from LIPGENE research before the potential scale of reductions in the incidence of the metabolic syndrome as a result of lipid modification become clear.

Scope for Private Initiatives? A notable development in 2005 was the launch of a scheme of vouchers by a Dutch health insurance company for its clients judged to be at risk of cardiovascular disease. These vouchers provide a subsidy of 40 per annum towards purchases of phytosterol spreads. An identical scheme has now been launched in France, but has attracted formal complaints from consumer groups because of the commercial link between the subsidy and a particular company s food product.

Cost-Benefit Conclusions The analysis presented here suggests: If the targeting is directed towards lipid-modified animal products, ranging from meat to dairy products to eggs, for the 20% of the EU population who are obese, the subsidy needed to cover all increased product costs would be 6 billion/year. If this approach manages to reduce the incidence of obesity by one fifth, i.e., from 20% to 16%, the overall annual costs of obesity would be lowered by over 6 billion, yielding a small net advantage. The trade-offs will only become better defined as the LIPGENE project generates scientific results.