High Fructose Corn Syrup Industry Analysis
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High Fructose Corn Syrup (HFCS) is a natural sweetener extracted from milled corn and wheat, used in the production of food products such as soft drinks, baked goods, and syrup. The manufacturers of HFCS purchase corn or wheat and refine them into HFCS through a milling process. Manufacturers then sell HFCS to food and beverage production companies. The HFCS industry has experienced negative annual growth of 5.5% from 2013 to 2018 and a decrease in product margin from 5.7% to 5.2% over the same period.
Our general thesis for understanding the evolution of this industry involves the following variables: (i) threat of substitutes – such as sugar and aspartame; (ii) final consumer taste and their increasing tendency of demanding healthier products; (iii) securing contracts with commodities' providers and food industries; and (iv) shrinking market.
For the purposes of this paper, we have restrained our analysis to the US national market.
Threat of Entry: Low
The threat of entry is Low for the HFCS industry. There are two characteristics of HFCS's market that should be highlighted when considering its barriers of entry: (i) capital expenditure; and (ii) securing suppliers' and clients' contracts.
First, the capital intensity of the HFCS is deemed high. New entrants must investment heavily in machinery and continuous PP&E and maintenance to be competitive in this market. Also, this industry demands highly specialized employees, resulting in high labor costs.
Second, there is high instability in this market as a result of fluctuating demand and volatile suppliers. To ease this concern, HFCS's major players have secured substantial suppliers' and clients' long-term agreements, ensuring stable operation and entrenching themselves as industry leaders.
In addition to barriers of entry, the HFCS industry has other characteristics that affect the threat of new entrants. There is a moderate level of concentration, almost 46.9% of the HFCS market is controlled by 3 major players. Additionally, the industry is experiencing slim and decreasing profit margins, which leave little room for new entrants to reach profitability in the industry. Finally, incumbents have strong advantages with respect to economies of scale. Without these benefits the high capital expenditure, lack of strong contracts, and low profit margin would prevent smaller players from being profitable in this market.
Rivalry Among Competitors: Medium
To assess HFCS's market competition, one should take into consideration the internal and external influences on competition. External competition has been harmful to HFCS's producers in recent years - this matter will be addressed in the "VI. Availability and Price of Substitutes" section.
Within the HFCS market, the competition is moderate, which can be highlighted by the decrease in this industry's profit margin from 5.7% to 5.2% from 2013 to 2018. The competition within HFCS players revolves mostly on offering the lowest possible price to prospective clients, however, this is mitigated by the maturity of the market and moderate concentration of incumbent competitors who have secured profitable contracts and domain over distribution channels.
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In terms of factors that contribute to stronger pricing rivalry, HFCS is a homogeneous product and, because of that, there is no apparent brand loyalty within clients and the market price is known by industry clients. Additionally, the market size has been decreasing due to the threat of substitutes and recent health issues related to HFCS. Lastly, the companies have had a high capital expenditure for building plants and setting efficient distribution lines, leading to a high exit barrier, since such investments would only be useful for other players in the same market.
However, there are factors softening pricing competition. For instance, HFCS is a mature market, with a moderate concentration (3 players own 46% of the market share). Also, the main players in this market have secured upstream and downstream contracts to ensure that they are protected from the fluctuations of demand and suppliers' inconsistency. Additionally, competitors maintain domain over their distribution channels to keep costs low.
It is important to highlight that there is no substantial international competition in this market. The imports account for only 0.6% of the total market share.
Buyer Bargaining Power: Low-Medium
In the High Fructose Corn Syrup production market in the United States, buyers have some limited bargaining power, stemming mostly from the level of concentration in buyer markets and supplier substitutability. Generally, the buyers of HFCS are producers/manufacturers of various sweet food products, such as soft drinks, baked goods, syrups, cereal, candy, cookies, bread, etc. The biggest buyer industry is soft drinks at ~45-50% of total HFCS demand. These industries have various levels of concentration, from high (soft drinks, cereal) to low (bread); therefore, the buyers with the highest bargaining power are Pepsi and Coca-Cola, which account for 28% and 10% of the soda market, or ~14% and ~5% of HFCS demand, respectively. As you can see, these are medium-sized stakes – nowhere close to being monopsony buyers, and therefore limited power.
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There are a few other sources of buyer power, most notably that the HFCS product from each producer is undifferentiated and there are not large switching costs among suppliers for HFCS buyers. This enables them to better ‘pit’ HFCS producers against each other. However, HFCS producers have used large, long-term contracts to combat this substitutability, trading off some margin to avoid profit-eroding price competition. Ultimately, these effects are muted and overall buyer power is Low-Medium in US HFCS production.
Supplier Bargaining Power: Low
Suppliers in the HFCS production industry have quite Low bargaining power, for three main reasons. First, suppliers (corn farming, corn milling, corn wholesaling; and vertically integrated corn firms) are in general more fragmented than HFCS manufacturing, which is more concentrated; in fact, 50% of corn farms are 100 acres or less in size. Second, the suppliers themselves are even less differentiated than the HFCS manufactures, as the literal corn that goes into HFCS production does not differ much in quality or features—only price. Finally, HFCS production is a small part of corn producers’ overall demand (vs. other areas like foodstuffs, livestock feed, biofuels, etc.); although this means corn producers could be more demanding in extracting rents from HFCS producers, it also means that it’s less ‘worth the trouble’ as the payoff is minimal relative to the overall business size—especially as the HFCS industry itself is already in top-line decline. Therefore, suppliers have very little bargaining power vis a vis HFCS producers.
Availability and Price of Substitutes: High
The threat of substitutes is High in the HFCS production industry. HFCS competes directly with its natural counterpart: sugar. The price of sugar began to decline in 2018, which is making it a cheaper alternative to HFCS for the time being. Additionally, public tastes have shifted towards, “all natural,” healthy eating, which has lowered the demand for processed sweeteners like HFCS as well as items with any added sweetener. HFCS must also contend with low calorie sweeteners, which offer a similar taste without the associated weight gain. However, HFCS does benefit from the fact that switching from HFCS to sugar or another sweetener is costly, both in terms of formulary (production) costs or consumer taste preferences, which could prevent current HFCS customers from switching.
Availability and Price of Complements: Low
The availability of price complements is Low for the HFCS industry. Potential complements include agricultural technology, fast food consumption, and baking ingredients. Agricultural technology prices could reduce the costs of corn, a key input for HFCS. The increase in consumption of foods or ingredients that complement sweetened goods will inherently increase consumption of HFCS. However, the ties between these complements and HFCS are not strong.
Additional Discussion (Questions)
- There are no real segments in this industry for the purposes of industry (profitability) analysis. The product is largely a standard commodity in the eyes of its buyers (hard to differentiate HFCS on features or ‘quality’- only price). Therefore, the only other way to segment is based on fructose % (namely, 42- or 55-percent fructose), but analysis along this dimension does not yield many interesting insights about profitability. The only point to note is that since HFCS-42 is slightly less sweet than HFCS-55 or natural sugar, it has been somewhat shielded from the shift in consumer taste away from sweet items (i.e., due to health concerns), and its revenue decline has been muted; therefore, its relative product share has increased. However, firms typically produce both types of HFCS, so the impact has been roughly equal across firms in the industry.
- Threat of substitutes. There is moderate internal rivalry, as competitors can only really compete on price and not HFCS ‘quality,’ however, this is limited by the few players and presence of strong downstream contracts. Substitutes (sugar, aspartame, etc.) are critical though because as consumers’ preference change with regards to health, obesity, additives, etc., demand for sweetener types swing wildly. The other forces are not strong limiters — and even serve to protect (i.e. capital intensiveness)—the industry’s profitability.
- There has been no clear strategy to mitigate the effects of the threat of substitutes. HFCS's market has been decreasing mostly because of customers' health consciousness which is something that cannot be reversed by the industry. Nonetheless, all large firms in this industry - Cargill Inc., Archer Daniels Midland Company and Tate & Lile PLC - have different sources of revenue in order to avoid depending solely in the HFSC segment. Through this positioning, the major companies have taken advantage of the economy of scale and became more profitable by sharing its distribution network with products from other segments. Moreover, by ensuring different sources of revenue, these players are not as susceptible to the fluctuation on demand nor to the volatility of the commodities prices. Finally, the industry engaged in a re-branding campaign to rename HFCS “corn sugar,” to compete with sugar’s “all-natural” consumer perception. Companies are also expanding to international markets where consumer tastes have not changed, particularly in developing economies as well as China, Russia, and Mexico (Tate & Lyle and Archer Daniels 10-K).
- Ten years ago, both growth and profitability were stronger in the HFCS production industry. Although 10 years ago was past the ‘heyday’ of when HFCS first started replacing natural sugar, at that time, consumer awareness of HFCS-driven obesity and the subsequent shift away from soft drinks / sweet goods were not as prominent as today. Much of the science and popular opinion has shifted in the last 10 years, driving substitution toward other sweeteners or non-sweet goods. This has caused top-line revenue growth to be negative for five years running and 6 in 10. Furthermore, HFCS producers are also getting squeezed on the upstream supply side, as corn prices have increased in the last 10 years due to competition with the feedstock and biofuel industries—but HFCS companies have not been able to pass the price increase onto their customers due to soft demand (as discussed) and excess capacity. Therefore, the market has shrunk, and margins have eroded on top of that.
- Archer Daniels Midland. FY18 Form 10-K for the Period Ending December 31, 2018 (filed February 19, 2019). https://archerdanielsmidland.gcs-web.com/static-files/084bcb66-8954-453e-9043-affdc4896757
- Miller, Anna. “IBISWorld Industry Report OD5945: High Fructose Corn Syrup Production in the US”. IBISWorld. December 2018.
- Tate & Lyle. 2019 Annual Report. Dec. 31, 2018.
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