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Chiquita Banana Case

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    How did the Common Market Organization for Bananas (“CMOB”) affect Chiquita? Six firms dominated the banana industry in the early 1990’s, three from Europe and three from the United States. In 1994, the three United States producers, Chiquita, Dole, and Del Monte, accounted for approximately 72. 4% of world banana sales. Chiquita accounted for 48% of worldwide banana sales and 66. 4% of banana sales of the three U. S. producers. Prior to 1994, Europe accounted for nearly 40% of world banana imports by volume, of which roughly 60% came from Latin America, the primary location of Chiquita Brand International’s banana production.

    However, in 1993, a common banana import policy, council Regulation (EEC) 404/93, became effective four months prior to the official integration of the European Union. Title IV of the regulation induced changes in banana import policy. Banana imports were divided into four categories: Latin American and non-ACP sources, called “third country imports;” “traditional” ACP imports; “non-traditional” ACP imports (ACP imports above “traditional” quota amounts); and EC imports. “Third country” imports, the category in which Chiquita fell, were restricted to a two million metric ton (m. t. ) quota with a 100 ECU/m. . duty. Imports in excess of the quota were subject to an 850 ECU/m. t. duty. The 850 ECU/m. t. duty was roughly 250% a. v. , while the 100 ECU/m. t. duty was roughly 30% a. v. “Traditional” and “non-traditional” imports were duty free, unless above the two million ton quota, which is well above the capacity of the smaller producers in this category. In addition to the quota and higher duties, “third country” and “non-traditional” importers (U. S. multinationals) were subject to a licensing provision limiting them to 66. 5% of “third country” quota. 66. 5% equates to 1. 3 million m. t. f bananas annually at a duty of 100 ECU/ m. t. At a 48% of the world’s market share, Chiquita would have accounted for 1. 82 million m. t of Europe’s 3. 8 million m. t. of banana imports in 1991 and 1. 91 million m. t of Europe’s 3. 98 million m. t. in 1992. (Note: these figures are assumptions and do not account for the probable lack of export to Asian countries. ) In 1993, under Title IV regulations and assuming licensing provisions were distributed proportionately to the three major U. S. -based banana producers, Chiquita exports to European countries would have dropped to 0. 86 million m. t. er year (at the 100 ECU/m. t. duty). That is a theoretical 0. 96 million m. t. decrease in European banana exports for 1991 and 1. 05 million m. t. decrease for 1992. Chiquita banana exports in 1993 cannot be calculated with available data, but the theoretical numbers from 1991 and 1992 suggest a significant drop-off in European exports following the inception of Title IV. The result for Chiquita was most likely surplus problems, finding new markets for banana exports, and flooding existing markets. The result of the EU’s banana import policy was a decrease in supply and an increase in price for EU members.

    The rest of the world most likely would have experienced an increase in supply and lowering of cost, but figures to quantify said scenario are not available. Assumptions: Chiquita’s market share, production, and sales figures in 1991/1992 and 1994 are similar, rendering the transitive property viable. b. How were EU consumers affected by CMOB? CMOB adversely affected not only banana producing and exporting nations but European consumers as well. CMOB created an artificial shortage of bananas in Europe and drove up prices. Europeans consumed 25% less bananas under the regime and paid 63% more for the privilege of doing so. http://news. bbc. co. uk/2/hi/business/8413979. stm). However, not all Europeans were affected equally. Germany was the largest consumer of bananas in Europe and had no restrictions on imports before CMOB (bananaramma p. 270). Once it went into effect, however, banana exports to Germany fell by 250,000 t per year. (p. 122 Historical overview of the Euro. Banana Import Policy) Retail prices rose 42% in Germany (bananaramma p. 270), and German consumers experienced welfare losses of $50 million per year as a result of the program. (p. 122 Historical overview of the Euro. Banana Import Policy).

    In contrast, countries that previously had restrictive policies were made better off as their real import prices of bananas decreased under the new regime. (Id. ) Paying more for bananas was not the only way that Europeans suffered from CMOB. Although EU government gained additional revenue with the introduction of common tariff and so did the preferred importer countries with the soaring prices for bananas, it is estimated that the lost consumer surplus as a result of CMOB was $2 billion a year. (p. 270 banaramma). Furthermore, the prior system forced EU consumers to pay $5. 0 to transfer $1 of aid to ACP countries while the CMOB framework increased the cost to $13. 25 to transfer $1 worth of aid. (p. 270 banarama) In other words, the European consumer’s cost of helping the former colonies more than doubled under the new framework. A more efficient way to aid the ACP countries would have been to provide direct foreign aid. Europe already provided $200-300 million in direct aid to these countries, so it had both the process in place and willingness of the population to engage in this more efficient and effective system of providing foreign aid. (272-73 bananrama)

    The ideal way to calculate the price elasticity of demand for bananas would be to compare the price and quantity of bananas imported into each country under the old regime to the price and quantity demanded under CMOB. Under such a calculation, each country would have its own price elasticity of demand for bananas. Since those numbers were not available in the case, we chose to compare the prices and consumption of bananas in Germany versus France prior to CMOB taking effect. (move to an end note: Germans, residents of the only free market for bananas in Europe, consumed 16. kg of bananas per capita at an average price per ton of 438 of ECU in 1991 while the French, residents of Europe’s most protective market, consumed 8 kg of bananas per capita with average price per ton of 604 ECU. (case p 7). The percentage change in price from France to Germany is (604 ECU-438 ECU)/438 ECU, which equals . 379. The percentage change in quantity from France to Germany is (8 kg-16. 6 kg)/16. 6 Kg, which equals -. 518. The absolute value of the percentage change in quantity over the percentage change in price is 1. 3. That calculation showed European demand to be elastic at 1. 3, so for every 1% change in price, the quantity demanded will change 1. 3%. c. What are the supply side constraints in the banana market? The slope of the supply curve demonstrates how quickly a supplier can react to a change in prices. The following issues can affect the slope of the banana supply curve: Labor: Bananas grow all year but in 13 week cycles, and they are harvested daily by cutting the stems by hand. (http://money. cnn. com/magazines/fortune/fortune_archive/2001/11/26/314058/index. htm).

    In its controversial history, Chiquita has experienced several situations of labor unrest that resulted in supply shortages. (case p. 6) Land: Growing bananas requires an abundance of flat, high rainfall land in a high humidity, low wind environment. (http://www. thecie. com. au/content/publications/CIE-banana_supply_elasticities. pdf, p. 6). Without access to this type of land, the ability to supply bananas is substantially reduced. Capital: Buying and cultivating land, putting in the labor and infrastructure to make the business operate, and creating an effective disease control process all cost a tremendous amount of money.

    If a firm has a capital crisis like Chiquita had when CMOB went into effect, it may not have access to the capital markets to cover these costs. Therefore, it may be forced to liquidate its land, cut down on workers, or skimp on disease control. Any of these moves could result in lower production available for the world market. Supply Chain Issues: During the 1990s, Latin American provided 75% of the total volume of bananas traded in the global market. (case p. 5). Approximately 85% of worldwide production was consumed in the US and Europe. (Id. t Exhibit 5). Therefore, transporting the bananas from the area of production to the market is an important part of the banana industry’s business model. Due to the perishability and fragility of bananas, an effective transport system must be maintained for bananas to reach the end consumer in a condition that is acceptable for sale. Roads need to provide smooth, efficient transport to prevent bruising and spoilage. Most of the Latin American countries responsible for the bulk of bananas sold in the EU are developing nations. (http://www. vinv. cr. ac. cr/latindex/agrocostar-30-2/08-Chacon-Historical. pdf, p. 123). Developing nations are not known for their high quality, smooth roads, so unless the producer invests substantial resources to provide transport from the farm to the docks, bad roads could damage or delay shipments and thereby reduce the total supply available to the world market. Similar to road concerns, poor maritime shipping methods and/or strikes at ports could also reduce the supply of bananas available in the world market. Discuss the steepness of the supply curve.

    The steepness of the supply curve really depends on the time period discussed. Although bananas grow in 13 week cycles, the plants need 9 months before they produce fruit and are highly perishable. (http://www. tropicalpermaculture. com/growing-bananas. html; see also case p. 4). Therefore, a supplier cannot act to substantially increase its supply of bananas in the short-term to react to a market price increase, and it cannot stockpile a supply of bananas for future sale at a higher price either. These facts suggest that the supply curve would be vertical.

    While the above factors suggest that the supply curve should be vertical, suppliers do have some techniques to reduce the steepness of the curve in the short-term. For example, the producer could hire additional workers which could produce a slightly higher yield. (http://www. thecie. com. au/content/publications/CIE-banana_supply_elasticities. pdf, p. 6) Another option would be to hire faster ships with better refrigeration units to ensure that more bananas reached the market in saleable condition. These techniques could possibly reduce the steepness of the supply curve during the short-term time period.

    In contrast to the short-term time period, the long-term supply curve should be very flat. With time on their side, producers can acquire more land, hire additional labor to work that land, and then plant more plants that will begin producing bananas after their initial growth period. In other words, they have time to plan for increased production, and holding any other supply constraints constant, the result will be many more bananas available for sale in the world market. Discuss the volatility of the supply curve

    The volatility of the supply curve is determined by factors which producers cannot plan for or control. When these events occur, they cause the supply curve to shift, thereby making prices volatile. Weather issues: Natural disasters such as hurricanes, tropical storms, and earthquakes have destroyed large portions of worldwide supply in multiple countries. For example, a 1991 earthquake in Costa Rica cut worldwide banana production by 10%. (case p. 6) Weather issues can also cause shipping delays which result in bananas arriving to their destination in a condition that is too ripe for urther transport or ultimate sale to the end consumer. Fruit disease: Periodic outbreaks of fruit disease could greatly reduce the available worldwide supply. For example, Tropical Race Four is a soil borne fungus that only affects bananas, and it’s caused “tens of millions of dollars worth of damage. ” (http://www. newyorker. com/reporting/2011/01/10/110110fa_fact_peed). Scientists believe that it will eventually find its way to Latin America, and since the bulk of world trade in bananas comes from that region, the disease could be devastating to the worldwide supply. Id.

    Political instability: While stronger international laws have greatly reduced the risk of expropriation (http://hbr. org/2010/04/the-hidden-risks-in-emerging-markets/ar/1), it is not out of the realm of possibility that a developing nation would decide to expropriate the banana industry within its own borders. Depending on the production within that country and what the country elects to do with its newly appropriated assets, the supply of bananas to the world market could be greatly reduced. d. Was the Framework Agreement to blame for Chiquita’s poor performance? Keith Lindner would like to blame CMOB for Chiquita’s fall from grace.

    The policy certainly did have some effect on Chiquita’s performance, but it was enacted in 2003 and did not take effect until October 1994 (case, p. 11). The company’s woes began long before that date. From 1991-1994, the corporation’s available cash fell from $712,005,000 to $178,855,000. During that same period, the company more than doubled its long term debt position ($41,065,000 in 1991 to $91,032,000 in 2004), and its interest expense on the income statement went from producing $88,406,000 in additional income to reducing income by $169,521,000. As you can see, much of the damage, including the tanking of the stock from $40 to $13. 3 per share, took place before CMOB even took effect. Chiquita’s first misstep was installing a 29 year old Keith Lindner as the COO in 1989. While he was the son of the CEO and majority shareholder, he proved to be wholly unprepared for the troubles Chiquita would face. (we have no profits article) For example, less than one month before Chiquita released the 1992 first quarter earnings, Lindner assured analysts that the company would hit its targets. When earnings fell 85% short of those estimates, he blamed unusual weather patterns and disease as the reason for the shortfall. (Id.

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