Assessing the Impact of Direct Marketing in Overall Business Strategy: A Double Hurdle Approach

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1 Assessng the Impact of Drect Marketng n Overall Busness Strategy: A Double Hurdle Approach Problem Statement As farms contnue to ncrease acreage, an ncreasng emphass on dfferent management strateges has nfluenced farm operators and managers to employ varous producton and marketng strateges. One such marketng strategy that has ganed sgnfcant mportance as a management tool for managers s drect marketng. Accordng to Govndasamy and Nayga (1997), two key drvers of the ncrease n the mplementaton of drect marketng are: 1) producers can receve a better prce drectly from consumers and ) consumers receve a fresher product compared to that provded by tradtonal sources. The drect marketng strategy has been employed n a wde range of crops and lvestock products (e.g. farmers markets and locally branded meats (Kohls and Uhl, 1998; Buhr, 004)). Fnally, drect marketng creates markets where people can buy produce from local farmers and growers reduces the dstance that food travels between producers and consumers, whch n turn decreases global envronmental polluton. The prmary goal of mplementng a drect marketng strategy s to capture a larger share of the consumers dollar. Several studes have shown that farm managers are ncreasngly usng drect marketng as a method to ncrease farm ncome (Carter 1994; Govndasamy 1996; and Nayga Jr. et al. 1995). Increasng farm ncome from the mplementaton of drect marketng can have ndrect mpacts on the communtes because as a farmer s ncome rses t stmulates the local economy and rural development (Darby et. al., 008; Gale, 1997). Lastly, a recent trend to ncrease access to healthy foods, ncludng organc foods, state governments have mplemented drect marketng assstance programs to enttes and farmers. These programs can nclude farm to nsttuton programs such as schools, hosptals, prsons or other state agences, farmers markets, roadsde stands, drect delvery, agr-toursm (such as pck-your-own farms) and subscrpton farmng, and communty supported agrculture (CSA). These are all examples of programs that provde small- and medum-sze farmers an opportunty to develop new markets wth often hgher returns for ther goods. Objectves Ths paper bulds on the works of Govndasamy and Nayga Jr. (1997) and Govndasamy, Hossan, and Adelaja (1999) by usng the Agrcultural Resource Management Survey (ARMS), a natonal farm level survey. Our study s dfferent wth those mentoned above, by studyng the producer sde of the agrcultural market. Specfcally, we examne the characterstcs of farm operators and mangers and not the consumer. Frst, we nvestgate factors such as operator and household characterstcs, fnancal and producton attrbutes, and regonal locaton and proxmty to metro areas that affect farm operators and managers decson to mplement drect marketng n ther overall marketng strategy. The second objectve of ths study s to assess the mpact of drect marketng on farm ncome of farm households, once they have mplemented drect marketng strategy. Our study s dfferent than those found n the lterature. Frst, n contrast, the majorty of the lterature on drect marketng focuses on the characterstcs of consumers purchasng goods and servces drectly from producers. Second, we use a natonal farm level survey. 1

2 Govndasamy, Hossan, and Adelaja (1999) only use a survey conducted for New Jersey. Ths study s conducted at the farm level natonwde wth the unque feature of a larger sample than prevously reported n the lterature, comprsng farms of dfferent economc szes and n dfferent regons of the Unted States. Fnally, n the prevous lterature many papers have nvestgated whether or not the mplementaton of drect marketng has had a postve mpact on ncome. However, none of these studes has lnked the mplantaton of drect marketng and ts contrbuton to ncome from farmng.. Data and Procedures Most of the prevous studes focus on factors nfluencng consumers buyng drectly from producers. For the purpose of ths study the underlyng assumpton of the Double-Hurdle model s that farm households make two decsons wth respect to drect buyng n an effort to maxmze utlty; whether to partcpate n drect marketng (partcpaton decson), and how much ncome they receve from partcpaton n ths actvty. The partcpaton and amount earned s determned by the same set of ndependent varables (Cragg, 1971). Therefore, n order to observe a postve level of ncome, two separate hurdles must be passed. Two separate latent varables are used to model each decson process wth a bnary choce model determnng partcpaton and a censored model determnng the ncome level (Blundell and Meghr, 1987). y = w α + ν Partcpaton decson (1) 1 y = x β + µ Income level or outcome equaton () The decson to partcpate n drect marketng relates to ncome level (Blundell and Meghr, 1987) 1. y = x β + µ f y 1 > 0 and y > 0 (3) y = 0 otherwse where y 1 s a latent varable descrbng the household s decson to partcpate n drect marketng; y s the observed level of farm household ncome from ths actvty; w s a vector of explanatory varables accountng for the partcpaton decson; x s a vector of explanatory varables accountng for the ncome, and ν, and µ are respectve error terms assumed to be ndependent and dstrbuted as ν ~ N( 0,1) and µ ~ N ( 0, σ ). The model assumes that both partcpaton and ncome equatons are lnear n ther parameters α and β. Consstent estmates of the Double-Hurdle model can be obtaned by estmatng (maxmzng) the followng lkelhood equaton. x β ( ) ( ) ( 1 y x β L β, α, σ = 1 - F w α F F w α ) σ f (4) 0 σ 1 σ 1 Ths model n the lterature s also referred as nfrequence of purchase model. We assume these two error terms are ndependent, snce ths assumpton s commonly utlzed n the double hurdle model (e.g. Su and Yen 1996) and there s an evdence that the Double Hurdle model contans too lttle statstcal nformaton to support the estmaton of dependency (Smth, 003).

3 where F(.) and f(.) are, respectvely, the standard normal cumulatve and densty functons and σ s the standard error. If the restrcton F( w α ) = 1 s mposed, the lkelhood equaton for the Double-Hurdle model reduces to that of the Tobt model. The estmaton of equaton (4) usng the Maxmum Lkelhood Estmaton (MLE) provdes consstent estmates of the Double Hurdle model, t mght not be effcent f the error term ( σ ) s homogenous across observatons. However, ths problem can be further mproved by accountng for the heteroskedastcty of the error term. In ths paper, we specfy the standard devaton as an exponental dstrbuton: 3 σ = exp( y' r). (5) where y s a vector of explanatory varables, also elements of x (Mhalopoulos and Demousss 001), determnng the standard devaton and r s a column of parameter vector. Data for ths analyss s drawn from the 00 Agrcultural Resources Management Survey (ARMS). ARMS s conducted annually by the Economc Research Servce and the Natonal Agrcultural Statstcs Servce. The survey collects data to measure the fnancal condton (farm ncome, expenses, assets, and debt) and operatng characterstcs of farm busnesses, the cost of producng agrcultural commodtes, and the well-beng of farm operator households. The target populaton of the survey s operators assocated wth farm busnesses representng agrcultural producton n the 48 contguous states. A farm s defned as an establshment that sold or normally would have sold at least $1,000 of agrcultural products durng the year. Farms can be organzed as sole propretorshps, partnershps, famly corporatons, non-famly corporatons, or cooperatves. Data are collected from one operator per farm, the senor farm operator. A senor farm operator s the operator who makes the majorty of the day-to-day management decsons. For the purpose of ths study, operator households organzed as nonfamly corporatons or cooperatves and farms run by hred managers were excluded. The 00 ARMS survey collected nformaton on farm households n addton to farm economc data collected through the regular survey. It contans detaled nformaton on off-farm hours worked by spouses and farm operators, the amount of ncome receved from off-farm work, net cash ncome from operatng another farm/ranch, net cash ncome from operatng another busness, and net ncome from share rentng. Furthermore, ncome receved from other sources such as dsablty, socal securty, and unemployment payments, and gross ncome from nterest and dvdends are also counted. Addtonally, the 00 ARMS survey quered farmers on f the farm grew crops, lvestock, poultry or ther products that were sold drectly to ndvdual consumers for human consumpton? The survey then quered farm operators on the gross ncome receved from drect marketng. Results It s nterestng to note that the double-hurdle model fts the data well snce ffteen (out of the varables specfed n the model) are statstcally sgnfcant n the partcpaton decson equaton. In addton, heteroscedastcty parameters of the contnuous varables 3 Although there s no general role to specfy the functonal form of the standard devaton, the exponental dstrbuton s chosen for convenence to ensure the postve value of the standard devaton (Su and Yen 1996). 3

4 are statstcally sgnfcant, mplyng the presence of heteroscedastc errors terms. Thus, the results are adjusted to account for heteroscedastcty. Prelmnary results from ths study, shows that farms located n the South, Northeast and West are more lkely to partcpate n drect marketng strategy. Ths s consstent wth the facts that that these regons, domnated by small and medum szed farms are lkely to partcpate n drect marketng and hgher farm ncome and often venture nto nche markets. The sze of the nearby metro areas s also expected to have a postve mpact on the use of drect marketng. Ths hgher earnng ncome base s an ncentve for operators to employ drect marketng methods ether though farmers markets or pck-your-own type strateges. Younger operators and operators wth off-farm ncome are expected to have a postve mpact on the mplantaton of drect marketng. Further, Mshra and Goodwn (1997) and Mshra et al, (00) pont out that off-farm work s often a choce of farm operators and ther spouses who resde near a metro area and have small and medum szed farms. Fnally, as noted by Mshra et al., (00) farm operators and spouses who work off the farm have hgher level of educaton and are more aware of news and market nformaton and keep up wth new trends and habt formaton n consumers. Fnally, farm s leverage s another mportant factor affectng mplementaton of drect marketng by the farmng operaton. Results ndcate that lower to debt-to-asset rato farmng operatons are more lkely to adopt drect marketng strategy. Ths fndng s consstent wth the fact that about 80 percent of small and medum szed farms have low debt. Conclusons In the ever-changng envronment of Amercan agrculture, farm operators and managers are always lookng for non-tradtonal marketng methods to employ n an effort to ncrease farm ncome. Drect marketng s just one strategy that farm operators could consder and extract a hgher share of the consumers budget and ncrease the ncome of the farmng operaton. Overall, we want to determne the characterstcs of operators that are mplementng ths strategy and how t mpacts ther ncome from farmng. Increasng the ncome of the farmng operaton can have ndrect effect on the local communty where the operaton s located and help spur rural development n the area. 4

5 References Blundell, R. and C. Meghr, Bvarate Alternatves to the Unvarate Tobt Model. Journal of Econometrcs, 34 (1/), Buhr, B. Case Studes of Drect Marketng Value-Added Pork Products n a Commodty Market. Revew of Agrcultural Economcs. Vol. 6. No.. February Carter, K. Drect Marketng of Produce: A Study of Farmers Markets n Jackson, Knoxvlle, and Memphs Tennessee. Unversty of Tennessee unpublshed M.S. Thess. Cragg, J Some Statstcal Models for Lmted Dependent Varables wth Applcaton to the Demand for Durable Goods, Econometrcs 39(5), Darby, K. M. Batte, S. Ernst, and B. Roe. Decomposng Local: A Conjont Analyss of Locally Produced Foods. Amercan Journal of Agrcultural Economcs. Vol. 90. N.. May 008. Gale, F. Drect Farm Marketng as a Rural Development Tool. Rural Development Perspectves. Vol. 1. N Govndasamy, R. Farmer-to-Consumer Drect Marketng: Characterstcs of New Jersey Operatons. Paper presented at the 1996 Pennsylvana Vegetable Conference and Trade Show, January 30-February 1, Hershey, Pennsylvana. Govndasamy, R. F. Hossan, and A. Adelaja. Income of Farmers Who Use Drect Marketng. Agrculture and Resource Economcs Revew. Aprl pg Govndasamy, R. and R. Nayga. Determnants of Farmer-to-Consumer Drect Market Vsts by Type of Faclty: A Logt Analyss. Agrculture and Resource Economcs Revew. August pg Kohls, R., J. Uhl. Marketng of Agrcultural Products. Prentce Hall, Inc., Upper Saddle Rver, New Jersey Mhalopoulos, V.G., and M.P. Demousss Greek Household Consumpton of Food Away from Home: A Mcroeconometrc Approach. European Revew of Agrcultural Economcs 8(4): Mshra, A.K., M.J. Morehart, Hsham S. El-Osta, James D. Johnson, and Jeffery W. Hopkns. Income, Wealth, and Well-Beng of Farm Operator Households. Agrcultural Economcs Report # 81, Economc Research Servce, U.S. Department of Agrculture, Washngton, D.C. Sept. 00. Mshra, A.K., and B.K. Goodwn. "Farm Income Varablty and the Supply of Off-farm Labor." Amercan Journal of Agrcultural Economcs. 79(August 1997): Nayga Jr., R. R. Govndasamy, T. wall, and D. Thatch. Characterstcs of Farmer-to- Consumer Drect Market Customers n New Jersey. New Jersey Agrculture Experment Staton. Pub. # P June Smth, M. D. (003). On Dependency n Double-Hurdle models. Statstcal Papers 44 (4), Su, S.B., and S.T. Yen Mcroeconometrc Models of Infrequently Purchased Goods: An Applcaton to Household Pork Consumpton. Emprcal Economcs 1(3),