Oakland Estimate the Elasticity of Demand and The Profit Maximizing Price Questions

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MONSANTO
This is an ECONOMICS class. This means use ECONOMIC TERMINOLOGY,
CONCEPTS AND DIAGRAMS!
Directions / questions to answer for individual case studies
Monsanto: There are three questions at the end. These are repeated here.
a. “How do you know that cutting the price of Roundup was a good idea for
Monsanto?”
b. “How might you estimate the elasticity of demand and the profitmaximizing price for 1995. Do you think Monsanto set the right price?”
What is the appropriate market structure? Does this change?
c. “If cutting price was a good idea, why didn’t Monsanto do it earlier?”
Key concepts
1) Examine the market structure(s). Does it stay consistent or not?
2) In a.) above, for any firm a “good idea” must do what? Show this.
Don’t just go with general comments. You might be better off
answering b. first.
QUANTIFY HERE. You can do it with the information!
3) For b. – don’t just estimate elasticity for 1995 (think: over time!!).
How does estimating the elasticity of demand help you to answer a. &
c.?
QUANTIFY HERE. You can do it with the information!
4) For b. – think markup power!
5) For c. – This is not only the market structure but economies of scope,
economies of scale, and learning effects. Make sure these are included
in your answer
Firms and Markets
Mini-Case
Monsanto’s Roundup®
Written August 2001, Revised July 14, 2003
When Pharmacia merged with troubled Monsanto in 1999, investors complained that
Monsanto would weigh down Pharmacia’s profits. Pharmacia apparently felt the same
way, keeping Monsanto’s drug unit, Searle, but selling 15% of the remaining company as
a precursor to dumping it altogether.
Investors couldn’t have been more wrong. Between Monsanto’s IPO in October 2000
and August 2001, its share price jumped 80%. Shares of Pharmacia (which still owns 85
percent of Monsanto) fell almost 20%.
How did Monsanto do it?
Monsanto
St Louis-based Monsanto was founded in 1901 to manufacture Saccharine. It soon added
vanilla, phenol, and aspirin. By 1990, Monsanto was a large diversified chemical
company producing nylon, plastics, films, hydraulic fluids, aspartame (Nutrasweet), and
pharmaceuticals (the last two through its Searle unit, acquired in 1985).
In the mid-1990s, Monsanto positioned itself as a high-growth “life sciences” company,
focusing on agriculture, food ingredients, and pharmaceuticals. When Robert Shapiro
took over as CEO in 1995, he pursued a vision of using cutting-edge science to generate
profits, raise living standards in developing countries, and produce a cleaner
environment. He added seed and genomics companies and spun off the basic chemicals
business. The strategy was to use the revenue generated by its hugely profitable
Roundup to finance research and development. Uncertainties associated with
biotechnology research and consumer fears of genetically modified foods, particularly in
Europe, led to the departure of Shapiro and the merger with Pharmacia.
Roundup
Monsanto’s leading product was Roundup, the trademarked name of glyphosate, a
chemical herbicide developed and patented by Monsanto in the 1970s. Roundup is
referred to as a nonselective herbicide, meaning it kills most plants. In the late 1990s, it
became the best-selling agricultural chemical of all time and an enormously profitable
product for Monsanto. This success was the result of several factors. One was a
conscious strategy to reduce price in the US, where patent protection gave it an effective
monopoly until September 2000. (Prices were lower outside the US, where patents
expired earlier.) Between 1995 and 2000, Monsanto reduced the price by an average of
9% a year. When volume increased by an average of 22% a year, revenue and profits
exploded. See Exhibits 1 and 2. Glyphosate-based herbicides produced net sales for
Monsanto of $2.4b in 2001 alone, nearly half the company’s total.
Another factor in Roundup’s success was the increasing popularity of conservation
tillage, an environmentally friendly method of farming in which crops are planted
without first plowing the fields. With less plowing, there is less loss of topsoil and
moisture. The problem is weeds. Instead of plowing them under, farmers eliminate
weeds before planting by applying a nonselective herbicide such as Roundup. Analysts
suggest that conservation tillage is sensitive to the price of herbicides, an important
element in its cost.
A third factor was the development of herbicide-tolerant crops. Monsanto’s Roundup
Ready corn was approved in 1998, and soybeans followed shortly thereafter. Monsanto
argued that Roundup and Roundup Ready seeds were complementary products, with
price reductions in one increasing demand for the other.
Even as patents expired, Monsanto was able to maintain high market shares. In Brazil,
for example, Monsanto’s patent expired in 1981, yet its 2001 market share was 81%. See
Exhibit 3. High market share, in turn, allowed Monsanto to exploit economies of scale
and work its way down the learning curve.
Postscript
Monsanto remains a high-risk company with strong upside potential. When the US
patent expired, Roundup revenue dropped sharply, leaving Monsanto increasingly reliant
on biotechnology. With exposure to Latin America compounding the fall in Roundup
revenue, the share price fell 50% in mid-2002, leading to the December resignation of
CEO Hendrik Verfaillie.
Questions
(a) How do you know that cutting the price of Roundup was a good idea for Monsanto?
(b) How might you estimate the elasticity of demand and the profit-maximizing price for
1995. Do you think Monsanto set the right price?
(c) If cutting price was a good idea, why didn’t Monsanto do it earlier?
Additional Information
•
•
•
Monsanto’s web site: http://www.monsanto.com
Bear Stearns Equity Research, “Monsanto: Yet another time of transition,”, January
9, 2003.
Salomon Smith Barney Equity Research, “Monsanto: A near-term catalyst is
lacking,” December 9, 2002.
Monsanto
Page 2
Notes
This case was prepared by Mariagiovanna Baccara, David Backus, Heski Bar-Isaac,
Luís Cabral, and Lawrence White for the purpose of class discussion rather than to
illustrate either effective or ineffective handling of an administrative situation. The case
was motivated by the article “A weed killer is a block to build on,” by David Barboza,
New York Times, August 2, 2001. The authors thank Frank Mitsch at Bear Stearns for
supplying the data in Exhibits 1 and 2. © 2003 NYU Stern School of Business.
Monsanto
Page 3
Exhibit 1
Average Domestic and International Prices of Roundup, 1995-2002
(Solid line is US, dashed line is International.)
50
45
Dollars per Gallon
40
35
30
25
20
15
10
5
0
1995
1996
1997
1998
1999
2000
2001
2002
Source: Bear Stearns proprietary data.
Monsanto
Page 4
Exhibit 2
Average Domestic and International Volumes of Roundup, 1995-2002
(Solid line is US, dashed line is International.)
80
Millions of Gallons
70
60
50
40
30
20
10
0
1995
1996
1997
1998
1999
2000
2001
2002
Source: Bear Stearns proprietary data.
Monsanto
Page 5
Exhibit 3
National Market Shares After Patent Expiration
Country
Argentina
Australia
Brazil
Canada
France
United States
Patent Expiration
1984
1988
1983
1990
1991
2000
2001 Market Share
75%
91%
82%
95%
85%
98%
Source: Salomon Smith Barney.
Monsanto
Page 6

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Tags:
elasticity of demand

Price discrimination

Operating Environment

monopoly structure

profit margins

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