Question

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.

1. Monsanto: There are three questions at the end. These are repeated here.
   1. “How do you know that cutting the price of Roundup was a good idea for Monsanto?”
   2. “How might you estimate the elasticity of demand and the profit-maximizing price for 1995. Do you think Monsanto set the right price?” What is the appropriate market structure? Does this change?
   3. “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. Also, you can quantify a few things to help your case.
3. For b. – don’t just estimate elasticity for 1995. How does estimating the elasticity of demand help you to answer a. & c.?
4. For b. – think markup power!
5. For c. - This is not only the market structure but economies of scope and learning effects. Make sure these are included in your answer

Answer 1

a.

Monsanto's one of the leading product was Roundup which gave them huge profit. Roundup is one of the chemicals that do not allow weeds to grow. Thus, roundup had huge acceptance in the field of agriculture and credited Monsanto's with huge profit Roundup used to kill the unwanted plants. Since there was patent associated with Roundup it was like monopoly for the Monsanto's and they had huge success. However when patent time period got over, it was still in the interest of the Monsanto's to lower the price of the Roundup because there will be competition in the market. The second important reason is that since Roundup was in huge demand as it was one of the best agricultural chemical, average production grew over time. Thus even though there was reduction in price, there was enormous profit. They also had the advantage of the economies of scale and therefore cutting down the price was not a bad idea at all for Monsanto's. Thus, Monsanto's strategy to lower the price was indeed a very good idea as they had huge demand with them for the Roundup and also because their patent tenure got over. They also had the advantage of the economies of scale because of which they can reduce the price

b.

As stated in the given text " 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 ", we can calculate elasticity from the given data as follows:

Price elasticity = Percentage change in quantity / percentage change in price = 22/9 = 2.44

hence 2.44 could be the elasticity in 1995.

To calculate profit maximizing price it is required to know about mr and mc which is not given hence can not be estimated.

c.

The first issue to address is that the price drop is not a controlled experiment:other things might have been changing at the sametime. Did the market for herbicides overall grow? We don’t know. Once you’ve made this point, you can think about estimating the value of elasticity by applying the ratio of variations method for year-on-year variations.

If you take 2.5 as a ballpark estimate, the ratio of price to marginal cost should be 1.67, so with a cost of 15 the price should be about 25, that is, lower than what Monsanto chose. There is a nimportant qualification to this estimate of optimal price: One possibility is that there is some form of price discrimination going on here. At the time this case takes place, Monsanto was also selling Round up Ready seeds, which is a complementary product to Round up. If seed buyers were willing to pay more than other users of Roundup, Monsanto could target both markets by charging less for Roundup and more for the seeds. Some observers suggest this isprecisely what Monsanto did.