Standardization, Grading, Market Information, and Contracts

1. Standardization, Grading, Market Information, and Contracts AG BM 102

2. Introduction • Livestock judging • Watermelons • Used cars • Good decisions require good information • Two problems – source of information & what does it mean • Three interrelated themes • Standardization and Grading • Market Information • Contracts

3. Grading- the subdivision of a commodity into classes, each of which has distinct acceptability to a group of buyer

4. Benefits of a grading system • lower transaction costs • improved price signal • lower risk • allows common storage • increases recognition of value differences

5. Benefits of a grading system • allocates product according to demand - juice vs fresh • better market news • allows futures trading & other forward contracts • broadens markets - distant markets - buffalo

6. Problems with grading systems • subjective • may ignore important differences – historically, protein in milk & cheese production • deterioration • honesty • definition

7. Example – beef grades • Eight quality grades for beef • The criterion is the amount of marbling – the higher the fat content of the meat, the higher the grade • But what if consumers want leaner meat?

8. Example – corn grades • 5 grades based on test weight, moisture content, broken corn and foreign material, and damaged kernels • Grade may affect storability • But feeding value is largely unrelated to these grades since this is determined by total digestible nutrients and crude protein

9. Bulgarian Tomato Plant • New owners bought old government tomato cannery • Wanted to contract with farmers – most of whom are newly independent farmers • What goes in contract? • Price, Quantity, chemicals, variety • Did not include quality

10. Bulgarian Tomato Plant • Worried farmers would believe factory downgraded quality to pay farmers less • A legitimate concern • Incentive to cheat is high • But without quality minimums who can produce high quality tomato products? • Why spend more to produce high quality when you aren’t paid for it?

11. Market Information • Grades & standards • Cash markets • Futures markets • Role of government

12. Market News • Public markets distribute market news to broaden market • Lancaster Farming prints it because readers want it • Limit to what market news the private sector will provide • Newspapers don’t publish minor markets • Internet offsets this somewhat

13. Private transactions • Most cattle sales are private transactions • Not in interest of packer to distribute prices • Congress is trying to require reporting • Minor commodities a problem • Especially a problem because it is difficult to even find a market • Goats, ducks, rabbits, emus, millet

14. The value of information • Information is key to good decisions • Need to know what market is paying • Need to be able to interpret price • If you have to see the product, news isn’t as valuable • Two extremes – wheat futures markets – horses

15. What is a contract? A contract is a legally binding agreement between two parties to do something, e.g., to exchange a product with specific characteristics at an agreed price

16. Introduction • Two end points – independence & ownership • In between some agreement to work together • These agreements are contracts

17. Some forms of contracting • Poultry • Grower provides • housing, • labor • a few other things • Integrator • owns the birds, • provides the feed • makes most of the management decisions.

18. Fruit and Vegetables • more management decisions to the grower • the processor controls • variety • planting schedule • harvesting schedule • spraying restrictions

19. Hogs • Driven by technological advances that allow larger-scale production • Require greater coordination between units and better management • Similar to poultry

20. Other Contracts • Cooperatives - try offset market power and help achieve goals beyond individuals • SW Vegetables Cooperative • Tuscarrora Organic Growers • High-oil corn, etc. -used to ensure supply • Corn - fix price in advance • Dairy - forward contract on price

21. Why contracts? • Advantages to processor • coordination of flow of inputs • More control of quality • food safety - pesticides • costs - adoption of technology - advances in genetics • adequate supply • can lock in margins with input and output contracts • economies of scale • bargaining power

22. Why Contracts? • Advantages to grower • guaranteed market • price known beforehand • technical help • financing • more bargaining power

23. Things to agree on • quality • quantity • price • delivery time and conditions. • management practices • system of penalties and premiums for below or above the specified quality • What happens if crop fails?

24. How do you find the price? • easy for corn • green beans - what do you need to get growers? • poultry - bargaining power important here • hogs – bargaining power

25. Concluding comments • Quality is not automatic • Describing product makes transactions work better • Grades make market news & contracts possible • Some are processor driven - vegetables, poultry • Some are customer driven - some dairy contracts – Pizza Hut • Some are producer driven - feed contracts, many dairy contracts