By Dermot Hayes, Professor of Economics, 515/294-6185, email@example.com, and Don Hofstrand, Extension Farm Management Specialist, 515/294-0844, firstname.lastname@example.org
The way U.S. farm producers market their products is on the verge of change. Today, the bulk of farm products is sold as commodities, because the commodity system is an extremely efficient way of collecting and transporting bulk products. This will change as the benefits of a differentiated product system become greater than the cost savings of the commodity system.
Producer returns will be based on the value of the skills and the level of risk that are needed from each producer.
There are three forces altering the balance between the commodity and differentiated systems.
1. Science has recently increased our capacity to create improvements in grain quality and grain composition. The commodity system is not sophisticated enough to accept modifications to the genetic structure of the plant that benefit particular customers, necessitating change.
2. The ongoing information revolution is reducing the costs of growing, transporting and processing differentiated products.
3. There is an increased willingness by consumers to pay for source identification and a wider selection.
All of this suggests an increased interest in market systems that better translate consumer needs into signals to individual producers or groups of producers.
There is no guarantee today’s farmers will benefit from marketing changes, despite the overall benefits that may accompany a change in industry structure. In a competitive market, returns will be based on the value of the skills and the level of risk that are needed from each producer.
The market is experimenting with several different ways to achieve vertical linkages. Following are four systems that may become the basis for a new agricultural structure.
Corporations that contract with producers
Two of the largest privately owned companies in the U.S. have recently initiated programs to encourage producers to grow grain under contract. Both will involve company input on the varieties to be grown, and both offer the producer some form of per acre revenue guarantee.
Cooperatives that contract with producers
Many times the businesses Iowa farmers interact with are cooperatives. For example, grain elevators are often cooperatives. These businesses pass back any profits in the form of annual dividends to their owners and ownership is open to those who do business with the cooperative.
Traditional cooperatives would seem like an ideal basis from which to launch an initiative to ensure that producers fare well in the future.
A newer form of cooperative has emerged to deal with some of the perceived weaknesses of the traditional model. These “new generation” closed cooperatives charge members a start-up fee and distribute profits on the basis of recent financial information and in proportion to the initial capital investment.If producer-owners show they are prepared to pay market rates to skilled managers, and to accept top-down decision making, these firms will be ideal for producer response to the ongoing structural changes.
The seed company approach
Seed companies are the obvious basis for input-supplier-driven integration in U.S. grain markets. These firms are sitting on a host of varietal improvements that are not yield increasing or cost reducing and that cannot demand a market premium in a commodity market.
An example of how seed firms might drive integration is an Ames-based company called E-Markets. This company uses a Web page to attract and organize producers who wish to grow specialty grains. Producers can find out which varieties are needed in their area, the date the grain should be delivered, and the premium they will receive. Buyers can find large numbers of willing growers in a particular area. Funds for this company come from seed companies who charge producers a premium for the seed that is required.
Similar industries that have undergone transformation have generally evolved into a franchise system. Examples of successful franchise systems include restaurants, hotels, convenience stores, gas stations and fast food outlets. All of these involve small independent businesses, which are best managed by owner operators. All require the owner take risks and get rewarded for taking those risks, all pay the owner for knowledge of local markets and all require a relatively large capital contribution.
This system would seem to have much to offer the typical Iowa producer. This would be particularly true if the value of the owner’s land and existing machinery were counted towards the initial capital investment, and if the owners hedged against excess profits by the parent corporation by buying corporate shares.
What should a producer do?
Producers should work within the system, rather than oppose it from the outside. Any of the first three systems (producer contracts with corporations, producer contracts with cooperatives, and the seed company approach)could eventually evolve into a system that is ideal from the producer’s perspective, but this will be more likely to happen if producers are pushing for changes from the inside.
Cooperatives and commodity groups are natural places to begin coordinating activities. Producers who work together to coordinate activities will be in a better position to face challenges because they will be able to produce identity-preserved products at cost-effective rates, and can negotiate with input suppliers and integrated operations.
The food system may evolve into a franchise system, if observations of other sectors of the economy are used as indicators. If this occurs, producers will give up some of their independence, but as long as they have the managerial and technical skills required to run a franchise they should be in a position to earn a reasonable return for their input.
Producers who continue to buy retail and sell wholesale will fail. Those who understand the importance of buying wholesale and selling retail will probably do very well.
Editor’s note: This article is an excerpt from a longer paper that appears in a new publication from Iowa State University titled “Agriculture in the 21st Century - Surviving and Thriving.” The publication costs $4.00 and is available by writing C. Phillip Baumel, ISU, 460B Heady Hall, Ames, Iowa 50011-1070. Make checks payable to ISU.
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