Standardization, Grading, Market Information, and Contracts

AG BM 102

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

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

Benefits of a grading system

• lower transaction costs

• improved price signal

• lower risk

• allows common storage

• increases recognition of value differences

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

Problems with grading systems

• subjective

• may ignore important differences – historically, protein in milk & cheese production

• deterioration

• honesty

• definition

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?

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

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

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?

Market Information

• Grades & standards

• Cash markets

• Futures markets

• Role of government

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

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

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

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

Introduction

• Two end points – independence & ownership

• In between some agreement to work together

• These agreements are contracts

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.

Fruit and Vegetables

• more management decisions to the grower

• the processor controls– variety– planting schedule– harvesting schedule– spraying restrictions

Hogs

• Driven by technological advances that allow larger-scale production

• Require greater coordination between units and better management

• Similar to poultry

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

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

Why Contracts?

• Advantages to grower– guaranteed market– price known beforehand– technical help– financing– more bargaining power

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?

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

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