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