Marketing Value-Added Grains and Oilseeds

June 12, 1999

PAER-1999-09

Jennifer Vandeburg, Graduate Student; Joan Fulton, Assistant Professor; Frank Dooley, Associate Professor; and Dirk Maier, Associate Professor of Biological Engineering

Value-added grains are grain products that have been enhanced, through genetic manipulation or special handling, to provide greater value to the end-user than their commodity counterparts. While some of these products have always existed, an explosion of new products has occurred in recent years. Examples of value-added grains that have received considerable attention recently are high oil corn, waxy corn, tofu soybeans, and high oleic acid soybeans.

In 1991, Tom Urban, then CEO of Pioneer Hybrid International, dis-cussed a new trend in agriculture—industrialization. He noted, as have other writers, that recent and ongoing changes in poultry, pork, and cattle production illustrate industrialization. Perhaps foretelling the move to value-added grains, he also pointed out that “It is, in fact, the coming change in grains and oil-seeds production patterns which is perhaps the least recognized, yet the most significant in the long run” (Urban, p. 4).

This article describes the life cycle of a value-added grain, identifies marketing issues associated with value-added grains, addresses issues associated with the physical and logistical needs of the market channel, and finally, closes with a discussion of the potential implications, for the market channel, of widespread use of value-added grains.

Life Cycle of a Value-Added Grain

 

Niche Markets

Most value-added grains start with very small production, serving a niche market, sometimes only one user. They tend to be produced in a limited geographic area, centered around the user, or the first point of sale. Because many of these crops involve a high level of yield or pro-duction risks, participating growers tend to be innovators and demand a high premium. These crops are grown under contracts, for acres rather than bushels. While the grower may receive a sizeable premium, other participants in the pro-gram, like the seed supplier, the grain handler, and the processor may operate at a loss on this venture in the initial start-up phase. The contract may also require on-farm storage to avoid comingling during the marketing process. These con-tracts are referred to as “buyer’s call” contracts because the buyer expects delivery upon request. Growers should expect a high level of involvement in monitoring and consulting by the coordinating contractor. In particular the genetics may be limited to one variety.

As technology develops, super high value crops may be possible, such as those containing pharmaceuticals. Super high value crops may never leave the niche market phase, however, some will evolve to the widespread contract production phase.

Widespread Contract Production

 Value-added crops that prove viable will experience expanded geographic production and enter into the wide-spread contract production phase. Dispersing production geographically reduces the contractor’s risk of total crop loss due to adverse weather. The agronomic risks for growers are also reduced as production experience expands and the premium is reduced from the niche market phase. Growers will still tend to be early adopters who are less risk averse than the average producer. Seed suppliers, grain handlers, and processors, who previously operated at a loss, now expect to see a positive return. The contract will probably still be for acres of production, but may start including a bushel goal. Harvest delivery may now be possible, but on-farm storage will be required in many cases. The available genetics will be limited to a list of approved varieties. While monitoring by the contractor will still be important, the intensity will be reduced compared to the niche market phase. Many value-added grains may stop here and stay at this volume of production.

Enhanced Commodity

The final phase of the life cycle of a value-added grain is the enhanced commodity phase. As value-added crops gain wider acceptance, the pro-duction area will expand. In some regions they will become “third commodities,” with production contracted in bushels and with harvest delivery available. Waxy corn has reached this status in central Indi-ana, since there are so many users in the region. As the agronomic and marketing risks are reduced, the premium to growers will shrink. The approved genetics list will expand to include a wider selection for growers to choose from. In addition, the monitoring by the contractor will be systemized.

Challenges in the Market Channel

A commodity market system relies on open market transactions to pro-duce and quickly move large quantities from the grower to the end-user. As the production and use of a value-added grain increases, an entirely different mindset for all participants involved in the market channel is required. While the high value of these grains and oilseeds derives from specific quality traits, exact knowledge of those traits secures that value. It therefore is necessary to preserve the identity of the crop through physical separation and special handling. An essential additional part of identity preservation is maintaining the integrity of the information about the product. This information must be transferred downstream to the producer and upstream to users. All this means extra time and investment in relationships and infrastructure.

Identity preservation (IP) starts with planting the right seed and continues all the way through transport to the end-user. While important throughout the system, IP is critical at any point where grain is transferred, such as from the producer to the grain elevator or from the elevator to the processor, because the risk of contamination multiplies at that point. Identity preservation is accomplished through careful testing and handling. The quality of the grain must be assessed, and then it must be stored separate from other products. Handling the grain may include added services such as closer management of grain deliveries, cleaning out dump pits, and specialized handling equipment.

The challenge for transferring and storing these crops is that value-added handling is an entirely different task than the one for which most grain facilities were designed. Most facilities were set up to quickly ship large amounts of grain that have been blended to an average quality. Value-added handling requires smaller grain bins, slower handling equipment to guard against kernel damage, and smaller shipment volumes. This may mean added investment for on-farm storage, extra equipment at the elevator, or renovation by the processor to handle smaller lots of raw material.

Value-added grains also require a change in how information is transferred along the channel. There is simply more information about a specific bushel of grain in terms of volume and precision. In addition to the traditional data like moisture content and test weight, information about genetic identity, chemical composition, and other quality traits* are now known. Acquiring compositional data, previously a severe stumbling block to the marketing of these products, is now faster and less expensive with the use of near infrared technology. To have value to the end-user and the other players in the market channel, the integrity of this information must be maintained throughout. To complicate things more, all this data must be transferred quickly.

At all stages of the market channel, there is a need for greater personnel training. All participants need to understand why this product receives different attention than commodity grain. The increased level of information will require better communication skills. Because much of this information will be collected and transferred electronically, training in computer-based technologies and skills will also be crucial.

Risks and Returns

One of the biggest questions being asked is “How do we share all this added value?” This refers to how the participants in the market channel allocate premiums. Each step of the market channel needs to at least cover its cost of doing business. Cur-rent grower contracts tend to use a formula of commodity price plus premium. For example, one formula for the final price on waxy corn is the corn futures price plus 25¢ minus local basis** (Clouse). Some products like high oil corn (HOC) use a graduated premium, with a greater reward for higher oil content.

Competition implies that premiums may vary among buyers. Some enhancements, like HOC, enhance grains’ performance in a traditional use. For example, compared to corn (#2 yellow) HOC is an enhanced energy source in rations. Other modifications, such as corn modified to make components of plastic, soy-beans with specific industrial use chemicals in them, or grains which include pharmaceuticals in their makeup, will create nontraditional uses for a grain or oilseed, necessitating a separation of pricing from the price of the base commodity***. If these crops are truly different, then their prices should not be affected by the supply and demand situation for the commodity. Likewise, their prices should be able to shift if there is change in the value-added crops’ supply or demand. One concern related to decoupling these prices is the loss of hedging capability. But if these are not related, crosshedging should not be viable (the point is they generally are related). Some other arrangement for risk management will need to be made. A possibility could be a risk-sharing arrangement within the grower contract.

To market value-added grains, the entire market channel must work closely together. One player could hold the whole process hostage by refusing to work with everyone else. That is why communication and coordination are important. There may emerge a role for a “coordinator” who assures an orderly marketing process through close communication. The coordinator may also have a role in allocating returns among participants.

Allocation of returns may be influenced by both the functions provided and the amount of risk taken. Producers face yield uncertainty. Handlers bear quality risk in handling and storage. Processors face contract risk if sufficient volumes are not produced to meet end user commitments. Finally, there is also risk to facility investments and research that does not prove to be economically feasible.

Requirements for Growth

An increase in the cultivation and use of value-added grains and oil-seeds requires growth in five areas: investment, communication, relationships, commitment, and trust.

  • Investment—Firms within the market channel are required to invest in the physical and human capital of the system. New testing instruments, storage capacity, and handling equipment require capital outlays. New systems require heightened employee training. In addition, greater research expenditure in areas of markets, genetics, agronomics, and processing is required as the market channel becomes more end-user responsive.
  • Communication—Because specific attributes make value-added grains valuable, the participants in the supply chain need to improve how they share information. Communication also needs to be enhanced throughout the system. Price can no longer be the only way to do this. Accurate information about when, where, and how a crop is to be delivered can be just as important as the chemical composition of the grain itself.
  • Relationships—All the participants in the supply chain need to work as a team toward a common goal. In the current open market system each participant is work-ing toward different goals. A crop is grown and pushed through the market channel. This needs to shift to a “pull through” system where all the players along the market channel listen to what the end-user wants and work toward that common goal.
  • Commitment—All the players must make a commitment to the system. They must all believe that they will be better off united. These systems will have a larger long-term benefit than short-term. Each system participant must be willing to endure difficulty to attain the system’s goals
  • Trust—Trust is also essential. One player’s success depends largely on the others doing their part. They need to be able to rely on each other. One player can hold up the entire system once it is in place. All system participants must have the assurance that the other players are com-mitted to the mutual goals of the system. Only then will each player be willing to take the investment risks needed to establish and nurture the system.

Summary

These components will come together to form a different, non-commodity based market system as value-added grains and oilseeds gain market share. Investment is needed to increase the communication through-out the system. The communication helps improve the relationships that will then make it possible for the participants to commit to the system. The final key, stemming from that commitment, is trust between play-ers that their teammates are equally committed and striving toward the same goal—to meet the needs of the end-user.

References

Clouse, Darren. A.E. Staley Mfg. Co., Lafayette, IN. Phone conversation. February 8, 1999.

Urban, Thomas N. “Agricultural Industrialization: It’s Inevitable.” Choices.4th Quarter 1991. pp. 4-6.

Kalaitzandanakes, Nicholas, and Richard Maltsbarger. “Biotechnology and Identity-Preserved Supply Chains: A Look at the Future of Crop Production and Marketing.” Choices. 4th Quarter 1998. pp. 15-18.

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