How do value-added producers manage risk from higher food process?

Posted on 05/22/2014 at 12:00 AM by Christa Hartsook

 

Blog article written by Dr. Michael Boland, University of Minnesota, boland@umn.edu

Over the past forty years, the all-food consumer price index has declined. As the oldest of 12 children whose childhood was in 1970s and 1980s, I remember fluid milk prices being variable. My folks bought 28 gallons a week from a milk man (yes, they still existed!). We had double digit increases in food prices in 1973 and 1974 but since then price increases have been about two percent annually. The inflation was caused by the increase in fuel and energy costs, coupled with depreciation of the U.S. dollar which caused imports to increase. The decrease in inflation beginning in the 1980s resulted from tremendous gains in productivity (more fluid milk per cow, etc.) and an increase in trade, allowing the United States to be better equipped to handle swings in prices caused by supply shortages.

Figures 1 and 2 show the price indices for selected foods since 2005. The 2014 price is the average of the prices predicted in April 2014 by USDA. We have seen a slight uptick in the percentage of consumer disposable income spent on food – from 9 to 9.5 percent in 2012.  Headlines you have read about recently include the California drought, higher beef and pork consumer prices, changes in state food labeling laws, and increased producer level prices for fluid milk.

So what does all of this mean for value-added producers?  I have been on several panels recently with individuals marketing artisan breads, non-GMO foods, organic foods, private label meat products, urban greenhouse vegetables, and similar types of products. Virtually every speaker has talked about the increase in prices and the fact that their prices are highly correlated with commodity prices. Furthermore, their ability to practice risk management using conventional tools such as the futures market are limited because they do not have scale in their business volumes, lack access to capital to meet margin calls, and if they had the capital, they would rather put it back into the production or marketing side of their business.

So what is a value-added producer supposed to do in this kind of environment with rising prices?  In the 1910s and 1920s, many marketing cooperatives were formed based on an individual commodity such as dairy, fruits, tree nuts and other products. These cooperatives had specific tasks – to enhance prices by managing significant inventories within a marketing year, generating consistent volumes to meet certain quality grades, etc. Managing price risk was part of this because now the cooperative could consider offering fixed price contracts for some duration of time and better link demand and supply.

Most individual value-added producers have the same problem that producers in earlier generations had, which is the inability to manage price risk. Consider a rancher marketing grass-fed beef or beef produced under some USDA Process Verified system. Conventional beef prices continue to rise because of various factors related to demand (string export markets, favorable U.S. dollar exchange rates) and supply.  Grass-fed beef producers utilizing some form of protein in a finishing ration such as corn or soybean meal see higher feed prices and uncertainty whether beef prices will stay high.

Will the expectations around price increases lead value-added producers to find ways to work together to cooperate on supply, etc.? The answer is yes. The development of food hubs, greater fixed price contracts and supply agreements between producers and buyers are all happening. The challenge will be whether the demand for conventional food products becomes strong enough such that some producers decide to sell in those markets. Producers pursue value-added products when prices are low. Only time will tell whether the discipline and sophistication of today’s buyers are such that producers will continue to sell within their value-added supply chain.  

For more information on Food Hubs, visit http://www.ams.usda.gov/AMSv1.0/foodhubs or http://www.ams.usda.gov/AMSv1.0/getfile?dDocName=STELPRDC5097504.



Figure 1. April 2014 USDA Economic Research Egg, Dairy, Fresh Fruit, and Fresh Vegetable Price Indices  (Source: Dr. Ricky Volpe and U.S. Bureau of Labor Statistics)


 
Figure 2. April 2014 USDA Economic Research Beef and Veal, Pork, and Poultry Price Indices  (Source: Dr. Ricky Volpe and U.S. Bureau of Labor Statistics)