Twitter

Welcome: Guest User

Register / Login

Forward progress for food supply chains

London, 21 March 2013

If there is one word to advocate for more integrated supply chains today it is horsemeat. I am glad to see more public discussion on how to address food security and other challenges for agriculture companies, but vertical integration alone cannot fully address today’s financial and operational risks.

Just before the horsemeat story broke, Rabobank released a report entitled, Winning through the Supply Chain.* The report states “The players in the F&A supply chains are now being asked to do more than ever before: produce more with fewer resources, access new markets, reduce costs, respond to new consumer demands, adapt to new outside influences and prepare for a long-term structural increase in demand.”

I agree with that statement. In fact, those are the very reasons why we at CMDirect are sure that online open trading is an essential tool for agricultural market participants. Technology has the ability to create more profit opportunities, more liquidity, establish new trading partners at nominal cost, and dramatically reduce operating costs.

Yet the bank suggests that the best way to address these issues is for F&A companies to collaborate up and down the supply chain (Figure 2). The report succeeds in describing the many benefits of cooperating upstream and downstream, showing how it adds value to all participants. However, their position describes open market trading as just “chasing price.”

Here we discuss:

  • How open market trading is much more than that,
  • The benefits and challenges of both approaches,
  • Why both must be integrated into an F&A company’s trading strategy.

Joint ventures (JVs) along the F&A supply chain and long term contracts (LTCs) are nothing new, and like all supply chains, the level of cooperation among companies ebbs and flows over time. Even before the horsemeat discovery, many companies have already been responding to the increasing grassroots demands for farm-to-table food standards and accountability. This could only be done, of course, with supply chain cooperation. These agreements also increase operating efficiencies, sometimes even eliminating a middleman.

Vertical integration through each LTC and JV provides bilateral incentives and opportunities; a farmer gets pre-export financing from a trade house at better rates than their local bank, the trade house gets a guaranteed supply, avoids broker commissions and often some loyalty in hard times of short supply. As the Rabobank report describes well, other benefits include reducing supply chain risk, increasing productivity and improving access to capital.

 

In practice, however, these benefits are often difficult to achieve. Here are a few things that can go wrong and why we cannot simply abandon open market trading.

Inherent Risks of Dedicated Supply Chains

  • Increased performance risk and default risk. Of course, participating in more than one dedicated supply chain is wise but still, what happens if a ‘captain’ of a supply chain representing a quarter of your volume goes belly up? If one link breaks, does everyone go down? And if collaboration results in fewer, but significantly larger entities, would that lead us into a situation in which the chain becomes too big to fail?
  • Where does the ultimate price risk lie? I agree that LTCs offer a guaranteed trade flow and provides the foundation for them to price the other side of the contract. It is unclear from the bank’s report how price should finally be established.Dearth of market information. While players gain more intimate knowledge of their upstream and downstream partners, they lose market signals and activity that would normally be factored into their strategic planning. If you’re not a player in the open market, no one will share his or her current knowledge of the fundamentals simply to satisfy your curiosity.
  • Lack of liquidity. The more dedicated supply chains, the more it pulls players off the open market. Is there anyone who could say that they can afford that loss of liquidity?
  • Lack of innovation. Sure, there may be some creativity in creating vertically integrated alliances, but who has not seen complacency in businesses that are predominately locked into long-term agreements?
  • Equal access to supply chains. Supply chain cooperation tends to occur in the middle of the chain. Thus, producers and consumers are generally left hanging where one wants to buy as low as possible and the other wants to sell high. This becomes a tug-of-war where the ultimate price risk lies.

If done properly, cooperation and sharing risk is shrewd. Yet in the real world, there are too many circumstances where the chain can, and will, break down. If one were to solely adopt a dedicated supply chain model, I can only imagine how challenging that would be in hard times. It is the opposite of food security.

Why We Need Open, Online Trading

There is no doubt that there are inefficiencies in today’s open market. Buyers and sellers spend hours siphoning through emails, broker reports, and shopping their book over the phone directly or through a broker. Moreover, F&A markets are so thin that sometimes even an indication of buying or selling interest could push the market away from you before you can get anything done. It’s an inefficient use of a company’s resources.

Yet open market trading is essential to all parties along the supply chain to manage both price risk and the physical flow. Without the definitive information the open market provides, how will the members of the chain determine where to invest their own capital in the long-term agreements? At some point, each company needs to assign a real value to the commodity. No open market trading means no objective point of reference.

Open market trading is the only guaranteed outlet where companies can lay off risk – both anticipated and unexpected. Nothing insures a company’s long-term health better than the liquidity and optionality that an open market provides.

As for the inefficiencies of open markets, electronic trading is the solution. Many entities have tried to use technology to mimic the offline open market, but a successful electronic platform needs to provide more than what phone brokerage and today’s direct negotiations offer F&A companies. If done properly, electronic trading can provide the following:

  • Direct market access at a fraction of the cost. An online marketplace is the most efficient place to find new trading partners and lay off risk.
  • Instant price discovery. See the entirety of the market in one location in real time. A day-end broker report is not actionable market information. Nor are the opinions of your upstream and downstream partners.
  • Sophisticated pricing optionality; providing members the confidence that they receive the absolute best price that the market offers.
  • Counterparty management; that provides for anonymous trading.
  • A level playing field on any given day. Whether you are a new entrant to the market, at either end (outside) of the dedicated supply chain, or finding yourself with a broken link in the chain, an open, electronic marketplace will always provide you with the ability to transfer both risk and the physical product.

Combining all of the above, online open market trading provides much needed market liquidity and optionality. Without it, dedicated supply chains won’t work.

F&A supply chain participants have significant challenges today managing risks, increasing operating efficiencies and building profits. I agree that joint ventures, long-term agreements and other forms of cooperation provide all participants with benefits in sharing risk and improving operating efficiency. Without a doubt, this cooperation benefits consumers through the increased standards in business practices, food quality and identity and thus overall food security.

Yet while dedicated supply chains are practical and profitable, they cannot succeed without a robust and open market. And that open market can be an even greater asset with the liquidity, efficiency and optionality that technology now provides. Let’s move forwards, not backwards.


By Julie Lerner

Julie is CEO & Founder of CMDirect, Inc, an online trading platform for physical commodities. She has spent her career focused on business development in thin commodity markets. E: This email address is being protected from spambots. You need JavaScript enabled to view it.

CMDirect, Inc. and its licensing arm, PanXchange, provide a patented web-based trading platform specializing in regional and international physical commodities. Already live in international sugar, the platform is ideally suited for thin and nascent markets wherein market makers can remain anonymous while negotiating multiple contract specifications and manage their counterparts in real-time.

CMDirect is looking for strategic partners to accelerate its growth. For more information, please see CMDirect.com,

PanXchange.com or contact This email address is being protected from spambots. You need JavaScript enabled to view it.

www.CMDirect.com

*Winning Through the Supply Chain; From Chasing Price to Adding Value in the F&A Sector; Robobank, February 2013.

View Here