Competing in Commodity Product Markets

AG BM 460

Introduction

• Commodity products represent most farm output & substantial portions of processed food

• The buyer has no particular loyalty to a supplier

• Many suppliers provide essentially the same product

• Price is the key to competition

Examples

• Most farm products • Flour• Vegetable oil• Beef • Institutional pack tomatoes• Private label grocery products• Feed• Fertilizer

Operating Environment

• Largely price taker

• Way to increase profits are to control costs and increase volume

• Products are not homogeneous, but structure of premiums and discounts well understood

Controlling Costs

• Keep labor productivity high

• Keep input costs down

• Operate near optimal efficient scale

• Manage capital structure well

• Keep operation modern, but not over-capitalized

• Get lucky

Increasing Volume

• Be competitive

• Be flexible in order size, payment terms

• Aggressively pursue incremental business (bids)

• Keep existing customers happy

• Provide good quality

• Keep your eyes open for new markets

Existing customers

• Often have a captive market – near plant

• Don’t take it for granted

• Remember these customers pay the bills

• May have cost advantage serving them, so per unit profit is higher than marginal customer

Customers on Competitive Fringe

• Face tough competition for these customers

• No supplier has intrinsic advantage

• Can easily get into a price war over them

Contracts

• Food service business – school lunch chicken nuggets

• Short term contracts – several bidders

• Can’t expect to cover all fixed costs on this business

• Need to understand cost structure – Catherine & plumbing contracts

Grades

• Quality differences important

• Higher cost to provide higher quality

• Higher price for higher quality

• Conscious decision about quality targets

• Need to understand cost structure

New Markets

• Entry often manageable

• What is cost of serving new market?

• What is potential revenue?

• Will it pay?

• Transportation costs, brokerage fees, etc.

Growth

• Must be able to grow

• Margins per unit decline over time

• Weak firms exit

• Growth requires new customers

• It also requires expanded production

• Existing plant or new plant?

• Buy or own? Scrap or refit?

Some Big Players

• Conagra

• ADM

• Tyson – with IBP operations & poultry

• Cargill

• Land O’Lakes & DFA

Concluding Comments

• Price competition

• Low barriers to entry

• Cost side important

• Capacity utilization important

• Pennies matter