The Changing Face of the U.S. Grain System
by Aziz Elbehri
Economic Research Report No. (ERR-35) 39 pp, February 2007
The U.S. grain system is increasingly marked by product
differentiation and market segmentation. More specialty crops now
require either some form of segregation or full-scale identity
preservation to keep them separate from conventional commodities.
Market segmentation within the grain system is driven by the need
to preserve its market value, or ensure purity of the product.
Internationally, U.S. grain markets must increasingly conform to a
new regulatory environment reliant on traceability and identity
preservation.
What Is the Issue?
Differentiated grain markets differ markedly from those for
commodity grains. The commodity market is characterized by minimum
common standards, a large number of buyers and sellers, and high
flexibility. Price is the primary coordination mechanism, with
commodity exchanges often the locus of price discovery. Pricing is
with reference to standard grades (e.g., number 2 yellow corn) that
are broadly accepted, enhancing market fluidity. By contrast,
differentiated grain markets have fewer buyers and sellers, higher
costs for segregation or full-scale identity preservation, and
specific quality standards, compounded by higher risks in
production and marketing. Differentiated grains usually command
price premiums, based on the extra costs incurred by producers and
shippers and willingness to pay at the processing or retail level.
This report examines the economics of grain differentiation,
including the cost implications of different protocols, the unique
risk factors of adopting IP (identity preservation) grains, the use
of contracts, and the role of government as a provider of market
information and facilitator of product-differentiated markets.
What Did the Study Find?
To preserve the identity of a specialty crop, segregation from
commodity grains or oilseeds is required. In some cases, this is
necessary to protect purity and to preserve the value of the
specialty crop. In other cases, the goal is to prevent
contamination through accidental commingling (for example, biotech
or not), or to protect products that are approved only for certain
uses (for example, industrial use only).
The cost structure for IP grains differs with the degree of
segregation and/or IP required. For highvalue grains, costs
encompass both segregation and identity preservation in the supply
chain, and the costs to mitigate risks specific to IP grain
markets. Volume shipped, shipping method, tolerance levels,
testing, and documentation requirements can influence segregation
costs.
Costs associated with risk mitigation depend on the type of
specialty crop as well as the purity level. Lack of compliance with
a product specification can lead either to a price discount or
rejection of a shipment by buyers.
Price setting under an IP grain system is characterized by
premiums or discounts relative to standard commodities, whether or
not production and marketing is under contract. Premiums are
affected by various factors, including the proximity of suppliers
to buyers and the cost and availability of substitutes. For many
trait-specific crops, price premiums rise or fall depending on
supply conditions for the generic commodity.
Differentiated grains require more coordination between growers
and handlers or processors, and more sharing of information. This
arises from the trait-specific quality attributes of IP grains:
within the supply chain, information must be conveyed about raw
materials, key ingredients, and production/manufacturing processes.
Assurance of product quality and authentication of process/product
claims is often required. Farm product suppliers (for example, seed
producers) must demonstrate that product attributes are verifiable
and show supporting documentation.
Production contracts are important for trait-specific grain to
ensure that the attribute-specific commodity is delivered and that
predetermined management practices are used. For the producer,
contracts can ensure a return adequate to cover costs of identity
preservation and any yield drag associated with trait-specific
varieties. Contracts can also ensure that there is a market for a
niche product.
Production and marketing of trait-specific grains involves risks
associated with price, quality, and information. Testing and
documentation bring greater transparency to the transactions (in
terms of quality and production processes), but the loss of
anonymity also exposes producers and handlers to new risks.
Farmers' management ability can affect both yield performance and
proficiency with contracts and relationships. On the buyer side,
contracts help meet the demand for specific product qualities,
improve cost efficiencies of product processing, and reduce
transaction costs.
Risks are typically higher for specialty crops than for generic
crops. Non-GM crops subjected to testing run the risk of rejection.
Organic grain can be accidentally contaminated. Pharmaceutical
crops are not licensed for food/feed use, so risk of contact with
the food supply can make their handling far more costly.
Sophisticated risk management practices are required to minimize
the chance of potential gene outflow. This entails a closed-loop
system with rigorous quality control and a tight chain of
custody.
Increasing grain differentiation in the U.S. food and feed
industry may put new demands on government, but it is not clear
whether USDA's traditional roles in commodity markets should be
extended to specialty grains. The collecting of price information
for commodities is not easily extended to specialty grains, which
are heterogeneous, small in scale, and locally concentrated.
Moreover, price information can be proprietary, established through
private supplierbuyer contracts. Likewise, USDA-approved grades for
specialty grains may not be justified since desired traits are
idiosyncratic.
As differentiated grain markets expand, the U.S. grain industry
faces new demands for identity preservation, segregation, and
product tracing. This will require adaptations in grain production
and handling, closer market coordination, more extensive
information systems, new risk management tools, a better
understanding of costs, and more thirdparty services for auditing,
verification, and quality assurance.
How Was the Project Conducted?
The project was based on an extensive analysis of the literature
covering industry case studies, academic research, and government
documents. Key findings-especially those relating to farm risk
management, cost of segregation, and IP market dynamics-are drawn
directly from analyses conducted at the Economic Research Service
with outside collaborators.