Streetwise Professor

August 16, 2018

Why ABCD Sing the Blues, Part II: Increased Farm Scale Leads to Greater Competition in Capacity and Less Monopsony Power

Filed under: Commodities,Derivatives,Economics,Politics,Regulation — cpirrong @ 6:34 pm

In “Why Are ABCD Singing the Blues?” I called bull on the claim that ag trading firms were suffering through a rough period because of big crops and low prices.  I instead surmised that gains in capacity, in storage and throughput facilities, had outstripped growth in the amount of grain handled, and that this was pressuring margins.  In yesterday’s WSJ, Jacob Bunge (no relation, apparently, to the grain trading family) had a long and dense article that presents a lot of anecdotal support for that view.  The piece also provides other information that allows me to supplement and expand on it.

In a nutshell, due to increased economies of scale in farming, farms have grown larger.  Many farms have grown to the point that they can achieve efficient scale in storage and logistics to warrant investment in storage facilities and trucks, and thus can vertically integrate into the functions traditionally performed by Cargill and the others.  This has led to an expansion in storage capacity and logistical capacity overall, which has reduced the derived demand for the storage and logistics assets owned and operated by the ABCDs.  Jacob’s article presents a striking example of an Illinois farmer that bought a storage facility from Cargill.

In brief, more integrated farms have invested in capacity that competes with the facilities owned by Cargill, ADM, Bunge, and smaller firms in the industry.  No wonder their profits have fallen.

The other thing that the article illustrates is that scale plus cheaper communication costs have reduced the monopsony power of the grain merchants.  The operation of the farmer profiled in the piece is so large that many merchants, including some from a distance away, are competing for his business.  Furthermore, the ability to store his own production gives the farmer the luxury of time to sell: he doesn’t have to sell at harvest time to the local elevator at whatever price the latter offers–which was historically low-balled due to the cost of hauling to a more distant elevator.  Choosing the time to sell gives the farmer the value of the optionality inherent in storage–and the traditional merchant loses that option.  Further, more time allows the farmer to seek out and negotiate better deals from a wider variety of players.

The traditional country market for grain can be modeled well as a simple spatial economy with fixed costs (the costs of building/operating an elevator).  Fixed costs limit the number of elevators, and transportation costs between spatially separated elevators gave each elevator some market power in its vicinity: more technically, transportation costs meant that the supply of grain to a country elevator was upward sloping, with the nearby farms willing to sell at lower prices than more distant ones closer to competing elevators.  This gave the elevators monopsony power.  (And no doubt, competition was limited even in multi-elevator towns, because the conditions for tacit collusion were ripe.)

Once upon a time, the monopsony power of elevator operators was a hot-button political issue.  One impetus for the farm cooperative movement was to counteract the monopsony power of the line elevator operators.  The middlemen didn’t like this one bit, and that was the reason that they excluded cooperatives from membership of futures exchanges, like the Chicago Board of Trade: this exclusion raised cooperatives’ costs, and was effectively a raising-rivals-cost strategy.  Brokers also supported excluding cooperatives because as members cooperatives could have circumvented broker commission cartels (i.e., the official, exchange-approved and enforced minimum commission rates).  This is why the Commodity Exchange Act contains this language:

No board of trade which has been designated or registered as a contract market or a derivatives transaction execution facility exclude  from membership in, and all privileges on, such board of trade, any association or corporation engaged in cash commodity business having adequate financial responsibility which is organized under the cooperative laws of any State, or which has been recognized as a cooperative association of producers by the United States Government or by any agency thereof, if such association or corporation complies and agrees to comply with such terms and conditions as are or may be imposed lawfully upon other members of such board, and as are or may be imposed lawfully upon a cooperative association of producers engaged in cash commodity business, unless such board of trade is authorized by the commission to exclude such association or corporation from membership and privileges after hearing held upon at least three days’ notice subsequent to the filing of complaint by the board of trade.

Put differently, in the old days the efficient scale of farms was small relative to the efficient scale of midstream assets, so farmers had to cooperate in order to circumvent merchant monopsony power.  Cooperation was hampered by incentive problems and the political nature of cooperative governance.  (See Henry Hansmann’s Ownership of Enterprise for a nice discussion.) The dramatic increase in the efficient scale of farms now means (as the WSJ article shows) that many farmers have operations as large as the efficient scale of some midstream assets, so can circumvent monopsony power through integration.  This pressures merchants; margins.

Jacob Bunge is to be congratulated for not imitating the laziness of most of those who have “reported” on the grain merchant blues, where by “reporting” I mean regurgitating the conventional wisdom that they picked up from some other lazy journalist.  He went out into the field–literally–and shed a good deal of light on what’s really going on.  And what’s going on is competition and entry, driven in large part by economic and technological forces that have increased the efficient scale of grain and oilseed production.  Thus, the grain handlers are in large part indirect victims of technological change, even though the technology of their business has remained static by comparison.


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  1. See Henry Hansmann’s Ownership of Enterprise for a nice discussion.

    Perhaps this (38 pages, 1988) paper is the precursor of the book: (Ownership of the Firm, Henry Hansmann). It is also nice!

    Comment by VN — August 17, 2018 @ 3:49 am

  2. An anecdote for you Craig.
    In the county of my boyhood, Somerset UK, the farmers were all beginning to specialise. Dairy: good pasture and you got the milk subsidy.
    All but one farmer, a cove named (IIRC) Jeff Braddick, who owned the smallest farm in the parish and was regarded as a bit thick, even by the other farmers.
    Jeff grew every grain and pulse crop you could think of, often on unsuitable bottom land, but he knew his land and he knew its history.
    So Jeff had a legal insider view of the markets and made more money trading than he did growing, though still collecting the ag subsidy.
    Not so thick as he seemed, especially when the Milk Marketing Board cut the subsidy.

    Comment by bloke in france — August 17, 2018 @ 3:47 pm

  3. It appears there’s been some innovative but fairly low-tech answers to allowing farmers to store grain without requiring the massive scaling-up to owning traditional storage facilities. Grain bags or ‘bag silos’- large polypropylene bags that can be filled – up to 33,000 bushels per bag – directly out in the field and left there, allow any size operation the temporal advantage of waiting for the market price to improve. This may not avoid that geographic monopsony but there can be a much better price paid in February vs. harvest time. If you consider that nearly every farm operation now has grain-bagging as an option – for about $25k in bagging equipment – bagging vastly increases storage beyond the traditional and listed capacities.

    Comment by Peter G. Warner — August 18, 2018 @ 5:15 pm

  4. Isn’t internet (or communications) based disintermediation contributing to this as well? In other words, is it not just the size of the farms and storage costs, but improved ability for producers and end users to find one another without traditional middlemen?

    Comment by Dave Mason — August 20, 2018 @ 11:42 am

  5. @Dave-

    1. Love your stuff from the 70s! 😉
    2. Yes, lower information costs have probably contributed to lower margins, but the timing isn’t quite right. The Internet has been around for quite a while, and was around when the ABCD were making a lot of money. It’s something that occurred in the past several years that accounts for the recent compression.

    Comment by cpirrong — August 20, 2018 @ 7:10 pm

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