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November 2010 Archive for Marketing Strategy

RSS By: Scott Stewart, AgWeb.com

Marketing Strategy

Know Your Weighted Average

Nov 24, 2010

 

Most people discovered back in middle school that numbers make them emotional. If you ever received a grade of 60 percent on a test, chances are you were not happy. On the other hand, how did you feel after scoring a 100?
 
What really mattered, though, was your report card. It defined how well you fared overall. In marketing, we call this the weighted average price. It is the grade that matters.
 
Your weighted average price is the value of priced bushels, un-priced bushels assigned the current market value, and hedge positions. This figure has the power to help you make important marketing decisions while remaining unemotional. To illustrate its influence, allow me to provide a true example.
 
A producer called, wondering what to do with priced corn bushels for the 2011 crop year. He felt he had sold the bushels “too soon” at the $4.30 futures price. The current price on futures at the time was $5.20 for the 2011 crop.
 
As it turned out, he had sold 20,000 of his 200,000 bushels at this level. So, only 10 percent of his estimated production was priced. Yet, with his gut telling him he was behind and in need of making up ground, he asked whether he should buy back those bushels.
 
Rather than focus on this one sale, we looked at his weighted average price. Here’s how we came up with his “report card” for that moment in time:
  • Multiplied 10 percent cash sold by the $4.30 futures price (equals 0.43)
  • Multiplied 90 percent  of the un-priced bushels by the $5.20 futures price (equals $4.68)
  • Added 0.43 and $4.68 (equals $5.11)
  • Summary: The weighted average price of his entire crop was $5.11 vs. the $5.20 futures price— hardly a difference when talking 10 percent of the crop. 
 
After looking at his sale through the lens of his weighted average price, this producer was able to rationally decide that it wasn’t necessary to buy back any of the 10 percent sold bushels. Going back to my middle school analogy, that 10 percent was just one grade along the way toward his final report for the year.
 
It’s necessary to note that given this producer’s risk tolerance, it was important that he make the 10 percent sale at $4.30. It was part of an overall strategy to incrementally capture opportunity and manage risk. Had the market gone down instead of trending upward, that sale would have been very important for managing risk. Incremental sales are part of an overall strategy to build the best possible weighted average price, taking into consideration your farm’s financial position and risk tolerance.
 
You can use the concept of weighted average price to consider future price scenarios and pre-plan your marketing decisions. Imagine the market going up a little or up a lot, or down a little or down a lot. Then, keeping your risk tolerance in mind, consider where you would have to make sales in order to maximize profits and minimize risk.
 
If you do not already pre-plan and assess your marketing using your weighted average price, I encourage you to do so. It helps eliminate second-guessing of decisions you execute along the way and can prevent you from making decisions in isolation—that is, decisions that are neither interrelated nor based upon preset goals.
 
All of your marketing decisions should be related. They ought to be made like they’re in the context of a spider web, in which an action at any point in the web creates a ripple that affects all parts of the web.
                                                                                                                                         
Scott Stewart is president and CEO of Stewart-Peterson, a commodity marketing consulting firm based in West Bend, Wis. You may reach Scott at 800-334-9779, email him at scotts@stewart-peterson.com.
The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Neither the information presented, nor any opinions expressed constitute a solicitation of the purchase or sale of any commodity. Those individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report.  Futures trading involves risk of loss and should be carefully considered before investing.  Past performance may not be indicative of future results. Any reproduction, republication or other use of the information and thoughts expressed herein, without the express written permission of Stewart-Peterson Inc., is strictly prohibited. Copyright 2010 Stewart-Peterson Inc. All rights reserved.

Are you feeling uncertain? There’s good reason for it.

Nov 10, 2010

In three out of the past four years, grain prices rallied during harvest, the opposite of what normally happens. In the one year they didn’t rally, 2008, prices were at record highs before dropping precipitously.  Again this fall we are seeing prices rally through harvest. It is great for bottom-line profitability, but it can be a long-term marketing challenge. The longer we see crop prices at this very profitable level, the more upward pressure we will see on land and land rent prices.

Last month, Sheila Bair, chairman of the Federal Deposit Insurance Corp., said that U.S. farmland could be the next “bubble.” It’s no news that farmland value has been on the rise. Values remain 58 percent above their 2000 levels in inflation-adjust terms.1
 
Who buys farmland? Mostly, farmers do. According to Farmers National Company, a landowner services company, 70 percent of their farmland sales are to farmers.3 Corporate buyers, such as insurance companies, have long taken advantage of solid returns on quality farmland. U.S. farmland has produced an average return of 11.6% a year since 1951.2
 
Land values and rents are rising for multiple reasons, among them: population growth and the annual loss of acreage to development every year are often cited. In my opinion, the real reason in recent years is demand for the products the land produces. A big part of that is ethanol and improved quality of life globally. Fundamentally speaking, it appears that farmland prices should continue to hold or gain value.
 
As a consequence of higher land values, cash rents continue to rise. This puts more pressure on you to be as profitable as possible. I’ve long talked about the importance of consistently taking out of the market as much as you possibly can within a reasonable risk parameter so that you’re prepared for down years. The reason: Prices offered by the market over the years tend to average near your breakeven. Also, you need to maximize profitability to be able to pay competitive rents or risk losing the ground.
 
Will we see a boom and bust in land values like we’ve seen in the housing and stock markets? The potential is always there. A boom-bust cycle starts when values go higher on sound fundamentals. It gains momentum when people are willing to pay too much.
 
The more immediate concern is unrelenting price volatility, which has become normal. The recent spike in the price of corn occurred for a couple of reasons: surprise and supply versus demand. The market was “shocked” by the USDA acreage report. Adding to the price pressure was the fact that American farmers produce most of the world’s grain, and a significant revision downward in yield suggested lower global supply. That translated into higher prices.
 
According to an October 2010 article in the Economist, “price volatility could be a more permanent feature of agriculture. The concentration of farming in a few big countries means that a hungry world is dependent for its food on stable production patterns in a small number of places . . . problems in one country can send shock waves through global markets.”4 A Business Week Special Report on Risk Management used the phrase “permanent volatility” to describe commodity markets in the future.5
 
Peter Brabeck-Letmathe, chairman of Nestle, said that increased consumer demand, growing bio-energy demand, and speculative trading were behind grain price volatility in 2008. He said, "The market has become much more volatile, because you have so much speculation in it ... I think this has become a permanent shift.”6
 
If you’re feeling uncertain, it’s simply because nothing is certain. No longer can we talk about “what normally happens” with any conviction. A myriad of factors influence price and can change prevailing sentiment at almost any time. Rather than allow yourself to become complacent with corn, and other crop prices on the rise, make sure you’re planning ahead for what you will do when it changes course.
 
Scott Stewart is president and CEO of Stewart-Peterson, a commodity marketing consulting firm based in West Bend, Wis. You may reach Scott at 800-334-9779, email him at scotts@stewart-peterson.com.
The data contained herein is believed to be drawn from reliable sources but cannot be guaranteed. Neither the information presented, nor any opinions expressed constitute a solicitation of the purchase or sale of any commodity. Those individuals acting on this information are responsible for their own actions. Commodity trading may not be suitable for all recipients of this report.  Futures trading involves risk of loss and should be carefully considered before investing.  Past performance may not be indicative of future results. Any reproduction, republication or other use of the information and thoughts expressed herein, without the express written permission of Stewart-Peterson Inc., is strictly prohibited. Copyright 2010 Stewart-Peterson Inc. All rights reserved.
1FDIC Chair Warns of Possible U.S. Farmland Bubble. Reuters, October 18, 2010.
2Farmland: The Next Boom? The Wall Street Journal, September 24, 2010.
3Is the farmland ‘bubble’ ready to burst? Ken Anderson, Brownfield Ag News, October 27, 2010.
4As high as an elephant’s eye. Another agricultural commodity surges. The Economist. Oct. 14, 2010.
5How companies are coping with unstable commodities. Business Week Special Report. Sept. 30, 2010.
6Food price volatility has become permanent –Nestle. Reuters. Nov. 13, 2010.
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