Guest blogger Mike Hogan, commercial analyst with Stewart-Peterson Inc., shares what happened when a group of agricultural lenders participated in a simulated marketing activity.
A well-known proverb suggests "There’s no substitute for experience." I think that’s a statement most of us can agree with.
Unfortunately, gaining experience – especially in the marketing realm – can sometimes be a costly endeavor if you don’t understand all the aspects and alternatives available.
It was that premise that prompted Stewart-Peterson to create a farm marketing simulation activity called "What’s Your WAP?" – with WAP standing for weighted average price.
Weighted average price is the net average price received over time for all of your milk production (or paid out for feedstuffs). It is calculated by averaging the value of priced milk per cwt., the value of un-priced production assigned the current market value, and the value of any milk with hedge positions. Averaging these values is important, because the price you receive for your production at any given point in time might be higher or lower than the current market price. It should be your goal to make strategic and incremental sales (or feed purchases) that build the best possible weighted average price for all your production long term.
The simulation allows participants to make milk and soymeal trades in a fictitious market setting. To truly mimic the risk that occurs in the real world, the activity includes three pricing periods, and as the market moves (within the three periods) each participant’s WAP moves. At the end of the activity, participants can compare WAPs with one another and determine how they did.
In short, this simulation provides a great opportunity to gain some practical marketing experience without the risk of real dollars on the line.
I was part of a Stewart-Peterson team that debuted the "What’s Your WAP?" activity during the trade show at the Wisconsin Banking Association’s Ag Lenders Conference in mid-April. The event draws approximately 120 bankers from over 60 banks and is the only bank-focused agriculture conference in Wisconsin.
Bankers who participated in "What’s Your WAP?" were told they owned a 400-cow dairy with an annual production of 12 million pounds of milk. Using futures prices and option premiums, they were charged with marketing one month’s production of milk (1 million pounds) and managing one month’s expected purchases of soymeal (40 tons). Futures contracts were offered, which replicates the pricing activity of a cash sale or forward contract. Cash sales and forward contracts were not allowed since those positions cannot be offset.
The response to this marketing simulation activity was overwhelmingly positive. We had more than 100 of the 120 attendees participate and actively engage in marketing their milk and feed. They were asking questions, competing with their fellow bankers, and working hard to improve their marketing.
This was a real opportunity for bankers to stand in the shoes of a producer, make marketing decisions and experience the outcomes of those decisions.
Among the participants in the simulation, we found that 70% beat the market average by using futures or options.
The table below shows the WAP for milk and soymeal. Those participants who were actively managing positions during the three pricing periods finished with a higher WAP for milk than those participants who did nothing.
For this simulation, lenders who took the market average for soymeal got the best price. However, it is also important to note that those who took the market average in milk got the worst price. Notice that the lenders who made pricing decisions for both milk and soymeal in two pricing periods did quite well. Overall, those lenders had the best WAP for both milk and soymeal.
In reviewing the results, it becomes evident that marketing has a "sweet spot" in the middle. If you do too little or are too overly aggressive and border on speculative activity, it can result in a diminished return. For this simulation, those who hedged were 2% better off across all price scenarios than those who engaged in speculative activity.
Marketing can be thought of like applying herbicides to your crops. You need to apply some, but doing three or four times the recommended rate can be detrimental. You need to find the middle ground.
From this activity, I believe two take home messages are clear.
· First, marketing does make a difference as opposed to doing nothing and accepting the average price. Great marketers manage milk and feed to get the best possible WAP for both over the long haul. By building the best possible price for milk and feed individually, you are also incrementally building the best possible margin for yourself.
· Second, we can conclude that marketing decisions can’t be a "one and done" deal to achieve the best results. In order to capitalize on every opportunity the market offers, you need to make incremental decisions that gradually build the best possible WAP for milk and feed. The key is being consistent and planning for the long-term.
Producers who consistently engage in marketing to build a strong WAP over time can minimize the unwanted highs and lows in the marketplace and remove the volatility from their revenue and expenses. Consistent marketers won’t always capture the best price, but they position themselves to also avoid painful losses. Think of it as building a financial cushion for the really tough years.
While this exercise was a simulation, it was also a realistic opportunity for participants to examine what great marketing looks like and the strategic focus that is so necessary. Our team at Stewart-Peterson can offer "What’s Your WAP?" as a free, educational activity to other groups as well. Contact me if you are interested.
Mike Hogan is a commercial analyst for Stewart-Peterson, a commodity marketing consulting firm based in West Bend, Wis. You may reach Mike at 800-334-9779, email him at [email protected]
Scott Stewart is CEO of Stewart-Peterson Inc., a commodity marketing consulting firm based in West Bend, Wis. You may reach Scott at 800-334-9779, email him at [email protected]
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