Ep. 9 Risk Management Challenges in Value-Added Agriculture

[00:01] Introduction: Welcome to Relevant Risk from the Fryar Price Risk Management Center of Excellence. Presenting conversations and Analysis about Risk and Risk Management for food and agriculture supply chain decision makers. From farmers to consumers and everyone in between. This is Relevant Risk.

[00:19] John Anderson: Hello this is John Anderson with the Fryar Price Risk Management Center of Excellence at the University of Arkansas here with another Relevant Risk podcast. And it’s been a while since our last podcast, we kind of got caught in the end of semester time crunch and summer activities, but we are back with another Relevant Risk episode and I’m very excited today because we have a new face with us, a new voice, I guess for the podcast, Trey Malone, joined faculty of the Agricultural Economics and Agribusiness Department in May. Is that right, Trey?

[00:52] Trey Malone: That’s right.

[00:53] John Anderson: So Trey comes to us from Michigan State University, where he has been on faculty, had been on faculty for a while, prior to that in graduate school at Oklahoma State. But Trey I want to give you a chance to give us a little bit of your background, just tell us briefly about yourself and introduce yourself to our listeners.

[01:10] Trey Malone: Yeah, thanks. I’m really excited to be here. I have been saying that I left Michigan at the best time in Michigan to come to Arkansas, at the hottest time in Arkansas. So I think I just like sweat while I sleep here.

John Anderson: (laughs)

Trey Malone: I’m still getting used to it, but I’m not far, from that far away. I grew up kind of in the armpit of the Panhandle and the Kansas Border. High school in Kansas. I did, I went to, did my undergraduate in Kansas City at a small Jesuit Catholic school, and then I did my master’s and Ph.D. at Oklahoma State. Most of that master’s and Ph.D. was focused on specialty crops. More of the post-farm gate side of marketing. My dissertation was actually on the economics of craft beer, so I published a bunch of papers on beer. I was the chair of the beer section for quite a while. If I wasn’t sitting here right now, I’d be at the Beeronomics conference in Dublin, Ireland. So, so beer is my forte, but, but it’s my forte in the way that it can educate us and inform us on how agriculture in the United States has transformed itself in the last 50 years.

[02:21] John Anderson: Right. So, and I want to come to that because that’s an important part of what we want to talk about. But a little more in your background, you worked at Oklahoma State with Jason Lusk.

Trey Malone: That’s right.

John Anderson: And Jason, it seems somewhat oxymoronic to talk about a well-known ag economist, but Jason is a very well-known ag economist for his work on consumer economics, among other things. Tell us a little bit about your work with Dr. Lusk.

[02:47] Trey Malone: Yeah, sure. So, Jason and I are still really good friends. And, you know, he’s one of my longest lasting coauthors, I guess. I started- I did my Ph.D. with him after doing a master’s on kind of economic impacts of local foods. And in my Ph.D., we focused a lot on developing better methodologies to collect data on consumers. From there, we’ve published all kinds of things. The last paper that we published was on resiliency in the US food system, especially how the ag market responded to COVID 19 disruptions, whether it changes in regulatory structures, and also just the way that people choose the eggs that they eat, that that also changed pretty dramatically. So so Jason and I’ve really spent a lot of time on the consumer end of the value chain. But I think that we’re looking forward to moving even deeper into the space that actually has some more relevance to the Arkansas side of agricultural producers.

[03:48] John Anderson: So I bring up Dr. Lusk’s work strategically here because I want to get into that with you a little bit. And it’s- to me- and a full disclosure here I was on faculty with Jason at Mississippi State back early in both of our careers, and one of the best colleagues I ever had, and just a brilliant guy. And Jason, I think over the last 20 years has been probably the top ag economist in developing this idea of the food system. A lot of us are- have been and I would say I in my career have been fairly compartmentalized into the commodity sector of the market because that’s where my work is. Those are the problems that I have been engaged with. But Jason did a lot to really bring out this idea of let’s evaluate what’s going on along the entire value chain and use that word that that term earlier. And I think that’s a good way to think about what we do in agriculture. And your work with beer is a good demonstration of that, right? Beer is a good example of an ag-related product that has a very sophisticated and well-developed chain for creating value that ultimately resides with the final consumer. And you’ve done a lot of work in that area. What I’m curious about today, and as we think about this from a risk management perspective, how are the challenges, and how are the risks different for a decision maker? When you think about moving from that commodity production space into this downstream value chain, how are the risks different and how are the challenges of managing that risk different?

[05:28] Trey Malone: Yeah, so there are a lot of differences-

John Anderson: Right.

Trey Malone: – you know, I always start with thinking about my granddad, because he- he’s one of these old school producers. He likes people, but he doesn’t want to interact with them every day, except for his buddies at the co-op.

[05:44] John Anderson: Wheat farmer primarily?

[05:45] Trey Malone: Yeah, wheat and beef cows. Dual purpose out in the panhandle of Oklahoma. You know, he gets most of his information from the co-op. When he’s marketing, it’s more about this pricing structure and trying to hedge risk with prices. But those prices actually convey all kinds of information, right? And what’s nice is that as a row crop guy, you don’t really have to think about what information is embedded in that price. You just get a price. Where the specialty crop producer or somebody that’s looking at something that’s more in the value chain has to think about what the long-term proposition is for that market. I think a little bit differently. So so let’s talk about beer. The number of breweries in the United States in the 1980s was less than 100. That’s- they all made basically the exact same beer. Yeah, I get the Bud and Coors tastes a little bit different. Supposedly, but- but actually if you do the blind taste test, they don’t. But since the 1980s on we saw this explosion, this proliferation of options at the grocery store and at the liquor store. So we now have over 8,000, maybe 9,000 breweries in the United States.

John Anderson: Oh wow.

Trey Malone: Each of those breweries is making probably ten different beers. So you go from having 80 breweries that were making more or less one beer to 8000 breweries that are making 10 beers.

[07:06] John Anderson: So that’s that’s an immense amount of product differentiation-

Trey Malone: Unbelievably large.

John Anderson: that’s going on with final consumers, and particularly if you put that in the context that I started with of commodity markets-

Trey Malone: That’s right.

John Anderson: -you know, when you talk about wheat, you do have some different varieties of wheat. You know you get your spring wheats, and your winter wheats, and your durums and you’ve got different grades within those. But what are you talking maybe, eight or ten distinctions if you’re pretty generous, and they’re fairly fine distinctions, but you’re talking about thousands of points of differentiation-

Trey Malone: That’s right.

John Anderson: in (inaudible) product market.

[07:33] Trey Malone: -and it gets even more complicated when you think about the difference between annual and perennial crops. So we worked a lot with hops up in Michigan where you have to not only decide you’re going to play in this value-added differentiated product space, but you have to predict years in advance what those consumers are actually going to want. So 10,15 years ago, the workhorse hop of craft beer was or is cascade to this day. So 10 years ago, if you could grow cascade, you’re probably going to be in a good spot. Well, that’s not really how it works now. If you’re a small producer, you have to develop a new cultivar. You have to think about this, this more differentiated space. And if you miss, well, that’s three years before you actually find out that you missed and you just sunk an investment that was probably a 10, 15-year investment that is a miss. And-

John Anderson: Wow.

Trey Malone: you know, the so right now, I don’t know, I haven’t checked the markets lately on cascade, but the last I checked, you could buy cascade for less than a dollar a pound. Or had you grown something else, had you picked chinook, maybe, you could probably, I don’t know, get five or six dollars a pound easy. And so it’s a completely different ballgame when you have to make those predictions years and years in advance in a consumer pull marketplace as opposed to a producer pull-push.

[08:53] John Anderson: So that’s an interesting concept to me. You’re talking about the hops market, which I think, you know, in with my background as a commodity market analyst, I would approach the hops market as a commodity market. You’ve got a raw cultural product there that’s a long way from being a final end product- consumer product, but it’s significantly affected by this differentiation that’s going on in that end product market.

[09:23] Trey Malone: So in the supply chain literature, they talk about something called bullwhip effects. So what that means is some minor change at the consumer level can lead to these increasingly large ripple effects down the supply chain. So so if we’re talking about hops, if all of the sudden people decide that they want craft beer, well, the hop market will get some type of an information signal, but they probably are going to overshoot the demand for that cascade hop, and the length of feedback within that hop market takes so long to regenerate some type of information for the producer that they could be shot in the water without even realizing it.

[10:07] John Anderson: So you’re describing a situation where what looks like at the consumer level, very minor changes in in in behavior, for instance, can result in massive risk-return differences at the producer level in an environment where there really aren’t many tools for dealing with that risk. Is that a fair-

Trey Malone: That’s right.

John Anderson: assessment?

[10:31] Trey Malone: And when we’re talking about tools, I mean, if you look at the way that farm bill policies and everybody else deal with specialty crops, I mean, they’re special-

John Anderson: Right.

Trey Malone: -so there are a lot more nuances to how, you know, these things can be insured or not-

John Anderson: Right.

Trey Malone: -how weather affects your harvest, how your storage costs change. All of these things are fundamentally different in each specialty crop marketplace.

John Anderson: Yeah.

Trey Malone: And I think beer is a good example, but COVID is even better of an example of exactly how that stuff works its way through a supply chain that is very unique from what I grew up with in the kind of beef, corn, wheat, soybeans (laughing)-

John Anderson: Right.

Trey Malone: cotton. (laughing)

[11:16] John Anderson: The sort of macro commodity world.

[11:18] Trey Malone: That’s right.

[11:19] John Anderson: Yeah. And again, that’s where I’ve spent most of my career and am most comfortable. But I recognize the differences. And if we can abstract a little bit in terms of what you’re talking about from hops, if you think about the specialty crop world and I don’t like that term, but it’s the term we’ve got, that I think communicates pretty well the kind of crops we’re talking about, generally smaller acreage, a lot of direct to consumer influence in those markets. Risk also means opportunity. So are there ways to turn this, if you’re a specialty crop producer, let’s say you’re a smaller scale, fresh produce market producer in Arkansas? How do you capitalize on that risk environment to turn that into an opportunity? Are there- are there principles that you could- that you could lay out there?

[12:06] Trey Malone: Well, absolutely. I think the first principle, though, and this is true for any agricultural producer, is to make sure that you completely and holistically understand your cost of production, because pricing is going to be a challenge. Understanding exactly how much you can actually earn on any type of product that you sell is going to be more difficult, I think because you don’t have some market that you can look at aggregated prices from.

John Anderson: Right.

Trey Malone: Your- odds are if you’re a small scale producer, let’s say you’re growing apples, how are you going to price your product? Well, maybe you have to just go to Wal-Mart and see what Wal-Mart is charging. And then based on that, you make some choice. It’s just not as thick-

[12:48] John Anderson: At least- at least as a benchmark.

[12:49] Trey Malone: As a benchmark, maybe. But you need to understand where your cost of production is to decide whether or not that Wal-Mart number is actually going to, you know, bankrupt you in the long term.

John Anderson: (laughs) Right.

Trey Malone: So- so you need to understand that before anything else.

[13:01] John Anderson: That’s great Farm Management 101-

Trey Malone: That’s right.

John Anderson: Know what you’ve got to have to live.

[13:05] Trey Malone: The second thing that you really have to think harder about is how you’re actually going to connect to your customer. You know, you can’t just drop these things off. One of the issues that you’ll see in some of the smaller scale production, especially from somebody that maybe wants to pivot from, you know, commodity commercial ag into some of this more localized stuff is they think they can just harvest, put it in a trash bag and drop it off somewhere. In that case of hops, maybe you just drop it off at the brewery and somehow the brewer is going to buy it-

[13:34] John Anderson: And that’s a very-

Trey Malone: That’s not how this works.

John Anderson: -That’s that’s that’s very much an attitude that has carried over from the large commodity world where there is always a ready market for those things. You can always haul cattle to the local auction. You can always take grain to the elevator pretty, pretty much always. That’s not necessarily the case in- when you when you’re in the smaller crop world.

[13:52] Trey Malone: Exactly. And there’s more of a relationship component to this that is very much risk management. If you have a relationship with the person you’re selling to, you can swing and miss every once in a while in terms of consistency and they still have that relationship and they’re going to be willing to come back to you. That relationship is very different in the commodity commercial ag world. You know, if you swing and miss in hops, so long as that brewer has been buying from you for a while, they trust that you’re going to come back to them with a better product next time. But if this is the first go-around with that brewer and you miss in terms of consistency or you don’t deliver the promise that you laid out in terms of the contract that you wrote, well, you’re done. And those brewers talk and you’re probably not going to be able to find many other people to take you on. So so it’s more- it’s kind of like how we think about input sellers selling into the, into the ag world-

John Anderson: Right.

Trey Malone: -where you know, if, if Chad starts messing you around on-farm, well you’re going to tell your friends not to buy from Chad anymore-

John Anderson: Right.

Trey Malone: -whatever it is, there’s the seed or whatever. In ag, you are the input guy and so you have to think about yourself in terms of developing those relationships.

[15:09] John Anderson: That’s a great analogy; I hadn’t thought about it that way. You mentioned connecting with consumers in this kind of marketing and this kind of food system. That process of connecting with consumers is something that’s changed dramatically in the last 15 years, certainly, even within the last two or three probably. Could you talk a little bit about how that process has changed and how is the continued evolution of technology changing that? What’s on the horizon there? I’ll ask you to speculate a little bit, maybe-

Trey Malone: Hm.

John Anderson: -everybody likes when an economist forecasts so how- where is that headed? Because it has changed a lot in a short time.

[15:49] Trey Malone: Well, let’s think about where it started. When I was a kid, every year I got a Red Delicious apple in my stocking-

John Anderson: (laughs)

Trey Malone: because

[15:59] John Anderson: I got an orange in mine.

[16:00] Trey Malone: Oh, okay yeah, well, because, you know, where I grew up, it was kind of a big deal for my parents to get

[16:06] John Anderson: Fresh fruit in the middle of winter.

[16:07] Trey Malone: -fresh fruit in the middle of winter. Looking back at it-

[16:09] John Anderson: I’ve got to interrupt you on this, because I have every Christmas tried to explain to my kids why fresh fruit is a traditional Christmas gift in a lot of places because, you know, we got an orange in the stocking. An orange how lame is that? Think about for most of human history.

Trey Malone: Right.

John Anderson: how remarkable seeing an orange in the middle of winter would be

Trey Malone: Yeah.

John Anderson: and then we have an hour-long lesson on ag markets and marketing, which is why my kids love ag economists. Anyway, go ahead. (laughs)

[16:37] Trey Malone: That’s why they love Christmas, too, I’m sure.

John Anderson: Exactly. (laughs)

Trey Malone: That’s what we all love about Christmas. But I mean, it’s absolutely true. You know, we take this for granted now. You know, one thing that I like to do in my intro classes is I’ll bring a red delicious apple and I’ll ask, “Who likes apples?” And I’ll just give them the apple and say, “All right,” you know, “You can eat it if you want,” and they’ll take a bite, and then I’ll start asking questions like, “Where was that apple grown? Do you have any idea who picked it?” No. “Do you have any idea where it came from, who shipped it?” No. You just know that I gave you an apple and you trust this apple that you randomly receive from some professor to eat it as we sit here-

John Anderson: (laughs)

Trey Malone: -how crazy is that? You know that that is just a remarkable food system. And I don’t know that we appreciate it enough, but I also don’t know that we realize how much it’s changed. You know, in the 1980s, we’ll go back there, the average grocery store had about 7,500 unique options. The average grocery store before COVID 19 had about 45,000 unique SKUs. So so we’ve seen this explosion in options. And I think apples show- tells a good story. Red Delicious now is not really what you like to eat. You know, like people are going to be looking for Honeycrisp, they’re going to be looking for the new Cosmic Crisp apple. It’s a different thing now where you have a producer- a consumer pull versus a producer push model. And so what that means is you need to understand what those consumers are really pulling. Regardless of how you feel about organic, if that’s what the premium tells you that you can make more money on, well, maybe that’s something that’s worth considering.

[18:11] John Anderson: So consumer pull versus producer push is that the demand at the consumer level is dictating what people are going to grow. And- and I would expand on that, and say maybe how they’re going to grow it, versus a model where producers grow what they can or what they want to, and that dictates, dictates, so to speak, what consumers have available to buy-

Trey Malone: Yeah, exactly.

John Anderson: -and you’re saying we’ve switched from one model to another. Now consumers are really in charge of what’s in that present in the marketplace, and by extension, in our production systems.

[18:41] Trey Malone: And I think back in apples, Honeycrisp is a good example.

John Anderson: Right.

Trey Malone: Everybody likes a Honeycrisp. It’s not a super easy thing to grow-

John Anderson: Right.

Trey Malone: But that doesn’t really matter (laughs). What matters is that you can-

[18:52] John Anderson: But it’s a very high- high premium product-

Trey Malone: That’s right.

John Anderson: -or at least it certainly was when it was a new variety.

[18:55] Trey Malone: That’s right. And it’s still, I mean, if you go to the grocery store, that’s going to be probably the most expensive apple on the shelf. And there are obviously demand explanations for that, but also supply explanations for why it’s so high-

John Anderson: Right.

Trey Malone: but this is exactly what I’m talking about. And that world is even more complicated, I think, for a specialty crop perennial grower who has to make these predictions. Well, chestnuts. I worked with chestnuts for a while. You know, most Americans have never even eaten a chestnut. I don’t know if you have.

[19:24] John Anderson: I don’t think I have.

[19:25] Trey Malone: I hadn’t- I don’t even know if I’d seen one before I started working with the growers. But you have to predict 20, 30 years out in terms of why you think that chestnut orchard-

John Anderson: Right.

Trey Malone: -is going to have some type of commercial value. And that’s hard.

[19:39] John Anderson: Not- not all that dissimilar from somebody making a decision of what pecan variety tree to plant.

[19:46] Trey Malone: Exactly. That’s right. Chestnut is a little bit more difficult because you even have fewer data.

John Anderson: I’m sure.

Trey Malone: You have the chestnut blight that wiped out all chestnut production in the United States for about 100 years. So this is like a brand new thing to the world of foodies, but- and we don’t really know what that looks like 30 years from now, at least we understand that pecans are in demand at some level-

John Anderson: Right. Good point.

Trey Malone: -and there’s some data to tell you what type of market you need to consider.

[20:12] John Anderson: Good point. I interrupted you. (laughs)

[20:14] Trey Malone: Well, I think pecans are a great example though. I think-

John Anderson: Yep.

Trey Malone: -you know, we live in the specialty crop world where you have to be even more cognizant of what the forecasts are telling you about the future of that demand.

John Anderson: Yeah.

Trey Malone: And you have to be more mindful of how you’re going to get that product to market because you can’t just drop it off.

[20:34] John Anderson: And you’re aiming at a- you’re aiming at a lot smaller target-

Trey Malone: Yeah.

John Anderson: from a lot of further distance. (laughs)

[20:39] Trey Malone: That’s right.

[20:42] John Anderson: Back to connecting with consumers. Could you say a little bit about again, technology’s mediating so much of this relationship now between consumers and producers? Big opportunities in that for producers, probably also some pitfalls and some difficulties. Could you talk a little bit about how this- the use of technology- the communications technology, social media, its applications into food systems, how is that changing marketing and what are the implications for risk there?

[21:17] Trey Malone: Well, there are a lot of risks. Risk management is a challenge, you know, so, I used to give a talk to Christmas tree growers. And one of the first things I’d do in that talk is I’d have them get out their phone and Google their Christmas tree farm. And a lot of times- it wasn’t uncommon that this would be one of the first times they’ve ever Googled that farm, you know because you get a lot of old school folks out there that just don’t like social media-

John Anderson: Right.

Trey Malone: -or the Internet or anything else. But they get on Google and they find out that there’s a five-star ranking system to their farm. And if somebody had a bad experience, that’s going to live in perpetuity on the Internet.

John Anderson: Right.

Trey Malone: And so it’s very risky when we think about what the social media world looks like. But what that also means is that you have to play in that world, like you can’t be a small-scale producer and not utilize some type of social media. And you also have to do it in a way that equips your customers with their ability to tell your story for you. So I think about like the Karate Kid, you know, everybody thinks they want to be the Karate Kid. You know, in my life story, I’m the Karate Kid, and maybe I have some mentors that are my Mr. Miyagi. If you’re going to use social media marketing with your small business or your small agribusiness, you need to think about yourself more like Mr. Miyagi. You have to be the one that is helping these people tell their own stories. And I think like that’s one of those nuggets to me that I think has a lot of salience, that your goal is to have that person leave your farm or have that person eat your product and walk away with such a positive experience that they can go brag about the awesome peach that they had at your farm, and that’s different. That’s very different than the business-to-business wholesale distribution channels-

John Anderson: Right.

Trey Malone: that we typically think about.

[23:13] John Anderson: That’s a very different insight than I’ve heard before. I couldn’t- I can’t tell you how many times I have been in meetings in the last 10 years and heard farmers exhorted to tell your story, tell your story-

Trey Malone: Mhm.

John Anderson: and usually, and again, that’s not always in a marketing context and maybe it’s more appropriate. But I like what you’re saying about- you’re basically saying you need to induce your customers to tell your story for you-

Trey Malone: That’s right.

John Anderson: -and that’s much more impactful.

[23:37] Trey Malone: I mean, yeah, the tell your story conversation and advocacy-

[23:41] John Anderson: Right.

[23:41] Trey Malone: -I think is dangerous because it creates this platform where we think that we know everything and these customers are idiots. And nobody likes to be talked down to.

John Anderson: Right.

Trey Malone: And so that’s not a particularly strong marketing strategy. The better marketing strategy is to realize that every dollar you make comes from their pocket and every, you know, word of mouth is so important to small local production because you’re in a small, contained space. You know, if I’m trying to sell local produce and I’m in Northwest Arkansas, it really doesn’t help me that much to have good word of mouth in Seattle.

John Anderson: Right.

Trey Malone: But if I do damage some relationship with an important person in Northwest Arkansas, it’s going to be a long time before I can regain that trust. So so it matters a lot more that you understand that you’re in the service of them to tell their family’s story or, you know, just their foodie story, whatever it is-

[24:41] John Anderson: Yeah.

Trey Malone: -it’s different.

John Anderson: And you can get a shout-out in their story and that can go a long way for you.

[24:47] Trey Malone: You know, and something else that I think is really interesting is like when we think about, you know, I think there’s sometimes there’s a little tension between the commercial commodity agriculture world and the specialty crop world, and there’s a lot of reasons for that. But one thing to keep maybe in mind in this advocacy space is that you know, if somebody goes to a choose-and-cut Christmas tree operation, odds are that’s the only farm that person’s ever going to walk on in their entire life. You know, the rest of us, we’ve been on farms a long time. But this is the one opportunity the entire agriculture sector has to reach that person as they go, cut down that choose-and-cut tree-

John Anderson: Yeah.

Trey Malone: -or, you know, go to a you-pick orchard. I get that there are a lot of costs associated with bringing those folks on. You go to risk. We could talk about insurance for days on those-

John Anderson: Right.

Trey Malone: but that is your opportunity as an industry to really reach across the aisle and provide some experiential learning to the people who come. And that’s really powerful. And I think that it’s underappreciated in kind of all of commercial agriculture.

[25:52] John Anderson: Yeah, that’s an excellent point. Trey, I feel like we could talk for a couple of hours about this-

Trey Malone: True.

John Anderson: -and we probably should come back and do another podcast on this in fairly short order. But based on our time today, I think we had the best sign off with a promise to resume this conversation in another podcast in very short order. I hope I can count on you for a commitment for another podcast.

[26:19] Trey Malone: A hundred percent, so long as there’s air conditioning in the building. Cause I’m not doing this outside (laughs)

[26:23] John Anderson: (laughs) Yeah, that’s a- we will definitely have air conditioning in the building or we will convene to another jurisdiction.

Trey Malone: Right, good.

John Anderson: But with that, this is John Anderson, director of the Fryar Price Risk Management Center of Excellence, saying thank you for joining us for Relevant Risk.

[26:38] Conclusion: Thanks for listening to the Relevant Risk podcast, a production of the Fryar Price Risk Management Center of Excellence in the Department of Agricultural Economics and Agribusiness within the University of Arkansas System. The Fryar Price Risk Management Center of Excellence carries out teaching activities through the Dale Bumpers College of Agricultural, Food and Life Sciences at the University of Arkansas in Fayetteville and research and extension activities through the University of Arkansas System Division of Agriculture. Visit fryar-risk-center.uada.edu for more information. Thanks for listening.