Rethinking the F&A Supply Chain - Impact of Agricultural Price Volatility on Sourcing Strategies

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Rethinking the F&A Supply Chain - Impact of Agricultural Price Volatility on Sourcing Strategies
Rethinking the F&A Supply Chain

Impact of Agricultural Price Volatility on Sourcing Strategies
Rethinking the F&A Supply Chain - Impact of Agricultural Price Volatility on Sourcing Strategies
Rethinking the F&A Supply Chain
                         Impact of Agricultural Price Volatility on Sourcing Strategies

                                                                                                                  #ONTRIBUTING AUTHORS
                                                                                                                  #AREL VAN DER (AMSVOORT                         4IM (UNT
                                                                                                                  #ARELVANDER(AMSVOORT RABOBANKCOM            4IM(UNT RABOBANKCOM

                                                                                                                  *OHN "AKER                                      $IRK *AN +ENNES
                                                                                                                  *OHN"AKER RABOBANKCOM                         $IRK*AN+ENNES RABOBANKCOM

                                                                                                                  2OSS #OLBERT                                    $AVID # .ELSON
                                                                                                                  2OSS#OLBERT RABOBANKCOM                       $AVID#.ELSON RABOBANKCOM

                                                                                                                  "ILL #ORDINGLEY                                 3EBASTIAAN 3CHREIJEN
                                                                                                                  "ILL#ORDINGLEY RABOBANKCOM                    3EBASTIAAN3CHREIJEN RABOBANKCOM

                                                                                                                  .ICHOLAS &EREDAY                                *USTIN 3HERRARD
                                                                                                                  .ICHOLAS&EREDAY RABOBANKCOM                   *USTIN3HERRARD RABOBANKCOM

                                                                                                                  #YRILLE &ILOTT                                  (ARRY 3MIT
                                                                                                                  #YRILLE&ILOTT RABOBANKCOM                     (ARRY3MIT RABOBANKCOM

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                          © Rabobank International Utrecht Branch, Croeselaan 18, 3521 CB, Utrecht, the Netherlands +31 30 216 0000
Rethinking the F&A Supply Chain - Impact of Agricultural Price Volatility on Sourcing Strategies
Contents | i


Executive summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                    1

This time is different! . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                  3

Section 1
Higher and more volatile prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                              5
  How did we get here? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       5
  So where are we heading? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .            10

Section 2
Maintaining control in an era of scarcity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                   11
  Gaining control of sourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .           11
  A continuum of sourcing strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                  11
  Strategies for success . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    14
  In short: Managing supply risk but not at any cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                15

Section 3
Strategic options being implemented . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                     17
  Strategic sourcing as a competitive advantage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                             17
  Real-life examples: Sourcing strategies in eight sectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                  17
  CASE 1: Plantation sector investing in agricultural land as a strategic asset . . . . . . . . . . . . . . . . . . . . . . . .                                                   18
  CASE 2: Supply-contracting to manage food safety risks in Chinese poultry . . . . . . . . . . . . . . . . . . . . . . .                                                         20
  CASE 3: Locking in raw sugar volumes through long-term supply contracts . . . . . . . . . . . . . . . . . . . . . . .                                                           22
  CASE 4: Barter trade as solution to soybean origination in South America . . . . . . . . . . . . . . . . . . . . . . . . .                                                      24
  CASE 5: Securing long-term sustainable cocoa supply by putting the ‘farmer first’ . . . . . . . . . . . . . . . . .                                                             26
  CASE 6: Global diversification in grains and oilseeds driven by demand/supply dislocation . . . . . . . .                                                                       28
  CASE 7: Brewers adopting a wide range of sourcing solutions in malting barley . . . . . . . . . . . . . . . . . . .                                                             31
  CASE 8: Dairy processors opting for substitution to limit impact of milk price . . . . . . . . . . . . . . . . . . . . .                                                        34

Section 4
Turning the sourcing challenge into opportunity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                             37
  F&A companies gearing up for scarcity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                       37
  When and how to respond: A framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                            38
  Nature of the agri commodity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .              39
  Internal company considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                 40
  External market conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .          41
  Alternative sourcing strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .             43
  In short: Picking winning strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                44

Conclusion: No shortage of challenges and opportunities in sourcing . . . . . . . . . . . . . . . . . . . . . . .                                                                 45
  Global food companies with market power to strengthen their position . . . . . . . . . . . . . . . . . . . . . . . . .                                                          45
  Smaller and midstream players to come under most pressure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                 45
  Global and regional trading houses to strengthen their positions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                                46
  Primary production to gravitate towards larger players . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                      46
  Beyond the next decade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .          46
Rethinking the F&A Supply Chain - Impact of Agricultural Price Volatility on Sourcing Strategies
Executive summary | 1

Executive summary

       Feast and famine cycles are not a new            patterns in developing countries, and
       phenomenon. World history is littered            changing biofuel policies throughout the
       with examples of cycles of agri-commodity        world. Furthermore, the supply side is facing
       abundance and scarcity and the impacts           limitations as productivity gains have stalled,
       they have had on food systems and indeed         farmers — ironically — face weak price
       on civilisations. As the world’s food systems    signals, and new frontier agricultural land
       have steadily moved towards becoming a           awaits substantial investment. A strong
       single global system, it was assumed that        supply response is not expected soon. As
       the risk of a scarcity cycle having a profound   a result, the global food system has been
       and lasting effect on the way food is            brought to a tipping point, and the battle
       produced and supplied to consumers               for agri commodities will only intensify.
       around the world was diminished.
                                                        Securing sufficient supply of safe, high-
       Yet this is not the case; the world is facing    quality raw materials at a price that allows
       increased agri-commodity scarcity.               an adequate risk-adjusted rate of return is
                                                        becoming inherently more challenging.
       In Rabobank’s view the world is facing a
                                                        This new challenge has changed the risk
       period of significant agri-commodity scarcity
                                                        parameters for many, if not all, food and
       that is set to last for at least this decade.
                                                        agribusiness (F&A) companies for the
       A number of important factors might change
                                                        foreseeable future. Companies that understand
       in the coming months and years such as
                                                        the significance of this transition — and the
       a double-dip economic recession or the
                                                        associated risks and opportunities — are
       rolling back of biofuels legislation. Although
                                                        responding by making step changes in their
       these changes may impact the timing of
                                                        approaches to sourcing.
       the outlook, they do not undermine the
       conclusion that global agri-commodity            Judging by the adjustments being made to
       prices are expected to shift higher and          F&A companies’ business strategies, the sector
       become more volatile. This in itself is not a    is recognising that we have entered an era
       new phenomenon — there are many prior            of scarcity. The battle for agri commodities is
       instances of agri-commodity price spikes         rapidly gaining momentum. Notably, larger
       being met with a strong supply response          F&A players, and even governments, are
       and a subsequent re-levelling.                   looking into minimising their risks by securing
                                                        their current and future agri-commodity
       But what is happening this time is
                                                        supplies, while at the same time dealing
       genuinely different.
                                                        with higher price-risk levels. In doing so, they
       Higher prices and increased volatility are       may well raise the stakes for companies that,
       products of strong demand drivers such           so far, have remained on the sideline.
       as economic growth and shifting dietary
Rethinking the F&A Supply Chain - Impact of Agricultural Price Volatility on Sourcing Strategies
2 | 2ABOBANK Rethinking the F&A Supply Chain

                                               When and how to respond are still open                Increased cooperation throughout the
                                               questions — whether to respond is not.                supply chain based on transparency, trust
                                                                                                     and sharing responsibilities, may provide
                                               Not surprisingly, given the complexity and
                                                                                                     a solid alternative for establishing control.
                                               interconnectivity in the F&A world, there
                                                                                                     Such alternative sourcing strategies are
                                               is no silver bullet. It is unlikely that one single
                                                                                                     currently being implemented with support
                                               sourcing strategy will work on all occasions
                                                                                                     from Rabobank to overcome some of
                                               and for each company. An F&A company may
                                                                                                     the challenges that this era of scarcity
                                               well need to develop a portfolio of sourcing
                                                                                                     brings along.
                                               strategies for each of its key agri commodities.
                                                                                                     Although the transition is inevitable, it is
                                               Control over supply is being pursued through
                                                                                                     not the endgame. While the next decade
                                               two strategic options — establishing direct
                                                                                                     will be dominated by a battle for agri-
                                               control over agri-commodity supplies or
                                                                                                     commodity supply, we conclude that this is
                                               focussing on market power to align the
                                                                                                     only the beginning of a profound transition
                                               supply chain. For companies that lack scale,
                                                                                                     in the global F&A sector. In the next 40 to
                                               another strategic option would be to focus
                                                                                                     50 years, the F&A sector will need to double
                                               on market power or financial headroom
                                                                                                     agri-commodity supply with access to only
                                               to achieve control, the emphasis being on
                                                                                                     about half of the current land, water and
                                               adapting their own businesses to circumvent
                                                                                                     mineral resources. Delivering this four-fold
                                               exposure to the increased risks.
                                                                                                     improvement in output is the over-riding
                                               Control may help manage supply risks, but             challenge facing the incoming generation
                                               it may also come at a price.                          of F&A leaders.

                                               These three strategic options break down              F&A companies that are able to successfully
                                               into multiple sourcing strategies ranging             tackle the challenges in the battle for agri
                                               from backward integration and land                    commodities will be best geared to capitalise
                                               investments to substitution and tolling. In           on the opportunities in the middle of this
                                               an attempt to simplify the diversity in               century. The best way for farmers to benefit
                                               possible responses, we have identified a              from this new reality is by considering
                                               continuum of response strategies, reflecting          increased cooperation with other farmers
                                               the balance struck between accepting higher           and becoming active partners in the chain.
                                               risks and the extra effort or investment
                                                                                                     Our message to all farmers and F&A
                                               required to offset those risks.
                                                                                                     companies is simple: act now!

                                                                                                     Piet Moerland
                                                                                                     #HAIRMAN OF THE %XECUTIVE "OARD
                                                                                                     OF 2ABOBANK .EDERLAND
Rethinking the F&A Supply Chain - Impact of Agricultural Price Volatility on Sourcing Strategies
This time is different! | 3

This time is different!

         Twice in the past five years, global agri-           prices over the next five to 10 years. This
         commodity prices have spiked significantly,          is a significant break from the past when
         catching companies, policy makers and                ever-declining real prices for agri
         consumers off guard and creating significant         commodities were the norm.
         disruptions in the global food industry
                                                              This new age of scarcity has caught many
         supply chain. When such extreme market
                                                              governments, companies and consumers
         disturbance occurs in other industries,
                                                              short and has already resulted in painful
         analysts are quick to reach for interpretations
                                                              adjustments. It highlights the increasing
         of paradigm shifts. ‘This time is different’, they
                                                              interdependence of global agricultural and
         claim, reaching for apocryphal metaphors of
                                                              food markets and reveals the risks of the
         brave new worlds. Rarely do they view rapid
                                                              relentless march of the global F&A sector
         price rises as bubbles waiting to burst.
                                                              towards supply-chain efficiency.
         In the world of agriculture, calls of ‘paradigm
                                                              Supply-chain strategies of just-in-time
         shifts’ and ‘new eras’ are less common. With
                                                              inventory management or horizontal
         its colourful history from 17th-century
                                                              integration made perfect sense in an era
         tulipomania to 21st-century boom-and-bust
                                                              of low and declining commodity prices and
         price cycles, as well as extreme weather
                                                              limited volatility. Today, these strategies are
         events and government policy shocks, the
                                                              under review. Traditional views on strategic
         food and agribusiness (F&A) sector has seen
                                                              stock-holding and vertically integrated supply
         it all before. But even with a historical
                                                              chains seem to make more sense now than
         perspective, the events of the last few years
                                                              they did over the past 30 years, a period
         provide strong arguments that this time
                                                              in which the search for economies of scale,
         things really are different. We are moving
                                                              convenience, consistency and safety
         into an era of scarcity, with higher prices
                                                              dominated corporate strategies.
         and increased volatility the new standard
         for a more globalised food industry.                 These strategies worked well in times when
                                                              value was created in developed markets by
         Driven by economic growth and shifting
                                                              brands offering increasing convenience,
         dietary patterns in developing countries,
                                                              functionality and value for the consumer.
         and changing biofuel policies around the
                                                              However, in these times of higher and more
         world, the acceleration in demand for agri
                                                              volatile prices the power balance is beginning
         commodities which began at the start of this
                                                              to shift, especially given the recessionary
         century has brought the global food system
                                                              trends evident in the major Western markets.
         to a tipping point. The ability of the system to
                                                              Companies that control the supply chains are
         adjust production to meet growing demand
                                                              now increasingly wielding market power and,
         has been structurally altered, suggesting a
                                                              as a result, will start drawing margins away
         continuation of higher and more volatile
                                                              from the other players in the chain.
Rethinking the F&A Supply Chain - Impact of Agricultural Price Volatility on Sourcing Strategies
4 | 2ABOBANK Rethinking the F&A Supply Chain

                                               In this report, we highlight a diverse range of
                                               strategies that F&A companies have adopted
                                               to deal with the higher, more volatile agri-
                                               commodity prices and increased scarcity.
                                               Three distinct categories of sourcing
                                               strategies are identified — increasing control
                                               of physical sourcing, focussing on market
                                               power and adapting business strategies to
                                               reduce and possibly circumvent supply risks.
                                               To illustrate our analysis, we have included
                                               eight case studies which highlight several key
                                               sourcing strategies. Furthermore, we examine
                                               the changes in business strategies already
                                               visible and set out a rationale for how
                                               these companies can determine the most
                                               appropriate strategies to adopt.

                                               An era of scarcity is upon us that represents
                                               a new order for the global food system
                                               and will require new strategies both from
                                               companies and policy makers. There is no
                                               simple way for companies to navigate this
                                               new era, no silver bullet. There will be winners
                                               and losers. Those who grasp the change first
                                               will have the best prospects for turning the
                                               new reality into an opportunity.
Rethinking the F&A Supply Chain - Impact of Agricultural Price Volatility on Sourcing Strategies
Section 1 Higher and more volatile prices | 5

1 Higher and more volatile prices

           How did we get here?                                                                                                                  The food mountains are now gone, subsidies
           The world of agriculture has changed                                                                                                  have been scaled back or restructured, the
           significantly over the past 30 years. It was not                                                                                      world population is now approaching
           so long ago that farmers were lamenting the                                                                                           7 billion, and the Asian economy has taken
           enormous food mountains in the United                                                                                                 off on a trajectory which has surprised many,
           States (US) and Europe resulting from the                                                                                             with forecasts suggesting that robust growth
           overproduction of food commodities under                                                                                              can be expected for the foreseeable future.
           protectionist agricultural subsidy regimes.                                                                                           Add in the impact of the current biofuel
           Such conditions weighed heavily on world                                                                                              revolution and the route to the current
           agri-commodity markets and resulted in                                                                                                tipping point begins to emerge. The Goldman
           extended periods of low prices with relatively                                                                                        Sachs Agricultural Commodity Price Index
           low volatility. At that time, the world                                                                                               over the last 40 years illustrates this trend
           population was considerably smaller than it                                                                                           (SEE &IGURE ). By this measure, nominal agri-
           is today, the emerging markets in Asia were                                                                                           commodity prices are at record highs, and are
           much less developed, and economic growth                                                                                              perhaps more importantly, extremely volatile.
           had yet to take off.                                                                                                                  Although each agricultural crop has its own
                                                                                                                                                 unique set of supply and demand factors,

             Figure 1.1: Agri-commodity prices and volatility, Feb 1972-Jul 2011
             percent                                                                                                                                                                                                                                         percent

             600                                                                                                                                                                                                                                                      36

             500                                                                                                                                                                                                                                                      30

             400                                                                                                                                                                                                                                                      24

             300                                                                                                                                                                                                                                                      18

             200                                                                                                                                                                                                                                                      12

             100                                                                                                                                                                                                                                                       6

               0                                                                                                                                                                                                                                                       0























                       Goldman Sachs Agricultural Price Index                                                                                                                                                            Series 2 = 180-day volatility

             Source: Goldman Sachs, 2011
6 | 2ABOBANK Rethinking the F&A Supply Chain

                                                                      many leading arable and tree crops have                                                                   $EMAND DRIVERS
                                                                      shown similar price rises (SEE &IGURE ).                                                               In the last half of the 20th century, the real
                                                                                                                                                                                price of agri commodities — taking into
                                                                      Remarkably, the world’s agricultural resource
                                                                                                                                                                                account the general rise in prices — trended
                                                                      base has maintained its capacity to
                                                                                                                                                                                downward at about 1 percent to 2 percent
                                                                      accommodate accelerated global demand
                                                                                                                                                                                per year. As the cost of producing commodities
                                                                      growth. While global food balance sheets
                                                                                                                                                                                fell following technical advances in improving
                                                                      show that there are sufficient reserves of
                                                                                                                                                                                yields and economies of scale, so too did
                                                                      staple commodities to meet world demand
                                                                                                                                                                                prices. But all that changed at the turn of the
                                                                      at present, there are some warning signs that
                                                                                                                                                                                century, with prices trebling in just 10 years.
                                                                      global food production will come under
                                                                      further demand pressure in the future. The                                                                Three main drivers have caused agri-
                                                                      existence of these warning signs, or the threat                                                           commodity demand to surge and pushed
                                                                      that they will materially impact supply, is                                                               prices above their long-term value trend in
                                                                      encouraging agricultural prices to rise and                                                               this century. Firstly, on top of an already
                                                                      behave in a more volatile manner.                                                                         growing global population, per capita
                                                                                                                                                                                incomes have risen along with growing
                                                                      Understanding the key historical demand
                                                                                                                                                                                economic prosperity in developing countries,
                                                                      and supply drivers and pricing trends
                                                                                                                                                                                particularly in China. Secondly, rising incomes
                                                                      which led to rising and more volatile agri-
                                                                                                                                                                                and increasing urbanisation have led to a shift
                                                                      commodity prices creates a clearer picture
                                                                                                                                                                                in dietary preferences away from grains to
                                                                      of what actions supply-chain players,
                                                                                                                                                                                meats and other higher value, calorie-rich
                                                                      consumers and governments should take to
                                                                                                                                                                                foods. Thirdly, the world-wide proliferation
                                                                      mitigate, or at least manage, the impacts of
                                                                                                                                                                                of government-mandated biofuel policies
                                                                      scarcity on global agri-commodity markets.
                                                                                                                                                                                has created a huge new source of demand for
                                                                                                                                                                                agri commodities. In the US alone, 40 percent

   Figure 1.2: Index of US wheat, corn, soybean and cocoa prices, 1957-2011

   Wheat US gulf ports price index, 1957-2011                                                                                              Corn price index, 1957-2011
  300                                                                                                                                      300

  250                                                                                                                                      250

  200                                                                                                                                      200

  150                                                                                                                                      150

  100                                                                                                                                      100

    50                                                                                                                                      50

     0                                                                                                                                       0



   Soybean price index, 1957-2011                                                                                                          Cocoa price index, 1957-2011
  350                                                                                                                                      300


    50                                                                                                                                      50

     0                                                                                                                                       0




   Source: IMF, 2011
Section 1 Higher and more volatile prices | 7

of the corn harvest is now consumed by the                                changed around 2000 when continuous
ethanol industry, representing the equivalent                             declines in yield growth began to have an
of an estimated 150 million acres of land.                                effect on supply, which has since fallen
There is no sign that these demand drivers are                            behind the acceleration in demand
abating. Rather, they are expected to continue                            (SEE &IGURE ) This lag in supply has occurred
and likely strengthen over the coming                                     despite the fact that about 175 million acres
decade. For example, the number of middle-                                of new land have been drawn into agriculture
class households in the world is expected to                              mainly in South America (soy and corn),
double over the next decade, with most of                                 South East Asia (oil palm) and Russia/Ukraine
the expansion taking place in developing                                  (wheat). It is often said that the cure for high
countries (SEE "OX ). Finally, although the                            prices is high prices. Although it is true that
rate of global population growth is slowing,                              high prices generally trigger a supply
the overall population is still rising and                                response that ultimately brings prices down,
forecast to hit 9 billion by 2050 compared                                given the challenges of declining yields and
to 7 billion today.                                                       growing demand, this time around higher
                                                                          prices are unlikely to bring prices down to
                                                                          previous levels. Another uncertain factor is
Prior to 2000, increases in demand for agri
                                                                          the time lag between the higher price signal
commodities were mostly met by growth in
                                                                          and a market response in the form of increased
the global capacity to deliver supply. Overall,
                                                                          production; the longer the time lag, the longer
the existing amount of land dedicated to
                                                                          the upward pressure on prices will last.
agriculture was able to meet the world’s
growing demands, despite large amounts                                     Over the last two decades, a growing
of high-quality arable land being lost to                                  imbalance has emerged between the relative
urbanisation each year. However, things                                    market power of farmers and the F&A

  Box 1.1: Demand growth from Asian consumers

  The middle-class populations of China and India are expected to treble over the next decade. This
  growth is expected to have a significant impact on the F&A sector because dietary shifts away from
  grain-based diets towards more protein and dairy are typically driven by middle-class households.
  With food consumption growth running at between 1 percent and 2 percent per year throughout
  Asia, the F&A supply chain’s Asian segment is expected to grow up to 20 percent over the next decade
  (SEE &IGURE ). Rabobank expects that the value-added processing sector will develop at an even faster
  rate as Asian consumers demand more sophisticated food products and regional capacity builds to
  support local market opportunities.

    Figure 1.3: Per capita food consumption growth in Asia by food commodity, 2008-10* to 2020f







          Sugar      Poultry Vegetable        Milk       Sheep        Pork        Coarse   Rice      Fish       Beef      Wheat
                                oils                                              grains

    *Three-year average

    Source: OECD, Food and Agriculture Organization of the United Nations, 2011

  The current rate of growth is further complicating already difficult strategic and competitive challenges
  for F&A companies. This demand growth will inevitably lead to increased dependence by the global food
  industry on the agricultural production regions of Australia, the Americas and the Black Sea region. The
  interdependence of the world’s ‘food bowls’ and the major demand growth regions is intensifying as
  every year passes.
8 | 2ABOBANK Rethinking the F&A Supply Chain

  Figure 1.4: Global yield trends for wheat and rice, 1965-2009

   7                                                                                5.0
   6                                                                                4.5
   5                                                                                4.0
   4                                                                                3.5
   1                                                                                1.5
   0                                                                                1.0
   -1                                                                                .5
   -2                                                                                 0

         Wheat            Trendline                                                       Rice, paddy           Trendline

  Note: Percentages based on 5-year moving average                                  Note: Percentages based on 5-year moving average

  Source: Food and Agriculture Organization of the United Nations, Rabobank, 2011

                                                companies that dominate the downstream                      trade flows and stock positions. As the rapid
                                                food supply and upstream farm inputs ends                   pace of consolidation in the global F&A sector
                                                of the supply chain. As F&A companies at                    continues, market power will concentrate in
                                                both ends of the chain see their market                     the hands of relatively few, but larger players.
                                                power increase, they seek to squeeze margins.               As these key players are strengthening and
                                                Farmers are squeezed between food                           integrating various market segments into
                                                companies wanting the lowest farm-gate                      proprietary supply chains they are also
                                                prices and input suppliers wanting the                      taking ownership of information flows. If
                                                highest price possible. As a result, despite                this remains the exclusive domain of the
                                                elevated global agri-commodity prices, the                  large players, it will become more difficult
                                                supply side response has not been strong                    for others to evaluate the fundamental
                                                enough to bring these prices down.                          supply and demand situation across the
                                                                                                            agricultural complex.
                                                /THER MARKET FACTORS SUPPORTING HIGHER
                                                PRICES AND INCREASED VOLATILITY                             'OVERNMENTS ALSO CONTRIBUTING
                                                With agri-commodity supply failing to match                 Government involvement in the F&A supply
                                                rising demand, stocks have been winding                     chain is not a new phenomenon but is now
                                                down and the result has been higher and                     having an increasing influence on not only
                                                more volatile prices. In addition, a number                 the trade flows of agri commodities, but also
                                                of other factors have been supporting higher                on the pricing of F&A products at many
                                                prices and increased volatility. All of these               stages in the supply chain. Whether through
                                                factors are accentuated by the tight global                 state ownership of farm-inputs procurement
                                                stocks situation. New land brought into                     and distribution, minimum support prices
                                                agricultural production is often in remote                  at the farm level, import tariffs or retail
                                                areas with more volatile yield profiles and                 price caps, government influence should
                                                higher long-term production and logistic                    not be ignored.
                                                costs. Since most agri commodities are priced
                                                                                                            The main F&A policy objectives for
                                                in US dollars, the weak US currency has also
                                                                                                            governments in developing markets are to
                                                impacted prices, as has the linking of agri-
                                                                                                            protect those segments of the supply chain
                                                commodity prices and energy prices through
                                                                                                            perceived to be the most vulnerable, namely
                                                biofuels and farm-input prices. Extreme
                                                                                                            the farmer, rural communities and urban
                                                weather events — possibly a result of climate
                                                                                                            populations. Governments need to strike
                                                change — and the government responses
                                                                                                            a welfare balance to ensure that rural
                                                they often inspire, such as the recent Russian
                                                                                                            communities remain viable. In this way,
                                                wheat export ban, have also caused prices to
                                                                                                            they can protect farmers’ margins, improve
                                                rise. Furthermore, the financialisation of agri
                                                                                                            national food self-sufficiency rates and
                                                commodities and speculation only add to
                                                                                                            manage rural-urban migration levels, while
                                                market liquidity and risks (SEE "OX ).
                                                                                                            also minimising inflationary pressures in
                                                Volatility is also being fuelled by a gradual               urban areas.
                                                decline in the public flow of information on
Section 1 Higher and more volatile prices | 9

Policy initiatives designed to reduce                                  affordability for the general population, may
the threat of food scarcity are typically the                          deny farmers access to the superior farm-gate
domain of governments and the United                                   returns needed to foster improved social and
Nations. In emerging-market countries,                                 economic outcomes, including agricultural
where self-sufficiency levels are lower,                               productivity. Security of food supply is of
these initiatives need to strike a balance                             paramount importance to countries that
between fostering economically and                                     are not self-sufficient and, over time, as
socially sustainable conditions in farming                             concerns around food security intensify,
communities and managing food inflationary                             policy changes which disrupt trade will
pressures in the general economy for                                   become more common. The inevitable
urban populations.                                                     result will be upward pressure on prices
                                                                       and increased volatility.
The use of trade policy often illustrates the
contradictions in finding this balance. For                            Concerns about rapid urbanisation and
example, export bans, which are implemented                            shortages in local food supplies in many
to insulate domestic food prices from global                           developing countries keep the dynamics
food-price inflation and maintain food                                 of primary agricultural production high on

  Box 1.2: Managed money in agri-commodity markets — another source of volatility?

  The increased transparency through the US Commodity Futures Trading Commission’s weekly
  Commitment of Traders report has brought to light speculative investors’ presence in agri-commodity
  markets in recent years. Speculative money is a critical component to futures and options markets as
  it adds liquidity. However, due to the often shorter term holding period, speculative investors can
  influence short-term market direction and increase price volatility. In instances of bullish underlying
  fundamentals, speculators tend to increase their net long position in agri commodities in expectation
  of capital gains. Similarly, when speculators hold a bearish view of the market they will take a net short
  position in order to profit from falling prices. When these noncommercial or speculative traders build a
  position which is a relatively large net long or net short position, their subsequent unwinding of
  positions can pressure prices as everyone generally moves for the exit at the same time. This can cause
  agri-commodity prices to disconnect from underlying fundamentals in the short term. However, we
  believe that underlying fundamentals will continue to be the primary driver to long-term agri-
  commodity prices.

  Recently, speculative money’s net long position in agri commodities has reduced from its record
  high, but it remains elevated (SEE &IGURE ). Noncommercial traders’ net long position in total agri-
  commodity futures and options has averaged 385,558 contracts since 2006. During the commodity
  boom of 2008, their net long reached 810,304 contracts at the end of August 2008 and subsequently
  fell to net short 110,194 contracts by December 2008. In the recent price rally in 2010/11,
  noncommercials’ net long position in agricultural futures surpassed the high of 2008, reaching
  more than 1,000,000 contracts in September 2010.

    Figure 1.5: Managed money position in agri commodities vs. S&P GSCI agri index, Jun 2006-Aug 2011
    thousand contracts                                                                                  S&P GSCI Agri Commodity index

    1,500                                                                                                                         600

    1,200                                                                                                                         520

     900                                                                                                                          440

     600                                                                                                                          360

     300                                                                                                                          280

        0                                                                                                                         200










        Managed money net long position            S&P GSCI Agri Commodity index

    Source: CFTC, Bloomberg, 2011
10 | 2ABOBANK Rethinking the F&A Supply Chain

                                                governments’ agendas. The political voting
                                                power of the rural population is also a key
                                                reason for governments to keep supporting
                                                the many small-holders. Due to the small
                                                farm size and general absence of scale in
                                                many developing countries’ agricultural
                                                production systems, governments have
                                                to subsidise farming costs to ensure that
                                                targeted self-sufficiency levels for essential
                                                agri commodities are maintained at
                                                targeted levels.

                                                So where are we heading?
                                                The drivers supporting higher prices and
                                                volatility that are in play today are likely to
                                                be with us for some time to come. We believe
                                                it will be at least a decade before we see the
                                                full impact of a strong supply response in the
                                                form of a new ‘green revolution’ style boost to
                                                productivity and frontier land development,
                                                and a marked change in biofuel policies to
                                                free up more grains for human uses.

                                                As scarcity increases over time, governments,
                                                industry players and consumers will need to
                                                make adjustments to attempt to mitigate the
                                                extent to which scarcity impacts the supply
                                                and pricing of agri commodities around
                                                the world.
Section 2 Maintaining control in an era of scarcity | 11

2 Maintaining control in an era of scarcity

           As CEOs and Boards of F&A companies                    commodities, manage price risks and, in doing
           around the world contemplate how to best               so, protect cash flows and margins.
           position their business models in response
           to the structural changes across the global            Gaining control of sourcing
           supply chain, the questions highest on their           F&A companies wanting to respond to
           agendas are how to secure a sustainable                increased supply risks and price volatility
           supply of agri commodities and how to                  have a range of options. They could either
           deal with increased price risk.                        reduce the impact by increasing control over
                                                                  sourcing or circumvent exposure by looking
           The preferred responses used to be based
                                                                  for alternative strategies.
           on ‘optionality’ in sourcing (the flexibility
           and agility to buy or sell from or to many             Control does not come for free; it implies
           suppliers or customers) and the use of                 lowering risk, which as we learn from the
           market-based risk-management tools such as             world of investments may lead to a lower
           hedging. Optionality and hedging tools gave            reward. The risk/reward trade-off for sourcing
           companies the agility to deal with unexpected          strategies is not as clear-cut as it is for
           factors such as sudden government policy               investments. Increased control over sourcing
           changes and other supply shocks.                       can also lead to higher returns. For example,
                                                                  control over a commodity or a supply chain
            In the era of scarcity that we are entering,
                                                                  may lead to better margins and a better
            these solutions will likely not suffice. In theory,
                                                                  return on capital employed.
            ownership of the entire supply chain from
           ‘farm to fork’ may seem an obvious solution,           In addressing the increased risk outlook,
           but in practice that is often difficult to achieve.    F&A companies will need to balance these
           Assembling and coordinating the mix of                 higher risks against the extra effort required
           expertise required in farming, trading,                to offset them. Such efforts range from
           logistics, processing and marketing is a major         operational aspects such as lower utilisation
           challenge, not to mention the size of the              rates, increased red tape, reduced flexibility
           capital requirement for achieving this                 and more management time to financial
           strategic position.                                    parameters such as cash investments, lower
                                                                  profitability margins and larger cash-flow
           Addressing the needs associated with
                                                                  swings. This trade-off between risks and
           supply-chain management and strategy
                                                                  efforts can be visualised as a continuum
           development will require some degree
                                                                  (SEE &IGURE ).
           of control, but not at any cost. The term
           ‘strategic sourcing’ encompasses the
                                                                  A continuum of sourcing strategies
           different approaches that F&A companies
                                                                  Numerous F&A companies are already
           are adopting to secure access to agri
                                                                  adapting their sourcing practices to the
12 | 2ABOBANK Rethinking the F&A Supply Chain

                                                 Figure 2.1: Sourcing continuum

                                                                           Increasing control over             Focus on market power                Adaptive strategies
                                                                               physical supply
                                                  Price volatility
                                                  and supply
                                                  insecurity risk       low                                                     high         high                         low
                                                  and financial)        high                                                     low         low                          high

                                                                     high – unique and high value to production processes                low – not critical to production processes

                                                 Source: Rabobank, 2011

                                                higher risk outlook to keep their competitive                           stage in the supply chain. This can currently
                                                edge. As different groups of F&A companies                              be seen in the sugar industry, where some
                                                have different inherent abilities to capitalise                         manufacturers have sought to vertically
                                                on the changes underway, and as the risk                                integrate upstream in order to secure supply
                                                profile for each commodity is developing                                (SEE CASE STUDY  ON PAGE ).
                                                differently, it should not be surprising that
                                                                                                                        ‘Farmer first’
                                                a variety of different sourcing strategies are
                                                                                                                        In some sectors, such as cocoa and beer,
                                                being implemented.
                                                                                                                        companies are actively assisting in the
                                                 )NCREASING PHYSICAL CONTROL OVER SUPPLY                              production process by working directly with
                                                Securing supply of agri commodities of                                  farmers. For these players, ensuring quality
                                                the right quality and at the right time is                              of supply is a key motive. For this strategy to
                                                becoming more difficult. However, this is                               work, investments in infrastructure (physical,
                                                an increasingly important success factor for                            technological) are usually required (SEE CASE
                                                both F&A players and governments given                                  STUDIES  AND  ON PAGES  AND ). Other
                                                that food scarcity will eventually constrain                            companies are trading farm input raw
                                                physical markets. This is particularly the case                         materials against physical delivery of agri
                                                as the majority of new demand from Asia                                 commodities (SEE CASE STUDY  ON PAGE ).
                                                is not necessarily co-located with existing                             Other examples include F&A companies
                                                production. Supply chains will need to be                               providing working-capital financing for
                                                developed or enhanced to accommodate                                    farmers in return for agri commodities or
                                                the resulting trade flows. Furthermore, there                           creating farmer loyalty by providing services
                                                are other factors currently affecting the task                          such as training.
                                                of securing sustainable supply, including
                                                                                                                        Regional diversification
                                                supply-chain ownership, government
                                                                                                                        One way to ensure supply is to use multiple
                                                intervention, scale, influence and capital
                                                                                                                        suppliers in one region, or in extreme
                                                efficiency. Individual sourcing strategies
                                                                                                                        instances, establish a presence in relevant
                                                within this category are investing in land,
                                                                                                                        production regions in order to better match
                                                backward integration, ‘farmer first’ and
                                                                                                                        demand/supply and keep closer track of crop
                                                regional diversification.
                                                                                                                        conditions to be able to reduce risks in case of
                                                Investing in land                                                       supply shocks. This strategy involves building
                                                Investing in land involves companies or                                 and maintaining many relationships, which
                                                governments buying the prime production                                 would obviously require a considerable effort.
                                                asset of any crop — land. Buying up land                                In the more extreme instances, even capital
                                                makes it possible to exercise direct control                            investments could be required in order to
                                                over crops and commodity output, which                                  make diversification strategies successful.
                                                can be used directly for further processing                             Diversification has become increasingly
                                                without having to deal with any other party                             important for grains and oilseeds companies
                                                in-between (SEE CASE STUDY  ON PAGE ).                               (SEE CASE STUDY  ON PAGE ).
                                                Backward integration                                                    These strategies deal with the issues of
                                                This strategy involves buying or setting up                             security of supply, managing risk and
                                                (greenfield) production, logistical or storage                          volatility, and structuring funding
                                                assets along the chain. The reason companies                            requirements. In a world of scarcity of supply,
                                                would pursue this strategy is similar to the                            companies pursuing one of these sourcing
                                                drivers for investing in land: getting direct                           strategies have made sure they have secured
                                                access to farmers/crops and controlling                                 supply, have control over quality and have
                                                quality of commodity output in an earlier                               control over price. Importantly, this removes
Section 2 Maintaining control in an era of scarcity | 13

the volatility of prices. However, all of this    contracts and other financial derivatives to
comes at a cost. Investments are required to      hedge out the risk of price changes are well-
make these strategies work. Therefore the         established. In other markets, such as for
F&A companies involved have to look very          malting barley and dairy products, these
carefully at their balance sheets before          financial instruments are under development
pursuing any of these strategies.                 but remain in their infancy. In all cases, players
                                                  with market power and stronger balance
                                                  sheets will be best placed to make full use
The second category, focus on market power,
                                                  of these tools.
is another way to gain control and mitigate
supply risk. In the increasingly volatile agri-   Reliance on brand power
commodity markets, F&A players are seeking        Another strategy used to deal with increased
new approaches to managing price-risk             commodity prices is to rely on brand power
exposure. These new strategies are mostly         to pass on the increased prices to the next
driven by relationships between players in        company or consumer in the supply chain.
the F&A supply chain, which are becoming          Branding can be seen as a key tool to achieve
more important in order to secure supply          this. Nespresso is a good example; premium
or make sure risks are under control. Supply-     beer brands are another, as agri commodities
contracting, horizontal partnerships, market-     are less than 10 percent of total costs.
based risk-management tools, reliance on          However, this strategy can be, or should be,
brand power and forward integration are           combined with other sourcing strategies.
common strategies within this category.
                                                  Forward integration
Supply-contracting                                A forward integration strategy can be used
Supply-contracting is commonplace. Many           if a company believes it cannot achieve a
F&A companies strike agreements with other        sustainable competitive advantage or is
companies within the supply chain to make         unlikely to achieve a competitive sourcing
sure supply of commodities is secure and safe.    strategy. It may work for this company to
Supply-contracting is mainly a business-to-       buy or set up processing assets in a later
business agreement, though sometimes              stage in the supply chain. This is done
agreements are between farmers and                in order to grab a larger portion of the
companies. The Chinese poultry sector             value-add of the processed product and
is a striking example of when companies           to improve negotiation positions vis-à-vis
enter certain agreements to ensure supply         food distributors. In effect, this will further
(SEE CASE STUDY  ON PAGE ). Recent greater     strengthen market power by locking in
price volatility and fears about sourcing         additional margin.
supply have encouraged companies with
                                                  These five strategies make sure that control
market power to revisit the terms of current
                                                  over supply is achieved and that risks are
agreements to increase certainty and
                                                  lowered. In most cases, not a lot of investment
duration of supply. For example, long-term
                                                  is required, or at least much less than in the
supply contracts have become more
                                                  physical control category. However, the
common in an attempt to secure origination,
                                                  control is less direct and less certain than in
i.e., lock in supply.
                                                  the first category. As a result, risks are higher
Horizontal partnerships                           and prices may not be as clear. For example,
Establishing horizontal partnerships is a         long-term contracts can be breached; this
strategy frequently seen in the food retail       happens frequently. The customer may then
market. Food retail companies expand              have to scramble to get access to a certain
their relative market positions through           commodity, which may have to be purchased
cooperation with competitors in regard            at inflated market prices.
to procurement to reinforce their negotiation
position vis-à-vis suppliers. This strategy
of entering into horizontal partnerships is
another way of exercising market power,
by combining purchasing forces.

Market-based risk-management tools
This strategy is, or used to be, very
straightforward — using financial market
instruments to lower/mitigate price and
volume-supply risks. In some F&A sectors,
such as the grains market, the use of futures
14 | 2ABOBANK Rethinking the F&A Supply Chain

                                                 !DAPTIVE STRATEGIES                              of an issue than before. However, some of
                                                The third category is a different solution to       these strategies may not come cheap —
                                                improving control over sourcing: adapting           investments in R&D or tangible assets may
                                                the internal organisation of a company to           be required.
                                                mitigate supply risks. The strategies in this
                                                category have a more internal focus on what         Strategies for success
                                                can be changed in the business model or             Given the dynamics around higher prices
                                                in the procurement strategies of a company          and increased volatility, we have identified
                                                to achieve more control and/or to reduce            four groups of companies as those that
                                                the risks.                                          appear best placed for success: those with
                                                                                                    the best access to agri commodities, those
                                                Finding niche markets
                                                                                                    with market power, those with the greatest
                                                This strategy of finding niche markets goes
                                                                                                    agility or ability to adapt to the changing
                                                along the same lines as reliance on brand
                                                                                                    market conditions and companies with
                                                power. However, it may be more applicable
                                                                                                    sufficient financial firing power. A common
                                                for smaller companies. Negotiation power is
                                                                                                    denominator for success in each of
                                                achieved through selecting a smaller target
                                                                                                    the groups is financial strength and
                                                market in which a substantial share is
                                                                                                    structured funding.
                                                achieved, rather than large-scale marketing.
                                                                                                    'LOBAL AND REGIONAL TRADING HOUSES WITH
                                                Ingredient substitution
                                                                                                    PREFERENTIAL ACCESS TO AGRI COMMODITIES
                                                In this strategy, alternative ingredients
                                                                                                    Global and regional commodity traders,
                                                are researched and even sourced to lower
                                                                                                    especially those with access to new growth
                                                direct dependency on one particular agri
                                                                                                    drivers, i.e., those with the most influence
                                                commodity. The dairy industry is a good
                                                                                                    over supply chains in Asia, are relatively
                                                example of where this strategy is being
                                                                                                    well-placed for success in an era of scarcity.
                                                implemented (SEE CASE STUDY  ON PAGE ).
                                                                                                    These companies are already moving
                                                Switching away from certain commodities
                                                                                                    further upstream in an effort to secure
                                                that may be scarce or volatile in price could
                                                                                                    supply at the source. In some cases they
                                                be a good strategy, but this may not be
                                                                                                    have directly acquired production assets,
                                                without risk. For example, replacing milk fat
                                                                                                    while in other cases they are strengthening
                                                with vegetable oil runs the risk of reducing
                                                                                                    relationships with producers as a basis for
                                                the quality, taste and shelf life of the product
                                                                                                    locking in supply.
                                                in question. Much of the success of this
                                                strategy will depend on the skill of food           'LOBAL FOOD COMPANIES WITH
                                                scientists to reformulate food products             MARKET POWER
                                                without too many compromises.                       The emergence of China and India as
                                                                                                    overwhelming demand forces and the sheer
                                                                                                    scale of their requirements is one of the most
                                                Becoming a tolling company could be a very
                                                                                                    remarkable changes seen in the global trade
                                                interesting strategy for F&A companies that
                                                                                                    of agri commodities in recent years. The range
                                                are struggling with their competitiveness.
                                                                                                    of players that facilitate this massive trade
                                                Tolling involves offering processing steps
                                                                                                    flow is becoming more concentrated as
                                                as a service provider without direct profit
                                                                                                    F&A companies seek to achieve the scale
                                                and loss exposure to raw material flow. As
                                                                                                    needed to influence the supply chain. As the
                                                the case studies show, companies have tried
                                                                                                    trade flows grow, so too must a company’s
                                                to insulate themselves from price volatility
                                                                                                    scale if it wishes to use market power to take
                                                by moving towards ‘cost-plus’ pricing
                                                                                                    its share of the trade. In countries with high
                                                agreements where price fluctuations are
                                                                                                    demand, the role of government influence on
                                                passed along the supply chain. In the latter
                                                                                                    these companies should not be ignored. For
                                                cases, whoever has the greater market power
                                                                                                    example, China exerts enormous influence
                                                gets to pass the costs on.
                                                                                                    over the global trade in soybeans, due largely
                                                Adaptive strategies are unlikely to secure          to its annual import requirement of between
                                                supply per se. Some may work to lower               50 million tonnes and 55 million tonnes
                                                the risk of supply not coming through, but          (about 60 percent of the annual world
                                                real control is not achieved. However, these        soybean trade). The sheer scale of China’s
                                                strategies may work well to gain more control       participation in soybean trade is enough
                                                over price and price volatility. Given that these   to influence the behaviours of midstream
                                                strategies are effectively about moving away        and upstream actors without having to
                                                from the issues surrounding commodities,            establish a tangible brick and mortar
                                                supply and price volatility should be less          presence in the country of origination.
Section 2 Maintaining control in an era of scarcity | 15

Global food companies — manufacturers,                • Focus on cost efficiencies, probably as a
retailers and foodservice companies —                   tolling manufacturer. Alternatively, focus
are well-placed for success in an era of                on supporting major food retailers and
scarcity. Their main advantage is that                  foodservice companies.
due to their market power — with strong
                                                    #OMPANIES WITH SUFFICIENT FINANCIAL
distribution channels and brands in their
                                                    FIRING POWER
respective market segments — they
                                                    As F&A supply chains across the world
are relatively well-placed to pass on higher
                                                    continue to consolidate, scale and efficiency
prices to downstream customers and can
                                                    will be preconditions to participating in the
negotiate agreeable terms with upstream
                                                    global F&A supply chain, rather than the
suppliers.They have reasonable chances
                                                    differentiating factors they once were. One
of being able to protect margins. These
                                                    of the defining characteristics that will
companies have three major advantages:
                                                    differentiate the highly successful players
  • Strong brands that customers support will       will be the ability to structure equity and
    keep these players in the game even if          debt in ways which facilitate continuity of
    faced with rising prices — they have greater    trade flows and deliver maximum return
    ability than most to pass on rising costs and   on capital invested.
    to protect margins.
                                                    In short: Managing supply risk, but
  • Loyalty from suppliers, who may be locked
                                                    not at any cost
    in legally, through long-standing
                                                    The questions of how to secure a sustainable
    relationships or through unique product
                                                    supply of agri commodities and how to
    specifications. Many food manufacturers are
                                                    manage price risk are central in shaping
    adding specifications to their products that
                                                    corporate responses as we enter an era of
    go beyond quality and price, e.g., carbon
                                                    scarcity. F&A companies will need to consider
    emissions, water footprint and sustainable
                                                    the current and future dynamics around
    production. These can have the effect
                                                    these issues as they build their supply-chain
    of capturing parts of the supply chain.
                                                    management systems and develop business
  • Scale that can leverage good margins            strategies. The role of governments, markets
    from suppliers and customers.                   and finance partners will all be important, as
                                                    the traditional drivers of competition. Market
                                                    power and other forms of control will be
                                                    increasingly sought after as F&A companies
Smaller midstream processors and traders
                                                    contemplate how to secure supply and
will face the greatest pressure from structural
                                                    manage risk without necessarily having to
changes in the F&A sector. Pressure will
                                                    take direct ownership of supply chains.
come from downstream major food
companies who are looking to squeeze
margins from midstream players or cut them
out of their supply chains completely, and
from upstream global trading houses that
are similarly looking to bypass the midstream
and focus on endmarkets.

Typically, midstream players are more
narrowly focussed, have less obvious options
for growth and weak balance sheets to
support alternative sourcing strategies.
Nonetheless, they do have options:

  • Develop intellectual property that makes
    them indispensible in the supply chain, for
    example, specialised application

  • Develop a differentiated offering for niche
    or premium markets. Midstream players will
    be better able to lock in margins in these
Section 3 Strategic options being implemented | 17

3 Strategic options being implemented

          Strategic sourcing as a                                             of step changes being made. However, not
          competitive advantage                                               all companies are taking a strategic approach
          Sourcing of agri commodities has always                             to sourcing, and those that are adopting a
          provided a competitive advantage for F&A                            strategic approach are not all acting in the
          companies. However, the global shift to                             same way.
          higher prices and increased volatility has
          pushed sourcing higher up the corporate                             Real-life examples: Sourcing
          agenda. F&A companies will increasingly                             strategies in eight sectors
          need to make choices between achieving                              The following eight case studies present
          incremental growth through ongoing                                  findings that highlight strategic approaches
          efficiency gains at the margin level or by                          to sourcing (SEE &IGURE ). These case studies
          making step changes to adopt a new                                  have been selected to represent and reflect a
          approach. Efficiency gains consolidate                              range of actual sourcing strategies which F&A
          sourcing as an operational issue for F&A                            companies are currently adopting to navigate
          companies, while step changes position                              the changing market environment as we
          sourcing as a strategic issue for CEOs and                          transition into an era of scarcity. Each case
          Boardroom discussions.                                              features one or two distinct sourcing
                                                                              strategies and also provides an alternative
          In our analysis of the activities and trends in
                                                                              strategy found in the same market.
          global F&A companies, we can see evidence

            Figure 3.1: Case studies and featured sourcing strategy

            Case                                                                                      Featured sourcing strategy

            1. Plantation sector investing in agricultural land as a strategic asset                  Investing in land

            2. Supply-contracting to get a grip on food safety in Chinese poultry                     Supply-contracting

            3. Locking in raw sugar volumes through long-term supply contracts                        Supply-contracting

            4. Barter trade as a solution to soybean origination in South America                     ‘Farmer first’ and barter trade

            5. Securing long-term sustainable cocoa supply by putting the farmer first                ‘Farmer first’

            6. Global diversification in grains and oilseeds driven by supply/demand dislocation      Regional diversification

            7. Brewers adopting a wide range of sourcing solutions in malting barley                  Supply-contracting

            8. Dairy processors opting for substitution to limit impact of milk price                 Ingredient substitution
18 | 2ABOBANK Rethinking the F&A Supply Chain

      CASE 1: Plantation sector investing in agricultural land as a strategic asset
      Interest in agricultural land has increased steadily in recent years, driven mainly by agri-commodity price rises and food-
      scarcity concerns. Many larger corporate F&A players have invested heavily in securing and developing tracts of land across the
      key agricultural production origins to strengthen their connections with the farm and attendant downstream supply chains.
      Agricultural production is typically still a family farming concern with large companies representing only a minor
      proportion of total agricultural production. However, as interest in agricultural land investment grows, direct and indirect
      stakeholders are seeking ways to strengthen their influence over the upstream agricultural production chain. Investors
      interested in agricultural land comprise the entire spectrum of investor demographics, from primary producers to
      sophisticated investors, and even sovereign governments. Despite the fact that the various parties invest in land for
      different reasons, they all recognise the over-arching rationale that scarcity will become an increasingly regular feature
      of agricultural commodity markets in the future.
      Investors in agricultural land can be broadly classified into four groups: land fund investors, existing agricultural
      production companies, midstream and downstream processors of agricultural commodities, and government-linked
      companies/sovereign wealth funds with national interest imperatives.
      Land fund investors
      Land fund investors’ interest in agricultural land is driven by its increasing strategic importance and the preferred return
      profile offered by fund managers selling these types of investments. In recent years, the agricultural land investment
      rationale has achieved significant traction across the investment community and has given rise to the proliferation of land
      funds which have focussed investing activities on the prime developed agricultural regions such as South America, the US,
      eastern Europe, the Black Sea region, Australia and New Zealand, and also the emerging regions in Asia and Africa. Investors
      in land funds are typically sophisticated, with patient capital and are interested in the favourable long-term investment
      profile of agricultural land.
      Existing agricultural production companies
      Some companies which already operate in the agricultural production sector are extending core competencies through
      the acquisition of existing farms/plantations, and development of greenfield farms/plantations in frontier agricultural
      production regions. One example is Sime Darby’s plantation expansion activity in Liberia, which will allow the company
      to better service export markets in Europe and other parts of Africa. Moreover, having recognised that suitable plantation
      expansion opportunities in South East Asia are becoming increasingly difficult to find, Sime Darby and certain other
      companies operating in the plantation sector are shifting their strategic focus to Africa. While Sime Darby’s Africa plantation
      strategy is still in its early days, fortunately the prospects are positive for equatorial regions where highly profitable crops
      such as palm oil and rubber thrive. This offers scope for the company to provide competitive labour conditions and
      sustainable employment opportunities for local workers.
      Midstream and downstream processors of agricultural commodities
      Midstream and downstream companies seeking to achieve greater control over the volume and pricing of raw materials
      is an emerging investor demographic. While there are limited examples of midstream/downstream companies investing
      heavily in agricultural production at this stage, players in this segment are expected to become more involved in these
      upstream activities in the future. In recent years, upstream acquisitions have been more prominent in the oil palm
      plantation sector, as compared to annual broad-acre cropping sectors where net profit margins are more volatile and
      therefore less appealing. Renowned for its biological production advantages, oil palm is arguably the most profitable
      agricultural production sector in the world today. Wilmar International Limited (WIL), known for its activities in the
      processing and trading of agricultural commodities worldwide, has heavily invested upstream in the oil palm plantation
      sector in Indonesia and Malaysia over many years, to reinforce strategic supply continuity imperatives. In 2007, WIL
      acquired, amongst other related companies, PPB Oil Palms (PPBOP) an oil palm plantation company with extensive
      plantation assets located in Malaysia and Indonesia. At the time, PPBOP owned a land bank of 363,405 hectares which,
      post-acquisition, more than doubled WIL’s land bank from 210,000 hectares to 573,405 hectares. As of end-2010, WIL’s
      plantation portfolio was considerable, consisting of 244,965 planted hectares.
      Government-linked companies/sovereign wealth funds with national interest imperatives
      Government-linked companies and sovereign funds have similar immediate imperatives to midstream/downstream
      companies. However, they also invest in upstream assets to ensure continuous and sustainable supply of agricultural
      commodities to meet broader, longer term national interest mandates such as food security. For example, in order to
      explore potential opportunities for joint investment in an agricultural food zone, Singapore established a cooperation
      with the Jilin provincial government in 2010 through Singapore Food Industries (a subsidiary of Singapore Airport Terminal
      Services (SATS), a government-linked company) along with other parties. The cooperation involves an estimated potential
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