Negotiating Agricultural Contracts: A Waxy Corn Example†
Teaching notes are available from the author upon request.
Abstract
Contracts are an increasingly prevalent tool for coordinating food systems; yet many decision makers may have little experience in setting or negotiating contract terms. This article outlines a contract negotiation exercise for an adult extension audience, and places participants in the role of contract writer or signer. Participants are asked to analyze a waxy corn contract and negotiate its provisions. The article summarizes relevant teaching points pertaining to agricultural contracts and presents materials for a specific example.
This case's objective is to provide an experiential learning exercise involving agricultural contracts. In particular, the decision case involves preparing for a hypothetical negotiation session between a waxy corn buyer and a producer. The buyer, Jake Brinks, is a relatively new grain originator representing BDM Starch. The potential producer, Ellie Myracle, is the manager of Aftermath Farms. After reviewing the decision case, participants are divided into management teams and asked to analyze a contract template according to Jake or Ellie's perspective. Management teams will seek to reach a contractual agreement via limited negotiation. Taken together, the contract analysis and negotiation are an experiential learning exercise for an extension and/or classroom audience. The exercise serves as a vehicle for discussing crop contract issues, including pricing, crop quality, delivery terms, and conflict resolution.
Jake Brinks—A Waxy Corn Buyer
The sky is orange-pink around BDM's plant as Jake Brinks steps into the main office. BDM Starch is a large grain processor whose starches are used as thickeners in food, particularly sauces, gravies, soups, and desserts. The central Indiana plant purchases waxy corn from local producers, and processes it for domestic and international shipments. Jake is a little nervous and excited at the start of the day; it is the first day that he will act as BDM's buyer of waxy corn, and, in fact, he is about to negotiate his first contract. In just a few moments, Jake will meet with Ellie Myracle, one of the managers of Aftermath Farms, to negotiate a waxy corn contract for the next crop year. Aftermath Farms has never grown waxy corn, but the farm has a great reputation for producing quality crops.
Jake received a standard contract from BDM's corporate office last week (exhibit 1). Many contract provisions are quite specific, but Jake has the opportunity to alter premiums and change contract terms as warranted. Last night, Jake wrote a few notes for the upcoming negotiation. He reviews them now:
- The mill only has enough storage capacity for two days of processing, so timely delivery of waxy corn is important. For this particular contract, Jake needs to spread delivery over four months (December, January, February and March) but cannot commit to specific days/times. In the past, BDM has allowed no more than 25% of an individual's crop to be delivered in any given month. Deliveries are accepted between 7 a.m. and 12 p.m. Monday through Friday.
- Quality is important. To get the highest processing yields, BDM entered into a joint venture with Piovartis, a company that has selected hybrids for the area. The Piovartis varieties make sense for the processing business, but producers are generally reluctant to purchase new, more expensive hybrids.
- GMOs are a concern for the buyers of BDM starches, especially buyers who use the starch as an emulsifier in food. Consequently, Jake needs to determine a cost-effective way to prevent GMO contamination that can occur directly when using GM seed or inadvertently via cross-pollination with nearby varieties. Testing is costly and time consuming.
- Price risk management is important for the starch plant. Jake has been instructed by the corporate office to sign contracts with payments based on a Chicago Board of Trade price (CBOT) (usually the nearest contract to the delivery date) plus a fixed premium. Premiums are to be negotiated at Jake's discretion. Typically, the premium is negotiated during contract signing, and producers can lock-in the futures price anytime before the delivery date.
- Management hates lawsuits. If there are any disputes, they prefer a mediated outcome following the National Grain and Feed Association bylaws.
Upper management was careful to tell Jake of previous contract mishaps. The information might be useful for contract negotiation and includes
- Producers have made unscheduled deliveries without prior notification, have delivered too much, or delivered to the satellite location 15 miles away.
- After planting, a hailstorm significantly reduced yields. Producers could not fulfill contracts, while a few suggested that the crop was actually owned by BDM and were not willing to buy corn to fulfill the contract. Importantly, producers failed to notify BDM of the shortfall until the delivery day, some months after harvest.
- Producers have reneged on contracts when competitors were offering significantly higher premiums. Defections reduce the available corn supply and have been very costly to BDM Starch.
- Producers have reported properly conditioned corn at harvest, but much poorer condition corn was actually delivered in later months.
- Producers have delivered one load of waxy to be tested, but subsequent loads were actually mixed with commodity corn.
- Producers have disputed the results of grading.
- Producers have argued that premiums were miscalculated (e.g., paid on too few bushels).
- Producers did not anticipate the additional costs of producing waxy corn. After harvest, these producers sought to renegotiate the contract to cover costs.
Ellie Myracle—Waxy Corn Producer
Ellie Myracle has been a manager of Aftermath Farms for fourteen years. After completing her degree in Agricultural Business, Ellie moved back to the family farm. While the farm has prospered producing commodity corn and soybeans, Ellie continues to seek opportunities that will capitalize on Aftermath's superior ground and good management skills. One of these opportunities is producing waxy corn for a local starch processor, BDM Starch. As Ellie sips a cup of coffee, she thinks about the waxy corn opportunity and glances over the notes she wrote in preparation for negotiating the waxy corn contract. Ellie compiled the notes after talking to other producers, the local extension educator, and doing a little research on the Internet. Ellie's notes include
- Research plots show that, on average, waxy corn varieties have yields comparable to commercial corn varieties. The trick is selecting the right variety for Aftermath Farms. At worst, a 10% yield drag is anticipated, and the average No. 2 yellow corn yield for Aftermath Farms is 155 bu/ac.
- At most, Aftermath Farms can grow 2,000 acres of waxy corn without stretching their storage resources too thin. The farm has storage capacity of 100,000 bushels and commercial storage is available for 20 cents per bushel until January and 2 cents per bushel per month beyond that time.
- Aftermath Farms can truck some of its waxy corn, but it has to balance deliveries with the winter labor needs of the livestock enterprise and family vacations to Florida.
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The local extension educator found a report that listed the potential additional costs for producing waxy corn beyond the cost of production for No. 2 yellow corn. The additional costs (on average) were:
Seed costs = 3 cents per bushel Handling/drying = 3 cents per bushel Storage/segregation = 2 cents per bushel Transportation = 6 cents per bushel Inputs (e.g., fertilizer) = 1 cent per bushel Management = 3 cents per bushel Total additional costs = 18 cents per bushel - Waxy corn will cross-pollinate with commodity corn. In general, 8 to 16 border rows are needed to separate varieties, and the border rows should be used as feed rather than as a processed product.
- Open market bids for waxy corn are offered by BDM's rivals on an ongoing basis. Premiums have ranged from 10 to 25 cents per bushel, but can be volatile.
Ellie chatted with several other waxy corn producers at the local coffee shop and heard some stories that might influence her negotiations with BDM. A few of the anecdotes that Ellie noted are as follows:
- BDM called for waxy corn delivery on May 15, even though contract terms stated a January 31 delivery date. Waxy producers faced additional storage costs, deteriorating quality, and personal property tax.
- An August hailstorm reduced production by 50%, and producers had to purchase waxy corn to fulfill contracts. Because hail damage extended through several counties, waxy corn was available only at a significantly higher price.
- Producers signed a basis contract with the local elevator for pricing and delivery in January. In this contract, the payment is equal to the nearby futures price plus a premium (i.e., the basis). The premium is negotiated at contract signing (well before delivery), but the March futures price is not locked-in until January. If the futures price is established in January, and the crop was not delivered until March, there is a chance that futures prices will increase significantly between the futures price lock-in day and actual delivery. The increase in futures prices constitutes a missed pricing opportunity that the seller cannot recover.
- The starch processor had rejected an entire contract (more than 100,000 bushels) based on a quality test of a single load.
- Scheduled delivery was limited to a single load each day for fifty-four days.
- The required Piovartis waxy corn variety resulted in a poor stand and yields. The producer was still required to purchase waxy corn to fulfill the contract.
- Payments are often miscalculated due to clerical error.
- Waxy corn was improperly graded.
- When a producer filed a lawsuit against BDM, he had to travel from Indiana to Minnesota to file in the proper jurisdiction. The trip, attorney's fees, and related expenses were substantial.
Ellie tucks her notes into manila folder and hops in the pickup to make the short drive to Jake Brinks' office. Ellie senses that waxy corn production might be a profitable enterprise for Aftermath Farms, but needs to see contract specifics before signing on.
As Ellie enters Jake's office, he offers her a cup of coffee and they sit down. After initial conversation, Jake leans forward in his chair to show Ellie the proposed contract and its provisions (exhibit 1). The contract is specific, but the premium schedule may be altered as warranted, and the quantity provisions still need to be completed.
Suggested Procedures for the Negotiation Exercise
The waxy corn contract negotiation exercise requires participants to be role players by representing either the contract writer's or signer's interests. The exercise emphasizes important contractual issues, and specific teaching points are available from the author.
To begin the session, the moderator briefly motivates the exercise by placing contractual issues in an agricultural context. For example, the moderator might emphasize changes in the food industry that have encouraged the use of contracts. The different types of contracts commonly used in agriculture also can be reviewed.
The moderator divides participants into teams so that a Grain Producer's Team matches every Grain Buyer's Team. Each team will spend thirty minutes reading the contract case, examining the generic contract, and analyzing the stipulations. Once the contract is analyzed, participants decide which provisions might be changed, and whether or not the contract should be signed. The moderator asks management teams to negotiate contract provisions for thirty to forty minutes.
Once negotiations are completed, the moderator debriefs the participants emphasizing key points and facilitating discussion. A moderator might first review the dynamics of the negotiation session and then focus attention on the contract's provisions.
Acknowledgments
The author gratefully acknowledges the helpful comments of Andy Seidl, Cole Ehmke, Mike Boehlje, Allan Gray, Ken Foster and Craig Dobbins, as well as the insights of two anonymous reviewers and RAE Case Study Editor, Scott Swinton. The case was initially developed for the Executive Institute for Commercial Producers, which was sponsored by the Farm Credit Services of Mid-America and the Center for Food and Agricultural Business at Purdue University.
