IDENTITY PRESERVATION IN THE ORGANIC WHEAT SUPPLY CHAIN

Shon Martin Ferguson

Dept. of Agricultural Economics

University of Saskatchewan

Saskatoon, Saskatchewan

S7N 5A8

Canada

Tel: (306) 966-4043

Fax: (306) 966-8413

E-mail:

July 1, 2003
Table of Contents

Introduction......

Purpose of the Paper......

The Organic Wheat Supply Chain......

Background......

Organic Wheat Transaction Types......

Identity Preservation......

Testing......

IP at the Producer Level......

IP at Intermediary and End-User Levels......

The Degree of IP and Production Costs......

Characteristics of Transactions in the Organic Wheat Supply Chain......

Transaction Costs in the Organic Wheat Supply Chain......

Producer/Buyer Transaction Costs......

Analysis of Producer/Buyer Transaction Costs......

Intermediary/Buyer Transaction Costs......

Analysis of Intermediary/Buyer Transaction Costs......

Summary of Transaction Cost Analysis......

Success Factors for Organic Wheat IP......

Existence of Success Factors in Non-GM Wheat and Other Grains......

Conclusion......

References......

1

Introduction

Identity preservation (IP) of grains in Western Canada is becoming an increasingly important issue for the industry. Changing consumer preferences, technological advances, international trade and increased regulation of food quality have created a need for IP systems (Hobbs et. al. 2001). The call for increased IP has been recently amplified by the potential for genetically modified (GM) wheat varieties to enter the supply chain. There are considerable worries that consumers may discount the value of GM wheat, resulting in substantial value losses to the wheat supply chain.

Many new grain products exhibit credence[1] attributes, involving production traits that entail public interest or output traits that have value only if its identity is preserved (Hobbs et. al. 2001). The value derived from such a credible quality signal can allow for the supply chain to enter new markets, or maintain current markets when a new quality trait enters the product, such as the GM wheat case.

Identity preservation of grain is one technique that can give consumers a credible quality signal for grain products. The most prominent example of IP in the grain industry is in organic grains. IP is a central marketing concept of organic grains, and has been practiced since the birth of the industry. There may be lessons that can be learned by the broader grain industry about IP potential for non-GM wheat and other grains by examining its functioning in the organic industry.

Purpose of the Paper

The purpose of this paper is to examine the IP system used in the organic wheat supply chain. The main objective of the paper is to describe how IP functions in the organic wheat supply chain. This main objective will be met by first describing and analyzing the supply chain members and relationships that exist in the industry. A Transaction Cost Economics (TCE) approach will be used to analyze these relationships. IP systems as they pertain to the organic wheat supply chain will also be explained. Given the relevant transaction costs and the IP system, the effect of IP on transaction cost efficiency in organic wheat will then be analyzed. The product of this analysis will be a set of success factors that allow the IP system to function in the organic wheat supply chain. The presence or potential for such success factors to exist in any non-organic grain supply chain will be evaluated to conclude the paper.

The Organic Wheat Supply Chain

Background

The organic wheat industry in western Canada is small compared to the non-organic wheat industry, but it is a fast growing segment of the wheat industry. Organic wheat acreage increased by 126 percent from 1998 to 2001 (AAFC 2002). There were 7899 acres of registered organic wheat in Canada in 2001, making it the second largest crop in terms of area. There were approximately 1200 organic and transitional producers in Alberta, Saskatchewan, and Manitoba in 2001. The number of producers and acres of wheat grown have grown since 2001.

There are several members of the organic wheat supply chain, consisting of primary producers, grain companies, brokers, export buyers, and processors (AAFC 2002). There are further upstream and downstream components of the supply chain beyond these five members, such as upstream seed providers, and downstream distributors and retailers of the processed wheat. This analysis will limit itself to these five members of the organic wheat supply chain and will examine the IP system as it pertains to wheat prior to processing.

There are several supply chain combinations between the five members. In the case of domestic or foreign organic wheat sales, the supply chain begins with primary producers selling to grain companies, brokers, export buyers, and/or foreign distributors, who sell to end-users (processors), or it can consist of primary producers selling directly to end-users. Producers can also sell to foreign end-users through a grain broker. To generalize, wheat transactions are therefore performed directly from producer to end-user, or through an intermediary. Horizontal transactions can also take place between intermediaries.

Given these possible supply chains, there are five main options for organic farmers to market their wheat. The first option is to sell to a Canadian processor, such as a mill. The second option is to sell through a broker or to an export buyer, which is common in the export case. The third option is to make a sale directly to an end-user. The fourth option is to sell to a grain company. The fifth option is to sell to an organic livestock producer.

The Canadian Wheat Board (CWB) is legislated to market all wheat and barley that is destined for export or domestic human consumption in the prairie region of Canada. The presence of the CWB creates a unique situation for organic wheat producers, since the CWB does not market on behalf of organic wheat farmers, but permits agents to market organic wheat with their permission. Within all the first four aforementioned options, some grain companies and Canadian processors act as agents of the CWB. In this case, the farmer makes the transaction with the CWB, and negotiates for an organic premium over and above the CWB price. Some Canadian grain companies and processors, as well as all foreign companies and brokers/export buyers are not agents of the CWB. In these cases, wheat must be sold at the pooled wheat price and bought back at the cash price from the CWB in order to maintain the integrity of price pooling, then the primary producer can sell his or her wheat directly to the buyer. In the fifth option, producers can sell organic wheat for livestock feed without interacting at all with the CWB. When wheat is sold through a CWB agent and a pooled price is received, the producer must still negotiate for the organic premium with the buyer. This contrasts to a non-organic sale of wheat through the CWB, where the total price is negotiated collectively.

Price discovery for organic wheat is very different than price discovery in non-organic wheat. For non-organic wheat, the CWB collects extensive surveillance of the supply and demand situation in all parts of the world. The CWB disseminates and distributes this information for their use as well as for producers’ use. There are also future’s markets for wheat in Canada and the U.S, providing price discovery information.

There is much less market information available to the organic wheat industry compared to the non-organic wheat industry, as there does not exist any institution that gathers and distributes wheat price information, nor is there a futures exchange for organic wheat. This results in significantly less information flows in the organic wheat case, especially for farmers. Despite these institutional limitations to price discovery, producers, intermediaries, and end-users communicate prices regularly through person-to-person communication.

Organic Wheat Transaction Types

The transactional relationship between the producer and buyer for organic wheat is either a spot market or a production contract. The “buyer” in this case can be one of the five options discussed earlier, and include either intermediary grain buyers and grain end-users. In the spot market case, producers grow their wheat and then communicate their available quantities and qualities to potential buyers. Producers and buyers must communicate individually with each other through telephone or internet. A producer may be in a situation where buyers tender bids to the producers if demand exceeds supply, but the producer may become a price taker at the mercy of buyers if supply exceeds demand.

Under the spot market or production contract scenario, contracts are written that specify the given quantity and quality to be transacted. These contracts specify the date on which the wheat is delivered, how many days in after the transaction in which the buyer must pay the producer, and which party is responsible for any transportation costs incurred. The buyer is given a sample of the wheat before the contract is signed, and the buyer usually specifies in the contract that he/she has the right to reject the wheat if the quality of the wheat is lower than that of the sample. These quality attributes can include physical appearance characteristics similar to those evaluated in non-organic wheat (appearance, protein content, dockage, etc.), as well as the organic nature of the wheat.

Production contracts between the producer and buyer are agreed to before the producer has planted his or her wheat crop. The contract specifies the same things as a purchase contract on the spot market, but may be more vague regarding the date upon which the wheat is transported to the buyer. A production contract can also include specifications on the type of seed used by the producer. Many production contracts allow for the buyer to monitor the wheat as it grows and as it is stored.

The incidence of monitoring by the buyer and more stringent production specifications implies that production contract transactional relationships entail a higher degree of vertical coordination between the parties than spot market transactions. This is not to say that vertical coordination is absent in the case of spot market transactions for organic wheat. Coordination exists in the organic wheat supply chain relationship between producers and buyers in the form of logistical coordination through IP protocols.

Spot market contracts are used exclusively by intermediaries and their buyers in organic wheat transactions. “Buyers” in this case refers to other intermediaries or end-users. These contracts specify the time, place, quantity, and quality aspects of the transaction. Some contracts are arranged after harvest, but some are arranged prior to seeding. The intermediary’s decision on when to contract with buyers depends on their perception of the risk of not being able to fulfil a contract. It is perceived as less risky to contract before harvest with organic wheat, as it is a very large crop with plenty of supply. Intermediaries must contract simultaneously upstream with producers and downstream with their buyers in order to minimize their risks. Quality inadequacy is the greatest uncertainty for intermediaries, because upstream producers may not deliver enough of the necessary quality required by the downstream contract (Neufeld 2003).

Identity Preservation

An IP system as defined by Dobson (2002) as a “closed loop” marketing channel that allows traceability of the commodity, beginning with the propagation of the parent seed through to the processed product on the retail shelf. IP systems use a series of protocols that require specific sampling and documenting procedures. The IP system is a tightly coordinated supply chain that documents the transfer of ownership and the quality attributes of the commodity as it is exchanged from seller to buyer. IP provides information to the consumer on the origin of a product and how the product was produced and handled.

In the organic wheat supply chain, IP gives consumers the necessary quality signal credibility that the wheat contains organic credence attributes. IP in organic wheat does not add credibility to other important quality characteristics, such as physical appearance, baking quality, and others attributes that determine wheat quality. Weather is the greatest cause of wheat quality variability (Wilson and Dahl 1999), and an IP system cannot negate this factor.

Testing

IP works best with the combination of solid record-keeping and testing results (Sparks Companies Inc. 2001). While strict documenting procedures are integral to the functioning of an IP system, an IP system is most effective with the ability to test whether or not a high degree of purity has been maintained. In the organic wheat supply chain, testing can check for “leaks” of non-organic wheat into the supply chain.

Organic wheat is a credence good, meaning that the quality attributes of organic wheat are impossible to discern, even after consuming it. There is not a convincing body of scientific evidence that purports that organic wheat is better for consumers than non-organic wheat. Despite this lack of evidence, many consumers believe that organic wheat is superior to non-organic wheat in its composition and production, and gain utility from its consumption in holding that belief. The main credence attribute that is “contained” in the wheat is the absence of pesticide residue in the wheat. Very small amounts of pesticide residue are allowed in non-organic wheat. Other credence attributes relate to the use of “sustainable” production practices, such as an absence of inorganic fertilizer.

It is impossible to scientifically test for all of the credence good qualities of organic wheat. Pesticide residues can be tested for, but this does not entirely rule out the chance that pesticides were applied to the wheat, since the residues of some pesticides may break down quickly enough to disappear before it is tested. Testing for pesticide residues is performed by some buyers of organic wheat (Pletz 2003), but it is prohibitively expensive. Thus, testing for organic purity cannot be an integral part of the IP system for organic wheat.

Given the credence nature of organic wheat and the inability to adequately scientifically test for organic quality attributes, an information asymmetry problem results (McCluskey 2000). Information on the quality of organic wheat is asymmetric because only food producers know if their products contain organic quality attributes. The IP system must rely entirely on documentation protocols in order to maintain purity along the supply chain.

Given the inability to adequately test for the attributes of organic wheat, many protocols are in required in the supply chain. Producers must be certified by an accredited organic certification agency in order to sell their wheat as an organically produced product. Intermediaries and end-users must also be certified by a quality assurance agency.

Producer certification agencies require the farmers to do many things that both ensure that their wheat is grown in an organic manner, and that its identity is preserved on the farm. The most significant and restrictive protocol required by producers is that their farm is entirely organic. “Parallel production” (producing both organic and non-organic outputs) is not allowed. This restriction aids to ensure that organic wheat cannot be mixed with non-organic wheat. Producers are also required to maintain strict documentation on their production techniques and on the location of their wheat once it is harvested. Buyers require that organic producers follow these procedures and require the documentation as evidence that the wheat is in fact organic.

IP at the Producer Level

IP at the farm level can take several forms, depending on the degree to which IP is requested by the buyer. The level of IP that is required by the certification agency is to identify the field or fields upon which the product was grown. Certification agencies do not require that wheat from different fields be kept separate, but buyers can request for this to be performed. This “field to plate” IP is the highest degree of IP that can be performed at the farm level.

IP at Intermediary and End-User Levels

IP must be stringently maintained beyond the farm gate in order for the final organic wheat product to be labeled as “organic” at the retail counter. Organic wheat IP continues as the wheat is transported from the farm. Affidavits must be signed and witnessed each time that the wheat changes hands. Information on the wheat’s “history” is passed along on a paper trail until a label is stamped on the final product. Transportation and handling containers must be thoroughly cleaned before use.

In the case of wheat purchased by grain companies or export buyers, wheat is transported to facilities where further cleaning and redirection can occur. IP is important in these facilities as well, but IP is practiced to varying degrees. The most important element preserved at these facilities is the organic attribute of the wheat. Elevators are often dedicated solely to organic grain in order to achieve this level of segregation. Individual producers’ deliveries can be segregated at these facilities, which allows for the highest level of IP to occur, but several producers’ organic wheat is often combined into one storage bin. There are also opportunities for blending wheat of different physical qualities in an effort to provide downstream buyers with a more homogenous quality.