Effects of Competition and Space on Country Elevator Grading Practices and Prices for Wheat

A simulation analysis identifies optimal wheat grading and pricing strategies for country elevators under three possible competitive structures.The three competitive structures are: I) an elevator is a perfect monopsony, with no competition in its potential trade area~2) an elevator has competitors that do not follow its lead in formulating a grading and pricing strategy~and 3) an elevator has competitors that copy its grading/pricing strategy.For each structure, an elevator and its competitors consider three possible grading and pricing strategies: 1) an elevator grades and segregates the wheat delivered, and also pays producers prices that differ according to the quality of wheat they deliver~2) an elevator grades the wheat received and segregates it to receive prices from next-in-line (Nll.)buyers that are adjusted for quality, but pays producers one price for all qualities ofwheat~and 3) an elevator does not grade the wheat received, nor does it segregate the wheat into different qualities or pay different prices to producers for different qualities.A sensitivity analysis identifies the optimal strategies over a range of reasonably likely operating environments, consistent with the range of conditions observed during the 1995, 1996, and 1997 harvests.The results show that country elevators facing no competition or competitors who did not copy should have graded and segregated, and paid producers different prices for different qualities on the basis oftest weight and dockage for the 1995, 1996, and 1997 wheat harvests.The price differentials were large enough for elevators to profit by passing on to producers 70 % of the differential received from Nll.. buyers.However, the price differentials were not large enough for shrunken and broken kernels (SBK).Therefore, country elevators would not have profited by grading and segregating, and paying producers different quality prices on the basis of SBK.There were low percentages of SBK for the 1995, 1996, and 1997 harvests.However, for elevators with competitors that copy their grading/pricing strategies, grading and paying producers different prices for different qualities would neither increase nor decrease profits compared to not grading.However, if the elevators chose to grade., and pay quality-related prices, they would pass on most or all of the price differential received from Nll.. buyers.This could potentially raise the quality oru.s.wheat.The results from the simulation and sensitivity analysis showed that a country elevator can profit from paying producers quality-related prices if price differentials received from Nll.. buyers are greater than two cents per bushel.Since Nil.. buyers have begun to charge .largerdiscounts for specific quality characteristics, the price differentials are usually greater than two cents for the most important quality characteristics.Therefore, early adopters can be expected to pass on 70010 of price differentials.The results show that the higher the price differential from NIL buyers, the higher the profits can be made by an elevator that grades correctly and passes on the price differential to for high quality wheat.As other country elevators adopt the practice.producers would have increased incentives to improve the quality ofwheat.If country elevators don't begin grading and paying prices based on quality, it could be hannful for the U.S. wheat industry.This is because countries with the reputation of high quality wheat such as Canada and Australia will continue to increase their share of world wheat exports while U.S. market share continues to decrease.As Johnson and King note, most of the grain in traditional market channels passes through country elevators.so prices set by country elevators for wheat of various qualities provide important signals from world markets to producers.Also.as consumers increasingly demand differentiated products, a market pricing system that does not adequately reward quality may lead to increased alliances and vertical integration.These may introduce inefficiencies of their own.Therefore.this author recommends to the USDA and Federal Grain Inspection Service that it consider ways to encourage elevators to grade correctly and pass on to producers quality-related price differentials received from Nllbuyers.Such action should increase overall quality of U.S. wheat.and might remove part of the incentive for increased contracting and vertical integration in the industry.In the long run, profits would not be increased by elevators for doing this, nor would they be reduced.If this is done, it would adequately transmit correct price signals to producers and this would give them incentives to improve the quality.

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