What the failed harvest means for you

The 2012 U.S. corn crop is forecast to total 10.8 billion bushels, a decline of 13 percent from a year ago. While planted area is pegged at a record 96.4 million acres, yields are forecast to decline to 123.4 bushels per acre, a decline of more than 20 percent from trend levels. The decline reflects the most adverse weather in more than 20 years to face corn growers.

Corn is the largest crop produced in the United States, equal to more than 50 percent of total crop production, by volume, in a normal year. As a result, corn prices are an extremely important driver of food costs for the U.S. restaurant industry. A few products, such as fructose and starch, are directly impacted by corn prices. And other grain prices (wheat, rice and oats) are impacted by an increase in corn prices. But the most important impact for restaurants is the eventual effect upon the price of proteins—beef, pork and poultry—and dairy products because of corn’s major role as a component of feed.

Because corn prices have risen so dramatically (up 60 percent since mid-June), the U.S. restaurant industry will begin facing higher costs for a broad range of products by late 2012 and through 2013. Consumer food prices were expected to rise by roughly 2.5 percent during 2013. Because of the drought’s impact on corn supplies, the 2013 rate of consumer food inflation is now expected to be 4 to 5 percent.

Historically, when feed costs (i.e., the price of corn) increase, livestock producer margins are reduced or become negative. Currently, the estimated margin for each of the protein groups, as well as the dairy sector, is negative. Ultimately this means production cutbacks and higher prices for beef, pork, chicken and dairy products.

It is all a good reminder of the value of employing solid and consistent principles in the management of commodity risk. Managing food costs requires a restaurant to first identify its risk-management goals and then develop buying strategies to meet those goals. While the ability to avoid higher costs due to the 2012 drought may be limited, restaurants should use this as an opportunity to rethink their risk-management goals and strategies.

There is a range of tools for restaurants to manage the impact of increases in the price of corn and other commodities. Taking positions in futures markets, often through your supplier, can help. Establishing “cost-plus” relationships for the procurement of chicken allows restaurants to better manage chicken costs by locking in feed (corn and soymeal) costs.

The commodity buyer’s toolbox

Tool: Cost plus
The buyer pays an agreed-upon price plus other non-feed costs like processing.

Pro: Good for cash flow

Con: Weak protection against market volatility

Tool: Cash forward
Locks in a price plus freight with a manufacturer

Pro: Good for cash flow, stronger protection against market volatility

Con: Hard to get long-term deals, some vulnerability to market fluctuations

Tool: Futures markets
Establishes contracts, usually through a supplier, for long-term purchase price

Pro: Strong protection against market volatility, long term

Con: Can be hard on cash flow and involves greater accounting costs if done by yourself

It’s worth noting that other items, most notably beef, are more difficult to manage from a commodity risk-management perspective. For example, beef trimming prices do not have a futures market, and trimming prices correlate well with live cattle futures. As a result, restaurants are currently largely at the mercy of the market with regard to beef costs.

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