The U.S. potato market is frequently treated as one whole. Instead of distinguishing between the fresh and processing sectors, researchers oftentimes lump the economics of the two markets together. This practice contributes to a lack of clarity regarding how the market for fresh potatoes interacts or influences the market for processing potatoes, and vice versa.
Research recently carried out by the Department of Agricultural Economics at Texas A&M University sought to shed light on the relationship between these two markets by using advanced statistical methods to evaluate how price and volatility in the two markets are connected. Specifically, the research aimed to test whether a leader-follower-type relationship exists between processing and fresh market prices.
A leader-follower relationship can be explained using a simple analogy. Imagine a man following a dog on a leash. As the dog moves forward, the leash prompts the man to follow close behind. While the man’s movements may not track exactly with the dog’s, they more or less follow the same path. The dog charts its own course independent of the man, while the man chooses his path based on the dog’s. The same can be said for many agricultural markets that are related yet different. In the case of potatoes, we want to better understand which market is the man and which is the dog, and whether this relationship is consistent.
The results of the study are both interesting and useful from a marketing perspective for the potato producer. Over the short run (weeks and months), we found that the processing market clearly leads the fresh market. The graphs below illustrate how a simulated shock in one market affects the other over time. A “shock” in this sense is any event that might affect prices, positively or negatively, and could include things such as an unfavorable health report regarding fried potato products, increased potato shipments from key terminals, etc. We see that a shock or disruption to price in the fresh market does little to change prices in the processing market. However, a shock to processing prices has a persistent and meaningful effect on prices in the fresh market.
What is driving the relationship, and how can producers use this information to more effectively market their crop?
There are two fundamental differences between the fresh and processing markets for potatoes. The first is the manner in which potatoes are bought and sold. Fresh potatoes are generally bought and sold on a spot or cash basis; in other words, the majority of the crop is uncommitted until the day it’s sold. Whatever the market is paying at the time of sale is what the farmer receives. In contrast, processing potatoes are grown primarily under contract. The potatoes are committed to a specific buyer at a specific price prior to harvest. The second difference is the actual structure of the marketplace. The fresh market encompasses hundreds of independent packing sheds, whereas the processing market has only a handful of very large, dominant firms that handle the bulk of the processing crop. The driving forces behind the leader-follower relationship lie in these key differences.
Imagine a scenario in which a major processor discovers late in the storage season that its previously contracted supply will not be adequate. At that point, the processor must seek out uncontracted potatoes, which will be found predominantly in the cash market for fresh potatoes. In this way, the fresh market acts as the safety release valve for the processing market, and prices will rise accordingly. The opposite is not possible because if a packing shed in the fresh market discovers a need for more potatoes, 1) it is likely the quantity needed to make up the shortfall is small relative to size of the market as a whole (remember, hundreds of independent packing sheds versus a handful of large processors), and 2) they cannot make potato purchases on the processing market because those potatoes are ostensibly under contract by the processors. In this way, any shock in the processing market has an outweighed effect on prices in the fresh market over the short term.
Over longer periods of time, the relationship actually reverses. Processing potatoes are typically only committed under contract one year at a time, meaning processing acreage may be substituted for fresh acreage. Changes in fresh price over the short term signal to the processors and producers that their contract prices must be adjusted in the next contracting period for processing potatoes, and a semblance of equilibrium is achieved. Thus, fresh price becomes the leader and processing prices the follower over the long run.
The implications of these findings are varied; however, all pertain to the way in which producers monitor and interpret prices in order to make production and marketing decisions. Fresh potato producers over the short run should not only remain attentive to the condition of the fresh crop, but also pay close attention to the processing crop in the field or storage. Any disruption—positive or negative—to the processing market will have an effect on the fresh market during the current crop year. Conversely, processing producers should be aware of pricing in the fresh market for the previous crop year, as those prices will in large part determine contract prices with processors in the current year.
By being well-informed and understanding these relationships, the producer stands to gain by making improved production decisions and minimizing some of the ambiguity that often accompanies negotiating processing contracts and fresh price.