Contracting Your Way To Sourcing Success
By George C. Kalogridis
Companies entering the organic food market assume that sourcing organic ingredients will be the same as buying conventional. However, the organic marketplace is unique. First off, at only 3 percent of the total food market, it’s a much smaller pond to fish from. Secondly, it’s growing at a 20 percent-plus annualized rate according to the 2007 Organic Trade Association’s (OTA) Manufacturer Survey. A small market, plus rapid growth means that in order to get what you want you have to play the game differently. Even long-time buyers of organic have found the need to adjust their buying programs to meet this ever-changing landscape.
If you look at sourcing from a conventional viewpoint or in regards to spot buying, it appears there is a perpetual shortage of organic ingredients, and research appears to confirm that perception. The Organic Trade Association’s (OTA) 2007 Manufacturer Survey reported that 55 percent of respondents stated that the lack of dependable supplies restricted their companies from generating more sales of organic product.
However, USDA’s Economic Research Service (ERS) recently released its first organic research database that reveals one of the biggest differences between sourcing organic versus conventional ingredients. The data provided by ERS found that 70 percent of organic ingredients are under forward contracts, leaving only 30 percent of organic ingredients available to companies that choose to buy on the spot market. Using anecdotal evidence, OTA’s Ingredients Forum suggests an even higher percentage of contracting, with an estimated 80 percent under contract prior to harvest.
This makes organic a thin market compared to conventional, where the majority of ingredient sourcing is not locked in with forward contracts. Attempting to source organic ingredients in a thin market, without forward contracts, will make it appear there is an ongoing shortage. However, with proper planning and strong buyer-supplier relationships, supply can be plentiful.
Plan for Success. Over the years, several large corporations have tried to change the organic market to fit into their ingredient sourcing and production programs to no avail. But seasoned organic processors know that they need to start contract negotiations shortly after harvest or oftentimes even before planting season begins. As many suppliers will tell you, if you let them know to plant the seed, they can meet the need. In some instances when companies need to take as much risk as possible out of ingredient sourcing, they lock up supplies as much as five years ahead of time with the farmer. This practice is commonly found in areas where a long term transition is necessary for new ingredients, such as orchard fruits and nuts as well as dairy conversions.
Forecasting is a very important part of the planning and contracting process as well. It’s often recommended to contract for 10 to 15 percent more than you think you’ll need. In most cases, it’s much easier to sell extra organic ingredients than to try to find the ingredients you are short on in the spot market. In fact, most ingredient brokers would be happy to help you find a buyer.
Get Down to the Details. Contracting can be as simple as a handshake. According to the ERS data, 27 percent of all organic deals are done this good old fashioned way. However, the organic market is trending towards the very detailed vendor assurance programs used by many of the world’s top food companies. These programs not only require the basic information on the ingredient being sourced, but very extensive details on how the product has been handled, with emphasis on quality assurance issues. Processors want to make sure that suppliers have the same level of quality control standards as their plants, since they do not want ingredients coming into their company that could possibly contaminate their facility. Some quality assurance issues to look at adding in your contract could include production, post-harvest or processing steps that decrease chances of micro contamination or cross contamination from conventional ingredients or allergens. This type of contract is often referred to as the “audit book,” since so much data is required prior to the final ingredient purchase. These programs are designed for the conventional market, but in most cases are applicable to the organic market. Your contract can be as detailed or as simple as you want. However, since the total pool of organic ingredients is much smaller, going by the book will not always be possible and you may have to make certain accommodations. Companies that want to make organic replicas of their existing conventional product line sometimes find that sourcing organic ingredients that are functionally the same as conventional can be daunting. Minimally processed organic ingredients are not always as standardized as conventional versions, which can use synthetic processing aids to ensure certain functional aspects.
As with conventional, the search for organic ingredients is worldwide. The ERS survey tells us that 35 percent of manufacturers’ ingredients come from international suppliers. Once again, when working with suppliers from different areas of the world it’s challenging to have a completely standardized ingredient. In the northern and southern hemispheres, varieties are different and there are often subtle differences in the ingredients from region to region, so again, you must adapt. To make the differences less noticeable and therefore more standardized, some manufacturers take all varieties of a specific ingredient, which have been sourced from different areas of the world, and combine them into one “melting pot” ingredient.
In addition to contracting for organic ingredients that meet a processor’s product specifications, the contract should also ensure that the ingredient is certified to meet the USDA’s National Organic Program (NOP) so that it can be imported into the United States and used in USDA certified organic products.
Another potential issue for U.S. processors to be aware of is that the depreciation of the dollar has made U.S. organic ingredients attractive to buyers in the European market. This fact has not been overlooked by U.S. farmers and they are working with their U.S. certifiers to add EU certifications. If just 5 percent of U.S. organic ingredients are lost to overseas markets, U.S. manufacturers will be looking at higher prices and shorter supplies in the 2008-2009 market. Quite literally, the U.S. will end up increasing the importation of organic ingredients to meet higher domestic needs, just as U.S. exports of organic ingredients increase. Thus if you rely on domestic ingredients as part of your company’s mission, it’s better to tie things up with U.S. producers now rather than later.
The ERS data shows that price determines 85 percent of all ingredient decisions. However, the need to secure a quality supply of organic ingredients does temper price considerations. Existing organic companies have had to walk a fine line between the search for lower prices and the need to keep organic farming economically viable. Driving prices so low that farmers cannot make a good return on their organic crops is a zero sum game. Push too hard and the farmer will sell to another company; pay higher prices and it’s hard to compete with companies that have relied on cheap imports to meet costing price points. Like the conventional market, organics has been enticed to find ingredients in China. However, due to the recent problems with imported conventional ingredients, organic suppliers are also being told “No ingredients from China.” Along with the continued increase in the value of the Yuan, China is no longer the bargain basement to the world.
That does not mean that the search for organic ingredients around the world has slowed. The new sleeping giant for organic may be India, where large regions of farming land have been designated as organic zones where conventional farming is prohibited. It makes economic sense for developing countries to reduce or eliminate the importation of conventional farming chemicals and instead use renewable resources to grow organic crops that can be sold at higher margins.
Once the contract is signed, it’s important to stay in contact with your supplier. Both domestically and internationally, farmers are by nature optimists; no matter how bad things look, they always hope that the harvest will be good. As a buyer you need to be a realist, and know the difference between a farmer’s hopes and real crop conditions. Visiting the fields several times during the growing cycle will limit any surprises at harvest time. But what if your company is not set up to do domestic farm visits? And how are you able to verify crop conditions overseas? Domestically, you can ask for a shipping point inspection from the federal market or state inspectors. For a small fee, the inspectors will travel to the farm or central location and test the crop to see if it meets USDA specifications. If a company views these inspections as an insurance policy to assure quality deliveries, then the cost is negligible.
For overseas purchases, there are many independent inspection labs that operate around the world. Companies can hire these inspectors to test the ingredient being purchased to make sure the ingredient meets quality standards. These labs can also perform microbial and pesticide testing on the ingredient prior to having it loaded into the container. While these overseas inspectors cost more than domestic, flagging a problem prior to shipping is worth every dollar.
Pricing and Payment
While published, centralized pricing is available to conventional buyers for any ingredient anywhere in the world, this pricing data is not available at this time for organics. Again this is due to the current size of the organic market. There are some services such as The New Farm Organic Price Report, which report organic farm gate sales, however, these prices are mostly for spot market buys. Developing a fair price for organic ingredients takes time on the phone talking with farmers and organic sourcing companies to get a “feel” for the market of each ingredient. First, try to get an idea of the supplier’s base cost of production, and then offer a fair price above that.
Providing a farmer with “seed money,” or another form of down payment, could also affect pricing. If you are willing to offer a down payment to help cover the preliminary production cost, or even go as far to help finance the farm’s transition to organic, you most likely will be able to secure a better contract price and create a long-term relationship. While there is no magic formula for figuring out the best pricing, there is one thing that every deal has in common—each one relies on building a relationship. One great way to do this is to get to know potential suppliers at trade shows. While the Natural Products Expos and the All Things Organic show are great places to meet suppliers of all kinds, if you are looking to meet farmers, you should try to make it to one of the big farming events such as Eco-Farm, Northern Plains or Acres USA.
In most conventional contracts, there are no “acts of God” clauses; the farmer or supplier must deliver what was pledged. In the organic market, acts of God clauses are very common due to the limited supply of ingredients. There is no “board of trade” where you can offset your risk with a futures contract. Some companies do buy organic commodity crops based on a fixed percentage above the “board,” but there is no equivalency between the conventional market and organic, so there is still some risk.
When sourcing organic, companies should spread their risk with purchases in different geographical locations within North America as well as overseas. With chances of crop failure, late delivery and many other things that can go wrong, sole sourcing is not a good practice. Even contracting 75 percent or more with one source may be too optimistic, unless your vendor has access to multiple sources of the same organic ingredient.
Another part of reducing risk is ensuring that your legal documents are legally binding. Know the laws in the countries that you are buying from but try to keep the contract based on U.S. law. If you have legal firms on retainer overseas then you’re covered but for most companies following the advice to have a third party inspect the product prior to shipment can eliminate the need for lawyers.
Finding Producers to Partner With
Before you start drawing up contracts, you must first find the producers that are growing what you need or are willing to do so. Many buyers start with a Google search. The Organic Trade Association’s website also links buyers to thousands of organic ingredients. Go to www.OTA.com, then follow the link to “Organic Ingredients.” You can also use the “Organic Ingredients Needed” link to publicly post the item you need. This site receives thousands of hits every day from domestic and international organic companies and farmers. New sources are added weekly, so the site is very dynamic. Should you require further assistance, the OTA site also features up-to-date information on government regulations and links to companies and consultants that specialize in organic.
Conclusion: Supporting Organic Growth through Contracting
Organic is a dynamic industry that is not going to be slowing any time soon. In fact, current projections show organics growing from 3 percent of the total U.S. food market to 10 percent within the next several years. There are many that see this growth and want to jump in, but before doing so, you must learn to look at sourcing differently.
Even though it may seem complicated, sourcing in the organic world comes down to two main things: planning and commitment—the key components of contracting. By contracting, you are not only ensuring that you have needed ingredients, you are also investing in the future of organic by encouraging growers and suppliers to take the leap needed to make more organic ingredients available.
George Kalogridis is a partner with the organic ingredient sourcing company Organic Partners International LLC (www.organic-partners.com). He has served as a board member of the Organic Trade Association and is past chair of the Manufacturing, Processing, Packaging and Labeling Committee, the GMO task force and is the current facilitator of the OTA Ingredients Forum. George currently serves on the board of the Biodynamic/Demeter Trade Association and is a member of the Non-GMO Project’s Technical Advisory Board. You can reach him at GeorgeK@Organic-Partners.com.