Agricultural Commodity Trading - Quite a Different Business

The Business of Agriculture Commodity Trading

Recently, I had the opportunity to take a detailed look at the agriculture commodity trading and risk management industry after being involved in a project. In this article I will share some considerations on agricultural products trading specialties and software that supports it.

While I have experience dealing with the securities market—which is sometimes classified as the commodities trading market—my impression of agricultural commodities trading is different from any other commodity trading business. I believe that it deserves to be classified as a stand-alone cluster within the trading and risk management business. There are some particular qualities that make it distinctive from similar business models that trade other commodities, and it can be very different from other encountered types of businesses such as: manufacturing, retail, etc.

Generally, commodities are products that are
•    produced at high volumes,
•    unspecialized and generic,
•    homogeneous, and
•    in standardized units of measure.

Metals, electric power, grains, or oil are a very good example of commodities that are either traded on commodity exchanges or via direct trading between companies. Agriculture products such as wheat, barley, maize, dry peas, soybeans, rice, and lentils (along with others) are typically traded within the agricultural commodities trading business—but this list varies largely depending on the country and market segment.

Here are some specific attributes of agricultural commodities:
a.    Different lots of the same product might have multiple quality characteristics, such as content of foreign matters, chemical composition, hardness, etc. Theoretically, the same commodity may be a variety of very similar but still separate products.

b.    The coexistence of multiple units of measurements and multiple variations in defining the same unit of measure (depending on the region or on the product) creates numerous problems for businesses. For instance, there are multiple definitions of a bushel: the weight of a bushel of corn would not be equal to a bushel of barley, or soybean because of their differing densities. Furthermore, a bushel of wheat may not match a bushel of wheat from another territory because different areas have different definitions of the term “bushel”.

c.    There is a considerable involvement of highly detailed logistics, transportation, and goods delivery activities. This is usually not a big issue when trading other types of products or commodities, for instance, metals or securities. However, in the agricultural commodities business managing this matter is really essential for a successful operation, and as a consequence, it diverts significant human and organizational efforts. These tasks may include all types of ground transportation planning, coordination, and tracking (trucks, railways), as well as a whole assortment of specific issues related to water transportation—from barge management and vessels forming (upcoming vessel loading planning, loading and other vessels transfers coordination, and related documentation issuing) to voyage and time charter control activities. The nature of agricultural commodities also complicates transportation tasks as products are often transported in bulk, and each loading or unloading shrinks the total volume.

d.    Commodities may be transformed from one product into another product during the transportation process. For example, the impact of undesired (and unpredictable) weather conditions during the shipment of wheat or rice can eventually result in the product being downgraded to a lower quality level or even to animal feed.

These factors, among others (unexpected events that can affect crops, sudden changes in prices due to political or economical events), bring an additional level of risk and complexity to the initially straightforward idea of trading generic and standardized products. There are many aspects to be considered and many risks to be analyzed and mitigated, in addition to usual business risks that are typical of entrepreneurial activities.

Commodity Trading Software

Energy/commodities trading, transaction, and risk management (ETRM/CTRM) software offers specific solutions for energy and commodity trading companies. Properly identified, selected, and implemented, trade and risk management (TRM) software is able to dramatically improve all sides of trading companies. Using TRM software, a business can reduce related risks by processing more accurate predictions and plans, make business more profitable, and reduce time and cost of front-, mid-, and back-office activities.

Generally, ETRM/CTRM software is an integrated package that fully or partially covers the majority of a trading company’s business requirements, including
•    communications and data integration;

•    transaction and deal capturing (front office);

•    risk management, reporting, and position exposure (middle office); and

•    settlement management (back office).

Many ETRM/CTRM vendors also offer extended out-of-the-box functionality that goes beyond trading activities and provides clients with additional features that help manage areas such as accounting, human resources (HR), and workflow management. Software packages that comprise front-, middle-, and back-office functionality along with managing accounting, HR, and workflows make it possible for a trading company to successfully manage most business aspects. The applications are often sold as a complete business suite and do not require an additional third-party software to administer the core business functions.

Another extended portion of ETRM/CTRM can be the functionality that supports the delivery of goods sold. For the commodity trading business, it is normal to conduct negotiations around the seller’s responsibility (e.g., carrying products to a certain location, or directly to the buyer’s site). In many cases, traders use third-party logistics and transportation services in order to avoid potential problems related to the delivery of products. However, not all companies are willing to undertake this type of outsourcing due to risk or other reasons. For companies who are willing to manage their own logistics, the only acceptable way is to handle the whole supply chain on their own and support the software’s functionality. Supply chain modules usually include logistics planning and scheduling, inventory management and visibility control, warehouse management, and transportation management, as well as specific for analysis and optimization of the supply chain as a whole.

Two Strategies in Commodity Trading Software Selection

Many commodity trading companies are affiliated with larger multi-business enterprises controlling diversified operations—from banking to manufacturing—and these holdings typically use enterprise resource planning (ERP) packages. Being part of a group, a trading division’s ETRM/CTRM system ideally should be capable of integrating with the holding’s ERP (or with few of them as an extreme), as well as with other types of enterprise applications. In this case, there are two major approaches possible for software selection:
•    CTRM software, being a stand-alone and self-contained system, can be used by a trading division to its maximum capacity, where all modules are implemented and running. In this case, CTRM is independent, and the company manages financials, HR, inventory, and workflow management on its own. Resulting data and reports can be exported on a regular basis to the holding company for consolidation and reporting. In this model, it is very possible to have functional duplication on two levels: multiple data entry, and duplicated data maintenance efforts. In some situations, though, it is an acceptable way to manage a business, despite its obvious weaknesses.

•    It obviously makes sense to share functions of financials, HR, workflow, inventory management, etc.  and some others with the ERP package. This approach allows companies to reduce or eliminate data entry duplications and streamline transaction flows. Financials, HR, inventory, workflow, logistics, and transportation management functions would be performed by an ERP system while a CTRM package will focus on core trading activities, such as deal-making, risk management, position reporting, and so on. A crucial feasibility condition for this approach is the integration of ERP and CTRM.

Commodity Trading Software Selection

Certainly, differences in the nature of the business model and the products lead to variations in software functionality. As the CTRM software market is not as mature as (for example) the ERP market, and because the overall number of vendors is significantly lower, a selection project at first glance appears to be less difficult than it really is. But in fact, it may be even trickier, because trading business as a set of business processes is less standardized than, for instance, manufacturing. Each trading company may have any number of its own unique procedures that are most likely not reflected in any shortlisted package.

Another problem is that the products a company works with dictate various documents, business processes, and handling procedures. Although they belong to the same commodity group (i.e., grains), risk management, transportation, logistics, and other processes may be organized and controlled very differently. In terms of the software, this means that two similar companies working in the same market segment may have such divergent processes that the same software can hardly be applied to them without source code customization.

There is certainly a demand for high-quality and fully integrated CTRM software products, and this software segment has been evolving noticeably over time. In spite of the complexity faced in the commodity trading space and the variations within business processes, the objectives of CTRM implementation projects are feasible and, if properly selected and implemented, can bring about the desired outcome.
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