Grain Price Hikes Squeeze Food Chain
Poor Harvests and Increased Demand are Sending Corn and Wheat Prices to Record Highs, Spiking Food Production Costs

By Malika Worrall

December 11 2007: 11:52 AM EST

(FORTUNE Small Business) -- Running a bakery is never easy, but lately it's been especially tough. In less than a year, Michael Kalupa of Kalupa's Bakery in Tampa, Fla., has seen the cost of bread flour increase 40 percent, while the milk solid he uses in nearly every product he makes has doubled in price, from $50 a bag six months ago to around $100 a bag today.

"Bakers all over the country are struggling. You can't absorb those kinds of cost increases," said Kalupa, who is also president of Retail Bakers of America, a bakers' trade group. "For a small wholesale baker who uses 150 bags of flour a week, the bill has gone up by $660 a week."

Rising grain prices aren't just hurting the neighborhood baker. Small businesses throughout the domestic food chain are affected by the skyrocketing costs of corn, wheat, soybeans and other grains. A perfect storm is hitting grain prices on all fronts: Poor domestic and foreign harvests this year thinned the supply of wheat, while increased demand from expanding sectors like ethanol production has pushed up the price of corn. Growing grain consumption in increasingly affluent economies such as China and India translates to more competition for U.S. buyers, while the weak dollar makes U.S. farm exports more attractive internationally, further increasing domestic prices.

"This is probably the most challenging environment for basic agricultural commodities in the past twenty-five years," said Greg Wagner, director of marketing and risk management at Horizon Ag Strategies in Chicago, Ill.

Common tactics for dealing with price fluctuations include negotiating deals that lock in prices or buying contracts on the futures market. But these "hedging vehicle" require volume buying, often beyond the reach of small businesses: "Small businesses don't have the flexibility to deal in bulk or the ability to manage risk like the larger entities," Wagner said.

The Philadelphia Macaroni Company, a pasta manufacturer and flour miller based in Philadelphia, Penn., doesn't even have the option to hedge the cost of one of its key ingredients, durum wheat: it isn't produced in sufficient volumes in the U.S. to be traded on the futures markets of domestic grain exchanges. As a result, says Bill Stabert, vice president of sales, the company has been completely exposed to durum wheat price increases, which have gone from $6 a bushel in November 2006 to around $18 last month.

"The prices at which we're buying wheat from the farmer goes directly into the cost of making the finished product. Oil, labor and manufacturing costs have had some impact, but the major factor is the raw material cost," Stabert said. "The last big spike in wheat pricing was in the early seventies, so this is uncharted waters. But you have to react, otherwise you go out of business."

Over the past four months, Stabert has had to repeatedly explain to customers why his company's prices keep going up - but he has no way of knowing when or how large the next increases will be.

Prices are increasing so rapidly that some of the bakers who buy bulk bread flour have had mills telling them they will not quote a price until the delivery truck is loaded and leaving the dock, according to Kalupa of the Retail Bakers of America.

"You don't know what the cap is," Stabert said. "The price is going up faster than you can get the customer to accept it. Not being able to determine what your costs are is the most stressful part of the pricing equation."

Rising grain costs aren't just an issue for bakers or pasta manufacturers. The ripples reverberate much further up the food chain, afflicting businesses throughout agriculture and related industries, a market that accounted for 4.5 percent of the U.S. GDP in 2005, according to the U.S. Department of Agriculture's Economic Research Service. Chickens, steaks and even cheese are becoming more expensive to produce: When grain costs rise, so does the expense of raising the animals that eat the grains.

It takes cattle rancher Tom Hendrix of Wray, Co., at least fifty bushels of corn to raise an 800-pound calf up to 1,400 pounds for the slaughterhouse. With corn prices reaching $4 a bushel, an increase of more than $1.50 in the last eighteen months, Hendrix's costs have gone up by at least $75 per calf.

Hendrix sells half of his weaned calves to feed yards each fall, which fatten the calves up for slaughter, and keeps the other half himself to sell on to large meatpackers six to eight months later. Hendrix is getting hit on both sides: raising calves himself is more expensive, but Hendrix also receives less for the young calves he sells, precisely because the feed yards now have to spend more on feed.

"On average, the price dropped at least $10 per hundred pounds in October. A 500-pound calf [sold for] $50 less than a year ago," said Hendrix, who is also a director of the Colorado Independent CattleGrowers Association. Passing on his rising production costs has not been easy for Hendrix, a rancher with a small herd who sells to large companies that can dictate market prices.

"It's a margin business," he said. "Whoever's at the bottom of the totem poll is going to get cut the worst."

Normally, Hendrix would substitute wheat or barley into his calves' feed, but with many grains at record highs, he's out of alternatives. Soaring feed costs and the unfavorable conditions of last winter, he says, have "put a lot of people in the cattle industry in pretty rough shape."

Things aren't much easier for George De Piro, a brewer at C.H. Evans Brewing Company.

The restaurant brewery in Albany, N.Y., has seen grain prices go up about 50 percent in the last year. While De Piro has a futures contract that shields him from recent, dramatic hikes in hop prices, barley is a constant worry. A twenty-keg batch of De Piro's "hoppiest" beer, Kick Ass Brown, uses only 15 pounds of hops but as much as 650 pounds of barley malt. Industrial brewers can use rice or corn to substitute for some of the barley or wheat malts, but craft breweries such as C.H. Evans Brewing, whose business depends on the distinctive flavors of its beers, are less flexible.

"With the malt you're kind of stuck with a specific variety, because otherwise people would notice the difference in taste," De Piro said.

Creative adaptation

One hope for small businesses is a market correction in the near future. High prices caused by short supply are one of the best incentives for farmers to plant more of a specific crop, increasing supply and eventually bringing prices down. Plans are already under way for increased wheat acreage in the European Union and in the U.S.

But with world wheat stocks at a thirty-year low, Horizon Ag Strategies' Wagner thinks it will take some time, and a lucky run of favorable weather conditions, for the market to fully normalize itself.

"Those people who are looking for relief are unlikely to see that any time real soon," he said. "But if Mother Nature cooperates, we should see wheat prices substantially lower six months down the road."

Improved wheat harvests won't cure the crunch around other crops like corn and soybeans, which remain subject to increased demand. To survive the new norm, small businesses have to cope the best they can - which often means creative adaptation.

Robert Ehrlich, CEO and founder of Robert's American Gourmet, a Sea Cliff, N.Y., snack company that makes the puffed rice and corn snack Pirate's Booty, has instituted a number of changes in response to increasing costs. For the first time in its 23-year history, the company is arranging longer-term contracts with its suppliers to lock in prices for the next year or two. It is also raising the prices of some products in February 2008 to offset higher costs of corn, wheat and soybeans.

"We have not had a price increase in over eight years," Ehrlich said. "We were forced to do this because we've seen price increases in a lot of our inputs at once."

Robert's will also be launching Simply Booty, a lighter version of Pirate's Booty. This new variation contains no cheese, because the aged white cheddar Robert's uses for the original product has risen from $2 to approximately $3 a pound in the past 12 months, due in part to the increased cost of feed for dairy cows. Without this ingredient, Simply Booty will require less grain and oil inputs, which are usually used in larger volumes to carry and apply the cheese.

Meanwhile, De Piro knows that changing the malt varieties in Kick Ass Brown would not go unnoticed by his customers - but he'll consider doing it anyway if costs continue to climb. Kalupa is advising members of Retail Bakers of America to get efficient with their balance sheets and look for areas where they can cut costs.

"Today we live in a world economy," he says. "It affects the baker on Main Street just like the trader on Wall Street."