Grain price hikes squeeze food chain

Poor harvests and increased demand are sending corn and wheat prices to record highs, spiking food production costs.

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(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.

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