Cargill: Behind the Profits of a Trading Operation

In most companies, the lines between trading-based operations and procurement tend to be formally drawn. But by the end of the commodities boom cycle in 2008, many companies, especially those in the CPG markets, were ready to explore the hiring of traders as an integral part of the Spend Management side of their operations. By focusing on risk reduction through contract structuring and related hedges and other financial instruments, traders can help companies to mitigate the dangers of rising price commodity markets -- especially in cases where it's impossible to pass on cost to customers in a transparent manner. But the stories of traders in corporate America are not all positive. Just as fast as you can say "Palladium" and "Ford" in the same sentence, it's possible to recount multi-million -- and even billion -- dollar fiascos from trades gone awry. Most recently, we've seen a number of airlines have to write-down the value of their hedges -- which has a direct impact on EPS -- because they're underwater relative to the market.

These headlines seem ironic given the context of the most common and appropriate role of trading inside companies -- to reduce risk. But some organizations not only focus on reducing risk from trading activities, but profiting from them as well. A recent Wall Street Journal (registration and subscription required) article does an excellent job going behind the scenes of Cargill's trading and global sourcing operations. These two functions inside Cargill appear to have a number of close linkages and played a role in helping the agriculture giant report excellent earnings last week for its most recent quarter. How did they do it? The sharing of information between the trading and sourcing functions, for one. Consider how "this past fall when global credit markets froze up, Cargill got wind of ships full of soybeans stranded in ports because buyers ran into financial trouble, people familiar with the trades say. Cargill's traders knew they could profit by buying the stranded beans at low prices, then shipping them to Cargill's own factories to be crushed into vegetable oil."

It's rare that situations like this seemingly appear on a regular basis -- unless you facilitate an environment where unearthing information is encouraged. At Cargill, management views information -- both supply markets and spend related -- as so important to the business that they financially incent their employees (including traders, procurement and other functions) to share it. Consider as one example how "the company adjusted its pay system a few years ago to reward agribusiness units and traders for advising each other about crop-disease outbreaks or shifting demands of fast-food chains. Pay is based partly on revenue generated by tips like these." In most lines of business, this type of behavior would be illegal. But in commodities trading and procurement, it's perfectly legitimate -- and it's nothing new to Cargill. In fact, the company's efforts go back nearly as far as the Rothchild's famous carrier pigeons -- well, maybe not quite that far. But they do go back to the 1920s when Cargill "used a private teletype system, called 'the wires' internally, to transmit intelligence to and from its far-flung offices." Today, Cargill uses a much more advanced intelligence infrastructure that allows its analysts to "track shipping activities across the world's oceans, just as the military might track missiles in a war room, say traders with knowledge of the system. Employees catalog vessels being demolished or built, diversion of ships to new ports, and their contents."

CPG companies that only recently started to consider hiring traders in 2008 might look at this picture and realize they're about to enroll their offspring in kindergarten when their kid's competition is about to receive a Nobel prize. But you've got to get started somewhere. And trading is all about information. I still remember stories from my wife and her business partner, both former metals traders, about how they'd buy aluminum from one floor of a large multinational metals company and sell it to another. How'd they do it? They exploited a lack of communication and intelligence between the sale arm (representing the mills) and the procurement and trading arm of the organization. All in a day's work, I suppose, for those with a trading mindset that exploits information asymmetry and supply market intelligence advantage -- an approach that is allowing Cargill to thrive in an economy where many companies are struggling to survive.

- Jason Busch

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