ACM capabilities in a nutshell – Contracting Part 1
In the agricultural business, contracts are an integral part of the daily business operations and how companies manage their relationships with farmers and other internal and external business partners. Contracts with farmers are typically categorized in two different types: production and marketing contracts. Usage of those contract types can vary based on different factors and are often also more typical for certain types of commodities than others. In production contracts, the farmer is typically paid by a company to grow the crop and the agricultural buying company is therefore owning the crop while the farmer is only getting paid for provided services. While in marketing contracts the farmers owns the crops and has an agreement with the buying company to deliver the harvested commodity within an agreed quality range during a specified period to a defined location and for an agreed price. Generically marketing contracts are more common in the grain & oilseed business and production contracts more common, but not restricted to perishables like fruits and vegetables as well as the livestock business
Basic contractual agreements exist since decades in the industry and while business requirements and scenario’s are getting more diverse and complex, the companies solution needs to be able to address those requirements to keep up with evolving demands and complexities.
While focusing on the processes defined in marketing contracts, the SAP Agricultural Contract Management solution provides a solution for many different types of contractual agreements to support various business scenario’s, means of contractual fulfillment or state of contractual negotiation to support the complexities of the agricultural business. This section will only give a very high-level overview of the most common types agreements that are being offered, but will not address the detailed requirements that may be specific to one type.
3rd party sales / purchase
These types of contracts are specifically designed to support the agreements with external counterparties like farmers, commodity buyers and processors or trading partners, while being fully integrated into the company’s risk and position management. Fulfillment of the contracts is typically governed by several factors like agreed quantity, delivery period, place(s) of delivery or type of commodity with accepted quality range along with various monetary agreements like prices, fees or expenses. These monetary agreements as well as other applicable contract terms and features will be covered in separate articles of this series.
A type of contractual agreement similar to 3rd party contracts, however where the companies counterparty is a different legal entity of the same organization as the company itself. Intercompany contracts follow in principal the same terms, rules and guidelines as 3rd party contracts, however with the assumption that always a pair of identical contracts exists in the system: one for the seller and one for the buyer.
Example: creating an Intercompany purchase contract in SAP Agricultural Contract Management will always create a mirror on the other side (sales in this specific example). Both contracts are always held identical in real-time. This is important for either of the two partners to have a full overview over all their contractual commitments as well as the impact to their risk position.
Intra-company contracts are very similar to Intercompany contracts, however with the main difference that both partners are part of the same legal entity. Example could be two different elevators or plants belonging to the same company but are operating as separate independent profit centers. ACM as a solution does allow in these types of agreements also to negotiate specific contract prices that can later (optionally) be used for internal cross profit center charges.
Vehicle contracts are 3rd party sales or purchase contracts where the fulfillment of the contract is not defined by a quantity, but by the number of executed loads (vehicles).
Example: instead of creating a contract of 9,000 BU that is deemed fulfilled when the entire 9,000 BU are being delivered, a vehicle contract can be set up that defines that the contract is fulfilled when the company receives or sends 10 vehicles with an average load of 900 BU. While total quantity is approx. the same in either scenario, the key difference is that in vehicle contracts the contractual obligation is only fulfilled after receiving exactly 10 vehicles, while in the quantity contract the 9,000 BU can be delivered in more or less shipments.
This type of agreement offers planning benefits to the company like for example the ability for a more accurate freight cost planning. The freight / transportation cost for the 10 vehicles as per example above can be negotiated upfront with a carrier.
When farmers delivering truckloads of grain to a location without having a commercial agreement or without having an agreed price in place the buying company still have to write a contract in order to officially document that the purchase or trade has been made. To facilitate the process of creating the required contract more easily, a dedicated spot contract process in ACM is provided. This process allows to create and price contracts automatically for either a single load or multiple loads combined over a potential longer period of time (in ACM: Accumulate to Own).
Pricing of the spot contracts can either be executed manually by the trader / merchandiser or can also be automated based of following rules:
- Spot End-of-Day (EOD) process: the contract is automatically created by a background job and is priced with the end-of-day price of the last available market price.
- Example: on November 7th the grain buying company received loads with spot requests. After market close (ie. CBOT market close) a batch job is executed that converts these loads into actual contracts and is pricing them automatically with the end of day market price of November 7th (the exchange and future period are determined based on a profile set up in the system)
- Spot Immediate: in the spot immediate process the contract creation is as indicated by the name triggered immediately by an end user without waiting for the batch job to be completed. Pricing information are also provided by the user.
Firm Bids / Offers
Other than previously listed types, Firm Bids / Offers (FBO’s) are not a legally binding contract but rather a time-based bid or offer by the company to buy / sell a specified commodity in defined period at a dedicated location(s) from a counterparty. A FBO can be converted into an actual contract after an agreement has been made or after other defined terms are met. The key driver for meeting such criteria is typically the contract price. FBO’s therefore provide the ability to either lock a bid price or define a strike price. Conversion will only take place, if the strike price hits or via manual user intervention in a by ACM provided work center. The ACM solution also provides interfaces to trigger an automatic conversion from FBO into a contract.
A Firm Bid to buy soybeans is created that defines that the basis price is locked at $0.10 per Bushel, while the contract conversion shall only take place if the futures hit a strike price of $13.00 of the in the FBO specified exchange and future period (Example: CBOT Soybeans for January 2024 period). The bid to purchase at these conditions will expire on November 10th 2023; after this expiration date a new bid with new terms has to be set up.
Similar to Firm Bids / Offers also Quotes are not legally binding contracts, but also time-based quotes by the company to buy / sell a specified commodity in defined period at a dedicated location(s) from a counterparty. Key difference to FBO’s is that quotes may have fully defined price agreements with fixed basis and future prices and are not specific to a single counterparty but can be accepted by any buyer/seller.
Example: a quote with an expiration date of November 10th 2023 to buy soybeans at a price of $13.05 is made to all farmers that are willing accept these conditions. Until the expiration date, the quote can be converted into as many contracts as requested by all farmers that the company is doing business with.
Prepayment agreement & Barter
For farmers to run a successful business it is crucial to have the right funds at the right time in place. This is not only important for business-critical investments like buying seeds or fertilizer, but also among many other possible reasons required to i.e. repair equipment or buy new equipment needed for harvest.
To secure these required funds farmers may have the option to either take bank loans, but also some agricultural buying companies offer to pre-pay their commodity purchase contracts. Meaning the farmer will receive the funds now for crops he will harvest and deliver at a future date. Prepayment agreements in SAP S/4HANA that are fully integrated into all stages of the ACM process offer the capability to capture all the needed terms of such a prepayment agreement and how also the company is being repaid. Some of the most important features of prepayment agreements include:
- Generic counterparty information and also if the prepayment was made to a single farmer or group of farmers.
- Credit information including generic credit checks which will allow the company to decide whether they want to approve the prepayment to the farmer.
- Collaterals used by the farmer as security.
- Interests’ information: company may charge interests if the prepayment was made for longer duration.
- Fees that may be charged to the farmer.
- References and other complementary information
Three generic types of prepayment agreements are delivered as part of the solution:
- Advances: typically requested for smaller amounts that are repaid in a short period. Often requested by the farmer already during harvest season to fund ad-hoc requests, like repairing equipment that is needed during harvest. Advances do not charge interests.
- Pre-finance: these types of agreements are typically requested for higher amounts and a longer repayment period. As those type agreements pose a higher risk for the company issuing the prepayment, they often collect collaterals to secure the loan and also charge interests. Pre-finance agreements can be made for one year or even longer period before the full amount is paid back by the farmer.
- Barter: In this type of agreement, the farmer is not receiving direct funds from the agricultural company but is receiving goods like seeds or fertilizer. Instead of paying directly for these goods, the farmer can opt to enter a prepayment agreement and repay the amount with his crops during harvest season.
Common factor for all types of prepayment agreements is that the farmer is repaying his dues by delivering crops to the company, instead of sending checks.
- Farmers receives a prepayment of $25,000 as an advance (no interests charged)
- First load during harvest, the farmer delivers 900 BU priced at $13.00 per BU for a total settlement amount of $11,700.
- The buying company will deduct the by the farmer owed amount until his dues are fully recovered. In this example they may not pay him for the first truck load and his owed amount is reduced to $13,300 after this transaction
- Alternatively, the agricultural company may still pay the farmer a small amount to the farmer. Example they pay him 10% of the settlement amount until his obligations are recovered. They would therefore pay him $1,170 while the other $10,530 would be applied against his prepayment agreement for a new open balance of $14,470.