Pricing Strategies for Processing Intermediaries in Agri-chains with Side Markets: Paradox of Ex-Post Pricing Flexibility

Abstract

We study an agricultural supply chain in an emerging economy, where farmers make land allocation decisions among alternative crops and have the option to sell their harvest either in a side market or directly to a processing plant, and where a government-mandated minimum price guarantee (MPG) is in place. Our study examines a range of pricing strategies that the processing plant can employ to favor a protected crop and the utilization of the processing plant. We begin by considering the Benchmark strategy, in which the plant strictly adheres to the MPG. Subsequently, we investigate two distinct pricing strategies: The Ex-ante strategy, in which the plant commits to an optimal predetermined final price at the start of the growing season; and the Responsive strategy, in which the optimal final price is determined at the end of the season after yield and side-market uncertainties have been resolved. Additionally, we propose the Hybrid strategy, which integrates both ex-ante pricing as a preseason commitment and ex-post price adjustments in response to realized uncertainties. We develop two-stage stochastic program models to analyze the farmer allocation and plant pricing decisions. Among other results, our study suggests that the ex-post pricing flexibility inherent in the Responsive approach may leave the plant worse off, even though price adjustments are plant-profit optimizing. We refer to this phenomenon as the ex-post pricing flexibility paradox. Due to this phenomenon, the Hybrid strategy, while consistently outperforming the Responsive approach, does not always dominate the Ex-ante approach. We propose execution variants of the Hybrid strategy that can guarantee outperformance on the Ex-ante benchmark. In long-term repeated interactions between the plant and farmers, the Hybrid strategy with historically credible probabilistic after-harvest price adjustments, proves effective. For short-term practices, defining a contingency region of relevant outcomes (e.g., yield realizations, side-market attractiveness, and processing margins) that triggers after-harvest price adjustments enables the Hybrid strategy to outperform. These findings urge caution when the plant considers adjusting after-harvest prices, and highlight the importance of building long-term and stable relationships in agri-chains for effective execution of pricing strategies that align incentives and optimize profits for all involved parties.