Each year, Growers A, B & C must decide whether to maintain, increase or reduce acreage. Every grower acts based on what he/she believes will be best for their individual farm. They analyze what all their neighbors are doing. How they coordinate their individual actions determine the outcome of the market for all. There are several situations that can arise. The Hop Growers’ Dilemma, outlined below, shows, very simply, how a market can play out in any given year and how growers’ individual decisions affect the outcome.
Growers A, B and C each plant acreage capable of producing one million pounds of hops for contracts representing 900,000 pounds of hops all contracted at $8.00 per pound for a total of $7.2 million. They leave a buffer so they can still fill their contracts if the crop is short. If they are not short but their neighbors are, those spot hops can be worth significantly more. Everybody’s crop comes in 5% short. The result, because of the buffer, is a surplus of 150,000 pounds. Prices for spot hops react immediately to the oversupply. Spot hops sell for $6.00 per pound providing $300,000 for each grower above their contracted value. Future contract prices decline from $8.00 to $7.00 per pound. The future value of each grower’s potential production declines by $1 million per year.
Growers A and B plant the same acreage as in option 1 for the same demand. In this case, grower C decides to produce only what he has sold, 900,000 pounds. Once again, the crop comes in 5 percent short and the spot price drops to $6.50 per pound. Grower C cannot fulfill his contract and is short by 50,000 pounds. Merchant X buys 50,000 pounds from Grower A to cover Grower C’s shortfall. Growers A and B make $325,000 each above the value of their contracted volumes from the value of their spot hops. Grower C receives $400,000 less than his contract value because he was not able to fulfill his contract. Future contract prices decline to $7.00 per pound. The future value of each grower’s potential production declines by $1 million per year.
Growers A, B and C decide to produce only what they have sold, 900,000 pounds leaving acreage idle. Again, the crop comes in 5 percent short. There is a 150,000-pound shortage in the market. Prices for spot and future contract hops increase as a result. Spot market prices rise to $15.00 per pound. Future contracts rise from $8.00 to $10.00 for the next three years. Growers contract their additional 100,000 pounds of capacity at the new higher prices for the following year, but receive no added benefit in the current year. The potential future value of their crop increases by $2 million per year.
In reality the hop market is much more complicated. Despite myriad variables that confront the grower and the hop market not mentioned in this example, the example remains relevant and demonstrates, in principle, how the market works. Any given grower has the potential to benefit incrementally in any year by having extra hops to sell. The incremental gain, albeit smaller than the contracted price is more attractive than the potential loss incurred when short.
Sales of spot hops at low prices today undercut the value of all production tomorrow. The Hop Growers Dilemma, demonstrates that growers are powerless when they act alone. It shows that very seldom do they have the ability to do what is right for their own farm and what is right for the industry at the same time. They only significantly affect the market when they act together. Every grower, however, sees every other grower as a competitor, which keeps cooperation from ever happening.
It’s not that growers cannot manage their production. It’s not exchange rates, or climate change or political differences that cause the hop growers problems. The problem is much more basic than that, which makes it all the more difficult to solve. Growers cannot trust each other. They do not act together as a unified group with common interests. Growers have figured out how to deal with Mother Nature, but human nature prevails.