The Economics of Agricultural Supply Chain Design: A Portfolio Selection Approach

Agrifood firms in the modernizing/globalizing world, both in developing and developed countries, regularly need to undertake innovations. They develop supply chains to accommodate the nature of the innovations. In this paper we analyze an innovator’s supply chain design problem. The design of the supply chain may include allocating resources between production of feedstock (agricultural products) and processing and marketing, and determining the amount of feedstock to be obtained through contracts. We show that the innovator determines its overall level of production taking advantage of its monopoly power in the output market, and behaves as a monopsony in buying feedstock from contractors. These decisions are constrained by the marginal cost of capital and the properties of production and marketing technologies. When the innovator is risk averse, risk considerations in production processing and marketing and the correlation between risks will affect both overall production and share of input purchased through contracts.