What makes a commodity a commodity? - Agiboo

While working in the field of commodity Trade and Risk Management (CTRM) software, I am obviously getting often the question of people elsewhere about ‘What do you actually do’. That is sometimes rather a challenge to explain to people outside the commodity industry. Many times I noticed that the concept of a commodity is for many not as obvious as for people within the industry. However when you start to talk about it within the commodity industry it appears that many have their own slightly different definition on it. When someone asks and I have the luck to be in our office, I will try to explain it using coffee and tea. I would put some green (of course Arabica as I prefer the taste compared to Robusta coffee beans on the table and let the person puzzle about the question about which one is the commodity.

The answers vary from none, both, tea or the correct one … the green coffee beans. However when I swap the tea for some roasted coffee beans it appears that the confusion on the subject usually increases as many indicate the roasted beans also to be a commodity. So what makes a commodity then a commodity? Well for me the first thing is that a commodity should be homogeneous, meaning that it is pretty much the same substance everywhere around the world. Usually I try to illustrate this with a pen and some sugar. Getting some sugar with your coffee, you expect the same wherever you are, i.e. white sugar, sure it can be a lump of sugar, or being packed in a fancy small sachet but the white sugar is everywhere equal. With a pen it is completely different, going to a shop and ask for a pen would involve all kind of questions from the shopkeeper. Should it be a fountain pen or a ball pen? What color should it be? An ergonomic grip? Etc. etc. It illustrates already that a pen is not a commodity. Probably that is also why the question about the pen was raised in the ‘Wolf of Wall Street’, the question to sell me some sugar would be a much bigger challenge.

The standardization 

A homogenous product, does that make a commodity as commodity? Well, partly I guess but there is more to it. For me the commodity should also have standardization and a listing at a commodity exchange. One could say that a green Arabica bean is not standardized, when we go into a luxury coffee store we can choose from all kind of different countries and when it is a very luxury one we even have the choice of different bean sizes (called screen sizes in coffee). So why is green coffee a commodity? Well the exchanges took the effort to create and define standard contracts, when you would go to website of the ICE (InterContinental Exchange) and you click on softs (as coffee is a soft commodity) you can find contract specifications on quality and origin. They have done that to enable a derivatives (Futures and Options) market for it.

Derivative market

For me a commodity is a commodity when it is both homogeneous and has a ‘liquid’ derivative market available. Liquidity is a subject on its own, but that is for a later moment. It is true that products which are homogeneous but not have a derivative market still share many characteristics, which results in similar logistical processes. Shipping 500 bags of coffee or tea raises similar challenges compared to shipping exactly 500 pens. How much is exactly in the bag? Will the weight of the bag be the same at arrival as loaded? As coffee is hygroscopic, which means that it attracts or loses moisture depending on climatic conditions. And many more of these questions which makes commodity trade so interesting.

Commodity Trade and Risk Management Software

For Commodity trade and risk management (CTRM) software it allows the offering to be broad and specialized at the same time, when supporting commodities which are listed on a commodity exchange as it requires all the functionality to support both the physical trade and the derivative trade, where at the same time the specifics of the commodity should be facilitated for trade, logistics and finance. This could mean anything from complexity in trade such as white premium (the premium for the difference between raw and white sugar) functionality for sugar or facilitating weight differences at shipment loading (tolerance) and weight differences during transport (franchise). The discussion about what a commodity makes a commodity will always be there and that makes for me the industry so interesting to work in as we take pride at Agiboo in facilitating all the variations, specialties and exceptions in the commodity industry with quality software tools.

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