The food industry is undergoing significant structural changes, as the industrialization of agriculture continues and there is increased consolidation and concentration of agribusiness firms. In a drive to increase efficiencies, businesses in the agri-food sector are developing closer connections with firms at adjacent stages along the supply chain to relay information and take redundant costs out of the system. In addition, a drive to achieve economies of scale has resulted in fewer and larger agribusinesses.

These changes have resulted in farmers facing a more competitive business environment and examining ways to improve the returns from their farm operations. One response by farmers is to form producer alliances, often structured as new generation cooperatives. In some cases, the driving force behind the formation of the producer alliance is farmers’ desire to move along the value chain and capture profits from other stages.

In other situations, producers find themselves without a marketing or processing plant when agribusiness close local facilities. Iowa turkey farmers are one example. When Oscar Mayer was closing a processing plant and feed mill, the producers formed Iowa Turkey Growers Cooperative and purchased the facility (Perkins). These producer alliances have the common objectives of producers working together to achieve/reach common business goals and capture additional value from the commodities they produce. The forms that an alliance can take include: new generation cooperative (NGC), limited liability company (LLC), partnership, corporation, buying or marketing group, joint venture, strategic alliance, as well as unique ownership arrangements with a regional cooperative.

The success of producer alliances often depends upon the answers to three important questions:

1. Is the alliance a good business investment?
2. Will the organizational structure work?
3. Are there other goals for the alliance, and do they compete with or complement the goal of business profitability?

In the following sections of this article, each of these questions is explained in further detail.

Is the Alliance a Good Business Investment?

There are two important questions to consider when evaluating whether an opportunity represents a good business investment or not. First, what are returns and risks associated with the business venture? Second, what is the potential for the business venture from the perspective of long-term strategic positioning?

Returns and Risks

 

A series of M.S. theses at Purdue University evaluated the returns and risks associated with producer investment in value-added business activities (Andreson, Jones, Rosa, Van Fleet). Three sub-sectors of agriculture were considered in depth: pork, corn, and beef. In each case, a stochastic simulation model was developed and alternative strategic business decisions for producers were identified and evaluated. Stochastic dominance analysis was used to determine the alternatives that were preferred by risk-averse producers.

Jones evaluated opportunities for hog producers investing in hog packing operations. A stochastic simulation model was developed first and then used to analyze alternative business strategies, including investing all equity in the hog farm and investing different percentages of equity in the hog farm, hog packing, and stocks (through the S&P 500) and bonds (through T-bills). Three different sizes of farrow-to-finish hog operations were considered: 300, 600, and 1200 sows.

Andreson examined opportunities for corn producers including investment in both wet and dry corn milling. A stochastic simulation model was developed to analyze the impact of investment in a dry corn milling (ethanol) operation. An important aspect of this research was the consideration of different government programs for corn producers as well as for ethanol operations.

Van Fleet and Rosa evaluated opportunities for cow-calf producers. The scenarios evaluated reflect decisions that cow-calf producers are currently facing. These include: retaining ownership and custom feeding in a feedlot, incorporation of improved genetics in the beef herd, different pricing grids in a coordinated marketing system, spring versus fall calving, and diversification into the stock market. The different pricing grids reflect situations that producers are currently considering with cooperative marketing programs that are being established by beef producers, while the spring versus fall calving is an important consideration for these groups as they need a steady supply of beef year-round to meet consumer demand.

Three important conclusions can be drawn from the results of the research involving the stochastic simulation analysis and the question of returns and risk:

1. producers will benefit from a balanced portfolio,
2. producers will benefit from leveraging into more profitable areas, and
3. government subsidies and programs influence investor behavior.

Producers will benefit from diversifying. Diversification into business activities other than the farm or ranch may result in both an increase in expected return and a decrease in the variability of returns (or a decrease in risk) when compared to a 100% investment in the farm or ranch.

It is important that this diversification result in a balanced portfolio. In particular, diversification into a value-added business related to a farmer’s commodity can be a good investment if there is a negative correlation between farm income and processor income. When a product is characterized by volatile commodity prices and relatively stable wholesale/retail prices, there tends to be a high degree of negative correlation between farm income and processor income. This phenomenon exists in the pork industry, and Jones’ research revealed that there is the potential for hog producers to diversify beyond the farm into processing and increase expected return and decrease risk. Of course, achieving this potential depends upon finding an appropriate business organizational structure for successful implementation. In particular, in the case of the processing of livestock, scale economies may make it infeasible for a producer alliance to directly own the entire processing plant because they may not be able to support a large enough operation to achieve economic efficiency.

Producers will benefit from leveraging into more profitable areas. Some sub-sectors of agriculture do not yield as high a rate of return as outside investments. In these instances, it is often argued that individuals place value on the lifestyle of farming or ranch-ing and thus are willing to accept the lower rate of return on their equity. Historical data on the profitability of cow-calf operations provide a picture of a sector of agriculture that often earns a lower rate of return than other investments. In these situations, with low rates of return, the diversification scenarios are attractive because the other investments yield higher returns.

Government subsidies and programs influence investor behavior. This conclusion is highlighted in Andreson’s study of corn producers investing in ethanol production. In particular, the business scenarios involving investment in an ethanol project were preferred only when subsidies for ethanol production were in place. It is therefore vital for producers to evaluate all relevant government programs as part of the evaluation of a new business venture.

Long-Term Strategic Positioning

A strategic business analysis that carefully and systematically identifies all assumptions and evaluates the potential actions and reactions of competitors is an important step in the evaluation of investment alternatives. A typical framework for this analysis is to examine the five competitive forces set out by Porter: barriers to entry, rivalry among competitors, substitute products, power of buyers, and power of suppliers. One particularly interesting result in Andreson’s analysis of the corn milling industries follows from the analysis of the “rivalry among competitors” force. In wet corn milling, industry concentration is very high, with the top three firms having almost 80%market share in the corn sweetener market and the top three firms having over 86% market share in the lysine industry. From the perspective of competitive rivalry, the wet corn milling industry is not a good prospect for any firm to enter and certainly not one for farmer-owned cooperatives or other producer alliances. The advantage of hindsight from a real-world example confirms this. Guebert reports an interesting 1994 meeting where Dwayne Andres, then CEO of ADM, urged Joe Famalette, then CEO of American Crystal Sugar, not to build the ProGold high fructose sugar plant. American Crystal Sugar did proceed with the ProGold plant, but it experienced financial difficulties and is now being operated by Cargill.

Will the Organizational Structure Work?

As noted above, producer alliances can be structured under a variety of different business forms, including: new generation cooperative, limited liability company, partnership, corporation, buying or marketing group, joint venture, strategic alliance, as well as unique ownership arrangement with a regional cooperative. There are advantages and disadvantages associated with each of these different business structures, and those advantages and disadvantages often depend upon specific business conditions. It is very important for investors in a producer alliance to get legal and accounting advice and then evaluate their specific business to determine the most appropriate organizational structure.

There is a second set of issues associated with establishing an organizational structure that will work for a producer alliance. Will the members cooperate with each other and work towards a common goal, or will they take on a competitive nature, resulting in the alliance falling apart? The conclusions from Fulton’s research on joint ventures and strategic alliances are useful here (Fulton et al.).

First, producer alliances are more likely to be successful when the benefits from working together in the alliance are larger. With significant benefits, members are more likely to overcome the challenges associated with working together in an alliance to have a successful business. Next, producer alliances are more likely to be successful when the membership is relatively homogenous and financially stable. It is easier to organize an alliance around common goals the more homogenous the group of individuals. In addition, an alliance made up of producers who are financially stable is more likely to be successful because the ability to withstand difficult financial times will be greater. The stability, and therefore success, of a producer alliance also depends upon there being a mechanism for penalizing any members who defect because it is inevitable that members will attempt to defect or renege on their agreements with the alliance from time to time. Finally, producer alliances involve significant interaction among the members. These businesses are more likely to be stable and successful when the members trust each other, are committed to the alliance, and communicate with each other.

Are there Other Goals for the Alliance, and Do They Compete with or Complement the Goal of Business Profitability?

It is important to identify and evaluate all of the goals that mem-bers, or potential members, of a value-added business or producer alliance have for the business. Examples of goals that members may have include: generating new markets for the commodities they produce, increasing member income, generating new jobs in the rural area, and enhancing rural development in the area. It is certainly the case that some value-added producer alliances will generate additional economic activity in the rural area, generate new jobs, enhance the local tax base, and strengthen local demand for retail goods and services. These benefits are described for a series of cases involving a new generation cooperative in each of Iowa, Missouri, North Dakota, and South Dakota in a USDA report (Rural Business Cooperative Service). However, lenders and investors will judge the success of the value-added business on the profitability of the business. If a producer alliance becomes too focused on some of the secondary objectives, it may not be able to achieve a level of profitability that is needed to sustain the business.

It is therefore important for potential investors in a producer alliance to first explicitly identify all of the goals for the value-added business. Then they can determine whether these goals are complementary or competing. Finally, they can proceed with the project focusing on the goals that are most important for the project.

 

References

Andreson, K. (2000) “The Risk and Return Implications of Value-Added Investments by Corn Producers.” Master’s Thesis. Department of Agricultural Economics, Purdue University.

Fulton, Joan R., Michael P. Popp and Carolyn Gray. (1996) “Strategic Alliance and Joint Venture Agreements in Grain Marketing Cooperatives.” Journal of Cooperatives. 11, p. 1-14.

Guebert, Alan. “Fructose Venture Sours On Farmers Cooperative Was Reportedly Warned Away From Business By ADM Executive.” Peoria Journal Star. Dow Jones Interactive Publishing. p. C2, November 25, 1997.

Jones, B.R. (1999) “The Risk and Return Implications of Value-Added Investments by Hog Producers.” Master’s Thesis. Department of Agricultural Economics, Purdue University.

Perkins, Jerry. (1997) “Banding Together: Iowa Turkey Co-op Moves Up the Food Chain.” Rural Cooperatives. (March/April 1997): 22-26.

Rosa, E.L. (2002) “The Risk and Return Implications of Strategic Business Alternatives for Eastern Corn Belt Cow-Calf Producers.” Master’s Thesis. Department of Agricultural Economics, Purdue University.

Rural Business Cooperative Service. “The Impact of New Generation Cooperatives on their Community.” USDA Rural Business-Cooperative Service. Report by a consortium of Midwest University researchers. http://www.rurdev.usda.gov/rbs/pub/RR177.pdf

Van Fleet, S. (2000) “The Risk and Return Implications of Value-Added Decisions by Beef Producers in Coordinated Supply Chains.” Master’s Thesis. Department of Agricultural Economics, Purdue University.