AgDM newsletter article, June 1999
By David Saxowsky and Marvin Duncan, Department of Agricultural Economics, North Dakota State University, 701/231-7441
(first in a series of two)
Some people are concerned about the adverse consequences of agricultural industrialization while others argue that it will offer new opportunities. As with any type of change, some people will benefit from agricultural industrialization while others will be adversely affected. It is perfectly reasonable to ask what the impacts of this change might be, who might gain from this process, who might lose, and why that is the case.
1) More opportunities
Due to agricultural industrialization, farmers will not be limited to large-scale commodity production to maximize their return. Instead, industrialization offers farmers an opportunity to be part of a system that focuses on developing differentiated products, which create an opportunity to be paid for the additional value. A farmer in this system will not have to settle for a commodity price.
As producers adapt to agricultural industrialization, they will develop new partnerships, obtain information differently, and contractual agreements will create new risk exposures.
The uniqueness of the product will increasingly be based on privately held and controlled market information and production technology. In this way, market power is created. The strategy can be described as attempting to increase earnings through a higher-valued differentiated product, rather than focusing only on lowering production costs.
2) Need for agricultural commodities will not be eliminated
Basic agricultural commodities will still be produced in massive quantities in the most cost-effective manner, often by large-scale commodity production. Both systems will exist side by side, often in the same community. Agriculture will encompass a number of strategies and systems for the profitable production of agricultural products. No longer will the farms in a community look alike in products produced and in the production systems used.
3) Economies of scale will not be eliminated
Technology will continue to expand economies of scale for farmers who produce commodities, and for the farmers who produce a differentiated product. Similarly, agribusiness firms will continue to strive to find ways to reduce production and distribution costs. Often, the strategy will be to adopt technology that facilitates economies of scale and specialization. That is, farmers will continue to be pressured to innovate and add new technology to lower per-unit production costs. Globalization of agricultural production, processing, and marketing also will add to those pressures. However, unlike the past, farmers will give more attention to expanding their businesses vertically by adding new steps in processing and marketing or by establishing strategic alliances with those who do.
Even though industrialization offers an alternative to producing and marketing a homogenous commodity, industrialized agriculture is capital intensive. Acquiring access to capital resources probably implies greater use of strategic alliances and business partners. Many farmers will choose to structure their business as a cooperative, corporation, or limited liability company to accomplish this. In short, farmers will increasingly be forced to choose between controlling all of a smaller business, or sharing ownership and control in a larger business organization.
4) Some farmers and agribusinesses will become part of a food production system
The increased reliance on acquiring, using, and controlling information will extend throughout the agriculture industry (suppliers, producers, processors, and marketers). For example, suppliers will need to meet the unique needs of farmers who are producing differentiated products rather than commodities.
These suppliers may need to change the way they operate their businesses. They, and the farmers they work with, will often become part of a vertically coordinated food production system. Within this system, input suppliers from one level will adjust their business to meet the needs of their buyers, as well as work with their suppliers to achieve a better match with the producer's unique needs.
Agricultural industrialization is not likely to increase the extent to which farms and agribusiness firms specialize in the commodities or products they produce. These firms will specialize whether they produce and sell a commodity or a differentiated agricultural product. Specializing, as opposed to diversifying, will most likely create efficiencies within the firm.
6) Increase in vertical business relationships
More of a firm’s business relationships will be vertical rather than horizontal. There still will be horizontal collaboration but these arrangements will be motivated by an attempt to gain economies of scale so a group can collectively participate in a vertically coordinated industry. The motivation will no longer be to wrestle market power from suppliers and buyers, but to strike alliances with them that provide increased profits. Farm businesses will view producers outside their group or alliance as competitors and suppliers and buyers as potential partner.
7) Businesspersons will be more dependent on one another
Vertical relationships will lead to less producer independence. But these relationships will increase opportunities to learn from those with whom they do business. Producers will have access to information that may not otherwise be available, at any price. Farmers and business persons may feel more like members of a team than individual business owners.
Farmers and business persons will specialize in their activity, knowing that others in the production chain also will specialize in their activity. They will know what products need to be produced and will place less emphasis on just producing as much as possible. Farmers will risk losing their place in the production chain if they are not able to fulfill their specified-quality product commitments. Business planning will involve working with both suppliers and buyers.
8) Increase the emphasis on acquiring, analyzing, using and protecting private information
As more information becomes private, fewer people will be capable of providing products and services, because they will lack the necessary information. Increased reliance on controlled information (production and marketing) will impact producers as well as those who provide service and products to producers. One method of acquiring and controlling information will be through strategic alliances that may be as simple as a supply contract or as complex as a multi-year commitment to deliver a defined quality and quantity of products on a pre-selected schedule.
9) Business persons will decide who they will conduct business with
Producers and agribusiness persons will decide who they will do business with. They will obligate themselves to deliver a specified product or service. They will need to manage the risk of not being able to produce the quantity and quality of the product specified in the contract. In return for managing this risk, the business persons will be assured of a market for a specified price and quantity.
Purchase decisions will not be based solely on price and quality. Increasingly, purchase decisions will be based on how well the supplier can meet the particular needs of the buyer. The needs of the buyer include timeliness, quantity, consistency, and precision characteristics. Even high quality, low cost items will be of little value to the buyer if they do not meet the particular needs of the buyer.
Everyone will not have equal access to information. Even a willingness and ability to buy information will not assure access. Farmers in strategic and contractual alliances may view their neighbors as competitors rather than as friends involved in the same industry. Farmers will view agribusiness firms as potential partners rather than as “greedy middleman”.
Partnerships will not be limited to the business next door. Businesses will be able and willing to enter into business agreements with other businesses that are located many miles away (even in other nations).
There appears to be concern among some who fear they will not be permitted to participate, even though they are willing to participate and consider themselves capable of successfully being part of a vertically coordinated agriculture industry. Those who do not participate in industrialization or lack the resources to be large-scale commodity producers will likely need to find substitute income for family living. This will either be in the form of leaving the farm or finding off-farm income to supplement the farm income.
10) The exposure to risk and how it is managed will change
Contract use exposes the parties to risks that commodity producers and processors do not currently face. One of these is the risk of having to deliver or accept delivery according to the contract, regardless of the cost of complying. Although farmers and other agricultural businesses will be expected to fulfill their contracts (and bear the consequences if unable to do so), they will be assured a market for their product and a source for their inputs.
Managing these new and different risks will be made easier by an array of market based risk management tools. Many of these are already being developed by commodity exchanges and insurance companies.