AgDM newsletter article, May 2000

Welcome to the new world of agriculture

by Jon Setala, marketing communications consultant in River Falls, Wisconsin, 715-262-5338, setala@win.bright.net

A new opportunity

"Biotech is now the science base for economic growth in the ag sector," says Michael Boehlje, professor of agricultural economics at Purdue University. "In the past, advances in the physical or mechanical sciences and developments in the chemical sciences provided the basis for new economic advantages for farmers. But today, biotechnology is creating the new opportunities."

Danny Klinefelter, professor and extension economist at Texas A&M University, agrees. He says biotech is now "the primary driver" for growth but points out that environmental issues and food product safety concerns are also pivotal. They may constrain the ability of American producers to exploit the new opportunities.

Dr. Steven Blank, extension economist at the University of California Davis, says,

"The American agribusiness sector has booming prospects." He is less excited about prospects for American producers. "Since biotech is largely a U.S. innovation, its initial benefits will come to producers here in the United States," Blank says. "Biotech firms will usually `outsource' their inputs, creating more opportunities for contract production. Producers who enter these agreements will gain a more secure market for themselves at least for the short run."

Dr. Boehlje says biotechnology is creating "component" agriculture in the U.S. Specific attributes and components have more value than traditional generic commodities and can command a price advantage for the producer.

Three components of the New Agriculture

1. General commodity production
2. Component specific production
3. Specific-attribute raw materials

Klinefelter says modifying the genetics of crops and livestock theoretically allows food and other product production with greatly enhanced value. Imagine meals that can slim down people who tend to obesity-or foods than can control allergies, high blood pressure, or high cholesterol.

"Someday your doctor may just prescribe a meal to treat your condition," Klinefelter says, "using a food that was genetically engineered to interact with your specific body chemistry in a particular and beneficial way. Genetically modified organisms (GMOs) are creating all kinds of exciting new opportunities."

Initially, foods that act like drugs may produce some increased anxiety about food safety, but Boehlje, HIinefelter and Blank all see the movement toward wider use of genetically modified crops and livestock as irreversible.

"The negative reaction Europeans had earlier this year to the import of genetically engineered food from the U.S. was just an education problem," says Steve Blank.

Given the stresses Europeans have experienced in forming their new Economic Union and several recent food safety incidents, U.S. grain export firms probably should have expected an adverse reaction and should have done a better job of preparing their markets accordingly.

Brave new agriculture

Boehlje says that continuing advances in biotechnology are causing two profound changes in America's production agriculture.

"First, agriculture is increasingly moving to a system of tightly aligned supplier `value chains' where farmers raise crops or livestock under contract for a specific processor or end-user," he says. "And second, agriculture is changing to a biological manufacturing mentality using process control and intervention technologies to monitor and regulate production."

Essentially, says Boehlje, biotechnology allows growers to manipulate and control the growth process of an organism and change the composition of its components. Process control technology gives producers the ability to track the organism's growth and development. The process is at work today in modern poultry buildings, where birds automatically weigh themselves by stepping on scales each time they take a drink of water.

Someday your doctor may just prescribe a meal to treat your condition-Danny Klinefelter

With intervention technology, producers can put things back on track whenever the organism's growth goes off schedule. An example of intervention technology is the delivery of plant food or chemicals to a cotton crop at the optimal moment through an irrigation system," he says.

These technologies result in production with more consistent quality and better cost-efficiency. Of course, the industrial revolution produced those same advantages over the traditional work of artisans and craftsmen. Factory production makes the skills and talents of traditional producers less vital.

That's why some farmers do not greet this change with much enthusiasm. "Their big fear is they're going to end up like broiler growers," HIinefelter says. Boehlje agrees but points out the new process also guarantees producers a price for their production. "And contract production is really not so new to a lot of American producers," he says. "Seed companies have relied on it for several decades.

"Farmers respond negatively because it challenges one of their fundamental values: independence. However, we are going to see less independent production and more interdependent production in coming years. If farmers think about the relationships they have with their landowners and lenders, they may see they have not been as independent as they thought."

Value chain value

Boehlje says farmers who participate in a value chain system can gain four benefits. But participation in value chains may be restricted to farmers of a certain size or in a certain locality.

"First, producers will have more opportunity to capture value," Boehlje says. "Second, they have less risk of being closed out from a market. Third, they are guaranteed market access. And fourth, they'll gain access to more innovations."

Value chain benefits

More opportunity
Less risk
Market access
More innovation

KIinefelter says production of GMOs for "nutriceutical" and pharmaceutical uses will be "very site specific, requiring a certain place, climate, etc. For example, champagne grapes and Tabasco sauce ingredients must be produced in areas with specific attributes."

Blank points out that proximity to the processing facility will also be important when perishability is an issue. "Broilers for Tyson must be produced within a 50-mile radius of their plant," Klinefelter says. He expects that organizers of new value chains will probably favor larger, highly efficient producers.

"Commodity markets will become the residual market for the value chains," Klinefelter says.

"Weather will remain a major factor in value chain production," Klinefelter says. To neutralize the potential affects of future El Ninos and La Ninas, some value chain operators may actually prefer contracting with farmers who have muftistate operations and can provide production in several different weather zones.

"When weather in some zones turns hot and dry, weather in other areas typically becomes more favorable for agriculture," Klinefelter says. Producers could capitalize on these correlations to mitigate weather risks somewhat the same way vegetable producers use "multiple windows" to mitigate "boom or bust" price risks. "It's just another `portfolio risk management' strategy," Klinefelter says. "A farmer might operate six sites, each at least 300 miles apart."

"Farmers need to stop expecting everything in agriculture to last forever and begin seeing enterprises as having a potential life of only 15 to 20 years, Klinefelter says.

For similar reasons, Blank thinks value chains will typically add overseas production as their second stage rather than increasing production in the U.S. Expanding overseas, Blank believes, will usually provide the value chains a lower cost basis plus create a hedge against the risk of crop failures in North America.

"At this point in time, there is real merit for agribusiness in having a globally focused expansion strategy rather than a strategy for expansion in the U.S. alone," says Boehlje. But Klinefelter says biotech's need for quality control plays to the advantage of U.S. producers with their quality control mechanisms.

If the niche fits

"Sometimes firms with new technology have avoided experienced farmers, preferring instead to employ people who are unfamiliar with traditional production methods," Klinefelter says. "These firms wanted people who they knew would follow their production procedures exactly." Sometimes that meant the firm even had to operate its own farms.

"Some of the new value chains may also require absolute control of production," Klinefelter says. "But for the most part, companies have found it makes better sense to contract with farmers because, if for no other reason, this frees up capital for other business needs." Boehlje believes many farmers in the U.S. will eventually end up becoming "qualified suppliers" or "franchised growers" holding a long-term production contract with a value chain.

"But these firms won't offer long-term contracts, initially," Klinefelter says. "In the beginning, value chains will just offer year-to-year contracts. They'll want to contract with dependable, low-cost producers. Over time, they'll purge the less efficient and less reliable producers from their programs. Eventually, as the pool of potential producers grows smaller and they begin to become more concerned about maintaining production sources for the future, these firms will begin offering long-term supply contracts to their very best suppliers."

Boehlje and Klinefelter envision these contracts as having a value that would be similar to the "franchise agreement" of a successful
beverage distributorship or fast-food franchise. They'll allow a good profit for the producer because the value chain's management will want these producers to stay in business.

Depressed commodity markets

Farmers who continue to produce agricultural commodities should not expect better market prices in the years ahead. "Commodity markets will become the residual market for the value chains," Klinefelter says. "Here's why: Suppose fm a value chain operator needing corn with 11 percent amino acid. I'm always going to contract for a bit more production than I expect I'll need to guard against crop failure.

Consequently, in most years fm going to receive more production than I'll actually need, so I'll usually end up dumping the excess into the commodity market, causing corn prices to decline. I won't care because fm just recovering some of my business expense."

Some producers will be able to make the transition, others will not - Mike Boehlje

On those occasions when production from the captive system falls short for some reason, the chain operator will have to go into the market to make up the shortfall because he will need to maintain production at his processing facilities. "If a lot of other value chains find they need to do the same at that time, as might be the case with a serious drought, corn prices will boom," Klinefelter says.

"As more and more value chain systems are established and comprise an ever-increasing segment of total U.S. production," Klinefelter says, "it's easy to see how they will tend to keep commodity prices depressed."

Boehlje predicts processors will regularly contract for 110 percent of their plant capacity, and he expects the commodity market will become a salvage market that's regularly glutted. "Traditional farmers operating without production contracts should expect commodity markets with more frequent downsides than up," says Boehlje.

Farmers are also going to find changes in the futures market. Klinefelter envisions satellites and information technology that will continuously monitor growing conditions in all crop production areas on the globe. This will connect to a commodity price forecasting mechanism that will produce far more timely and more accurate reports. "This will affect market risk for farmers," Klinefelter says. "Growers will find they'll need to be part of an organization with access to this information to protect themselves."

Few farmers, more stress

Clearly, the changes identified by the economists won't ease the stresses facing American farmers. Those stresses may even increase as the agricultural industry consolidates. Many more farmers will be taken out of business because of changes in the agricultural industry. This isn't because they're bad farmers. It's because, Blank says, "America simply doesn't need their production anymore." Farmers are not the only ones affected by this stress, either. Boehlje says all of rural America and all of the agricultural infrastructures in the U.S. are being impacted.

"Farmers need to stop expecting everything in agriculture to last forever and begin seeing enterprises as having a potential life of only 15 to 20 years," Klinefelter says. "They need to think in terms of entrance and exit strategies."

In this environment, Klinefelter believes advantage goes to "the early adopters" who will enjoy the full premium available from each new enterprise or opportunity that emerges. He says those who delay will be less well rewarded due to "premium decay."

"Creativity will affect a farmer's business survival, too," Klinefelter says. "That, plus the speed with which change occurs, his ability to recognize opportunity and his ability to manage people."

Boehlje points out that biotechnology is profoundly changing the role of agriculture. Instead of just producing raw commodities, farmers can now consider producing raw materials for a whole new set of industries.

This is a time of genuine opportunities for many U.S. producers. Nevertheless, farmers need to realize that there is no "correct" kind of agriculture that we "need to get back to." The era of production agriculture in the U.S. they grew up with is passing. "Some producers will be able to make the transition, others will not," says Boehlje.

Blank says, "there has never been any question about the ability of American farmers to produce. It's their ability to profit that has
the question." This new era will produce more opportunities for farmers to profit. That's the good news for farmers. But these opportunities are different from what most farmers would have preferred and not every farmer will find them available or attractive.

 

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