Four companies control over 70% of beef, hog, sheep and soybean processing. Poultry and processed vegetables are at nearly the same level. -Heffernan(1994)
The sustainable agriculture literature is replete with references to the deleterious effects of "vertical integration". The most recent Southern example is the plethora of criticisms of the North Carolina swine industry following the waste spills of the summer of 1995 (e.g. Kidwell, 1995). Poultry integrators are often criticized for trying to create low prices at the farm gate while requiring that farmers have the best technology.
Though Southern farmers are wary of integrators, results of surveys and focus groups of Southern and, especially, Kentucky farmers indicate there may be much to learn from the successes of vertically integrated industries. Farmers want research and education to help them integrate production and marketing to create their own value-added enterprises.
The phenomena of farmer-owned value-added enterprises is growing increasingly widespread, especially in the Midwest. Mainstream farm publications [such as The Furrow (March-April, 1995)] regularly chronicle this trend. In fact the July 4, 1994, issue of the business magazine Forbes introduced some such successes with the headline:
According to H. Smith (1994), these value-added enterprises are not traditional cooperatives. The new processing cooperatives are owned and operated by active farmers and ranchers who become members of these new organizations by purchasing shares in the operation and supplying additional up-front purchasing capital to fund new equipment, research and marketing costs. Memberships and stock transfers are usually reviewed by a board of directos who ensure that new members are actively engaged in farming. Tight membership monitoring, sincere commitments from farmers, and adequate capital have enabled many farmer-run processing cooperatives to attain higher prices for members and to successfully compete with similar corporate-owned facilities for market share.
The Midwestern states where locally-owned, value-added (LOVA) enterprises are springing up are providing marketing research dolars which require involvement of local farmers and communities. North Dakota makes over $1 million available each year to fund feasibility studies and market research, as well as legal fees and other start-up costs associated with the establishment of new crop or livestock-based businesses. Sarah Vogel, North Dakota Commissioner of Agriculture, says this research and development support has enabled the creation of over 30 farmer-owned crop and livestock value-added ventures. Vogel says she and other Agriculture Commissioners from around the nation are developing a proposal for federal legislation that will make block grants for similar rural development initiatives available to each state from the federal government. "The federal government should help emulate and foster this kind of state-supported rural economic development," Vogel says, because it has been successful at adding value to farmers' income and the rural economies they support. "People are beginning to see opportunities that could run to $10 to $20 million," according to Duaine Flanders of the Agriculture Utilization and Research Institute (AURI) of Minnesota.
The farmer-directed marketing research has enabled farmers to focus on: retail and consumer demands for quality products, capturing newly-emerging markets for unique products, and diversifying risk by establishing a strategic relationship with other processors in the market.
"Let's face it," says John Gardner with the North Dakota State Research and Extension Center, "if you're going to process mainline commodities, the only way to compete with ADM and Cargill is to make your product or your operation unique."
The research and development funding has enabled farmers to obtain "a whole new set of skills that you generally don't learn on the farm," says Ralph Hilgendorf of Whole Grain Millin Co. who processes and markets his own grains.
One of the most successful examples of North Dakota's farmer-operated cooperatives is the Dakota Growers Pasta Cooperative in Carrington, North Dakota. The cooperative was formed in 1993 by more than 1,000 farmers who were unhappy with cash market durum prices. "Pasta demand and prices were going up while durum prices were going down...farmers in North Dakota knew they could do better," says Gardner.
Cooperative members now receive approximately $7.00 per bushel for their wheat in the form of cash grain payments and processing dividends. Dakota Growers Pasta Cooperative has displaced many of its corporate competitors by supplying retailers across the country with pasta processed from the highest grade durum wheat. Pasta sales have already been booked with quality-conscious retailers into 1996.
But these farmers' successes pale against the backdrop of continuing expansion of huge corporations establishing integrated poultry and swine operations throughout the South. The success of these corporations shows the opportunities for farmer groups if state policy supports farmer-directed value-added projects as state government has in the Midwest. Food processing companies expect a return of 18-20% yearly on their investment (Heffernan, 1994)--making their sector the most profitable in the nation except for health-related companies. Food processors can make these kind of profits partially because farmers typically receive a maximum of 2-3% return on invewtment--with much of that coming from government program payments.
Farmers today only receive an average of 26 cents, compared to 37 cents in 1980, for every dollar spent on food at the store. Many farmers do much worse. Wheat farmers only get 6 cents of the bread dollar and only 2-3 cents of the packaged cereal dollar goes to farmers. The ability of farmers to stay in business will be continually weakened unless they can capture more of that 74% which goes to processing and marketing--the value added after production.
Mark Drabenstott of the Federal Reserve Bank of Kansas City says industrialization of agriculture is speeding up due to powerful new forces: a new consumer and a new producer. The consumer is highly discriminating and demands customized food products to meet changes in lifestyle and eating habits. The new producer is armed with the capital and technology and production capacity to meet consumers changing demands (see Hewitt, 1994).
State government can help groups of farmers and local businessmen to become the new integrators of production and marketing. Someone will integrate production and marketing in nearly every commodity in the near future. The question is: Will the profits from those efforts come to Kentucky?
Though economics and business research is not widely consulted in sustainable agriculture circles, the literature on entrepreneurship will be required reading if value-added enterprises are to be catalyzed in Kentucky. The guru of entrepreneurship is Joseph Schumpeter (1947). He defines innovation as the key to economic change. Innovation is defined as setting up a new production function--distinguished from science and technology which are not necessarily involved. He applauded the decline of older non-innovating firms as creative destruction and key to a capitalist market economy.
"This process of creative destruction is the essential fact about capitalism... It is not [price] competition which counts but the... competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their very foundations and their very lives."
Innovation in this sense predicts small business success, while use of technology does not according to research by Young et al. (1993).
How can state government help farmers become innovators? By stopping the competing on cost alone, and begin creating new production systems which anticipate consumer demand. Innovation being distince from technology, research and education which integrate production and marketing must focus on decision-making and not on introduction of new technology.
As Delay (1993) shows, a key characteristic of successful small firms is seeking multiple sources of information in order to put together the industry-transforming innovations. State government can help make those sources of production/marketing integration information available to farmer entrepreneurs.
The quality differentiation ideas of W. Edwards Deming and others who advocate continual change toward quality differentiation to maintain marker share are second nature in business circles. But this is a far cry from the commodity mentality and strategies which have historically driven agribusiness operations (Peterson and Swinton, 1992).
One problem with asking state government to assist entrepreneurs is that bureaucracies and entrepreneurs mix about like oil and water. Total Quality Management (TQM) is often mentioned as a path to reinventing government. But one of the early contributors to the TQM movement was Schumpeter, who established the principle that creative destruction is the key to market-based economic development. Bureaucracies seek to perpetuate themselves and insulate themselves from market signals. Gibbons and Sethi (1993) show how some conservative bureaucracies have managed to buck this trend and embrace innovation. Will Kentucky agricultural and rural development bureaucracies be able to encourage creative destruction and assist farmer-entrepreneurs in creating the value-added industries which can transform the rural South?
Nearly every major agricultural state has a program to provide financing for agriculture. These programs recognize that agriculturally basic enterprises warrant special consideration because of th unique benefits they provide. Standard economic development finance authorities judge projects largely by the number of jobs they provide. Agribusinesses not only provide jobs, they support all the farm families need to produce raw materials and all the suppliers of the farm families.
In one popular example, seventeen states are using tax-exempt bonds to provide capital for agricultural loans to help "beginning" farmers. These tax-exempt small issue agricultural Private Activity Bonds (Aggie Bonds) have provided nearly half a billion dollars. The largest programs are the Iowa Agricultural Development Authority($151 Million) and the Illinois Farm Development Authority ($134 million). These programs provide a method of financing for which neither states or the federal governmet assume any risk. Private banks are able to make reduced interest loans due to the issuance of tax exempt bonds.
Value-added enterprises: catalyzing and financing.
Other states have specifically targeted value-added enterprises with tax-exempt bond programs. Texas has the largest such program ( a $200 million revolving loan program supported by a bond issue).
However, in creating new enterprises to add value to agricultural commodities, the most success has been obtained by states which have established programs designed to help farmers, groups of farmers and local businessmen to organize to create new businesses.
Since the Mississippi State Legislature established the Food and Fiber Center in 1974, assistance to catfish processors, for example, has created such a strong marketing alternative that Mississippi farmers long ago passed all other states and now market 44% of all the catfish sold in the country. Mississippi's program is budgeted through the Extension Service and provides the same sort of feasibility analysis, assistance in organizing and technical consultation provided by similar programs in other states. The REVAMP program in Iowa provides these services through the Department of Agriculture with a link to the Department of Economic Development for financial assistance. REVAMP goes a step further in providing mentors to help farmer networks establish the feasibility of their proposed enterprise. Minnesota and Kansas have created independent non-profit corporations to provide help for businesses and farmers in product develoment, organizing new enterprises and feasibility analysis.
One of the most successful programs for heling farmers create their own new value-added enterprises is the Agricultural Product Utilization Commission in North Dakota. Over 30 new cooperatives are creating new marketing opportunities for farmers thanks to start-up support from APUC. The first was the Dakota Growers Pasta Cooperative which began at the end of 1991 and now has over a thousand members, a $40 million facility, and processes 120 million pounds of pasta a year, contributing to a doubling in durum wheat prices in North Dakota since plant start-up.