Positioning the Farm for Long- term Viability Michael Boehlje Center for Commercial Agriculture Purdue University.

Positioning the Farm for Positioning the Farm for Long-term ViabilityLong-term Viability

Michael BoehljeCenter for Commercial Agriculture

Purdue University

What Is Strategy?What Is Strategy?How a business creates value for

its customersThe key questions

◦Who? – customer focus◦What? – products/services◦How? – processes/procedures to

deliverDoing the right thing (doing

things right is operations)

Strategic thinking is all about change:◦Anticipating the future◦Shaping the future◦Capitalizing on the future

What is Strategic Thinking?What is Strategic Thinking?

What is strategy?What is strategy?

Strategy is….◦ Looking longer term◦ Capitalizing on change◦ A stream of decisions◦ Focused on a purpose◦ Managing strategic risks◦ Creating a unique and valuable position◦ Choosing what not to do

Successful

Strategy

Long-term, simple and

agreed objectives

Profound understanding of the competitive

environment

Objective appraisal of resources

Common Elements in Successful Strategy

EFFECTIVE IMPLEMENTATION

Monitoring and Measuring Performance

Monitoring and Measuring Performance

ImplementationImplementation

The Strategy Decision Framework

Goal/Mission/VisionGoal/Mission/Vision

Assess the Firm’s Capacity

Assess the Firm’s Capacity

Assess the Business Climate

Assess the Business Climate

Venture ChoicesVenture Choices

The Strategic InitiativesThe Strategic Initiatives

VISION/MISSIONVISION/MISSION

Developing a Developing a Business/MissionBusiness/MissionWhat business are we currently

in?Who are our customers, and

what are they buying from us?How does our business go about

satisfying our customers’ needs?What skills and capabilities is our

business especially good at?

Components of a Vision Components of a Vision StatementStatementCore ideology

◦ Core Values - timeless guiding principles◦ Core Purpose - reason for being

Envisioned future◦ Big Hairy Audacious Goals (BHAG) -

clearly articulated goals ◦ Vivid description - a graphic description of

what success and the future will be likeRecognition of service to stakeholders

◦ Owners/creditors◦ Employees◦ Customers

The Business Climate

1. The Economic Recovery

Status of the Economic Status of the Economic RecoveryRecovery

Tax Policy•maintain lower rates, increase depreciation deduction

Auto sales

Fed policy (QE 2) and interest rates

Business investment/lending (the last stage)

11

22

33

44

55

66

77

Year end retail sales

Consumer confidence

Impact

Employment/Unemployment

Status of the Economic Status of the Economic RecoveryRecovery

China policy (interest rate and reserve increases, price controls)

Municipal/state debt

Commercial real estate

Government spending/Deficit/Budget Dilemma

88

99

1010

1111

1212

1313

O to

Housing prices/sales

European sovereign debt

Oil Prices1414

International crisis (Middle East/Japan)1515

2. Global Food and Biofuels Demand

• Economic Growth

• Population Growth

• Dietary Transition

• Energy

Global Economic GrowthGlobal Economic Growth

• IMF July World Output Projectionso 2007 5.2%o 2008 3.0%o 2009 - 0.6%o 2010 4.6%o 2011 4.3%

IMF -2nd half of 2010 slower

due to financial turbulence

in Europe (Greece, Spain, …)

2011 Real Economic Growth 2011 Real Economic Growth Rates %: IMFRates %: IMF

Animal Protein as a Share of Total Protein

% of U.S. Corn Used for % of U.S. Corn Used for EthanolEthanol

PriceCostsYields/productivity/efficiencyChanging rules/regulations/relationships

3. More Volatility in Agriculture3. More Volatility in Agriculture

U.S. Net Farm Income and U.S. Net Farm Income and Government PaymentsGovernment Payments

10 Year Average = $67.7B

Margin Risk is Also Margin Risk is Also SubstantialSubstantial

Resurgency of RiskResurgency of RiskHigher cash costs – fertilizer, seed,

chemicalsHigher land rents/valuesHigher feed costsMargin compression/riskFewer risk management optionsLess effective government safety netMore counter party riskIncreased working capital needsFinancial reserves critical

EPA/environmentalLand useEnergy policyFood safetyAntitrust/GIPSAImmigration

4. Increased Regulations for the 4. Increased Regulations for the SectorSector

Higher interest ratesHigher leverage for growing businessesAvailability/access

5. Higher Capital Costs for 5. Higher Capital Costs for Farming BusinessesFarming Businesses

Interest Rates on Real Estate Loans – Interest Rates on Real Estate Loans – Chicago Federal Reserve BankChicago Federal Reserve Bank

Department of Agricultural Economics Purdue University

Forward 3-mo LIBOR Rates Forward 3-mo LIBOR Rates as of 4/15/2011as of 4/15/2011

0%

1%

2%

3%

4%

5%

6%

Forward 3-mo LIBOR Rates Actual 3-mo LIBOR Rates

Global productionLand accessLabor/management accessContracts/preferred supplier

arrangements

6. Increased Competitive 6. Increased Competitive PressuresPressures

7. More Opportunities

Business Reinvestment Upgrade/modernize Distressed assets Farmland Deleverage

Business Venture ChoicesBusiness Venture Choices

1. Strategic Fit Your passion – focus An experiment – flexibility

2. Expected annual earnings Current income Growth in earnings Synergies Tax consequences

How Do You Choose?How Do You Choose?

3. Risk Earnings Value

4. Capitalization Credit/Leverage Required Working Capital Funding Equity Dilution

How Do You Choose?How Do You Choose?

5. Entry/Exit Entry/purchase premium Liquidity/flexibility Ease of exit Succession/business continuity

6. Value Creation Gain/loss potential Inflation hedge Option value Terminal/residual value

How Do You Choose?How Do You Choose?

7. Management Your capacity/competencies Complexity Control

8. Portfolio Diversification – related or unrelated Concentration – horizontal or vertical Options

How Do You Choose?How Do You Choose?

Assessing the CapacityAssessing the Capacity

(strengths and weaknesses)

ResourcesResources

Inputs into a firm’s production process such as capital equipment, skill of individual employees, patents, finance, and talented managers.◦ Tangible Resources – Assets that can be seen

and quantified◦ Intangible Resources – Family commitment,

networks, organizational culture, reputation, intellectual property rights, trademarks, copyrights

By themselves resources do not create a strategic advantage for the firm.

Core CompetenciesCore CompetenciesResources and capabilities that

serve as a source of competitive advantage for a firm over its rival.

Not all resources and capabilities are core competencies.

Many suggest that firms should identify and concentrate on only 3 or 4 core competencies.

Core CompetenciesCore CompetenciesIdentifying sustainable competitive

advantages is the keyCore competencies are normally the

root of that sustainable competitive advantage

Four requirements:◦Rare◦Durable◦Nonsubstitutable◦Costly to Imitate

STRATEGIC STRATEGIC POSITIONING FOR POSITIONING FOR SUSTAINABLE SUSTAINABLE COMPETITIVE COMPETITIVE ADVANTAGEADVANTAGE

Strategic PositionStrategic Position

Successful businesses will answer a fundamental question:

Where will my firm focus itsresources and its

passion?

Strategic PositionStrategic Position

Is the way a firm goes to market.Is the fundamental way the firm

creates value for the customer.Is the passion of the organization.Drives the organization’s resource

investment decisions.Is built around the firm’s core

competencies, the firm’s primary skills and sources of competitive advantage.

Example of Possible Positions in anAgricultural Production Firm

◦Low-cost, bulk commodity producer◦Customer-oriented specialty products

producer◦Full-service, consumer-focused custom

farming operation◦Efficient, partnership-focused contract animal

feeder◦Technology-focused, cutting-edge animal

breeder

Positioning OptionsPositioning Options

Alternative Strategic Directions

Commodity Product StrategyCommodity Product Strategy Production Emphasis – the focus is primarily on

production activities rather than marketing or finance Manufacturing Mentality – the science and

systematic process of producing food products rather than the art of raising commodities is emphasized

Low Cost Producer – cost control is critical to being competitive in a commodity business

Large Scale Operation – larger scale operations generally have cost advantages over smaller scale units

Outsource Resources – land is rented; machinery is leased or custom hired

Open/Impersonal Markets – markets are open to all who meet gross commodity product standards at publicly known prices

Downside Price Risk – excess worldwide production can result in significant downward price movements

Independent Decision-Making - the traditional independent farmer provides most of the managerial and other resources and makes most of the decisions

Differentiated Product Differentiated Product StrategyStrategy End-user Focus – the focus is on a final consumer or food

processors needs rather than commodities Distribution/Marketing Mentality – marketing and

distribution decisions and expectations of consumers are as (or more) important than production considerations

Value-Added Production – the additional revenue to be gained by further processing and distribution is emphasized

Smaller Scale Operation – a focus on a segmented consumer market and niche markets allows and encourages small scale, more nimble and flexible producers

Insource (own) Resources – more land and other resources are owned because the scale of operation is not beyond the financial resource base of the smaller producer

Negotiated Markets – responding to consumer needs and producing products with specific attributes requires more direct communication throughout the chain

Relationship Risk - contracts can be terminated and alliances severed unexpectedly

Interdependent Decision-Making – the negotiated linkages with suppliers and processors reduces independence and forces joint, interdependent decision-making

IMPLEMENTING IMPLEMENTING STRATEGYSTRATEGY

Key Implementation Key Implementation DecisionsDecisions Business Enterprise Focus

◦ Product◦ Production/process technology

Growth/Downsizing◦ Focus/specialize◦ Intensify/modernize◦ Expand◦ Diversify◦ Replicate◦ Integrate◦ Network◦ Delay/wait and see◦ Downsize

Key Strategic DecisionsKey Strategic DecisionsMarketing and Channel Linkages

◦Sourcing and purchasing resources◦Merchandising and selling

products/servicesFinancial/Organizational Structure

Business/legal choices Leasing options Equity sources Debt decisions/instruments

Key Strategic DecisionsKey Strategic DecisionsSocial ResponsibilityManagerial Style/Lifestyle◦ Learning new skills◦ Time/labor contribution◦ Risk/stress level and attitudes◦ Living expenditures

Expansion

Focus

Intensify Expand

Diversify

Replicate

Integrate

Network

Phase IPhase II

Figure 1. Strategic Growth Options

ASSESSING ASSESSING STRATEGIC STRATEGIC RISK/UNCERTAINTYRISK/UNCERTAINTY

Categories of Risk Illustrative Sources of Risk

Financing and Financial Structure

Debt servicing capacity, leverage, debt structure, non-equity financing, liquidity, solvency, profitability

Market Prices and Terms of Trade

Product price volatility, input price volatility, cost structure, contract terms, market outlets and access

Business Partners and Partnerships

Interdependency, confidentiality, cultural conflict, contractual risks

Competitors and Competition Market share, pricing wars, industrial espionage, antitrust allegations

Customers and Customer Relationships

Product liability, credit risk, poor market timing, inadequate customer support

Distribution Systems and Channels

Transportation, service availability, cost, dependence on distributors

People and Human Resources Employees, independent contractors, training, staffing adequacy

The Universe of Risk

Source: Adapted from Tech, Edward, “Microsoft’s Universe of Risk” CFO, pp. 69-71, March 1997

Categories of Risk Illustrative Sources of Risk

Regulatory and Legislative Export licensing, jurisdiction, reporting and compliance, environmental

Political Civil unrest, war, terrorism, enforcement of intellectual property rights, change in leadership revised economics policies

Reputation and Image Corporate image, brands, reputations of key employees

Strategic Position and Flexibility

Mergers and acquisitions, joint ventures and alliances, resource allocation and planning, organizational agility

Technological Complexity, obsolescence, the year 2000 problem, work-force skill-sets

Financial Markets and Instruments

Foreign exchange, portfolio, cash, interest rate

Operations and Business Practices

Facilities, contractual risks, natural hazards, internal processes and controls

The Universe of Risk

STRATEGIES FOR STRATEGIES FOR SUCCESSSUCCESS

Strategies for Success in Strategies for Success in Turbulent Times: Turbulent Times: Ten Strategic InitiativesTen Strategic Initiatives

1. Choose a Strategic Direction (Commodity vs. Differentiation)

2. Capture the Potential of Uncertainty3. Manage/Mitigate Risk4. Manage Slack/Flexibility5. Manage Capital Cost and Structure6. Adopt New Technology7. Improve Operations/Efficiency8. Partner with Buyers and Suppliers9. Grow the Business10.Become a CEO

Alternative Strategic Directions

Commodity Product StrategyCommodity Product Strategy Production Emphasis – the focus is primarily on

production activities rather than marketing or finance Manufacturing Mentality – the science and

systematic process of producing food products rather than the art of raising commodities is emphasized

Low Cost Producer – cost control is critical to being competitive in a commodity business

Large Scale Operation – larger scale operations generally have cost advantages over smaller scale units

Outsource Resources – land is rented; machinery is leased or custom hired

Open/Impersonal Markets – markets are open to all who meet gross commodity product standards at publicly known prices

Downside Price Risk – excess worldwide production can result in significant downward price movements

Independent Decision-Making - the traditional independent farmer provides most of the managerial and other resources and makes most of the decisions

Differentiated Product Differentiated Product StrategyStrategy End-user Focus – the focus is on a final consumer or food

processors needs rather than commodities Distribution/Marketing Mentality – marketing and

distribution decisions and expectations of consumers are as (or more) important than production considerations

Value-Added Production – the additional revenue to be gained by further processing and distribution is emphasized

Smaller Scale Operation – a focus on a segmented consumer market and niche markets allows and encourages small scale, more nimble and flexible producers

Insource (own) Resources – more land and other resources are owned because the scale of operation is not beyond the financial resource base of the smaller producer

Negotiated Markets – responding to consumer needs and producing products with specific attributes requires more direct communication throughout the chain

Relationship Risk - contracts can be terminated and alliances severed unexpectedly

Interdependent Decision-Making – the negotiated linkages with suppliers and processors reduces independence and forces joint, interdependent decision-making

Capture Potential of Capture Potential of UncertaintyUncertainty

Mitigate the downsideCapture the upsideAn “options” approach

Manage/Mitigate RiskManage/Mitigate Risk

Operating margin riskFinancial riskStrategic uncertainty

Manage Slack/FlexibilityManage Slack/FlexibilityLean operationsSlack or reserves on strategic resources Financial reserves Management-growth/start-up

Choose what not to do/pursueMaintain flexibility

Manage Capital Manage Capital Structure/Debt UseStructure/Debt Use

Lock in rates – 5 yearModerate debt use/pay downHold reserves (working capital)Fund growth with equitySlow growth rate

Adopt New TechnologyAdopt New TechnologySimplification technologyPrecision/process control technology

Automation/information technology

Improve Improve Operations/EfficiencyOperations/Efficiency

Use standard operating procedures (SOP)

Focus on quality/consistencyImprove operations/efficiencyContinuous process improvement

Closed loop systems

Grow the BusinessGrow the BusinessNatural result of success (reinvest earnings)

Economies of size criticalReplication strategyGrowth from the coreCollaborate/cooperate/partner

Partner With Partner With Buyers/SuppliersBuyers/Suppliers

Preferred customer for suppliers – better deals

Preferred customer for buyers – know your customer

Be a CEOBe a CEO

TEPAP revised

Traditional◦ Walk around hands on

management ◦ Hierarchical command and

control structure◦ Incenting behavior not

critical◦ Operations oriented

◦ Do it all◦ Little/no compensation◦ Internal expertise◦ Can add activities without

giving up◦ Closed information system

◦ No need for replication◦ Family personal dynamics

dominate◦ Interpersonal skills not

critical

New◦ More remote, “in the office”

management◦ Team structure

◦ Right incentives critical◦ CEO mentality – people,

money, relationship, strategy◦ Leadership and delegation◦ Well compensated◦ Out-source/hire capacity◦ Trade off’s – can’t add without

giving up◦ Open access information to

get right messages and incentives

◦ Must scale or replicate◦ Business relationships

combined with family dynamics

◦ Interpersonal skills are critical

Management Practices of Management Practices of Modern ProducersModern ProducersAdapt quickly to new technologies that are

either cost lowering or value increasingDevelop a standardized system of

command and control or standard operating procedures

Utilize alliances with “partners” both to learn from them, and also to extend the scope of the business

Are supply chain oriented seeking ways to maximize value/lower cost from farm inputs to the dinner table

Management Practices of Management Practices of Modern ProducersModern ProducersContinually seek to gain

economies of size Perfect a

technology/management/scale structure and then replicate it in other locations or in other businesses

Effectively use both debt and equity capital to continually grow the business

Management Practices of Management Practices of Modern ProducersModern ProducersUse automation and information

technology to improve precision and systematically control production processes

Focus on quality of product and consistency of production processes

Recognize and emphasize buyer expectations in their choice of product and production practices

The New AgricultureThe New AgricultureWhat we will do – biological

manufacturing of specific attribute raw materials for nutritional, pharmaceutical, industrial products, animal agriculture and other end-uses.

How we will do it – integrated value chains that enable genetics to “plate” traceability

How we will compete◦ Quality (better)◦ Speed to market (faster)◦ Cost (cheaper)◦ Ability to manage risk.