Tight supplies occur in lots of supply chains. Pick any industry with rapidly rising demand and you are likely to see at least the occasional glitch in the supply of a key component or input. Still, the setting described in a recent Wall Street Journal article is fairly unique (Hunger for Organic Foods Stretches Supply Chain, Apr 3).
Nature’s Path is among a number of organic-food purveyors taking steps to tackle supply constraints that are hampering the growth of one of the hottest categories of the U.S. food industry. Companies including soup maker Pacific Foods of Oregon Inc. and publicly traded burrito chain Chipotle Mexican Grill Inc.are digging deeper into the supply chain with such moves as financing farmers, offering technical training and hiring full-time headhunters to recruit organic growers.
The efforts are aimed at ramping up organic-food output that has failed to keep pace with surging consumer demand, due in part to the significant costs and risks that U.S. farmers face in converting from conventional to organic farming. Longer-term, the steps could help bring down organic-food prices that have been bolstered by tight supplies, companies say.
According to the article, retail sales of organic food have tripled in the last ten years and that has put a lot of pressure to increase the output of organic products.
There are several aspects of this story that are interesting. First, it is a fragmented industry in the sense that the brands that are selling are in multiple categories so there is no one solution. In contrast, a particular smart phone might be in tight supply because of a shortage of a particular chip or because of issues with its display. Solve that problem, and the phones will flow. Here, we are talking about both organic grains and organic chicken. Expanding grain output isn’t going to help the chicken market.
A second factor is that organic farming is riskier than conventional agriculture. I am not referring here to, say, a greater risk of insect infestations because of not using pesticides. Rather, as the article notes, there are not specialized option markets for organics so growers cannot hedge market risk the way other farmers can.
A final point is that the switch to organics does not happen overnight. Depending on the product it can take one to three years. Over that time, farmers incur the reduced output and higher operating costs of organics without being able to charge a premium.
So what can a growing organic business do in order to assure it has adequate supply? The article discusses several possibilities. First, it can backward integrate. That is what Nature’s Path, the firm mentioned in the above quote did, buying 2,800 acres of farmland to assure it had access to a sufficient supply of wheat and other grains. (Of course, they then had to contract with farmers to actually execute the farming.)
The other approaches discussed are more contractual.
Mr. Simon said Hain three years ago sought to counter ingredient shortfalls for its Garden of Eatin’ tortilla chips by promising farmers in Texas, Minnesota and elsewhere that it would buy organic blue and yellow corn for up to three to five years. …
Two years ago, Chipotle, which said it seeks to purchase as many organic ingredients as practical, began providing financial incentives to help farmers of black beans in Oregon and Washington transition from conventional to organic production. In 2014, the fast-casual chain paid higher-than-conventional prices for about 500,000 pounds of beans grown on farmland shifting to organic—equal to more than 10% of its organic black-bean purchases—even though it wasn’t able to market those to consumers as organic, a spokesman said.
Signing long-term contracts or committing to pay higher than market prices are certainly less costly than buying farmland outright. They also sacrifice some control. Chipotle’s bean farmers, for example, could possibly sell to someone else once their fields have been certified as organic. I would guess that Chipotle has locked in some volume from them once the transition is complete but that is going to have some finite span. While Nature’s Path can be fairly sure that it will own farmland five years from now, Chipotle may not be as certain with its supply of beans.