Beyond Vertical Integration: Vertical Coordination As A Way To Capture Market Value

Vertical integration in the food, agricultural and biofuels (FAB) industries has been a topic of much focus and discussion over the past several years. The increased use of vertical integration within the sector has often been seen as a way for companies to increase value captured in a product and improve efficiencies in production, among numerous other reasons. However, due to the number of challenges faced by those engaged in vertical integration, more attention should be given to the idea of vertical coordination. Vertical coordination may be a path more appropriate for companies within the FAB industry to ensure they capture a return on their investment, while avoiding many of the concerns and challenges associated with vertical integration.

FAB industries are continuing to see advances in technology, development of specialized products, and numerous other scientific and technological developments. However, the growing cost of these technologies and advancements means that the companies making these investments need to ensure they capture a portion of the resulting economic value. This need to capture value is one of the reasons often cited as a need for vertical integration.

Before we take a closer look at the idea of vertical coordination, let’s take a quick look at some of the challenges facing vertical integration in the FAB sector.

Vertical integration

Vertical integration occurs when one company outright owns two or more stages of production. As one way for companies to seek greater economic value, there are both benefits and limitations to adopting this model in the FAB industries. Benefits cited for vertical integration include the ability to capture or retain a higher amount of the economic value of the product, increased control over product quality and consistency (helping meet consumer demand) and greater control over the timing of production (meaning the ability to greater adjust to the ebb and flow of market demand).

Over the past several years we’ve seen a number of companies making strategic decisions to move into other parts of the supply and production chains. While this does have benefits, there are also limitations. Many of these relate back to the traditional role of independent producers and the various relationships these producers have with other players in the industry.

One challenge to vertical integration is statutory. Several states have laws in place designed to protect the role of the independent producer, preventing corporations from engaging in certain agricultural activities. Nine states currently have some form of anti-corporate farming law in effect, including South Dakota, Minnesota, Nebraska and Kansas. Typically, they restrict a company’s ability to engage in farming or to acquire, purchase, or otherwise obtain land for agricultural production. Many have an exception for certain types of family-owned corporations.

There are other regulatory concerns for vertical integration though, at both the federal and state level, particularly in certain aspects of the FAB sector. Federal regulation may limit such moves, particularly in light of the renewed focus of the U.S. Department of Justice and USDA on issues related to market concentration and mergers. Mergers have seen increased scrutiny from federal regulators and approvals are becoming more difficult to obtain. From challenges to proposed mergers (JBS Swift and National Beef) to challenges even after completion (Dean Foods and Foremost Farms), the regulatory focus is shifting at the federal and state level. The recent USDA/DOJ workshops highlighted this concern, with vertical integration, competition and industry mergers being a key theme throughout all of the nationwide workshops, and not often portrayed positively.