Beyond Vertical Integration: Vertical Coordination As A Way To Capture Market Value
In the future, vertical coordination will consist of increasingly complex production, commodity marketing and licensing agreements.
The aforementioned workshops also highlighted another limitation when it comes to vertical integration, public and community perception. Proposed mergers involving vertical integration are seeing increased resistance within the public sector as well. Independent producers often encounter much less resistance when developing a new venture than a proposed vertically integrated project. When it comes to marketing, the public’s perception and support, for independent producers can also be a benefit, as opposed to the public’s possible antipathy toward vertically integrated companies in one sector.
Other potential challenges to vertical integration include production and market risk. As any producer can tell you, farming is a risky business. Yet for vertically integrated companies involved in production agriculture, programs such as federal crop insurance and federal farm programs are less likely to be available to help manage the associated risks.
Another limitation is the cost of capital, such as the price of purchasing land for agricultural production. Good farmland in parts of the Midwest, such as in northwest Iowa, may sell for as much as $10,000 an acre. These types of prices are often barriers for developers of technology and other products who seek to enter this aspect of the market.
One final challenge those looking at vertical integration may find is the perception that the independent producer, with their connection to the land, is a better steward for that land. This, of course, requires that those independent producers have access to the most recent seed traits, technology and other advances.
Vertical coordination
While there are benefits to vertical integration, the challenges are many. With increased focus on market competition and more state and federal regulatory attention, alternatives to vertical integration that still allow companies to obtain a return on their investment are receiving attention.
While vertical integration involves corporate ownership at more than one level, vertical coordination, on the other hand, involves a company capturing value at two or more stages of production without ownership of those other stages. Due to some of the limitations and concerns with vertical integration, vertical coordination may be a more appropriate option, and it is likely that we will see these arrangements become more common, and complex, over the next few years.
Vertical coordination within the FAB sector is not new, nor uncommon. One example is the corn industry. The majority of corn traded in the United States is No. 2 Yellow Corn. This designation applies without regard to the germplasm or traits contained within the corn. Corn users, including feed companies, food processors and biofuel processors, all purchase No. 2 Yellow Corn from the same nonsegregated U.S. corn supply.
While the simple designation No. 2 Yellow Corn is used to identify corn in the market, there is nothing simple about the seed itself. Over the years, yield of No. 2 Yellow Corn has increased due to the development of traits related to concerns over drought, pest control and weed control. As the market currently stands, the developer of the trait realizes value through increased prices for the seed itself and, at times, chemical sales as well. Beyond that, there is generally little or no value passed along to the developer. Those at the other end of the process, the food processor, feed mill or biofuels processor, typically have little care regarding these types of traits that may be embedded in the corn they purchase.
Traits have been developed for a number of crops, including non-hybrid crops, to assist producers in obtaining the maximum possible yield. However, trait developers rely on the purchase of seed to obtain the value of the trait and to receive incentives to continue to develop new traits. The saving of seed by independent producers for use in a second year of production is a major concern for these developers, as the ability to obtain value for those traits is dramatically affected by this practice. While certain steps such as patents and licensing agreements protect trait developers, these are only effective if the trait developer is able to detect illegal seed saving. The cost and potential business disruption of enforcement create inefficiencies in the system.
