Supply Chain Issues in Small Agricultural Enterprises by

Supply Chain Issues in Small Agricultural Enterprises by Cerry M. Klein and Wooseung Jang Department of Industrial and Manufacturing Systems Engineering

Preview • • Introduction Problems and Objectives Models Conclusions Department of Industrial and Manufacturing Systems Engineering

Introduction • Agricultural Production • Large sector of economy • Leading exporter • Embraces new technology • Derivatives, GPS, etc. • Small Farm Enterprise • • 350, 000 “Large Farms” – 95% of inputs – 95% of outputs 63% decline in farm ownership – 97. 5% decline for minorities 1, 000 acres needed to break even Federal Subsidies - $27 billion – 10% to farm owners – most of which were large farm owners (policies not helping) Department of Industrial and Manufacturing Systems Engineering

Introduction • Concentration Ratios in Agriculture • CR 4 = % market controlled by 4 largest firms • Flour Milling • CR 4 (1982) = 40%; CR 4 (1997) = 62% • Soybean Crushing • CR 4 (1977) = 54%; CR 4 (1997) = 80% • Pork Packing • CR 4 (1987) = 37%; CR 4 (1998) = 57% • Beef Packing • CR 4 (1990) = 72%; CR 4 (1998) = 79% Source: Heffernan (1999) Department of Industrial and Manufacturing Systems Engineering

Introduction • The Farming Enterprise • $185 billion annually on inputs such as chemicals, seeds, land, supplies, etc. and in return sales of $210 billion worth of outputs • 1950’s net farm income as a percent of gross farm income was 35 percent. Today it is 17% • Industrialized agriculture has embraced new technologies and management procedures – including supply chain management and web-enabled methodology • The small farmer does not have the size or production capacity to realize the necessary efficiencies of industrialized agriculture Department of Industrial and Manufacturing Systems Engineering

Introduction Farmers’ Share of the Food Dollar, 1954 to 1998 Source: Economic Research Service (2000) Department of Industrial and Manufacturing Systems Engineering

Introduction • Rural Communities and The Farming Enterprise • “Decentralized land ownership produces more equitable economic opportunity for people in rural communities, and offers self employment and business management opportunities. Farms, particularly family farms, can be nurturing places for children to grow up and acquire the values of responsibility and hard work. ” • “As small farms and farm-workers succeed. . . they will fuel local economies and energize rural communities across America. ” The National Commission on Small Farms (1998) Department of Industrial and Manufacturing Systems Engineering

Introduction • Small Farm Enterprises • For the small farm enterprise to be viable it must be able to respond quickly to product differentiation and to establish niche areas of product “farmers will increasingly be producing commodities with specific attributes called for by food processors who are responding to retail demand. Traditional patterns of farming will change; more products will be produced for niche markets and for international tastes. There will be higher pay-off for the entrepreneur on the farm” (Kinsey and Senaur) “market segregation may provide niche opportunities for producers who are willing to keep their product segregated and sell based on specific attributes rather than in bulk. ” (Baumel) Department of Industrial and Manufacturing Systems Engineering

Introduction • Small Farm Enterprises • “Rural people are disadvantaged regarding access to the basic technical knowledge to use the expanding infrastructure effectively”. U. S. Dept. of Commerce report on the digital divide (U. S. Do. C, 1999) • This is borne out in the Hopkins and Morehart (2001) study that shows only 0. 33 percent of all sales and purchases in agriculture during 2000 were conducted online. In addition only 1% of all farms connected to the internet conducted sales online. Department of Industrial and Manufacturing Systems Engineering

Introduction • Small Farm Enterprises • Do not have readily available tools and methodology to assist in effectively accessing or “organizing” new value-added or niche markets for their products • They lack the capability to take advantage of the newly developed technologies in information systems to construct supply/value chains that reduce their vulnerability to risk while increasing their direct profit. • An area devoid of contributions at the research level Department of Industrial and Manufacturing Systems Engineering

Problems and Objectives • Strategic Decision Making • “links between food manufacturers, wholesalers, and retailers are complex, ill-understood, and changing rapidly” Kinsey (2000) • Logistics • unlikely that a group of homogeneous small farmers will be in a common geographical area • Information Technology and E-commerce • • web-based technologies and e-commerce will be essential tools in the development and management of supply chains The advantage of this is to provide enhanced market access for rural small business and for organizing markets and supply chains • “the role of information technology has largely been ignored” (Buhr 2000) Department of Industrial and Manufacturing Systems Engineering

Problems and Objectives To efficiently deliver products small farmers need to: • Create or reengineer their supply operations to meet the requirement of speed and flexibility • Integrate and coordinate the system, which includes • customers, suppliers, information, productions, inventories, transportations, quality, prices, partnerships, and interdependencies. • The lack of predictive models to analyze supply chains and ecommerce might be part of the reason for the low visibility and chaotic situations that exist in supply operations. • New business models are needed to help assimilate, simplify and manage supply chain operations. Department of Industrial and Manufacturing Systems Engineering

Problems and Objectives To become and remain competitive through niche markets small farmers need to: • Develop virtual co-ops for leverage • Embrace e-commerce and web-based technologies to expand their markets. • Interact globally with suppliers and buyers • Create “new economic spaces” (Greenspan, Kelly and Gottlieb and Fisher) Department of Industrial and Manufacturing Systems Engineering

Models Department of Industrial and Manufacturing Systems Engineering

Models • Strategic Planning and Decision Making • Decisions include: • • To join or form a co-op What type of product to produce and how much Determination of when to take a product to the market Contract and pricing, capacity decisions, etc. • To join or form a co-op seems to be a very important decision and is considered here. Department of Industrial and Manufacturing Systems Engineering

Models • Co-op Problem • Without joining co-op can only sell individually and directly to customer • If join a co-op, usually more stable demand larger customer base. Also, not necessary to sell directly to customer • Question is whether to join or not, which is dependent on co-op size. What is the optimal size of the co-op? Department of Industrial and Manufacturing Systems Engineering

Models • Co-op Problem • Assumptions • Multiple homogeneous farmers producing one specific product • Production quantity is assumed to be Q • Each farmer faces local demand X, which is stochastic and has probability density function and cumulative distribution function • The price of the product for the local and direct farmer-consumer sales is equal to p 1 • local demand price is not affected by outside factors such as other co-ops and grocery stores Department of Industrial and Manufacturing Systems Engineering

Models • Co-op Problem • Suppose that the demand from wholesalers and institutions is expected to be D, and the sales price per item is , where p 2<p 1 • If n farmers form a co-op, total production quantity is n. Q > D. Assume each farmer sells D/n items through the co-op and the rest, Q-D/n, to local customers • If a farmer only sells products directly to local customers without using a co-op, then the revenue given by is f(0) Department of Industrial and Manufacturing Systems Engineering

Models If a farmer is a member of an n-farmer co-op, then the revenue is given by It is possible to show that f(n) is an increasing function in terms of n 1 , when and unimodal if Department of Industrial and Manufacturing Systems Engineering

Models Can use this model to determine whether or not to join a co-op. There exists a Q* and an n* such that Department of Industrial and Manufacturing Systems Engineering

Models • In other words: • A farmer should not join a co-op if the expected marginal price of direct selling is larger than the price obtained through the co-op participation • A farmer should always join a co-op if his production quantity is larger than a certain threshold value • Otherwise, the farmer’s decision should depend on the size of a coop. • The values of Q* and n* can be explicitly computed and used to assist individual farmers who try to measure the value of forming and/or joining a co-op. Department of Industrial and Manufacturing Systems Engineering

Models • B 2 B and B 2 C Models • When are direct sales to customers profitable for the small farmer? • Quantity and pricing strategies to optimize farmers’ profits • Because many products are perishable, farmers need to find balances between lower, yet certain profits, and higher profits with uncertainties • Analytical models can provide operational decisions so that farmers’ overall expected profits are maximized Department of Industrial and Manufacturing Systems Engineering

Models • B 2 B and B 2 C Models • Once a co-op is formed, various operational decisions should be made. Both the co-op and wholesalers desire to make decisions that maximize their profits, but only coordinated decisions can realize this objective • Joint coordination can result in decreased operation costs and reduced uncertainties, which will eventually yield greater satisfaction for participants. This is widely done in industrialized agriculture but is virtually nonexistent in small farm operations, (Hobbs and Young 2000) Department of Industrial and Manufacturing Systems Engineering

Models • B 2 B and B 2 C Models • Example: Supply Contract and Pricing Decisions • Assume: • Co-op suggests the sales price (p 2) for its products to wholesalers • Wholesaler decides on an order quantity (D) so as to minimize the total cost • Wholesaler faces random demand later from retailers and may need to pay either a holding cost (h) or a shortage penalty (s) • The pdf and cdf or the random demand is given by: and Department of Industrial and Manufacturing Systems Engineering

Models • B 2 B and B 2 C Models • The profit function for the supply chain is equal to the revenue of the wholesaler minus the wholesaler’s holding and shortage costs minus the co-op’s production cost Where is the sales price of the wholesaler Department of Industrial and Manufacturing Systems Engineering

Models • B 2 B and B 2 C Models • If the wholesaler follows an optimal ordering policy based on the well-known Newsboy problem, then and the profit function can be rewritten as follows Department of Industrial and Manufacturing Systems Engineering

Models • B 2 B and B 2 C Models • One of the objectives is to decide an optimal transaction price between the co-op and the wholesaler so that above function is maximized. After some analysis, we can show that the optimal transaction price satisfies Department of Industrial and Manufacturing Systems Engineering

Models • B 2 B and B 2 C Models • This results show that the optimal price is decreasing in demand if the production cost is strictly concave while the price is constant if the production cost is linear. • This implies, if a product has a concave production cost, a larger co-op can offer the product at a lower price enticing more wholesalers to the supply chain, and the addition will provide a profit increase for all existing members. • We can conjecture that eventually only well-coordinated large co-ops will survive. Therefore, it is necessary for a co-op to be aggressive in increasing demand, especially at the beginning stage of the supply chain. • If production cost is linear then smaller co-ops can compete because the optimal transaction price should be the same regardless of the size. Thus, the operation of a co-op should focus on other issues such as quality and customer service rather than becoming large. Department of Industrial and Manufacturing Systems Engineering

Models • Accepting a New Contract • Contract between buyer and cooperative defined by price and quantity (p, D) • Let p 0 be price for local buyer now • Assume have current contract (p 1, D 1) and considering new contract (p 2, D 2) where n. Q>D 1+D 2 • Accept New Contract if Department of Industrial and Manufacturing Systems Engineering

Models • Amount of Product for Farmer to Supply • Suppose that the farmer contributes R products then the revenue is • The optimal delivery quantity for the farmer assuming they are required to deliver a quantity between R 1 and R 2, R 1 < R 2 is then Q R 1 Q - -1(1 - p 1 /p 0) R 2 if Q<R 1 if R 1 < Q < R 1 + -1(1 -p 1 /p 0) if R 1 + -1(1 - p 1 /p 0) < Q < R 2 + -1(1 - p 1 /p 0) otherwise Department of Industrial and Manufacturing Systems Engineering

Conclusions • Initial stages of study • Need real data • Co-ops in Mississippi, California, Illinois, and Missouri • • Models need to be extended to more realistic scenarios Problems difficult, but interesting due to the uncertainties Important problem from a political and policy standpoint Supply chains are in a highly variable, high risk, low margin, seasonal, niche market environments – may relate or be applied to certain “dot. coms” Department of Industrial and Manufacturing Systems Engineering