THE ‘COSTCO-IFICATION’ OF AGRICULTURE

What American consumer doesn’t love a retail experience in which you can, in one stop, buy a new TV, eyeglasses for the kids, tires for the family car, steaks for the grill, jeans for the whole family, and enough toothpaste and granola bars to last six months?

 

The success of mega-retailers like Sam’s Club and Costco are proof that this is something of an American dream for many busy consumers today, especially young families with changing material needs and a limited budget. And now, Costco is taking steps to stake major claims in not just the consumer side, but the production of one of its most popular products.

 

Costco has offered a $5 rotisserie chicken for years at the majority of its stores. Consumers say it’s a huge hit and quite a bargain, and that’s stirred major demand in the retailer’s 514 U.S. stores. It has also created a problem: The 8 percent year-over-year increase in the last nine years has outpaced the supply of chicken available to Costco.

 

The solution: Raise their own birds. Earlier this year, the first of more than 500 planned new chicken barns in the Midwest opened in eastern Nebraska. Those barns, owned by Costco and Lincoln Premium Poultry (LPP), will be managed and operated by area farmers, with 100 percent of production going to a new processing plant in Fremont, Nebraska, just northwest of Omaha. The plant will process 2 million birds per week and use 350,000 bushels of corn every week. Costco officials estimate the facility and farms will have a $1.2 billion economic impact in a 100-mile radius around the plant where birds will be raised.

 

It’s not been a small investment; Costco, LPP and the farmers raising the birds will invest more than $300 million in the construction and management of the barns. Though the development has come under fire from different opposing interests with different concerns, it’s been a boon for area farmers struggling to make ends meet raising corn and soybeans, both of which are trading in sub-profitable ranges.

 

The Costco project came at an ideal time and, provided it is successful, represents a new business model for agriculture. Despite some vehement detractors in some sectors of the industry, vertical integration has been around in agriculture, in one form or another, for a long time. But, this takes that integration further. The consumer spoke with his or her wallet, then the retailer responded and now has the pieces in place to provide a consistent supply chain that it owns and operates — controls — itself. Costco customers wanted their rotisserie chicken and they’re going to get them.

 

Five years from now, corn prices will likely have risen. So, those 350,000 bushels of corn Costco needs to feed those birds will be more expensive. But, there are contracts in place and bird numbers to deliver to stores, so the company has to keep cranking out the goods. If that starts to happen at a loss — or anywhere close to it — you can bet Costco will act. That may first be contracting corn in larger amounts to lock in a lower price. Or, it may be changing production — like leveraging one of Kemin’s animal health products— to make birds healthier and more efficient. Either way, Costco’s vertical integration will make its way to another sector of the entire supply chain. Now, it will control not just the product itself, but the inputs required to make it.

 

So for example, Costco’s next step may be to purchase a cooperative with multiple locations in close proximity to its 500 chicken barns, enabling it to now control its corn supply, including transportation and distribution. And, it may enter into large contracts with other input providers like vet clinics and companies like Kemin to secure necessary animal health services and inputs, thereby helping ensure a steady supply of birds.

 

It’s not totally absurd to envision a day when Costco contacts a large farm machinery manufacturer and places an order for a specific number of machines to raise a specific amount of grain to raise its chickens. And, it’s just as easy to imagine Costco one day employing a seed buyer to work with the likes of Pioneer and Monsanto to secure the right seed corn in the right quantities to maintain its chicken supply chain. Who could be bidding on the next 80 acres of farmland for sale? A representative for Costco. Sure, it may transfer land to corporate hands, but it can and still be managed by local family farmers.

 

So, in the end, Costco’s effort to continue to provide its customers with the rotisserie chickens they enjoy so much could lead it to just about every specific sector of the crop and livestock industries.

 

The end result will be a vertically integrated system literally from the earliest stages of production directly to the end product, all owned, managed and controlled by Costco. Many in agriculture — like the free market purists and staunchest believers in the importance of independent agriculture — won’t like it one bit. And, they have every right to believe that. But for two key demographics in the equation — the consumer and the farmer who’s looking for profit potential in areas outside conventional row crop production — profit potential and the resulting ability to continue to sustain multigenerational family farms will trump any reluctance, especially with a large company like Costco backing the entire system.

 

And Costco won’t be the last company to try it. Though it’s already happening to some degree for some large retailers, the trend will continue, with the likes of Wal-Mart, Target and Amazon.com getting in on the action. It’s starting with $5 rotisserie chickens now, but the possibilities to vertically integrate and control production systems are essentially endless for the world’s largest retailers. People laughed at Jeff Bezos when he launched his online bookseller in 1994, but now the company is among a few that can reshape how food is produced.

 

Yes, this change faces a lot of hurdles before it becomes mainstream; most commodities are bought and sold on a market basis, and selling into those markets has been a major mode of operation for farmers and ranchers for generations. And, there is a lot of money and infrastructure tied to today’s system of ag markets. In some sectors — namely beef cattle production — “vertical integration” has long been something of a four-letter word. But, just in the last 20 years, the sentiment has changed considerably. Though beef is well behind the pork and poultry sectors, it’s likely that sector will see more vertical integration in the future. The average crop farm has followed a general growth trend over the last century, and vertical integration will be a likely partner to that growth in the next century.

 

But, it may not come easily. Vocal opposition to vertical integration, as well as consistent calls for the sustenance and survival of family farms in the U.S., will resist the transition. But, will that opposition be to the new corporatization of agriculture itself, or will it be to the level of change that process will entail?

 

In a time when farmers and ranchers are struggling, it’s important to keep our eye on the prize: The continued welfare of family farms in the U.S. If a 30-year contract to raise chickens for Costco enables a young farmer to continue his family’s legacy and keep the operation in his family’s hands, it’s important to focus on that outcome. He may not sustain success by independently marketing corn and soybeans and instead do so fulfilling contractual obligations to Costco. But, at the end of the day, does it matter if he’s still successfully doing what he loves?

 

This evolution will require a lot of adaptability from ag retailers and others in the agricultural supply chain to recognize their path-to-market may change considerably when working with customers who become part of a production system like the Costco rotisserie chickens. Tomorrow’s seed corn may not be purchased by farmers themselves, but by representatives of a mega-retailer with whom those farmers have contracted bushels. The farm machinery dealership may become a thing of the past, replaced by distributors whose deliveries are negotiated by representatives of the companies contracting out grain production intended for a specific purpose at a specific retail outlet.

 

It will be important for agriculture companies to not only stay abreast of the change and how it’s happening, but more importantly, understand how it specifically impacts their customer base, including how they pursue new customers. Future versions of today’s seed corn, fertilizer, chemical and machinery will be utilized in growing a crop. And, farmers will still be the ones ensuring those inputs perform well. The ones footing the bill and managing those costs may be entirely different. By starting to think about that change now, you won’t be surprised when the change does begin to occur.

 

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