Pundit’s Mailbag — Reshuffling The Tree Fruit Industry
Jim Prevor’s Perishable Pundit, January 28, 2009
Our piece, Tree Fruit Industry In Turmoil, brought much attention, including drawing this letter from a man whose name is synonymous with industry efforts to make the consumer experience of consuming tree fruit a more satisfactory one:
Thanks for illuminating the challenge in the tree fruit industry. There is a swifter current just under the surface than what is casually observed. I have attached a few comments from my perspective.
We appreciate your intelligent insight to the produce industry dynamics.
Steve was then kind enough to lay out his assessment of things:
Tree Fruit Industry in Turmoil: A decade of declining gross receipts, rising costs, inefficient organizational structures, rising retail prices and persistent inconsistent eating quality has brought the industry to this tipping point.
The root cause of the problem is a decline in consumption. CTFA strategic plans over the last 5 years zero in on the consumer’s frequent disappointment with their experience with peaches, plums and nectarines. The Perishable Pundit’s own family’s experience and discussions with consumers across the country have confirmed this.
The average retail prices have crossed the $2 per pound mark the last two years and the consumers are making a value judgment. This decline in consumption has fundamentally shifted the pendulum of supply and demand. Gross receipts to the growers have been flat-to-declining over the last 10 years with the cost of production, packing and distribution increasing at an accelerating rate.
What the California tree fruit industry is currently experiencing is not only a change in volume from orchard pull-outs but also a change in the structures of the organizations. The organizational structure of a company greatly impacts the efficiency of the business, the consistency of the product quality and its margin structure. The advantage of being a vertically integrated operation is being magnified. The flatter organizational structure, the improved coordination, the ability to make investments at all levels (varieties, farms, packing, post harvest handling, distribution and marketing) to raise the value of the product. The lower costs across all functional area is leveraged by the cumulative margins being available to support the entire entity, as opposed to separate profit-driven entities diverting profits from reaching the ranch. The result is a combined advantage favoring the vertically integrated operations.
The results of the last two years are driving us to this tipping point. Year 2008 saw a steepening of the decline of revenues and accelerating production costs, given the $.50 increase in minimum wage, higher costs for fuel, fertilized, packaging, transportation and water.
The current financial crisis is not so much one of liquidity of the lenders as it is a flight to quality. The old model of lending against land values is gone. The lending criteria have tightened and only the most credit-worthy, from a cash-flow standpoint, will have access to capital to maintain and expand their operations.
The “tree fruit bailout” is one of growers and companies bailing out of the industry. This will lead to significant shifts in the supply positions of the vertically operations and non-vertically integrated commercial packers and marketers. We are aware of one large packer closing their doors, two medium-sized packers will also not return in 2009, a significant amount of acreage is attempting to be sold that will likely change hands of marketers.
Several “marketers” who have advanced millions to growers are at risk of not recovering this capital. This desperation has put a significant amount of acreage on the market with a very limited pool of buyers. The land prices are down significantly from two years ago and the trend is expected to continue. These dynamics will be impact the marketing of tree fruit in 2009 and will be amplified in 2010.
The flight to quality is not only limited to the financial institutions… we are seeing the same with vendors, talent and customers. The top 5 companies in the tree fruit industry are all vertically integrated. They are being offered opportunities daily in the form of ranches, talented people and related services.
HMC is one of these top 5 companies. Over the last 3 years, we have been investing for quality in our current ranches, packing facilities, distribution and marketing to advance the consistency of our offering to the consumer and our customers in all channels. A deliberate move was made over the last three years to suspend our annual land purchase practice. Land prices became inflated fueled by the real estate boom in central California.
During this time we redirected this capital investment into existing assets, updating varieties, smoothing supply curves, R&D, etc. The current market situation has brought prices and available properties to the point where we are again strategically purchasing land to expand our stable base of production.
We are optimistic about the future of the tree fruit industry. This optimism is based on our knowledge that by aligning the supply chain, we can deliver a consistent eating experience that the consumer will respond to. People, like your son, love a great-tasting peach and this has not changed. The inevitable thinning on the industry will bring supply and demand into balance and the industry will be in the hands of capable marketers who can extract the true value of the product.
We appreciate Steve’s willingness to both explain the nature of the problems and provide a hopeful perspective on the future. Of particular note is that Steve does not simply posit that “the last man standing” after weak players go broke will survive but suggests that the future of the industry lies not just in reducing production but in a difference in the nature of business organization in the tree fruit industry.
Specifically, Steve believes that a vertically integrated supply chain is easier to align toward the production of fruit of enhanced eating-quality. Since Steve explains that “The root cause of the problem is a decline in consumption,” a reorganization that produces better eating quality contains the seeds of an industry rebound.
More broadly, Steve points out that all of production agriculture is experiencing a flight to quality on the part of banks in making lending decisions. This is startling for many as the continual rising value of land over the past several years covered a multitude of sins.
Rising land values meant that growers always had new collateral, so, as a result, they didn’t actually have to pay back money they borrowed. With that party over, banks are imposing normal business criteria and lending only to projects that provide evidence the bank will get paid back.
It is not really a crazy standard but can feel oppressive to those who operated in another mode for so long, and it doesn’t just apply to tree fruit. All over the country, indeed, around the world, growers are being asked to establish that their operations are likely to be profitable and produce free cash flow.
Some won’t be able to do so, and so production will drop in many areas. As Steve points out, this dynamic creates opportunities for well-financed companies willing to invest. Land, personnel, suppliers, customers all get put up for grabs when an industry reshuffles. Reduction in production also reshuffles the deck on the relationships between buyers and sellers. Many a buyer who has felt free to dictate price and terms may find nobody willing to sell under those conditions. Won’t that be a wake-up call!
If we can come out of all this, in tree fruit and elsewhere in the industry, with suppliers that are not only larger but more focused on consumers with better abilities to provide consumer value, the reshuffling, though painful to many, will be a big win for the produce industry.
Many thanks to Steve Kenfield and HMC Group Marketing for sharing this perspective with the industry.