Issue No 11, January 1999.

NOTICE: Hard copies of the Australian New Crops Newsletter are available from the publisher, Dr Rob Fletcher. Details of availability are included in the Advice on Publications Available.

2. Critical Success Factors and Strategic Issues in New Agricultural Enterprises

Dr David A McKinna
David McKinna et al. Pty Ltd
Rear 131 Victoria Avenue
Albert Park 3206
Telephone: 03 9696 1966
Facsimile: 03 9696 1965

[David McKinna is the principal of David McKinna et al Pty Ltd, a Melbourne based marketing consultancy with an international client list specialising in strategic marketing.

David McKinna et al Pty Ltd has been involved in the area of market development and strategic marketing in a number of industries, primarily concerned with meat products such as venison, ostrich, emu and aquaculture, over a number of years. All these industries follow a rather predictable pattern involving four stages viz the embryonic stage, the speculative stage, the commercialisation stage and the maturity stage (as indicated in the figure).

In most cases, new enterprises start off with great optimism but suffer a rapid demise, tarnishing their image. The demise usually occurs in the transition between the speculative and the commercialisation stages.

During the first, embryonic stage, pioneers discover a new enterprise. This can originate from an overseas visit, can be the result of a desire to commercially farm a naturally occurring native animal or plant or may be the result of a search by farmers in traditional industries seeking out new income sources, as a result of a downturn in their traditional industries.

Pioneers can independently identify the same potential industry and be unaware of each other for years.

The new industry often starts as a hobby or adjunct to another commercial farming enterprise.

Enthusiasm for the new idea drives the pioneers to conduct independent research about their subject and farming starts on a limited scale. Local interest or intrigue prompts them to participate in field days and local shows.

The second stage in the life cycle is the speculative stage. During this stage pioneers foresee a huge commercial potential and start to interest others, who may be driven by an interest in capital gains and tax deductions.

The entrepreneurs' enthusiasm for the project becomes infectious as they actively promote the enterprise, often claiming super profits.

These schemes are often driven by a prospectus attracting public funding.

If there is strong interest in the new industry, the price of production units such as breeding animals, plants or seed, grows exponentially. This becomes self feeding. The increase in value supports the notion that there is money to be made.

More investors are attracted and prices rise even further, even though there is virtually no commercial production because breeding materials are so valuable.

At this stage, the number of players grows exponentially but each has a small number of production units. Industry associations form as the need to manage the industry becomes apparent.

Invariably the speculation bubble bursts, usually within three to four years. The demand for breeding materials is satisfied and prices drop. The more astute participants withdraw, causing an acceleration in the price drop with prices going into free fall as speculators panic.

Most speculators get burnt.

The industry falls into disrepute, receiving adverse publicity and often being the subject of a government enquiry.

While the speculative stage is coming to a halt, there is a band of quiet achievers who are developing commercial operations.

Typically, these operators get in early and don't pay a high price for their stock. The new industry is still a sideline to some other enterprise, but it is steadily growing in scale.

These operators adopt a professional approach, undertaking research and adopting new farming practices to improve productivity and product quality.

During the commercial stage, the number of people in the industry typically declines but the average farm size grows steadily.

Research agencies start to pay attention to the new industry and may devote some resources to it.

Success at the commercial stage is mixed but new agricultural industries often go through a very depressed period. Farm gate returns from the product can decline as production increases and the latent demand, which is usually quite thin, starts to become satisfied.

The extent and rate of the decline depends a lot on how effective the industry is at developing markets and building demand for its product(s).

The declining farm gate returns pro-duce a natural adjustment process; the less efficient operators drop out and the better ones enjoy acceptable returns, but at a diminished price because of their efficient production.

The final stage occurs when the new agricultural industry reaches maturity.

There is a stagnation in production levels and consolidation in the number of farms.

The industry experiences commodity cycles and mixed profitability, like other agricultural industries.

At the maturity stage the industry tends to be well organised with a strong industry association, stable management and good links with government.

Large corporate farms often arise, with large holdings of production units combined with processing, value adding and trading arms.

The critical time for new agricultural enterprises occurs during the transition between the speculative stage and the commercial stage.

For example, the venison, emu and ostrich industries have not managed this transition well.

On the other hand, the Tasmanian aquaculture industry has managed this stage well through the government's ability to control production. Breeding stock has been managed and farming leases controlled.

A big problem arises if the price of production units does not reflect their commercial value but their speculative value instead.

With the speculative component removed, price reflects what can be received for commercial production on world markets.

At the peak of the speculative stage in the ostrich industry, breeding pairs were selling for more than $30,000 when the commercial value of the birds for slaughter was less than $1,000 each. The ostrich industry should have encouraged the slaughter of birds to start the development of markets and the establishment of processing and distribution infrastructure.

Only inferior quality culled birds were available for slaughter which meant that insufficient numbers were available to sustain any commercial slaughter facility and the quality of meat and skins was not good.

There were no products available for cutting trials, cooking and palatability testing or as samples for chefs to taste and evaluate.

Hence, demand was not being expanded at the rate required to absorb the production increases occurring. The big problem is the speed of the adjustment process. Because the speculative element withdraws abruptly without any apparent warning, prices drop dramatically. If this were to occur more gradually, there could be some adjustment.

Such crashes are inevitable and highly predictable.

The performance of a new agricultural industry, the extent of the fall and the extent and speed of recovery are totally dependent on how well the industry manages itself.

Most problems with new agricultural enterprises can be traced back to a lack of critical mass, that is, having insufficient volume to support and finance the framework and business systems.

Critical mass means having sufficient volumes in an agricultural industry to support:

• An economical processing and value-adding infrastructure,
• Economical trading and distribution networks,
• An effective market development and promotion program,
• The administration of the industry, and

The long term financing of development.

This is a "chicken and egg" situation.

Once production volumes reach a certain level, there are adequate product and resources to support the necessary systems and programs.

However, in order to get volumes up to these threshold levels, the systems and structures need to be in place.

Critical mass needs to be achieved quickly.

Unless this occurs, it won't happen at all because the economies of the new industry quickly become undermined.

Ultimately, the problem of critical mass is solved by having adequate capital.

When any business enters a new venture it expects to invest heavily up front but will not reach a break-even point in terms of profitability for three to five years.

To finance this, it has to borrow capital or maintain a cash flow from other profitable business.

New agricultural enterprises don't usually have access to such start-up capital.

Governments are reluctant to invest money because of the risk and the dismal track record of previous ventures.

The ostrich industry attempted to solve this problem by forming the Australian Ostrich Company which floated shares to raise capital for industry development and commercialisation.

Unfortunately, they didn't raise enough capital as their listing was seriously under-subscribed.I believe that most new agricultural enterprises would be highly successful if they had adequate seed capital to finance the infrastructure and systems for their commercial development.

Our extensive work in new agricultural enterprises has allowed us to identify a number of critical success factors that that need to be addressed by new agricultural industries.

It is essential that any new industry has an effective industry association which represents the vast majority, if not all, stakeholders and is capable of developing a cohesive long term vision and plan for the industry.

There must be enthusiastic support on a broad scale.

New enterprises almost always have some form of industry association but they often can't get agreement on fundamental issues.

Most have good intentions but have difficulty in working through, and achieving consensus on the extremely complex issues that confront a new industry.

New industries comprise a rich diversity of supporters.

They attract traditional agriculturalists who are seeking to develop or are curious and entrepreneurs or city-based investors, who are usually professionals and other successful business people who have funds to invest and are seeking some form of tax relief.

Within industry associations, there is fragmentation in thinking which often divides on geographical lines since participants from different areas or states have different ideas.

There is also a lack of finance to adequately fund the required infrastructure simply to administer the industry.

Effective industry associations require a lot of money to run. Relatively small associations have annual operating budgets in excess of $300,000 per annum.

Industry associations play a pivotal role in directing a new industry. Their job is to ensure that the systems, financial mechanisms, policies, strategies and programs are in place.

They also need to establish an effective working relationship with the three levels of government which typically have a strong impact on new industries at a number of levels such as planning, taxation, market access, financial support, etc.

The four essential elements for an effective industry association include:

• An effective executive director/chief executive with good support staff.
• A strong board which collectively has experience in finance, legal, marketing, business management, technical production, agropolitics and government relations. If this is not available from within the industry it must be sourced through external directors.
• Full support from the industry itself with high representation among stakeholders.
• Adequate finance and financial mechanisms and structures. This needs to be far more sophisticated than a mere annual subscription.

It needs to be legally constituted with a capital base which can be used as collateral to borrow money to finance projects. Many industries are opting for a quite sophisticated shareholder basis, even to the extent of attracting speculative investors from outside the industry.

New enterprises must have sufficient capital to finance infrastructure, systems and research and development.

For example, processing and value-adding plants usually do not have sufficient capital and throughput to make them economically viable and can expect to run at a loss for the first three years.

Hence, working capital is needed to subsidise the operation in these early years.

Capital is also needed for market development, promotion, the establishment of trading systems, Research and Development, etc.

Once the industry is up and running, these things can be readily financed out of cash flow or there is the ability to borrow because the enterprise can now demonstrate that it will be profitable.

The problem with new agricultural enterprises is that capital is required up front with the prospect of not being repaid for five years or so.

Agricultural producer groups have difficulty in raising such capital because they are mature and inherently generate low profits.

Governments are reluctant to provide loans or grants because these enterprises are considered speculative.

Industry floats have had a chequered history in agriculture because there is a lack of such capital available.

Traditionally in Australia, the approach to financing collective activities is to form a co-operative.

Unfortunately the co-operative structure needs a steady and reliable cash flow to survive.

Under the regulatory provisions of co-operatives, there are limits on borrowing monies or retaining earnings.

One possible solution is to attract a commercial partner with the capital, interest and expertise to finance and operate the commercial arm.

Possible partners may be companies such as Wesfarmers, Elders, Bunge, ConAgra, etc. These organisations are cash rich and have the required management expertise.

The downside of such partnerships is that the industry must relinquish control and share profits.

Like any commercial agricultural enterprise, new agricultural industries must strive for world's best practice in production.

Almost without exception, new agricultural products are internationally traded, and can expect strong competition from other countries.

Trading competitors may benefit from some form of comparative advantage, either in climate, labour, access to superior breeding materials, etc.

The new industry must be profitable in the light of what is usually formidable global competition.

Farms must be able to maintain their commercial viability as farm gate prices decline, which is inevitable.

The production systems of new agricultural enterprises are usually not well understood by the industry or by the traditional research agencies.

Departments of Agriculture and other research and extension groups are invariably on a steep learning curve, basing knowledge on that gained from previous experience in more traditional agriculture production.

As well, breeding materials are at an early stage of evolution with growth, yields and quality often low relative to that of the traditional industries.

New agricultural industries often fail to establish an effective processing and/or value adding infrastructure. Virtually all but basic commodity items need to be value-added or processed in some form or another.

Processing/value adding with new agricultural industries requires:

• Establishing appropriate tech-nology and production systems, usually by adapting technologies from other industries. Unfort-unately, this can involve compromises in productivity and quality, when compared with purpose-built technology.
• Skilling the labour force.
• Achieving economic through-put levels, since new agricultural enterprises do not have the through-put in the early stages to justify or finance an efficient processing/value adding plant. This problem can be exacerbated by the geographical spread of the participants.

Any business enterprise needs to be underpinned by a market-focussed product description and quality culture.

A product must be described in terms of its key performance attributes.

Quality and product description for new enterprise products are important because the unit price is often high and the customer is not confident in its use.

The key quality/performance specifications for a new product need to be determined, along with quality assurance procedures that predict the quality and performance of the product and its suitability for various end users.

This can mean a substantial R & D program involving performance trials for the product, end-use evaluation involving consumer taste panels and the development of measuring technology.

Considerable time and investment is required to develop the necessary quality assurance procedures, systems, standards, etc.

If a new industry does not get quality right at the outset, reputation and returns will be rapidly eroded.

Whilst quality assurance/specification systems need to be market-driven, they also need to be sensitive to the realities of production. There must be effective communication between the consumer and the producer. The price/product valuation schedule must be based on the value of the product to the consumer.

If quality compliance becomes too difficult for producers, they seek alternative outlets thus fragmenting the industry. Selling outside the system results in the undermining of prices and returns.

Quality culture must be based upon a process of continuous improvement.

Most new enterprises lack a cost- effective trading and distribution infrastructure.

For bulk commodity lines, there is an international network of multi-commodity brokers who can put together back-to-back deals.

However, the real problem comes with finished and perishable products which require a distribution and representation framework to get the production onto supermarket shelves or into food service outlets.

The economies of distribution are heavily driven by volume. It becomes excessively costly to distribute small quantities of product across a wide geographical market.

In most cases it is uneconomical to establish a dedicated trading and distribution network.

The best solution seems to be some form of strategic alliance with organisations which distribute complementary but non-competitive products to the same customer base.

Whilst this point is numbered sequentially as number 7, after capital availability it is the second most important success factor.

The economies of a new enterprise, and particularly its ability to endure the transition from the speculative to commercial stages, is under-pinned by the ability to develop market demand at the level and rate of growth to absorb the rapidly expanding supply.

With new products the market is very thin; it only takes 5 or 10 tonnes of oversupply to flood the market and cause the prices to free fall. It is therefore essential to develop new markets to ensure that all product can be placed at an economical price.

Market development problems include:

• Lack of funding. Market development activity, particularly promotion, is quite expensive and usually requires activity both locally and overseas.
• Product availability. Market development activities need to occur to create demand before the product becomes available for consumers to buy. Such activities can be restricted by a lack of product, including the problem of not having samples for prospective customers.

Export market development is very costly, even just to research market opportunities. Market surveys and the appointment of agents is costly.

Special promotional material needs to be developed to cater for cultural or language differences.

A large amount of work is needed to develop protocols to gain export market access. There are immense opportunities for new products in the Asian and European regions but there are market restrictions. A key element of market development is promotion. New agricultural industries struggle because they have low budgets for promotion and cannot interest the larger promotion agencies which have the expertise and proven track records.

A minimal market development and promotional exercise for one market can cost $100,000.

Branding is a proven marketing tool. If done well, branding will generate brand loyalty and premium returns and will give an industry a greater degree of control over the marketing channel.

Marketing and promotional programs are more effective if they are focussed on a brand.

Generic promotional programs help to develop an industry, but benefits flow to the competition as well.

Branding is more than labelling a product. It needs to be underpinned by a strong marketing strategy and culture, committed to quality.

The discipline needed is often not available in a new industry.

The integrity and strength of a brand depends on the lowest common denominator.

Product markets usually have no difficulty in disposing of the top quality product at a high return.

All industries inevitably produce a certain percentage of lower quality/less preferred product, regardless of their commitment to quality and this product must be disposed of satisfactorily.

Value adding to re-engineer or re- position this less desirable product is often essential to maintain the new industry's viability.

The long term success of a new enterprise is invariably determined by how well it manages this transition.

The speculative stage generates awareness and interest in a new agricultural industry and attracts capital.

However, this stage invariably becomes highly destructive, threatening the industry's long term viability and damaging its image.

There is a role for government in regulating the speculative stage.

At the very least, it should tighten up the requirement for prospectuses on new enterprises. There is a need to ensure that potential investors or participants are well informed about what they are getting into, the longer term prospects, critical success factors, and so on.

The transition stage also requires a steady growth in the quantity of commercial product coming on to the market.

One approach would be for the industry to subsidise part of the difference between the commercial price and the production price through some form of industry scheme.

New enterprises need R & D on several fronts:

• On farm production
• Product description and quality
• Processing and value adding
• Product performance
• Transportation and distribution
• Market research and intelligence

The traditional research providers for agricultural enterprises are more frequently adopting a user-pays approach to their activities and new industries have little available funding with which to bargain for R&D attention.

Mature agricultural industries typically fund R & D from production levies which usually attract a government subsidy.

Unfortunately new agricultural industries do not have the infrastructure or political clout to put such systems into place.

One of the key roles of the industry association is to identify R & D priorities, and to ensure that the funding and expertise are in place.

New enterprise industries are likely to face novel bioethical issues which the industry associations must be ready to deal with effectively as they arise.

For example, the issue of products from genetic engineering has the potential to become a highly emotive issue.

Voluntary codes of practice developed in close consultation with welfare or lobby groups and government is a good starting point.

The behaviour of new enterprises follows a very predictable pattern with the issues and performance factors being common.

Unfortunately, the same mistakes are repeated.

The more successful new enterprises are usually the ones with some degree of government control to prevent or minimise the highly damaging speculative boom.

The idea of new agricultural industries forming some form of strategic alliance with a big brother company is attractive for long-term viability.

The big brother company has the capital, vision and management structure to manage the industry through the transition from speculation to commercialisation.

When large companies put 'hurt money' on the line, they will do everything they can to make it succeed.

Contact: Dr Rob Fletcher, School of Land and Food, The University of Queensland Gatton College, 4345; Telephone: 07 5460 1311 or 07 5460 1301; Facsimile: 07 5460 1112; International facsimile: 61 7 5460 1112; Email: r.fletcher@mailbox.uq.edu.au

[New Crops Home Page] [New Crops Program] [Australian New Crops Newsletter] [New Crops Publications] [Order Form] [People] [Crop Profiles] [Other Resources]

originally created by: GK; latest update 6 June 1999 by: RF