Chickenization: How Far can Vertical Integration Go?

By Candace Krebs

Vertical integration has created new opportunities, added efficiencies and given farmers access to the consumer market at levels they couldn’t accomplish alone. But it has also concentrated ownership, pushed more of the financial risk onto farmers and in extreme cases severely restricted market access, particularly in segments like poultry and hogs.

It’s no mystery, then, why farmers tend to view it as either a necessary evil or as something they love to hate.

Could the crop industry ever get to a point where farmers are totally controlled by integrators, as in the poultry industry, a phenomenon sometimes called “chickenization?”

Chris Hurt, an ag economist at Purdue University, has spent his entire career — nearly 40 years — studying industry structure. He notes there’s always been one big deterrent against grain handlers, processors and marketers owning the farm: crop farming is land extensive rather than land intensive.

“As you get beyond 2,000 or 3,000 acres, or 50 or 60 miles, it’s difficult to concentrate that much production. Too much land is tied up in ownership by different families,” he says. “Having said that, among tenants there has been a movement toward larger size and an effort to overcome some of these distance issues. We could see more of that in the future. If there was a marketing mechanism for land that made it easy for people to bid on what was closest and swap out land farther away, we would probably see that accelerate.”

As farm size grows and numbers decline, it also becomes more feasible for a handful of big companies to offer production contracts to a limited number of preferred suppliers.

“Potatoes are primarily raised in this way, with 25 or 30 producers providing nearly all of what the companies need,” Hurt explains.

Contractual Wrench in the Works

Admittedly one thing that has thrown a wrench into these trends is the rise of specialty markets, with recent agricultural census data showing increases in the number of very large and very small farms, but a decline among those in between.

Roughly 20 years ago, an early push for more identity preservation led to the presumption that crop supply chains would become increasingly coordinated. That never materialized to the extent many people thought it would, Hurt says. Such a high degree of segregation proved impractical within the limits of existing infrastructure. 

“The economic advantage turned out not to exceed the cost,” Hurt says.

Contractual arrangements have also been tempered somewhat by the inevitable churn of a capitalist economy. When highly integrated companies try to gain an advantage by tying up superior genetics through copyrights or patents, for example, their efforts have met with mixed results, Hurt said. At one time, some poultry and pork integrators pursued a strategy of buying up genetics companies. What they learned is smaller, more focused companies often developed better genetics faster.
 
“Ultimately they decided to leave that business to other companies. What they realized is if you are locked into a certain technology and somebody else comes up with something better, you have to be able to shift quickly or you become uncompetitive,” he explains.

Chickenization

Phil Howard, an associate professor of community sustainability at Michigan State University, also notes the tendency for new marketing opportunities to bubble up in unexpected ways. He points to a recent move by WH Group of China, the owner of Smithfield Foods, to buy feed grains directly from farmers, with the goal of cutting out the middleman, reducing costs and sharing back some of the savings with producers.

He also notes that production contracts for crops haven’t functioned in quite the same way as captive supply contracts in cattle or hogs. Pre-arranged livestock delivery obligations often provide packers with enough supply to step out of the negotiated market at certain key periods, whereas the market for grains is too fragmented and diverse to be used in that manner, he says.

Still, Howard doesn’t think farmers should turn a blind eye to consolidation. “For soybeans there are still competing buyers. But as there become fewer buyers, there is more pressure to enter into production contracts to get more stable prices. The problem is the initial favorable terms tend to become less favorable over time,” he says.

Farmers as Long-Time Integrators

Farmers have fostered vertical integration by forming cooperatives to gain leverage through collective ownership and control of processing and marketing. As cooperatives grow, one downside is they often come to resemble the same firms they are competing against, finds Howard. Large dairy cooperatives, for example, have been accused of driving down prices to farmers while paying executives millions in salaries and benefits.

“There’s no guarantee a co-op will continue to represent the interests of its farmer-owners, especially as they scale up and more people get involved and there are more layers of bureaucracy,” he notes. 

At the same time, co-ops face similar merger and acquisition pressures as the rest of the industry. “It’s a challenge for them to identify niches where they can find value for their farmer-owners and remain competitive with corporations, which public policy currently favors,” he concedes.

Individual co-ops forming larger networks and joint ventures to increase inventory and generate greater bargaining power is a growing trend that Howard is now studying. A classic example is OFARM, which stands for Organic Farmers’ Agency for Relationship Marketing. The umbrella marketing group, based in Minnesota, represents six organic grain and livestock marketing cooperatives that operate in Illinois and 18 other states. Together they account for the largest farmer-controlled block of organic grain in North America, according to USDA.

Poultry meat is one of the fastest growing organic markets

“One of the fastest growing organic markets is poultry meat, and that has created huge demand for organic soybeans,” says John Bobbe, OFARM’s executive director. “Here in the U.S., we do not produce anywhere near what is required, so we import 70 percent of the organic soybeans that are being fed. But it’s not that the beans couldn’t be raised here, it’s just that farmers haven’t been sent a signal that we need the acres. And imported grain flies in the face of what consumers want when they buy organic.”

In addition to fighting for organic integrity in the marketplace, OFARM is working on developing contractual models that are favorable to farmers. “One of the big questions for us is how do farmers get control of contracting mechanisms, so that the contracts are written by farmers rather than by the buyers or brokers?” he says.

One thing he encourages organic farmers to do is invest in on-farm storage. He also reminds them there’s strength in numbers.

“To have a say, farmers have to become involved, and they have to be loyal,” he says.

Bobbe does worry that Rural America’s sense of solidarity has changed since he was growing up on a conventional dairy farm in Missouri.

“One of my master’s professors at the University of Missouri, who was among the last in the department to have a farm background, used to say farmers have no instinct for self-preservation,” he recalls. “If they would only act collectively it could work, but because they don’t have that instinct, they end up susceptible to divide and conquer.”