V ertical C oordination I n M alting B arley A S ilver B ullet for C oors ? L indsey H iggins P ablo R amirez Texas A & M University College Station, Texas

C oors’ S trategic D ecision How can our supply chain management structures withstand the economic threats of a dynamic world market?

C ase O bjectives Determine the theoretical framework that best describes Coors Brewing Company’s decision to contract their malt barley input needs Determine how the resulting analysis will apply in Coors’ attempt to capture more market share in the changing world economy

T heoretical F ramework Transaction Costs Theory Agency Theory Contractual Incompleteness Key Aspect: These 3 theories are not mutually exclusive and to a large extent intertwined

C ontinuum of T heoretical F ramework Neo-classical Vertical Integration Spot Market No contracting Transaction Costs theory Verbal contract/ agreement High Asset Specificity High Quality Requirements Agency theory Complex contract relationship Simple legal contract Low Asset Specificity Low Quality Requirements

T heoretical F ramework Transaction Costs Theory Agency Theory

Three Primary drivers: 1.Uncertainty 2.Asset Specificity 3. Measurement Costs T ransaction C ost T heory

U ncertainty of B arley P rices Source: Data obtained from USDA

U ncertainty of B arley P rices

Three Primary drivers: 1.Uncertainty 2.Asset Specificity 3. Measurement Costs T ransaction C ost T heory

C omparison of S tandardsCoors USDA Grade 1 MinMax Plumpness 180% Plumpness 275%79% Color points40 Protein8%13.5% 1 Base price screenings 2 Thin Price Screenings

Asset Specificity 0 Spot MarketContractVertical integration G raph of T ransaction C osts T heory Source: Williamson 1991 Transaction costs

Three Primary drivers: 1.Uncertainty 2.Asset Specificity 3. Measurement Costs T ransaction C ost T heory

Price Quantity 0 Average Total costs Relationship of average costs between externally and internally coordinated markets. Source: Barkema 1993 Average Transaction costs Average cost of measuring quality Average cost of grains Externally Internally

Additional costs in a contractual agreement –Legal fees –Agronomic costs –Negotiation costs –Selection of growers –Costs associated with the transfer of risk from producers to Coors via contracts T ransaction C ost T heory Yet, Coors determined that the transactions costs on a spot market basis outweigh these additional transaction costs associated with contractual agreements.

–High uncertainty associated with Barley prices and quantities –Highly specific needs for quality inputs –Implications associated with measurement costs Therefore “Transaction Costs” is the primary theory that best describes Coors’ malt barley contracting program T ransaction C ost T heory

A gency T heory Coors addresses the issues associated with agency theory through Unique barley variety seed purchased from Coors Strict specifications Contracts not renewed if quality standards are not met Improved information technology

C ontractual I ncompleteness Concepts of Contractual Incompleteness will always be present Bounded by rationality Doesn’t specifically motivate their decisions, nor does it best describe their structure

P rospects for T he F uture Tougher competition and tighter margins Changing legal requirements –GMO –Traceability –ISO 9000 – Food Safety Beer is a mature industry Need to find new markets

C oors in a G lobal F uture StrengthsWeaknesses Mergers in Canada and UK Single site brewery Experience with contracts gives them the ability to trace back to the farm level Difficult to implement the same level of coordination in multiple countries

C oors in a G lobal F uture OpportunitiesThreats Growing markets in other countries Different tastes and preferences in other countries Trend for differentiated premium beers Low growth in the US Microbreweries market is exploding

S ummary Quality specifications motivate the use of contracts Economics of supply chain structure leads to the minimization of transaction costs Thus, adverse selection and moral hazard concepts are addressed in the arrangement of the contracts Their ability to meet traceability and other protocols will allow them additional market access

S elected S ources Barney, J. “Gaining and Sustaining Competitive Advantage”. Cook, M. and Peter Barry. “Organizational Economics in the Food Agribusiness, and Agriculture Sectors.” Amer. J. Agr. Econ Martinez, S. “Vertical Coordination of Marketing Systems: Lessons from the Poultry, Egg, and Pork Industries.” United States Department of Agriculture, Economic Research Service Jones, E. “The Role of Information in U.S. Grain and Oilseed Markets”. Review of Agriculture Economics. Williamson, O. “Transaction-Cost Economics: The Governance of Contractual Relations.” J. Law and Econ. 22(1979): Grossman, Sanford and O. Hart. “The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration”. J. of Political Economy.

Other Theories Increase profits in noncompetitive markets Price discriminate Create barriers to entry Shift price and production risk to firms that can manage risk more efficiently Ensure input supplies Sustain a strategic competitive advantage

Cumulative Distribution Function (CDF) graph