What Tools Are Useful in Identifying Opportunities and Threats? Strategic Business Planning for Commercial Producers Business Environment What Tools Are Useful in Identifying Opportunities and Threats? In managing a farm business, we are reminded daily that there are many things that are beyond our control. We have no control over the weather. There are often new rules and regulations introduced by various government agencies. There are changes in customer desires. There are actions taken by competitors that we must be aware of. The list could go on and on. These are events that are all part of the environment in which the business operates. © Purdue University, Center for Food and Agricultural Business, 2002

Strategic Business Planning for Commercial Producers Business Environment Objective Improve your ability to identify opportunities and threats by scanning, monitoring, forecasting, and assessing the business environment In this section we will discuss a structure for analyzing the business environment that will help identify opportunities and threats to the farm’s long-term profitability. Our goal in this section is to improve our ability to identify opportunities and threats to the farm business by scanning the business environment. © Purdue University, Center for Food and Agricultural Business, 2002

Environmental Dimensions Strategic Business Planning for Commercial Producers Business Environment Environmental Dimensions Economic Industry Environment Internal Business Structures Culture, Resources Customers Competitors Creditors Communities Trade associations Owners Suppliers Governments Special interest groups Employees Sociocultural Demographic Three environmental dimensions are important when we consider our business strategies. One dimension is the societal environment, another dimension is the industry environment, and the last is the internal business environment. We will discuss two of these here – the societal and industry environment. The third, the internal environment, is discussed in another section. Good managers need the ability to scan the market around them and understand the effects that forces such as technology, demographics and the government have on the major players in market (customers, competitors, suppliers, etc.). Political/Legal Global Societal Environment Technological © Purdue University, Center for Food and Agricultural Business, 2002

Segments of the Societal Environment Strategic Business Planning for Commercial Producers Business Environment Segments of the Societal Environment Demographic Population, age, income distribution Economic Growth in GDP, currency exchanges rates, inflation, interest, budget surplus/deficit, personal and business savings rates Political/legal Antitrust laws, tax laws, labor laws, deregulation philosophies, environmental philosophies As illustrated in the previous slide, there are six segments in the societal environment. These factors influence not only agriculture but all other industries. Demographics is concerned with the population, age and income distributions. An increasing number of people means an increasing demand for food. Change in income levels means that there will be changes in the types of food demanded. Rising incomes are associated with a shift from grain based diets to larger quantities of animal protein. Increasing world per capita income leads to demands for more differentiated products. An aging generation of baby boomers means a transfer of wealth an the retirement of many farmers. Economic facets of the environment relate to the forces that regulate the exchange of materials, money, energy, and information. The growth rate of the economy (GDP), inflation rates, interest rates, the budget surplus or deficit of various government units, and personal and business savings rates are just a few examples of important general economic items to monitor. While these items may not have short-term implications for how agricultural businesses operate, over time they can have important implications. Currency exchange rates provide and example. A sudden increase in the strength of the dollar will make our exports of agricultural products more expensive to U.S. customers. There may be little change in the short run but if the strength of the dollar continues over time the supply from other countries will increase and U.S. exports will decline because of our higher relative price. Political/legal forces have to do with the allocation of power and have to do with constraining and protecting laws and regulations. Antitrust laws might be changed or enforces in different ways. Concern is expressed over the consolidation of input suppliers, buyers of agricultural commodities, the ownership of livestock by packers. These issues relate to how much power individual businesses will have in the market place. Environmental regulations provide still another example in this area. © Purdue University, Center for Food and Agricultural Business, 2002

Segments of the General Environment Strategic Business Planning for Commercial Producers Business Environment Segments of the General Environment Sociocultural Position on “family farms,” attitudes toward GMO’s, quality of work/life, value for rural communities Technological Product innovations, applications of knowledge, focus of private and government supported R&D Global Important political events; critical global markets; different cultural, political, and institutional attributes; trade surplus/deficit Sociocultural forces regulate the values, mores, and customs of society. They help us define what is good and bad, acceptable and unacceptable. How does society view farmers? What opportunities does this provide us? What threats will it create if that view changes? What is the public’s view of GMO’s? As this view changes over time, what opportunities and threats may appear? People’s view of the quality of work or life in production agriculture can have important implications on the ability to hire needed employees. Technological forces create problem-solving inventions. Will finding the solutions to problems be supported through public R&D or will this come from the private sector. This has important implications for intellectual property rights, patents, and access to this knowledge. The U.S. economy continues to evolve from an industrial economy to a services and information economy. What opportunities and threats exist for agriculture in this evolution? Global forces remind us that we need to consider more than just the domestic scene. There are important political events in other parts of the world. There are world organizations WTO that influence trade relationships. How do other countries view food security? © Purdue University, Center for Food and Agricultural Business, 2002

Industry Analysis: The Five Forces Strategic Business Planning for Commercial Producers Business Environment Industry Analysis: The Five Forces Threat of New Entrants Bargaining Power of Suppliers Bargaining Power Of Buyers Industry Competitors Rivalry Among Existing Firms Shifting our attention to an analysis of the industry, we want to look more closely at the forces at play here. A model that is often used in industry assessment is the Five Forces model. Michael Porter developed a framework that models an industry as being influenced by five forces. The strategic business manager seeking to develop a competitive advantage over rival firms can use this model to better understand the industry context in which the firm operates. These forces include the rivalry among industry firms, the bargaining power of buyers, the threat of substitute products, the bargaining power of suppliers, and the threat of new entrants. Threat of Substitute Products or Services © Purdue University, Center for Food and Agricultural Business, 2002

Industry Analysis: Modified Five Forces Strategic Business Planning for Commercial Producers Business Environment Industry Analysis: Modified Five Forces Threat of New Entrants Other Stakeholders Bargaining Power of Suppliers Bargaining Power Of Buyers Industry Competitors Rivalry Among Existing Firms Since its development, others have suggested that there is really another force that needs to be recognized. This is the force of other stakeholders. These many be local government units or other community groups such as labor unions and environmental organizations that influence industry activities. In assessing each force we are concerned with how the force limits the ability of business in the industry to earn profits. Lets look at each force in more detail. Threat of Substitute Products or Services © Purdue University, Center for Food and Agricultural Business, 2002

Strategic Business Planning for Commercial Producers Business Environment Buyers/Customers Who are they? Who will they be? Who should they be? Are we serving specific segments? What are the specific needs of our customers? What important/anticipated changes will take place for our customers? Let’s start with the bargaining power of buyers. Before we can do this we need to decide who are the buyers or customers of our business. Is the food consumer your customer? Well, ultimately yes, however for most farmers there are several channel players or middle men between the farm and the consumer. You need to identify the key customers for your business. Have you considered treating the grain elevator owner/manager as your customer? Is it possible that the pork packer could be your customer? What would happen if you asked the soybean processor that you deliver to what you could do to make your product more valuable to him/her? Money is made by filling unserved needs. To find these opportunities you have to ask questions. This slide raises several questions about customers. How many of these questions can you answer for your customers? © Purdue University, Center for Food and Agricultural Business, 2002

Strategic Business Planning for Commercial Producers Business Environment Power of Buyers Buyers affect an industry by their ability to force down prices, bargain for higher quality or more services, and play competitors against each other. Factors to consider about buyer: Buyer purchases a large portion of seller’s product Alternative suppliers are plentiful Switching costs are low There is potential to integrate backwards Low margins make bargain hunting necessary Product is high percentage of buyer’s cost Now that we have defined our customers or buyers, lets consider the power that they have. Buyers can influence an industry by their ability to bargain for lower prices. If a customer purchases a large part of your production, if there are plenty of suppliers, or if switching costs are low buyers will have more power. If the buyer can easily integrate backwards and create their own supply, this also contributes to buyer power. If the buyer is facing a low margin or the product is a high percentage of the buyer’s cost, then the buyer will not want to pay more than is necessary. As one thinks of production agriculture many of the buyers that we have as customers have the ability to bargain for lower prices. But by picking our customers we might be able to make some improvements. A processor may have a better margin than the grain elevator. If we combine with other farmers to sell, we might be able to reduce the amount of our product that goes to a single buyer. This might also make us a more dependable supplier, raising the buyer’s cost of switching to another supplier. If the buyers have power, then it is your job to show them how we add value. A firm can defend against buyer power by increasing switching costs through added features, customer service etc., or by considering forward integration. Show them how you can lower their costs. For instance, delivering a load of a just-harvested crop during the middle of the day is what everyone does. Maybe it is of value to the buyer for you to deliver at another time – like the early morning. A barley producer receives 10% more for his crop simply because he has agreed to deliver his barley anytime day or night. He has the same product, but he has added a valuable service. © Purdue University, Center for Food and Agricultural Business, 2002

Threat of Substitute Products or Services Strategic Business Planning for Commercial Producers Business Environment Threat of Substitute Products or Services Product that can satisfy the same need as another product. Examples might be: Chicken for pork or beef Wheat for corn in feed rations Chemicals for mechanical weed control Consider Switching costs Product-service bundle A substitute is a product that can fill the same need as an existing product. In commodity production, corn for one farm can be easily replaced by corn from another farm. Other examples include the substitution of chicken for pork or beef, using wheat rather than corn in feed rations or shifting from mechanical weed control to the use of chemical herbicides. The threat of substitutes will be great when the cost of switching is low. When thinking about substitutes it is important to consider the product-service bundle. While it may be easy to find substitute products, the services that come with the product may be more difficult to reproduce. The service side may be a way for the farm to differentiate itself from its competitors. In terms of substitutes, it is about products that enter the market that are a replacement for the products that your firm produces. For example, wheat for corn or poultry for beef. It is important to think broadly about potential substitutes. Who would have thought 10 years ago that the seed would replace the need pesticides. There were more than a few Ag Chem companies that were not prepared for this substitute (GMO seed). A company might defend against substitutes by increasing buyer switching costs, constant product innovation, and bundling products. © Purdue University, Center for Food and Agricultural Business, 2002

Industry Rivalry & Our Competitors Strategic Business Planning for Commercial Producers Business Environment Industry Rivalry & Our Competitors Who are they? What drives our competitors? What are their vision, mission, goals, and objectives? What are our competitors currently doing? What is the competitor’s view of itself and the future of the industry? What are our competitors’ capabilities? Where do we hold an advantage over our competitors? Just as with our customers, it is important to understand our competitors. Discussing rivalry or competition among businesses or farms is something that makes many of us uncomfortable. It is easier to think about the South American farmer as a competitor because we don’t personally know him. But we personally know many the the people that operate competing farms. Our kids attend the same school, we may belong to the same church, or serve on the same community board. Just as we need to know our customers, we need to know our competitors. Where do we compete? What are the motivations of our competitors? What are our competitors capabilities? Until recently, there has not been much competition in product markets. Farmers have had access to large commodity markets where any one could sell. My sale of corn does not influence my neighbors ability to sell. Not all product markets are of this nature. There is competition in the seed corn market. If I get the contract, my neighbor may not get one and vise versa. Another market where we recognize competition is the land market. In this market you can quickly identify a group of farmers that you would consider your competitors. As the food system becomes more coordinated, it appears that there will be more competition in the product markets. © Purdue University, Center for Food and Agricultural Business, 2002

Strategic Business Planning for Commercial Producers Business Environment Rivalry Among Firms Amount of direct competition among businesses in the industry Factors to consider: Number of competitors Diversity of rivals Rate of industry growth Product characteristics Height of exit barriers Amount of fixed costs Regardless of our feeling about competition, it exists and we need to recognize that intense rivalry among firms can reduce profit levels. Items that can increase competition in the industry include a large number of businesses with diverse ideas about how to compete, a slow growing industry, and the production of products with very similar characteristics or in other words the production of commodities. Competition can also be heightened by exit barriers. Owning assets that can be sold only at steep discounts relative to their value in production keeps the assets in production. Even though we often like to think otherwise, these characteristics indicate that rivalry among firms in production agriculture is likely to be high. Fixed costs are another contributor to this rivalry. We have a fixed investment in machinery, facilities, and labor. If we could farm a few more acres we could lower our per unit costs by spreading these costs over more production. We bid aggressively in the rental market for these additional acres. If we are not careful, we may find that our per unit costs don’t decline because of our aggressive bidding. The high level of rivalry among firms, especially in the land market, can limit the profitability of production agriculture. To reduce this force firms should usually look for ways to differentiate from rivals, other than price, that is hard for rivals to replicate and valuable to customers. © Purdue University, Center for Food and Agricultural Business, 2002

Strategic Business Planning for Commercial Producers Business Environment Threat of New Entrants Potential for new comers to the industry Factors to consider: Economies of scale Capital requirements Access to distribution channels Product differentiation The threat of new entrants can also influence industry profitability by increasing product supplies and thus lowering prices. However there are often barriers to entry. These barriers may be in the form or economies of scale – entering firms may have higher costs of production because of their smaller size. Capital requirements can be another barrier. The capital required to have an efficient level of production may exclude some people from entering. Gaining access to the distribution channel or a market can also be a barrier. As contracts have become more important in production agriculture, the inability to get a contract will prevent some people from entering. For example, if you do not have a contract for tomatoes with a processor, entering tomato production on a large scale would not be a good business move. If we can find a way to differentiate our business from others, the strong relationship that we create with our customers can prevent others from entering. While there are significant barriers for new entrants to clear, there continue be state and federal programs for helping bring new entrants into the industry. © Purdue University, Center for Food and Agricultural Business, 2002

Strategic Business Planning for Commercial Producers Business Environment Power of Suppliers Suppliers affect an industry by their ability to raise prices or reduce the quality of purchased goods and services. Factors to consider: Dominated by a few large companies Buyer only buys small portion of suppliers goods and services Product or service is unique (high switching costs) Substitutes are not readily available Suppliers affect the industry by the price and quality of the goods and services that they provide to the industry. The supplier or supplier group will be powerful if the supplier industry is dominated by just a few large companies. The supplier will also have an advantage if the buyer buys only a small amount of the supplier’s total production. This will make the buyer unimportant to the supplier. The supplier will have power if what they are providing is unique or there are high costs associated with switching. An example of this might be your yield mapping software. Replacing the software my be inexpensive, but learning to use the new package may take a lot of time. This cost may prevent you from changing. Again as one thinks about the characteristics of production agriculture, suppliers can exert significant influence. A firm can defend against supplier power by having multiple suppliers, considering backward integration, or searching for substitute inputs. Some farmers have taken steps to make the power relationships a bit more equal through cooperative buying. By making purchases together, they make a larger purchase and thus become more important to their suppliers. And for the most part, there are substitute products available and the costs of switching for many inputs is not high. © Purdue University, Center for Food and Agricultural Business, 2002

Strategic Business Planning for Commercial Producers Business Environment Other Stakeholders Include Local units of government Community organizations Special interest groups Creditors Can influence: Cost of doing business Risk Environmental regulations/requirements These stakeholders could be various units of government, community groups, special interest groups, or creditors. These groups can influence businesses in the industry by changing the cost of doing business, the risks associated with conducting business, or the type of environmental regulations that are faced by the business. The influence of these groups will often vary from region to region. In some cases, community groups or special interest groups convince units of government to pass new laws or regulations that increase the cost of doing business. Over time these changes affect where various enterprises will locate. © Purdue University, Center for Food and Agricultural Business, 2002

Competitive Actions to the Five Forces Strategic Business Planning for Commercial Producers Business Environment Competitive Actions to the Five Forces Positioning Identify skills and abilities that our business must have. Influencing Changing the forces in the industry. Anticipating & exploiting change Examine the forces, forecast the magnitude of each underlying cause, determine likely profit picture of the industry and then craft a strategy. As you think about the forces affecting the industry, the important thing is to act on what is learned. What can be done? We can use what we have learned to identify the critical skills or abilities that our business must possess if it is to succeed. We may try to influence the forces through participation in commodity groups, community organizations, or the political process. Combining what we know of the industry forces and our business strengths and weakness to develop a strategy that will allow use to take advantage of the opportunities that are presented. © Purdue University, Center for Food and Agricultural Business, 2002

Assessing Current Position Strategic Business Planning for Commercial Producers Business Environment Assessing Current Position The bottom-line: Analyzing the dimensions of the external environment with respect to your firm, your competitors, and your customers will help identify potential opportunities for improvement and potential threats to success. This process of using the Five Forces Model should have helped you think about the markets you compete in. You should be able to anticipate where they are going. This will help you to position your business to take advantage of changing situations. © Purdue University, Center for Food and Agricultural Business, 2002

Strategic Business Planning for Commercial Producers Business Environment Strategic Business Planning for Commercial Producers © Purdue University, Center for Food and Agricultural Business, 2002