An Evolving Classification Scheme of Local Food Business Models

By Allie Bauman, Colorado State University; Dave Shideler, Oklahoma State University; Dawn Thilmany, Colorado State University; Merritt Taylor, Oklahoma State University; and Blake Angelo, Colorado State University

In response to growing public interest in regionally-focused food systems, there is an increasing array of business models and innovations for small and medium-sized businesses to choose between when considering how to enter and/or expand in these markets. However, beyond case studies there exists little analysis that evaluates market performance and stakeholder welfare associated with these business models. The Ag of the Middle group first developed a scheme to categorize value chains in the early 2000’s (http://www.agofthemiddle.org) that helped to justify the need to further explore how new marketing initiatives may intersect with scale and financial sustainability.

We propose a typology of business models within the local/regional food system that builds on the Ag of the Middle concepts and can be used by producers, coalitions and communities to better understand potential outcomes of their food system development choices. Using currently available directories, literature (including existing bibliographies such as those compiled by UC-Davis) and information gleaned from program Websites, this paper simplistically groups enterprises by where they fall along a continuum of enterprise scale (measured by revenues or other economic measure) and market orientation (direct, intermediated and wholesale).

The representative categories of business models in the typology will help small and medium-sized farmers learn how their operations best fit into their local/regional food landscape. But as systems continue to change and evolve, enterprises can also consider what is required to expand or transition into another category, and how their business might respond to changes in the local economy and/or market linkages that commonly occur within each model classification. Figure 1 was modified from the Agriculture of the Middle schematic to visually represent the resulting typology. Although this categorization will still be overly simplified, it may help to illustrate how food systems are redeveloping across the US driven by different place-based factors.

 

 

Firgure 1

Figure 1 represents all the components of a food system, which includes aspects focused on serving the local markets and other aspects which are focused on production agriculture and exporting products outside of the region. The typology can be divided into four quadrants using the sales volume as the horizontal dimension and the value-added (operating profit margin) per unit of sales as the vertical dimension. The types of models are ordered, and connected by arrows, to represent common evolutionary steps that operations may take if their current marketing choice or portfolio has to be rethought because of financial challenges, plans to expand or decrease in scale, or new marketing opportunities that are perceived.

The top two quadrants (and their subcategories) will be the focus of this paper, as they correspond most directly to the business ventures found in local and regional food systems. Before discussing these quadrants in detail, consider traditional commodity production (lower right quadrant) as a contrast to various points along the continuum in Figure 1. While farmers maintain ownership of their farms, they lack managerial and pricing control due to pressures to maximize throughput within distribution companies which carry many different product lines. The squeeze on producer prices causes farmers to increase planted acres in the hopes of increasing profits through higher volume of production, lower input costs due to economies of scale, and risk management tools like futures contracts which commit farm managers to specific commodities and/or practices.

The local food business models seek to reverse the governance and price trends that traditional commodity production has fostered. To this end, it is not surprising that some commodity producers are using local food production as a means of diversifying marketing strategies and contributing social benefits to their communities (Izumi, Wright and Hamm, 2010; Bloom and Hinrichs, 2011). However, these instances of blending local and commodity oriented production are rare; a notable example is Sysco, the largest food distributor in the U.S., who established pilots to incorporate local products into their traditional distribution system in two regional projects (Cantrell, 2010).

With the traditional commodity production model in mind, consider the upper left hand side of Figure 1. One finds the Direct Marketing category and, as illustrated by the boxes on the outer ring, it includes enterprises which have the potential for lower sales volumes but the potential for a higher value per unit of sales. Because of shorter supply chains, and greater market autonomy, enterprises focused on farmers’ markets, community supported agriculture, roadside stands and online sales allow the farmer to capture all the value added and marketing margin associated with their products.

The right-hand side category corresponds to value-based food supply chains, which seek to provide farmers with higher value per unit than traditional outlets, while enabling larger volumes of sales due to collaborations, cooperative enterprises, or other organizational relationship that allows for the aggregation and/or more broad distribution of individual farmers’ outputs. The more subtle differences across this sector are the level of ownership, managerial control and pricing power the producers retain. Each of those factors allow producers to maintain sustainable margins they feel are necessary to provide the quality, customer service and regional sourcing that buyers may seek. As the models rotate toward the commodity quadrant, the types of buyers or independent profit-seeking behavior of third parties will exert pressure on the prices received by producers and drive them down.

The consumers and/or Business-to-Business (B2B) customers are important elements to consider because the type of customer may influence the relevant scale, marketing position and potential profit margin that can be expected. In general, there is an inverse relationship between volume and margins. And, many enterprises may have a discriminatory marketing strategy, with some higher margin sales targeted to direct market clientele, but larger volumes needed to cover overhead costs of their operation supported by high volume sales to institutional buyers. Yet, the loyalty of customers is likely to positively influence pricing power (CSA shareowners/members, wholesale buyers who are in long-term partnership may provide stable returns through informal contracts/relationships). These nuanced characteristics are reflected in each model’s box on Figure 1 and in Table 1, which is able to capture the customer types, managerial control and pricing power dimensions explicitly.

Table 1: Producer Characteristics of Local Food Business Models Typology

 

Direct Marketing

As a broad category, direct marketing encompasses several marketing models that have emerged as fast-growing segments in local food system assessments, consumer research and food access programming. They are also an important component of discussions about beginning farmers and scale-appropriate market access. Farms with less than $50,000 in sales make up 81% of the farms selling local food and are more likely to sell their products exclusively directly to their consumers (Low & Vogel, 2011). For the typology, they represent high-margin outlets, but sales volumes and the ability to scale up are limited because of seasonality, casual nature of customer relationships and low share of consumer dollars spent in these markets.

Online Sales and Roadside Stands

Online sales and roadside stands allow for the higher margins desired in direct markets but do not allow producers to “leverage” the power of more grouped markets, where customers are driven to a larger set of vendors for more convenient shopping and greater variety of products. Thus, they are relatively low on the vertical axis of Figure 1. Still, a savvy marketer, a farm enterprise located on a well-traveled transportation corridor or one who uses online sites strategically may overcome this challenge. Online sales are typically conducted on individual farms’ websites as well as aggregation sites that act as a virtual marketplace, but where all distribution takes place through the individual farmer. MarketMaker is a rapidly expanding online tool that currently covers twenty states, that showcases farms with an online presence and includes a variety of other marketing partners and channels (http://foodmarketmaker.com). Moreover, its mapping application allows for those traveling to locate and map farms, ranches, fisheries and wineries that offer on-site markets as well.

Farmers’ Markets

The USDA Agricultural Marketing Service has been monitoring the growth in farmers’ markets since 1994 and provides a comprehensive directory of markets nationwide (http://search.ams.usda.gov/farmersmarkets) as well as a number of support services for market managers*. In addition to the USDA directory, a number of other online directories exist including Local Harvest (http://www.localharvest.org), and state specific sites (e.g., Oklahoma (http://okfarmandfood.org), Colorado (http://coloradofarmers.org)).

Data is one of the biggest challenges when it comes to evaluating farmers’ markets and the business strategies of their vendors. Although secondary data has improved over time (like the Agricultural Resource Management Survey (ARMS) sampling that began in 2008), collecting primary data through surveys of farmers’ market vendors and customers has been a more common approach to enrich the understanding of firm- and community-level contributions (e.g. Otto and Varner, 2005; Hughes et al., 2008; Henneberry, Whitacre, and Augustini, 2009; and Ruelas et al., 2012). Although commonly cited as a great start-up marketing choice, there is some agreement that potential sales volume may be limiting to vendors.

It is also important to understand linkages between the local economy and direct food markets; Brown and Miller (2008) provide a comprehensive review of the literature on farmers’ markets from 2002 to 2008, updating a previous literature review that surveyed similar studies from 1940-2000 (Brown, 2002). Surveys have covered a wide range of topics from basic economic data (e.g. consumer spending, vendor sales, and number of vendors/customers) to spillover spending in nearby businesses to market opportunities (e.g. new business/product incubator and expanding operations) to social impacts (e.g. community involvement and health).

Community Supported Agriculture (CSA)

In addition to selling products at a farmers’ market, an increasing number of farms provide their products directly to their consumers through community supported agriculture agreements. A variety of research has been conducted on CSAs (see the National Ag Library’s compilation of resources at: http://www.nal.usda.gov/afsic/pubs/csa/csa.shtml). Woods et al. (2009) surveyed 205 CSA producers in Illinois, Indiana, Kentucky, Michigan, Missouri, Ohio, Pennsylvania and West Virginia with a focus on business and marketing practices. Similar studies from different parts of the country include Perez, Allen and Brown (2003) in California, Oberholtzer (2004) in the Mid-Atlantic regions, and Bregendahl and Flora (2006) in Iowa.

Given what has been found about the unique characteristics that define a typical CSA consumer and the best management practices and benchmarks for CSA operations, this model may provide more stable profit margins with an ability to scale up in areas near urban consumer centers. For this reason, it is placed higher on the vertical axis of Figure 1.

Local Harvest (www.localharvest.org) and Wilson College’s Robyn Van En Center CSA Farm Database (www.wilson.edu/about-wilson-college/fulton/robyn-van-en-center/csa-searc…) are two of the most comprehensive directories of CSAs. A casual scan of the literature illustrates less is known about the linkages between local communities and CSAs compared with farmers’ markets, but one might imagine it is a direct marketing channel used by producers to manage the less predictable nature and timing of farmers market schedules and revenue streams.

Value-Based Food Supply Chains

As illustrated in Figure 1, value-based food supply chains may serve as a mechanism to scale food enterprises or systems up without losing all marketing control; Low and Vogel (2011) found 50-60% of all local food sales were marketed through intermediated channels such as restaurants, grocery stores and regional distributors. They concluded that, “Farms with over $250,000 in sales have a comparative advantage in intermediated sales because many restaurants, grocers, and regional distributors demand timely large volumes of food with consistent quality” (Low & Vogel, 2011, p. 5). But within this larger category, several different business models have emerged with different organizational and marketing strategies, as well as depth of connections with customers, that may influence differentiation and prices.

Farm Direct to Wholesale

The most common wholesale outlets that farms sell their products to directly are specialty retailers, restaurants, and institutions. King, et al. (2010) presents case studies of five products across the country and compares supply chains. Common themes that emerged include the long term relationship and the informal contractual nature of the relationships; how collective organizations, such as a food cooperative, play a central role in the success of the supply chain; and that prices paid to the farmer are higher than commodity counterparts, but some tension does arise in finding a price that works for both the buying and selling businesses. Each of these points helped to define the position of this marketing strategy in Figure1.

Farms selling their products directly to restaurants is a natural pairing given the restaurant demand for locally grown products: locally sourced meats, seafood, and produce have topped the list of Top 20 restaurant trends since 2010 (ÉCulinaryForecast, 2014). Several studies evaluated the economic viability of farms selling direct to local restaurants and discuss ways in which producers can tailor their marketing strategies to work effectively with chef-buyers and maximize economic benefits (Sharma, et al., 2012; Thilmany, 2004).

One of the main challenges to the approach of producers selling their products directly to wholesale buyers is the relatively high transaction costs borne by the wholesale buyer compared to purchasing products from full-line distributors. Because wholesale buyers are purchasing products from many different farmers, rather than one single buyer, and often without a contract, such transaction costs can be prohibitively high (Feenstra, et al., 2011; Thilmany, 2004).

Among the other models in this quadrant, mult-farm and ranch organizations come together to mitigate the challenges of marketing individually and see collaborative action as a way to lower transaction costs: initiatives commonly grouped under the term food hub. Barham, et al. (2012) provides a well-accepted definition of a regional food hub defined as “a business or organization that actively manages the aggregation, distribution, and marketing of source-identified food products primarily from local and regional producers to strengthen their ability to satisfy wholesale, retail, and institutional demand” (p. 4). The most comprehensive directory of food hubs can be found on the USDA AMS Food Hub website (www.ams.usda.gov/AMSv1.0/foodhubs).

Figure 1 includes several business models that align with the above food hub definition, but they vary by the degree to which farmers retain control over their products and utilize a central organization to assist with market coordination and distribution. There are a variety of different types of food hubs, which can be differentiated by organizational structure (e.g., for-profit or non-profit) and types of activities/operations (e.g., distribution, value-added processing;Vanderburgh and Moraghan, 2014); the scope of our discussion is limited to those food hubs which primarily focus on connecting the producer with the consumer. Using terms from Vanderburgh and Moraghan (2014), the discussion focuses on first-mile aggregation, last-mile distribution and retail markets. A variety of case study papers have been written on the many different types of food hub business models in existence including: Day-Farnsworth, et al. (2009); Lev and Stevenson (2011); Stevenson (2013a and 2013b); and Hardesty, et al. (2014).

Multi-Farm CSA

Multi-farm CSAs allow the farmer to retain control over their products (in terms of setting production levels and/or prices), but farmers use a collectively-owned (which sometimes also includes consumer owners), centralized system to market, sell and distribute their products. Schmidt, et al. (2011) conducted a case study on a farmer collaborative that aggregates, markets and distributes local products to individuals, businesses, retailers and restaurants through both a multi-farm CSA (500 members and seven types of shares) and a wholesale marketing program (intervalefoodhub.com). The model provided favorable returns to producers, but one of the main challenges faced was maintaining equity among producers given the wide variety of volume and product type. The Oklahoma Food Cooperative and High Plains Food Cooperative (in Kansas and Colorado) are similar models seeking to maintain some control with producers. However, multi-farm CSAs have inherently limited volume by their pre-contract orientation (e.g., institutions pre-purchase shares of production before the production season begins, which means that ‘excess’ produce cannot be sold to other clients).

Producer Food Hubs

Following along the value-based food supply chain continuum is the stage where the producer leaves all elements of the supply chain to a central organization, similar to a mainline distributor, but with governance aligned with collaborating producers’ missions. This shared vision of its stakeholders, commonly because they carry geographically differentiated or similarly labeled sustainable products (organic, free-range), could be thought of as a shared commitment to the economic viability of both the producer and the distributor (see Day-Farnsworth, et al. (2009), Jablonski, Perez-Burgos and Gomez (2011), and Stevenson (2013a)).

Fair pricing is a key distinguishing characteristic of this value chain model, but also a challenge in this type of food hub as the organization and the producer both aim to maximize profits while working in an environment of small margins. Again, there may be tension about financial sustainability as the need to hire skilled marketing employees increases mark-ups and if grant funding is used initially to establish the hub, long-term viability may require tough decisions on how to capitalize new investments and increase technical and scale efficiencies without negatively impacting producers and their bottom lines.

Hardesty, et al. (2014) and Stevenson (2013a) explore multi-stakeholder cooperatives, owned by both producers and consumers: High Plains Food Cooperative and Idaho’s Bounty. Both cooperatives have remained very regionally focused, providing an internet based retail sales platform, sales coordination services, and distribution services. In this business model, producers retain control over pricing and managing their relationship with retail customers** and the cooperative is mostly responsible for aggregation and distribution.

Given public support for food hubs such as this, participating producers are often not asked to make initial financial contributions to food hubs, but as grant funds used for initial operations subside, producers will need to play a more engaged role in the financial and marketing operations. However, there are also models where community organizations see enough public value from hubs that their commercial activity is supported by non-profit missions and resources. Also amongst the food hubs represented in Figure 1, Stevenson (2013b) explores Red Tomato, a non-profit focused on marketing and logistical coordination, that contracts with local trucking companies for distribution services. Although Red Tomato is not owned by producers, a core group of producers are involved in the governance and decision making alongside the more traditional management, without the mission to be profit seeking.

Similarly, the non-profit Fair Food Farmstand in Reading Terminal Market provides a retail market opportunity for producers who meet the production standards agreed upon by the organization. While these organizations can generally accommodate larger volumes of sales than multi-farm CSAs, the value-driven orientation generally means that inclusion of all socio-economic classes trumps profit maximization, which results in lower value per units sold so that the produce is affordable to all who want to participate.

Conclusions and Future Directions

The Ag of the Middle research coalition began an important discussion of the financial sustainability of redeveloping food systems almost a decade ago. Since then, a myriad of market innovations have emerged within the direct and value food chain segments that they highlighted. Figure 1 furthers their typology and provides a brief summary of unique aspects of the most common models highlighted in recent food system outreach projects, applied research, and government program evaluations and reports. Although there are already a number of directories and frequently updated bibliographies informing food system stakeholders on the diverse set of initiatives emerging, we used this piece to sort food system models according to their core economic competitive advantage with a key focus on enterprise scale and market orientation (direct, intermediated and wholesale), as well as managerial considerations.

 Our hope is that a generalized typology of marketing choices will assist small and medium-sized farmers to determine how they best fit into their local/regional food landscape and how their business might respond to their own desire to grow or respond to future innovations in their local economy and/or market linkages in the future. The categories outlined in Figure 1 are necessarily broad, but may help enterprises identify their current position(s). And, as they move forward with future planning, this summary may direct them to the most relevant case studies, literature and market players so effectively compiled in a number of directories and bibliographies developed by key food system organizations.

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