Ag Retail and Porters Five Forces
I have long been passionate about the entirety of retail businesses. The history has always caught my attention.
From retails inception, people exchanged cows and sheep in trade as far back as 9000 BC.
The first proper currency extends as far back as 3000 BC in Mesopotamia.
The first retail stores come in a bit later. By 800 BC in ancient Greece, people had developed markets with merchants selling their wares in city centres. The development of these stemming from the need for distribution. Even retailing is where branding started – in order to showcase consistency, quality, and safety in a retail setting, brands were started as signalling mechanisms.
To where we are today in the consumer retail space and the evolution to e-commerce and physical retail experiences – the entirety of the industry and it’s complexity fascinates me.
Couple this with my agricultural passions and professional experience primarily being in the ag retail industry and you get a love for ag retail and considerable thought going into it.
I have wanted to put together a few different thoughts and topics within retail so I’ll be building out different blogs and thoughts stemming from this theme and my passion for it.
To start, I want to consider the industry as a whole and Porters Five forces within it.
Who is Michael Porter?
Michael Porter is an American academic known for his theories on economics, business strategy, and social causes. He is credited for creating Porter's five forces analysis, which is instrumental in business strategy development today.
What are Porters Five Forces?
1. Competitive Rivalry - This looks at the number and strength of your competitors. How many rivals do you have? Who are they, and how does the quality of their products and services compare with yours?
Where rivalry is intense, companies can attract customers with aggressive price cuts and high-impact marketing campaigns. Also, in markets with lots of rivals, your suppliers and buyers can go elsewhere if they feel that they're not getting a good deal from you.
On the other hand, where competitive rivalry is minimal, and no one else is doing what you do, then you'll likely have tremendous strength and healthy profits.
2. Supplier Power - This is determined by how easy it is for your suppliers to increase their prices. How many potential suppliers do you have? How unique is the product or service that they provide, and how expensive would it be to switch from one supplier to another?
The more you have to choose from, the easier it will be to switch to a cheaper alternative. But the fewer suppliers there are, and the more you need their help, the stronger their position and their ability to charge you more. That can impact your profit.
3. Buyer Power - Here, you ask yourself how easy it is for buyers to drive your prices down. How many buyers are there, and how big are their orders? How much would it cost them to switch from your products and services to those of a rival? Are your buyers strong enough to dictate terms to you?
When you deal with only a few savvy customers, they have more power, but your power increases if you have many customers.
4. Threat of Substitution - This refers to the likelihood of your customers finding a different way of doing what you do. For example, if you supply a unique software product that automates an important process, people may substitute it by doing the process manually or by outsourcing it. A substitution that is easy and cheap to make can weaken your position and threaten your profitability.
5. Threat of New Entry - Your position can be affected by people's ability to enter your market. So, think about how easily this could be done. How easy is it to get a foothold in your industry or market? How much would it cost, and how tightly is your sector regulated?
Now, if we were to apply this Five Forces model to ag retail, what would it look like? Where would ag retail land? And what does that mean?
The best way to utilize this model is through the lenses of a specific business itself, however I am generalizing which limits the depth. I do want to use this as a jumping off point for other retail articles in the future where specifics can be dug into.
1. Competitive Rivalry – The competition is relatively robust in North America. Many small towns have 3-5 retails servicing a 60km (40mile) radius. There are somewhere around 1000 retails in western Canada and somewhere in the vicinity of 10,000 retails in the USA.
The biggest thing that feeds this rivalry is that there are a finite number of acres and inputs given the geographical constraints that we see today (more on this later) and a one time window. All of retail has a window (eg: summer clothing, winter clothing), but it’s different in ag. In traditional retail you can get rid of much of the investor at blow out prices because ultimately the consumer can use the following year. In ag inputs many farmers do not have heated sheds for storage, or would prefer not to tie up chunks of capital in something they can purchase next year, not to mention other potentially quality issues like settling out of crop protection products. This urgency to get product out the door in that small window puts significant pressures on being the first in the door with the farmer and the first to bring those products up to the farmer. This puts pressure on margins as well as the quality of information that drives recommendations – because ultimately, any product left in a retails shed costs money to ship back and store and can also hinder their targets with suppliers.
I know ag retail gets a bad rap in numerous ways, but if you compare to consumer grocery or farm parts or even equipment dealerships, the level of competition is significant, and this puts pressures on retails.
2. Supplier Power – Retails are extremely reliant on their suppliers. Generally speaking, they are the reason retails have anything to sell at all! The thing is, that’s the case with all retail businesses. However, ag is different. In the consumer space, there is constant innovation, new companies being started and unique geographical options just to name a few. These retails have significant power over their suppliers and wield it every chance they get.
In ag retail it is slightly different. While the retailer has the direct relationship with the farmer, the physical assets and the credit offerings, the ag retail only has so many options of suppliers to merchandise their sheds with. Whether we are talking seed or fertilizer or crop protection, there are a limited numbers to buy from. On top of this these manufacturers have high gross margins that enable them to market heavily to influence customer (farmer) desires and they are exceptionally savvy at managing this relationship with programming. This combination of low optionality, significant marketing budgets and strategic programming has tilted the power back to suppliers across most product lines.
Part of this can go back to vertical integration as well, not just in terms of owning a manufacturing plant, but the movement or flow of product through the supply chain such as distribution warehouses and custom application services actually ensures more influence over the supplier because you are more in control of how product moves within your supply chain and your doors.
3. Buyer Power – Farmers are the primary buyers in an ag retail setting. While ag retails tend to dictate the price there is a shifting influence of farmers over the ag retail based on their size and position in the marketplace.
There tends to be enough competition in the market place generally speaking, few switching penalties involved (switching penalty might be inability to obtain credit elsewhere or distance for example) and a comparatively similar product line offering, so farmers are able to work with the retail to obtain prices below SRP.
Where the retails tend to have more power over farmers is in the realm of pricing transparency. Today there isn’t a lot of postings of prices all over the place – part of this is driven by manufacturer programming and traditional practices. This is changing (more later) which means there is more power shifting back to the farmer.
The more customers a retail has, the better for the retail. As ag retailers sales grow it should indicate increasing margins, both gross and net (however in reality market dynamics dictate this heavily).
4. Threat of Substitution – Without a unique product line or service offering ag retails are commoditized. If you do not have something exclusive to your business as an ag retailer, then there is not something that keeps that customer coming in the door. Now, ag retailer is driven by relationships so there is something to be said about culture and employee retention to manage through this, but all things equal a unique product, service or value proposition to the customer is one of the best ways to manage a substitution of some other retail. Often this needs to be driven by looking 3-5 years out, anticipating what is necessary and understanding it as a retailer, creating a market for it and creating demand for it. This goes hand in hand with the supplier points in #2.
Ag retail has traditionally bundled services, products, credit, logistics and knowledge into their offering to customers. The other aspect is how parts of this “bundle” can get broken up. Once this bundle gets broken up, say by an independent agronomist offering, 3rd party credit or 3rd party services, the value proposition becomes less and less to the customer meaning the threat of substitution of other components of your offering (eg: crop input products) increases.
5. Threat of New Entry – This has changed over the course of the last number of years. Traditionally, one would look at the thread of a new entry as a small risk because being able to invest in assets takes significant capital, securing supply takes connections and industry knowledge and having a significant enough list of customers to target was a difficult combination to come cross generally speaking – then scaling this over a large geography was exceptionally difficult. Think about this in context of what it takes to enter the online e-commerce widget selling business – there are stories of creating a business like this in under 24 hours and having revenue within that time frame!
Much of this remains today, however what has changed is the ability to reduce time and space through digital connection and the aggregation of demand. This is still difficult to achieve. Farmers Business Network for example is working towards this and has ~12,000 customers over the course of 4-5 years, multiple countries and hundreds of millions in investment. Even with a customer base that’s not huge in the grand scheme of things, but still large they have been unable to secure supply from manufacturers in Canada for example.
Through the internet there has been the rise of other marketplace based models like Meristem Ag and CommoditAg. These organizations do not necessarily empower a bunch of new competition to enter the space, but they do empower current retails to broaden their serviceable area, increasing competition and changing the competitive dynamics across all markets. They also are able to reduce pricing information asymmetry, changing competitive dynamics.
What does this all mean?
It’s how they all interact together that creates the headwinds and dynamics within an industry. Ag retail is no different.
Within each of the five forces you can decipher a way to differentiate as a retailer and limit the impact the “force” has on you. This will look different for everyone based on their desires and goals.
Significant competition? How do you differentiate your product offering and service offering to bring something unique to customers in your geography that others can’t or wont?
Suppliers have a lot of power over you? What product lines can you look at instead? Who can you partner with to develop your own line of products? What can do to negotiate better with suppliers? How can you lower your cost of good throughout the supply chain or overhead costs?
Threat of substitution? Again, similar to above – product innovation can be a component of this. Better, unbundled service offerings can also be a component of this. And the services go beyond traditional chemical delivery or crop scouting, but towards digital service offerings and services driven through unique customer insight that can be developed through superior data capture and utilization – not just agronomic data, but purchase behaviour and more.
New Competitor gaining entry? Identify what your customers value (not what you think they value and not what the broader market values) by segmenting them by how they purchase and what they prioritize.
You’ll notice that having a proprietary/unique product offering in the marketplace is associated with a couple of the aspects of the Five Forces. This may inherently be my bias towards this practice showing through – as I think superior market, customer and geographical knowledge, can go a long way in differentiating in the marketplace to serve and add value to farmers through product innovation… If you look at many successful retails/distributors they have tended to be ahead of the curve when it comes to proprietary, unique products they are positioning. They have figured out what is missing in the market place, done research, created a product and positioned it to their customer base – I think organizations like Winfield United have done a good job of this and have likely increased their customer retention and share of wallet at least in part through this practice. It takes foresight and investment to get to that point, but it seems to work well.
What tools can you use in conjunction with Five Forces?
The SWOT analysis is a great ancillary tool within the Five Forces Framework as it can help to identify how you can “win” in a given area against your competitor.
A few others I really like:
Strategy Diamond which is one of my favourites for use conjunction with Five Forces analysis and just in general.
While this is a broad and generalized overview I think it lays a foundation of reference as I write more about the topic and dive deeper into specifics of ag retail, e-commerce and digital business strategy. There is always going to be variation by geography, but as we know with agriculture and farming is very fragmented.
The dynamics are constantly influencing one another and constantly evolving. Failure to stay on top of and assess leaves organizations open to falling success and disruptive companies that are looking to better serve farm customers.