We’re reporting back with operator perspectives in hand…and the answer is (drumroll please): it depends. As you probably expected!
Earlier this month, we had the pleasure of moderating an incredibly insightful panel discussion at the National Good Food Network 2016 Food Hub Conference in Atlanta:
Economics of Small Scale Processing
“Frozen local” seems like a great solution to season extension and new market access – but is it financially feasible? When and how? This session will explore the strengths and challenges of a variety of approaches to small-scale processing, using both financial analysis and operational context. A panel of food hub operators from across the nation will draw from their own experiences addressing this critical need in food system development.
Jim Hyland, Owner & CEO, The Farm Bridge
Tyrie (TJ) Smith, Food Hub Manager, Food Bank of Northeast Georgia
Brandon Seng, Director of Workforce and Food Programs, Goodwill of Northern Michigan
This Part II blog post provides those of you who weren’t able to join us in Atlanta with access to the unique and invaluable perspectives on the potential of local frozen shared by these expert panelists.
Unfortunately, there are no silver bullets or perfect answers, but their decisions and the context in which they were made can serve as an important reference when evaluating how you might invest in frozen local.
As we did in the panel, we’ll share insights in reference to the components of a basic economic model:
Revenue = Product Price x Product Volume
Minus Costs of Goods Sold (COGS)
Equals Gross Margin
Minus Sales, General and Administrative Costs (SG&A)
Equals Operating Margin
Minus Interest, Taxes, Depreciation & Amortization (Impacted by Capital Investments & Financing)
Equals Net Income (Net Profit or Net Loss)
Before we jumped into their business model decisions, we first had each of our panelists introduce themselves and discuss the context in which they make their decisions: their organization’s mission and goals, their operational assets, the buyers the seek to serve, agricultural production in their region, their competitive landscape for local frozen product, and their access to funding.
Intro to Our Panelists & Their Organizational Goals
- Brandon Seng, Goodwill of Northern Michigan: Brandon oversees the Farm to Freezer program at Goodwill Industries of Northern Michigan in Traverse City. The program is coming into its fourth year of operation. Its primary goal is to provide a transitional workforce development program, and Brandon shared some inspiring stories of how the program has truly changed lives of participants. The operation began by sourcing produce from local growers to freeze and sell into Farm to School programs – Brandon’s background. They are now sourcing a diverse selection of conventional and organic produce from over 30 regional farms, and selling to 40 different retailers and 30 schools. Pictures of the beautiful branding on their 2 and 5 pound packages for retail sale wowed the crowd. Their operation is housed in a 3,000 square foot facility where they utilize a blast freezer, as an alternative to cryogenic gas, to process up to 2,000 pounds of produce every day.
- TJ Smith, Food Bank of Northeast Georgia: As the Food Hub Manager for the Food Bank of Northeast Georgia, TJ is deep in the planning stage for the organization’s A Fresh Approach to Hunger program through which the organization will flash freeze local produce, allowing them to increase their procurement of produce and make it available to their participating food pantries year round. He shared an interesting point of context that food banks are increasingly focused on sourcing produce because (1) the shelf stable goods they have historically relied on are becoming less available due to the expanded markets for previously donated canned goods now provided by discount stores such as Dollar General and (2) because food banks are increasing their commitment to providing food that supports the health and wellness of their clients. Last year the food bank turned away 4 million pounds of produce, and typically had the best success taking in and moving only the “semi-perishable” products like potatoes, carrots and squash. That’s about to change thanks to their investment in a high volume cryogenic individually quick frozen (IQF) machine. The IQF operation is being built out as part of a $4.8 million capital campaign and the team is gearing up to begin processing this harvest season.
- Jim Hyland, Farm Bridge: Jim owns and operates Farm Bridge in New York state: a merger of two organizations formerly know as Winter Sun Farms, founded 9 years ago, and Farm to Table Co-packers, founded 6 years ago. This mission-driven for-profit business serves as a co-packer for producers as well as a processer of regional products sold under the Farm Bridge brand. Individual quick freezing is just one type of processing that is offered by Farm Bridge. The business generates approximately $4 million in revenue annually, with IQF generating 18-20% of that revenue. Farm Bridge operates out of a 30,000 square foot facility that was previously an IBM office building, using a cryogenic machine for frozen processing. The business is committed to serving growers of all sizes, paying growers fair prices, and moving more regional product into wholesale markets. Jim sees IQF as a critical component of his business, not necessarily because of its profitability but because it enables Farm Bridge to work with large-scale buyers, which in turn creates a volume and consistency of demand that allows Farm Bridge to serve growers of all sizes.
With each of these operators’ organizational goals and context in mind, we then turned the discussion to the operating model decisions they’ve made in relation to the economic model components previously mapped out.
Revenue = Product Price x Product Volume
The discussion related to revenue focused on everything from making smart decisions about what you sell, how you price and sell it, and ensuring you have ample volume of product to sell.
Which products should I sell? How will I sell them?
If you’re selling retail or direct to consumer, you might want to:
- Develop unique, high-value products to create demand. Grocery shelves are lined with pretty boring mainstream frozen products. The goal isn’t to compete with those products, but instead to turn folks onto frozen who might not otherwise consider it. Farm to Freezer’s colorful cauliflower medley or Saskatoons are great examples. Look for opportunities to produce organic frozen product lines.
- Invest in branding and marketing that tells the story. Promote the story of farmers you work with. Develop compelling branding that highlights the mission of our organization. Ensure that consumer can easily identify the product as local and feel proud of impact they can have year-round with their purchase of it.
Both of these strategies can help secure a premium price point and maximize sales.
How should I price my products?
When setting prices, especially when selling into institutional markets, you have to balance both your own cost of goods (more on that below) as well as market pricing for comparable products (plus, hopefully a premium for local). It is important to have a full line of products for your buyers, and to avoid selling any products priced at a level where you generate no gross margin. But also recognize which products within your line can generate a higher margin, versus which may be tighter. While individual products may be more or less profitable, based on market pricing and cost of goods, the overall average gross margin across your suite of products should be viable at least at 25-30% margin.
How much supply will I need for production? How might it flux over the year?
In some cases, finding the volume of supply that is needed to fill demand can be challenging, particularly if a food hub does not have access to medium or large-scale farmers in its region. TJ mentioned the challenges that the food bank is facing in terms of accessing supply, given the prevalence of very small farms in Northeastern Georgia. Most of these farmers had no food safety protocols in place, and were not yet ready to sell beyond direct-to-consumer channels. TJ has been providing food safety and wholesale readiness training to these farmers to ensure the food bank can source from them at launch.
Finally, figuring out how to operate twelve months of the year is essential, to generate year round revenue and maximize utilization of equipment, and also to provide full time or year round jobs. That may mean expanding the operation in the off-season to include processing of finished goods and/or non-local products.
Cost of Goods (COGS)
Jim Hyland displayed a pretty spectacular slide outlining some of the costs of goods associated with a handful of Farm Bridge IQF products. It may have been the most photographed item of the entire conference! As he presented the slide, it became clear how many things, small and large, to consider.
- Product cost: price paid to growers. First, of course, is how much you are paying growers. Paying growers fairly and on time is important, and not an area that can be squeezed – leaving frozen local in a tricky position in terms of generating ample margin for itself.
- Frozen processing costs: nitrogen. The biggest drawback to using a more space efficient, higher scale production cryogenic IQF machine over a blast freezer is the ongoing cost of nitrogen. Jim described his nitrogen costs at 19 cents per pound of Farm Bridge frozen product. He advised other operators to monitor the fluctuation of price on this input. Jim found his prices increasing due to rising oil prices, though these prices have not settled back after oil prices declined. Even small increases to nitrogen costs result in significant changes to cost of goods.
- Frozen processing costs: labor. Labor is a critical component that surfaced many thoughts. Jim explained that he has a team of 75 employees in the high season, running shifts 24 hours a day. There are many ways to help them be efficient and effective. Two examples he provided – having growers harvest greens high, to eliminate some of the chopping that his workers would have to do and having growers pack cherry tomatoes in large boxes, rather than smaller retail style packaging. Because Brandon’s Farm to Freezer program is focused on workforce development, his perspective on labor is less about maximizing efficiency and more about ensuring the program is adequately training and preparing workers. However, the organization did make dramatic changes to its workforce training to reduce the cost of labor. Early on Farm to Freezer had a 90-day training program, which has since been reduced to a one-week intensive program before workers are processing.
- Additional costs of goods sold discussed: price of packaging, kilowatt hour pricing to run a blast freezer that utilizes cold air (negligible in comparison with the cost per pound of cryogenic gas), and the cost of water.
Sales, General & Administrative Costs (SG&A)
SG&A covers your fixed costs. As your operation grows from a small base, you want to make sure the growth of your SG&A is aligned. If you can start with a leaner staff, a smaller facility and fewer costs that will hit you before you even turn on your processing line – the better off you’ll be. We didn’t go into as much depth here, and instead focused on capital investments upfront that may impact both COGS and SG&A upon launch.
Interest, Taxes, Depreciation & Amortization (Impacted by Capital Investments & Financing)
What equipment do you need to freeze your product? How might this change over time?
One of the biggest decisions a frozen local processing facility has to make is what kind of freezer to use. The primary options explored:
- Blast freezers. Farm to Freezer uses a large blast freezer with a processing speed of about 2,000 pounds per day. This requires a manual process with staff completing pre-freezing processing steps such as chopping, trimming and/or blanching, spreading the prepped product out in single layers on sheet trays and putting the trays into a blast freezer that individually quick freezes the product within 2-3 hours. From our research, equipment suppliers such as Modern Portable Refrigeration provide blast freezers that can freeze up to 1,000 pounds per hour at a cost of approximately $100,000 upfront and anticipated operating expenses of less than $35 per day.
- Cryogenic tunnels. Farm Bridge uses a cryogenic tunnel with a much higher processing speed of about 2,000 pounds an hour and a smaller footprint. According to Jim, cryogenic tunnels utilizing liquid nitrogen run about $75,000. With these machines, product is blasted with liquid nitrogen while being agitated to keep it separate, reaching an individually quick frozen state in a matter of minutes. Food Bank of Northeast Georgia has secured a cryogenic tunnel for its operation. In our research we found a range of cryogenic tunnels ranging from $75,000 to $150,000 depending on the tunnel’s capacity and state: used as sold by Aaron Equipment or new as sold or leased by Linde Group and Air Products. We also found there to be an additional ongoing cost of the nitrogen tank rental averaging $1,000 per month, and significant upfront costs in addition to the machine itself, including piping installation from the nitrogen tank to the freezer, oxygen sensors, and a cement pad for the tank.
Ultimately, the primary tradeoff appears to be efficient scale of production volume. Cryogenic IQF machines are more expensive to operate – sometimes prohibitively so depending on product price and margin – due to the significant costs of nitrogen, but they freeze product exponentially more quickly resulting in a slightly higher quality and a higher potential daily output, particularly important when facility space is limited and target productions volumes are high. Cryogenic can be the better option when you have a high price product for sale that requires the highest quality, fastest freezing, such as frozen seafood, meats and finished goods. In these cases, the cost of nitrogen per pound can come out of a larger price and margin per pound base.
While blast freezers take more manual effort to spread product on trays and load, and take much longer to freeze – this labor inefficiency may be considered a benefit in some models. Labor flow can be designed to complete other pre-freezing processing steps while freezing is occurring, which may result in only slightly lower labor costs at lower production volumes. Additionally, you might value labor utilization over efficiency. If you are focused on workforce development like Farm to Freezer, the blast freezer approach gives you an opportunity to employ and train more people. If you have supply or demand limitations, and could never fully utilize a machine that processes 2,000 pounds per hour, than you also likely wouldn’t need to invest in a cryogenic machine.
What about the processing equipment needed to prepare a raw product for freezing?
While the panelists did not talk at length about pre-freezing processing equipment, it became clear that panelists had invested in some very unique equipment to help get produce ready for processing, such as a snipper machine for green bean processing. It was clear that it had been challenging to find the right equipment to meet the needs of their unique operations at varying levels of scale. They lamented that engaging equipment manufacturers for this process was a catch-22, while they could be helpful, these guys are also motivated to sell– making it difficult to trust their perspectives on what equipment is truly needed. They mentioned a few companies out there to help folks get started including Alard and Charlie’s. Similar to the considerations for freezing equipment, automation and efficiency should be balanced with labor utilization goals.
And how do equipment choices impact your funding strategy and financing costs?
Each of these operations utilized grants, and in the case of Farm Bridge, forgivable USDA loans to help finance these high cost equipment purchases. It is important to pursue low or no cost funding options, to avoid launching a local frozen processing facility that has too high of a debt burden to ever be financially viable. TJ did share one important piece of wisdom: “do your research before applying for your grant, and don’t make promises you can’t keep with respect to throughput volumes, or the number of growers or residents you might be able to reach.”
And as bonus, here are a few additional operational considerations discussed:
- Consider partnerships with other organizations to avoid or reduce upfront investment. Brandon described Farm to Freezer’s innovative strategy of outsourcing frozen processing to a nearby IQF facility with a cryogenic tunnel, in the peaks of Farm to Freezer’s processing season. They also leverage a partnership with a frozen storage facility to manage their peak storage needs. This enables Farm to Freezer to manage higher production levels without having to invest in equipment and storage needed to handle the maximum product volume they may get during the peak season. This strategy is only viable if nearby partners exist, but is certainly something to look into upfront.
- Accurate forecasting of supply and demand requires upfront communication. Working capital is needed upfront to pay growers for their inputs before the finished products are sold to buyers. Jim described the importance of planning with growers and buyers early on and comprehensively. His goal for Farm Bridge is to end the season no more than 10% off the original forecast.
- Set aside budget for unforeseen expenses. TJ provided one example when he discovered he needed to fund a $25,000 concrete pad for the IQF machine’s cryogenic gas tanks. Do as much homework as possible on the potential costs associated with your equipment choices, but set aside additional budget for things that might come up.
Again, no silver bullets, but overall, what seems to be true is that a batch freezing approach like Farm to Freezer’s may have more potential for financial viability within a smaller scale, earlier-stage, highly focused operation. On the other hand, Farm Bridge’s positioning of their cryogenic IQF production as a critical component or loss leader within a much larger operation makes strategic business sense, even though the business line may not be highly profitable itself. It is important to note that two of the three panelists represent organizations that are not necessarily looking to maximize or even achieve profitability. This reminds us that frozen local has a myriad of benefits beyond the economics that might be well worth the effort if grant funding can be secured ongoing to cover a portion of its operating costs.
The main takeaway is: Do your homework! Start with your organizational context and goals. Research your supply and demand landscape and engage your target set of buyers and growers in a needs analysis. Take this data and make informed decisions on business model structure, then choose the right equipment set with attention paid to flexibility and scalability. Finally, develop a financing strategy and growth trajectory that appropriately reflects your goals.