Earlier this year I had an incredible opportunity to join Pasture One, a mission-driven distributor of sustainable, grass-fed beef. Our small team had a mandate to support ranchers using techniques that promote carbon sequestration and grasslands regeneration. While the opportunity was shorter-lived than anticipated, it was a fantastic experience. Unfortunately, the business closed suddenly due to a single tragic event, and in so doing, reminded me of a classic business school lesson: supplier risk.
Supply Chain Management in the Food Industry
Supplier risk and supply chain management should be a key area of focus for any business involved in the production, distribution, and sales of physical goods. As a former private equity investor, I recognized a key area of focus during due diligence was on supplier concentration and supplier relationships. A loss of a supplier can be a difficult hole to dig out of.
While many entrepreneurs and executives prioritize product development and sales, overlooking supply can be a critical mistake. Suppliers are essential business partners and mismanagement can lead to the demise of a company. Suppliers provide not only the raw material inputs that products are made from, but also components, labor, and services such as expertise or production and manufacturing services.
For reasons that became very clear to me upon reflecting on my experience at Pasture One, supply management in the food industry is a uniquely difficult challenge that requires extra focus. Strong supply chain management is particularly important to ensure food businesses can control availability, quality, and cost.
Availability: Product availability is critical to maintaining customer relationships, thus, supply chains must be set up to ensure consistent availability that can scale with the business. Large retailers operate on tight margins, cannot afford empty shelf space, and demand to be able to keep their shelves full and products stocked throughout the year. If a small food business is unable to meet the demands of its customers, it may lose that shelf space permanently.
Quality: Perhaps in no industry more than the food industry is the quality of the final product more directly tied to the quality of inputs, including both the raw materials and manufacturing processes. Supply chain management must focus on developing consistent, high quality raw materials as well as developing relationships with trusted manufacturing partners who deliver consistent results. Poor quality control can lead to inventory losses, high waste, and worst of all, a poor customer experience.
Cost: The most obvious and often the most challenging factor is managing input costs. Food businesses cannot usually pass along increased costs to customers and rising costs can cripple a business of any size. Rising input costs were cited as a key reason that the natural food company Annie’s sold to General Mills in 2014 for $820 million. Increasing costs had hurt margins and overall company performance despite rapidly increasing revenues. Prior to acquisition the company’s stock had fallen 22% for the year. Under Mills, Annie’s was expected to improve margins by lowering costs through greater purchasing power.
Supply chain management is a key area of focus when evaluating performance and positioning of any business. “Porter’s Five Forces,” one of the most-used frameworks for analyzing the competitiveness and attractiveness of an industry, identifies the “bargaining power of suppliers” as one of the five key pieces to understanding the business environment. Supplier power is influenced by a number of factors such as the number of suppliers, switching costs, and the degree of differentiation between inputs. As supplier power increases, the business prospects become increasing risky and uncertain. Due to the limited supplier base, high switching costs, and importance of quality, businesses in the the burgeoning natural and sustainable food industry often face a high degree of supplier power and, therefore, have an extra challenge with regard to supply chain management.
The Case of Pasture One
When I joined Pasture One, there was a lot of work to do. The business struggled with fluctuating margins, impaired inventory, and few efficient processes and procedures in place. The business had less than ideal relationships with customers and partners, significant past due receivables, and a high degree of supplier concentration. I was part of a new team brought in to turn the company around. In addition to improving the underlying operations, we had an aggressive growth mandate for the year and needed to develop rapport amongst our new team and stakeholders. The good news was we had patient investors and a world-class team to get the job done. The first few months were challenging and fun. I was learning a new industry, fixing processes and developing new relationships with teammates, suppliers, vendors, and investors.
We made incredible, rapid progress. The company flipped its margins from red to black, collected past-due receivables, improved relationships with customers and vendors, and implemented new tools and procedures to ensure the business could scale efficiently and effectively. With operations running smoothly, the team could focus on growth and strategy. We strategized about long-term opportunities and thought about investments, vertical integration opportunities, and innovative ways to disrupt a very traditional industry. We began to grow rapidly as well. In a few months, we had new customer accounts lined up and were on pace to hit our aggressive revenue targets.
As the business scaled, we began to lean increasingly on one particular supplier who would often represent half to three-quarters of our weekly orders. We recognized this as a risk to the business, but in this nascent industry there were few ranchers providing quality products that met our strict sustainability and animal welfare criteria at the scale we needed. We focused on developing strong relationships with all of our suppliers and in particular our largest supplier. We kept in touch regularly, paid on time, and communicated openly on upcoming orders. Despite these efforts, Pasture One was not prepared for an unfortunate tragedy. Unexpectedly, our primary supplier passed away. It was a sad loss for his family and the sustainable agriculture movement, and unfortunately, the beginning of the end for Pasture One.
We continued to source from our rancher’s business for a few more weeks, but soon discovered he did not have a business continuity plan. We quickly lost our primary supply. The race was on to find a short- and long-term solution to revamp our supply chain. As weeks went on, we reached a point with no realistic scenario to provide a consistent supply to our customers, and in the end Pasture One shuttered its operations.
Supply Chain Challenges in the Good Food Industry
Supply chain management is exponentially harder when scaling a business in a new market where the ecosystem has not been developed and there are few suppliers to choose from. With the natural foods industry booming and consumer demand for new and innovative food products increasing, many brands are scaling rapidly in new markets. Companies selling pea protein, super food snacks and bars, dairy alternatives, cricket protein, and other innovative food products have raised millions of dollars to grow their presence. However, as these businesses scale, they often rely on immature supply chains and markets creating additional challenges and risks.
While private companies do not disclose information regarding risks, this problem permeates even the largest natural food companies. Boulder Brands, a formerly public company that owns brands such as Smart Balance, Udi’s, EVOL and others, highlighted significant risks throughout its supply chain in its 2014 Annual Report which stated “only a limited number of manufacturers may have the ability to produce our products at the volumes we need, and it could take a significant period of time to locate and qualify such alternative production sources.” The report also notes that “it may be difficult or expensive to find co-packers to produce small volumes of our new products. Co-packers may impose minimum order requirements and any failure on our part to meet these requirements could increase our costs.” The filing highlights risks related to commodity cost increases and the importance of effective supply chain management including raw materials suppliers, manufacturing partners and in-house manufacturing facilities.
Even small food businesses that have plenty of access to raw materials face significant supply chain management challenges. Smaller businesses often must meet high minimum order quantities (MOQs) which can render them reliant on a single supplier and facing significantly higher input costs than larger competitors. Furthermore, with limited employee resources, managing a complex supplier universe can absorb more resources than a small business can afford.
Reliance on third-party manufacturing parties and shared kitchens can provide another challenge. In addition to navigating shared spaces and limited hours, there is always significant risk when relying on other small or startup organizations. In October 2018 when kitchen incubator startup Pilotworks closed, 175 businesses were left without a kitchen virtually overnight. Pilotworks is a famous example, but co-packing and shared kitchen operations are notoriously difficult to manage profitably, posing a constant risk of a kitchen or manufacturing partner closing unexpectedly. New Venture Advisors previously discussed the Pilotworks closure here.
Lessons: Prepare For The Worst, Hope For The Best
Despite the risks inherent with any supply chain there are many steps businesses of all sizes can take to mitigate supply chain disruptions.
- Due Diligence: Performing due diligence on suppliers is essential. Businesses should try to understand the economic health of their suppliers and how important a customer they are to their suppliers. In a natural food business, it is also important to ensure suppliers are ethical and meeting the requirements they claim to.
- Diversification: Supply chain diversification is the best way to mitigate risk, although not always possible. Sourcing inputs from more than one supplier and constantly evaluating new suppliers is a crucial aspect of supply chain management. This process will improve the ability to flex up during periods of high demand and ensure fair pricing. While small businesses may not be able to afford to work with multiple suppliers or vendors, as operations scale, it is important to evaluate if the additional cost and logistical complications of using multiple suppliers is worthwhile to ensure the business can endure in the case of a disruption.
- Contract Alignment: If sales contracts are in place, aligning supply contracts will be important to ensure the availability of cost-controlled supply to meet sales commitments.
- Inventory: This can be difficult from a cash-flow perspective and impossible with perishable supplies, but some businesses may find value in holding raw materials in inventory if their supply chain is unstable and costs fluctuate rapidly.
- Right of First Refusal: A business that has significant reliance on a small supplier with an uncertain future may want to consider negotiating a right of first refusal to acquire the supplier in the case it has financial difficulties or is put up for sale. This will ensure the opportunity to control the supply chain in the event the current supplier wants or needs to sell.
- Vertically Integrate: When operations begin to scale, businesses should evaluate directly sourcing some of their inputs through vertically integrating. This could include acquiring farming operations or building a processing facility. It would likely require significant capital investment and a larger team, but could lead to lower costs, more stability, and more quality control.
- Strong Relationships with Suppliers: Treating suppliers well and paying invoices on time is essential. A supplier may pass up the opportunity for a higher price to a new customer if their current customers pay them on time, communicate well, and make their operations easier. Businesses should never underestimate the value of personal relationships and being good partners.
Good Food businesses face risks throughout the supply chain and despite best efforts, not all risk can be avoided, as my experience at Pasture One demonstrates. However, businesses and executives can take steps to evaluate and proactively manage and mitigate existential supply chain threats.
If you are small business owner who has dealt with supply chain challenges or has other suggested management techniques, we would love to hear from you.