Vertical Coordination in The Malting Barley Industry: A

1
Vertical Coordination in The Malting Barley
Industry A Silver Bullet for Coors

• Brian C. Briggeman
• Joshua D. Detre
• Case Study prepared for the 2004 American
  Agricultural Economics Association Denver, CO

2
Background

• Adolph Coors founded Coors Brewery in Golden, CO
  (1876)
• Growth
• 2002 acquisition of Bass Brewers (UK)
• Increased net income by 8
• 2002 net income 161.8 million
• 2003 net income 174.7 million
• 9th largest brewer in the world
• In discussions with Molson
• Competitive Advantage
• Rocky Mountain Fresh

3
Production Contracts

• Secure supply of high-quality barely
• Strict Standards
• Price premium to barley farmer
• Idaho Barley Commission
• 2002 Malt Barley 5.67/cwt
• 2002 Coors Production Contract 6.75/cwt
• How does this affect costs in the value chain?

4
Agency Theory

• Principal and agent
• Farmer pursues goals that differ from Coors
  (moral hazard)
• Shirking results
• Asymmetric information (adverse selection)
• Farmers may have hidden information-knowledge
• Production history
• Production costs
• Risk sharing
• Use financial incentives to motivate workers
• Farmer must be willing to accept the contract
• Farmer must take efficient actions

5
Agency Theory

• Why Agency Theory is not the whole story
• Little difficulty of performance measurement in
  contracted barley
• Occurs because Coors pay the farmers on the value
  they create
• Residual returns to barley production go to the
  farmer therefore there are incentives to pursue
  efficient actions
• Multiperiod relationships limit the existence of
  hidden information

6
Transactions Costs

• Firms are designed to minimize the total costs of
  transacting
• Farmers may be able to exploit learning and scale
  economies
• Farmers are specialists who make necessary
  investments to develop expertise and exploit
  scale economies
• The market provides intangible benefits
• Integration may give rise to additional costs
• Agency
• Influence

7
Transactions Costs

• Why Transactions Cost Are Not The Whole Story
• Problems
• Costs of transactions indistinguishable from
  other costs
• Technical efficiency gains from contracting
  outweighs the agency efficiency (minimization of
  transactions costs) of vertical integration
• Efficiency does not always imply cost
  minimization
• Coors does not force the farmers to bear all
  risks
• Repeated relationship between Coors and the
  farmers
• Reduces uncertainty
• Makes investments in assets more profitable

8
Why Ownership and Property Rights Work for Coors

• Incomplete contracts, bargaining costs, moral
  hazard, and influence costs are sources of
  inefficiency in business relationships
• Assignment of ownership rights affects the
  magnitude of each of these problems and
  possibilities of creating value

9
Why Ownership and Property Rights Work for Coors

• Farmer ownership accompanied by secure property
  rights
• Effective institution for providing incentives to
  maintain a supply of quality barely
• Without them there are dulled incentives for
  farmers to make the investments necessary to
  ensure quality barley

10
Coors Not Buying The Farm

• Objective for the law of property rights is to
  assign them in a way that creates value
• Important rights be assigned properly initially
• Coase states if transaction costs are low and
  rights are assigned, secure, and transferable,
  there will be efficiency
• Contract arrangements between Coors and the
  farmers have evolved towards an efficient
  arrangement that allow both parties capture
  mutually available gains

11
Coors Not Buying The Farm

• Difficulty of performance measurement in barley
  production
• Coors wants the farmer to have possession of
  residual decision rights and residual returns.
• Decisions regarding the use of the assets that
  are not explicitly covered in the contract
• Will make efficient decisions because he will
  want to maximize returns

12
Coors Not Buying The Farm

• Coors has multiperiod relationships with key
  barley suppliers
• Provides an incentive for fair treatment
• Reputation is an effective control mechanisms of
  the contract
• Arms length transactions are preferred to
  ownership
• Consequences for performance when contracts are
  granted for the next year
• Presence of a learning curve, which means
  long-term relationships are valuable
• Very difficult to transfer knowledge and
  experience

13
Value Chain affects on Property Rights

• Supply Chain Management Activities
• Contract standards ensure high quality barley
• Creates a benefit position relative to
  competitors
• Accomplished through property rights
• Operations
• Production processes for Coors are higher
• Predictable costs (COGS per Sales 54)
• Affect on contract bidding

14
Value Chain affects on Property Rights

• Distribution
• Economies of Scale
• Minimum Efficient Size
• Sales and Marketing
• Building product image through
• Branding, pull advertising, and product promotion
• Breadth of product line
• Service
• Savings due to recycling can be passed onto the
  production contracts

15
Value Chain affects on Property Rights

• Profit Margin
• BOTTOM LINE
• Willingness to pay for Coors products
• Why? Competitive advantage attributed to our
  differentiated barley

1999 Beer Industry Leaders Anheuser Busch Coors Miller
Operating profit 23.51 6.73 12.47
Operating margin 25 7 15
Source Sanford C. Bernstein Co., Inc. April 17, 2000 Source Sanford C. Bernstein Co., Inc. April 17, 2000 Source Sanford C. Bernstein Co., Inc. April 17, 2000 Source Sanford C. Bernstein Co., Inc. April 17, 2000
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Beer Naturally

• Production contracts via property rights are the
  most efficient form of organization for Coors
• Source of Competitive Advantage in the Value
  Chain
• Where to go from here
• Economies of scale in operating expenses
• Continued selective acquisitions, mergers, and
  ventures
• Product proliferation
• Co-branding
• Capture cost advantages while maintaining benefit
  advantages

17

• Thank you for your time and attention
• Please feel free to ask any questions you may
  have about our presentation

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Table 3. Income Statement Data for the Adolph
Coors Company, 1998 to 2002 (millions of dollars)
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Table 4. Other Performance Information, 1998 to
2002
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Table 5. Scale Advantages Are Key In Beer
Industry 1999 (/Barrel)
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Table 7. Yahoo Beer Industry Statistics
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Table 8. Dunn Bradstreet Industry Quartiles
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Table 8. Dunn Bradstreet Industry Quartiles
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Table 8. Dunn Bradstreet Industry Quartiles
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Table 8. Dunn Bradstreet Industry Quartiles
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Table 8. Dunn Bradstreet Industry Quartiles
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Table 8. Dunn Bradstreet Industry Quartiles
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Factors in Coors Organizational Structure

• Specificity
• Frequency and Duration
• Complexity and Uncertainty
• Difficulty of Measuring Performance
• Connectedness

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Coors Not Buying The Farm

• Difficulty of performance measurement in barley
  production
• Since care is especially difficult and/or costly
  to measure for Coors, the solution would be allow
  the farmer to be the owner
• He has residual control and is the residual
  claimant
• The farmer will have the proper interest in
  maximizing the residual value of the asset