Controlled environment agriculture, or facility agriculture as it is commonly known, consisting mainly of greenhouses, vertical farms, and container farms, has now received a lot of attention and made significant progress. Technological advancement and consumers' growing concern about where their food comes from are two factors contributing to the rise in the popularity of facility agriculture. This year’s Covid-19 pandemic in particular, while devastating in many ways, has prompted individual consumers and families to spend more time understanding where food comes from and how it’s grown.
Facility agriculture has unique advantages in this regard. AppHarvest is a successful example of facility agriculture that has attracted a lot of attention from agritech and mainstream media. AppHarvest's "world's largest greenhouse" in Morehead, Kentucky, is about to start production. Not only is celebrity chef Martha Stewart joining the board, but AppHarvest's upcoming IPO on Nasdaq via a backdoor listing has drawn industry and media attention.
Equilibrium Capital, an early investor in AppHarvest, also invested in Revol Greens, another facility agriculture startup. The company previously announced a $68 million funding round, bringing its total raised to date to more than $200 million.
While there is clear interest in building controlled environment farms, the actual development path is not as widely discussed and mapped out as clearly. According to general consensus within the industry, creating a successful controlled environment farm requires three elements:
In our opinion, a potential facility farmer who has all three elements is in a very good position. If it only accounts for two of the three elements, it means that the opportunity is not bad. However, each lack of one element poses a formidable challenge to the commercial success of facility agriculture.
Take AppHarvest as an example, it is "all three". Its founders have expertise in facility agriculture; Mastronardi Products provides distribution; it is backed by multiple investors, including Equilibrium Capital, and is publicly traded.
The following is an analysis of the three elements and the requirements for each element:
Is the team capable of developing and operating a controlled environment farm cost-effectively? The limited number of individuals with both development and operational skills could hinder the profitability of a farm if an additional management team were required.
Now for individuals and teams looking to start a facility farming company, the first decision to make is often: Greenhouse or Vertical Farm?
Factors to consider here include:
* Industry development stage: The greenhouse industry is more developed than vertical farming and has more surrounding infrastructure. Specifically, there are more options for the construction of the greenhouse.
* Land Efficiency: Vertical farms require far less land per unit of output than greenhouses. In areas where land costs are high, vertical farms may be the first choice.
* Demand: Forecasting demand is a critical part of this decision-making process. If demand exceeds the capacity of a single-story growing structure, such as a greenhouse, then vertical farms may need to be considered.
* Electricity Costs: Electricity is one of the largest costs in a vertical farm or greenhouse. Typically, the energy consumption per unit of yield required to operate a vertical farm is higher than in a greenhouse, so the power and cost required in the area where the farm is located will influence the decision.
* Cost of building, purchasing equipment, and purchasing systems: The cost of building a greenhouse or vertical farm varies widely.
After deciding on a vertical farm or greenhouse, we can start thinking about capacity.
How to determine capacity?
Productivity can be calculated with the following formula: Productivity = (horizontal planting area) x (number of planting areas) x (number of plants per unit area) x (rounds per year)
Greenhouses are grown horizontally. In addition to the horizontal planting areas, space is required for a range of non-planting needs, including space for packaging, preparation, personnel, transportation and management.
Capacity variables include: product type, technology usage, plant growth cycle, production size, downtime, loss rate.
Example calculation: ([3,000 square feet of planting area] x [2 planting sites per square foot]) x (5 floors) x (10 rounds per year) = 300,000 plants per year.
Site selection and development
Once you have decided on a vertical farm or a greenhouse, and determined your capacity, the next step is to choose a location. Often, operators already have a location in mind; they may own the site, want to live in an area, or see a special opportunity there. In addition to the above factors, key to the site selection process are the attributes of the site and its location. Factors to consider when conducting due diligence on a site also include:
Site usage laws and regulations, public infrastructure, ground and water, barriers to entry and exit, local community impacts, the availability of skilled labor to form a strong team.
Depending on where the site is located, local government regulation of facility farms can vary widely.
Distribution depends on capacity, farm location and price.
Distribution starts with the relationship with the customer. Farmers need to reach out to potential customers for their products and discuss product needs and prices with customers.
When working with retailers, it is beneficial for operators to take a pragmatic approach to forecasting demand. Retailers are motivated and will overestimate demand in order to avoid product shortages; however, excessive approaches can create excess production for operators. Many operators prefer purchase agreements, where customers agree to buy a specific quantity of a product at a specific price.
Additional considerations for capacity include:
* Distribution production is concentrated on a limited number of customers,
* Optimizing excess capacity to meet the increasing demands of existing customers,
* Optimize part of the output to meet new customers,
* Capacity utilization requires a delicate balance of being flexible enough with enough yield to run a profitable farm.
Proximity to customers affects the following: distribution, product marketing (retailers pay a premium for local ingredients), and labor.
Understanding needs and clear goals will determine how to price. If the goal is to maximize short-term revenue, contracts that maximize capacity may be the best choice; if the goal is to maximize mid- to long-term profitability, smaller contracts with a range of customers will be beneficial.
Being realistic and being relatively conservative is crucial for operators when pricing their products. This is especially the case when selling to the retail end. In most cases, we recommend that facility farm operators set prices between conventional and organic produce. There may be room for higher prices in some parts of the retail end or when using special packaging.
Despite recent news that the entire facility agriculture industry is on a fundraising spree, capital is not limitless. In almost all cases, the key decision is where and when to invest. Even where capital appears to be "unlimited", investors demand acceptable returns.
Capital trade-off decision
Buy or build? Buying a successful facility farm has costs, but it also reduces time to market. Acquisitions include structures, systems, and customers and employees.
Technology: It can provide efficiency and quality benefits; however, it can also limit product mix and product packaging diversification.
Location: Generally, land ownership is not a variable; however, the value of the land and the advantages of the site need to be considered compared to other locations.
Planting area: Generally speaking, maximizing construction capacity will generate the most income; however, it may not generate the greatest total profit or return on invested capital.
Source of capital
All kinds of capital are investing in the controlled environment agriculture market. The exceptions are senior loan providers such as banks and certain financial companies. Historically, banks have only made loans to experienced operators and those whose funds are guaranteed by the government or other highly rated entities.
Sources of funding/financing include: individual and private family offices, venture capital and private equity investors, junior capital departments of financial institutions, investment departments of companies, vendor financing, lease financing.
Supply and demand
The importance of the three factors of operations, distribution and capital and the interplay between each cannot be underestimated.
For example, limited access to capital may require reducing farm space, affecting the number of customers it may serve. Decisions made with one factor taken into account require re-examination of decisions made on each of the other factors. This fluidity and balance persists throughout the life of the facility farm.
As with all businesses, every decision has trade-offs. Focusing on customer needs is the number one priority, however, many operators tend to focus on operational efficiency. In the final analysis, operators need consumers who are willing to buy their products at a price that is profitable for the farm, which also requires end consumers to understand their products and attributes, so running a farm needs to keep an eye on supply and demand.