During a recent quick trip to California to visit the Pundit’s sister and celebrate the Pundit parents’ 51st wedding anniversary, the Pundit, Mrs. Pundit and the Jr. Pundits, Primo and Segundo — aka William, age 7 and Matthew, age 5 — all had a delightful visit with Al and Mary Vangelos.
Al is sagacious and Mary is a woman of omnifarious kindness. She extended the Pundit an invitation to visit the Vangelos home back in 1990 when Al and the Pundit — except we weren’t the Pundit yet! — were working day and night to help the old United Fresh Fruit and Vegetable Association prevail over troubled times.
It took 19 years to make the visit happen but, as they say, the longer the waiting, the sweeter the kiss. And, of course, Mary had extended the invitation to a single guy and got a whole family. Still and all, it was an unseasonably cold day in California but we were warmed that day by the ember of friendship and mutual respect that has glowed more brightly with the passing years.
Al has had and still maintains many roles in the industry, but the most prominent is the President and CEO of Sun World, so our conversation inevitably strayed to a discussion of some of the challenges facing growers and, particularly, the California tree fruit industry. We knew the problem was serious and Al provided additional insight.
On the flight home we reflected on how we ought to write a piece discussing the matter when what should be waiting in the mail but a letter from another prominent tree fruit executive explaining what is going on the industry:
Indeed California tree fruit is in tough straights.
Estimates are that perhaps 7,000 acres were scheduled to be pulled out of production at the end of 2008 (some wish it was 10,000 acres), especially among some white-flesh varieties, which are currently dramatically over-produced. Even when acreage is pulled out, it is usually replaced with more productive varieties, so it seems there is always pressure from more volume even if from fewer acres planted.
For a number of years the popularity (and high price returns) of white-flesh peaches and nectarines primarily in the Taiwan market produced heavy plantings, but as volumes of whites have hit dramatic levels, there has not been significant market expansion domestically or in other export markets.
The variety of all summer fruit choices and availability has grown dramatically over the last 5-7 years, and a real battle has emerged over ‘shelf space’. As we all know, the average shelf space dedicated to produce has not changed significantly over the years, but the list of items offered in that same shelf space has probably more than doubled in the last decade.
Retailers have steadily moved away from standard ‘margin markups’ to a philosophy of ‘space utilization’ and ‘yield per square foot’. With more items to manage in a fixed amount of ‘real estate’, the value of real estate becomes more valuable and costly to manage; therefore it demands a higher yield per square foot of utilization. Big promotions are increasingly harder to implement. We have discovered that tree fruit demand is increasingly inelastic, and retail prices rarely have any correlation to FOB prices or producer costs.
From June to September, there is increasing commercial production and home grown supply of peaches, for example, in all of the contingent 48 states. With transportation costs being a significant cost component (not to mention the plethora of ‘promote local’ programs), consistent access to many markets is at times dramatically restricted for long periods of time throughout the season.
Unfortunately, eating quality is highly variable and difficult to manage in most tree fruit cultivars. The factors of variety, bloom timing, where fruit sets on the tree, pruning and thinning techniques, harvest timing, Brix-acid variability and post-harvest treatment all conspire to make the optimization of flavor a constantly moving target. At times it seems as if every single fruit is an individual, and achieving consistency in the eating experience is ever more challenging. Not meeting a consumer’s expectation, consistently, is but one reason total per capita consumption of most tree fruit cultivars has remained flat for years.
The last 2 seasons, California tree fruit producers have been crushed with a market oversupply that has not been mitigated through increased consumption, market expansion, or significant acreage adjustment, and the financial consequences for growers has been extremely harsh.
The consequences of the confluence of all of these factors has resulted in acreage being pulled out, some growers large and small pressured out of business, thus forcing the consolidation (or closure) of many packing operations.
With very low, and in many cases, negative returns, capital reserves have disappeared to meet all of the production inputs for many growers. Traditional crop financing with banks or serviced by packing houses have dried up. Even if you have some remaining capital reserves, or the ability to borrow them, finding the ‘will’ to risk scarce cash resources to prune, thin, and culturally manage a crop to harvest with little encouragement for a profitable season is wearing on everyone. Then, there is the economy; unemployment, and a worldwide recession (for some, depression has arrived).
There will be survivors. Certainly, there are opportunities. I suspect Warren Buffet is buying at Berkshire Hathaway, not selling.
In the California tree fruit business, those growers who have held together the right mix of varieties, market timing, who are teamed with a knowledgeable packinghouse company will continue to find ways to enhance the eating experience of their peaches, plums, nectarines, pluots, and apricots and will achieve adequate market penetration to be profitable (even if marginally).
The 2009 season will be a severe test, but it will sharpen everyone’s focus on improved ways to capture and retain their hold on the very competitive ‘battle for shelf space’, and an opportunity to present their best fruit this coming summer. We can only hope.
It is quite a letter. It correctly details so many of the trade’s problems:
1. We seem like hamsters on those wheels sometimes. The dominant variety is in overproduction compared to demand. So everyone looks to produce newer varieties that are getting better returns, that puts these new varieties in over production so the returns shrink, then the cycle begins again.
2. Retailers have become more sophisticated. The relationship between the FOB, the retail price and retail profitability is complicated. Even if lowering a retail price does increase movement, it doesn’t necessarily increase retail profitability and even if expanded space for a product increases movement for that product, this doesn’t establish that the retailer wouldn’t be better off devoting the space to something else.
The letter didn’t mention it, but there is something else: Many retailers just care less about the supplier community than they once did. The relationships aren’t as personal, the accountability to higher-ups more intense and the connection of buyers to the produce industry more casual. Lee Scott just finished his time as CEO of Wal-Mart. Once upon a time, he was prone to say things such as, “We need our suppliers more than they need us.” By the time he left, he had stopped saying such things.
3. Inelastic demand. Most produce items are very inexpensive and have limited traditional meal opportunities. So cutting the price of tree fruit may help for a short promotion but it just doesn’t boost demand very significantly — especially because if you cut prices on, say, peaches, the place the increased sale often comes from is from plums or nectarines! The industry tries but doesn’t really have the resources to boost consumer demand.
4. The locally grown programs are causing many problems not fully realized. This disruption of markets is one of them. It is very difficult for traditional growers and packers of a single line of product to plan volumes and manage sales.
5. The inability of the tree fruit industry to offer a consistent-quality eating experience is increasingly problematic.It makes consumer promotion difficult and makes retailers hesitant to push the product. Not to mention that it makes consumers hesitant to buy.
Interestingly enough, when we speak to growers, they barely mention these things as their problem; they tell us that the problem is that the banks won’t finance them. Several growers have mentioned that at this time of the year they would have been getting money for pruning but that the banks won’t lend.
Though we know we are being told the truth and, certainly have written enough about the financial crisis to know the seriousness of the situation, it strikes us that this is not the complete story and that the problem points to why solving this financial crisis is so difficult.
The situation is not that growers, who every year for 30 years have borrowed money for pruning and what not, finished the season, paid it all back every year and owed the bank nothing for months till the next cycle started, are now suddenly unable to borrow.
If that was the problem, then a burst of liquidity would solve the problem.
Unfortunately, due to the profitability reasons referenced in the letter, the banks seem to have often been rolling over these loans or portions of them. Often they seem intertwined with land value, and as long as land values kept rising, the banks were collateralized and thus prepared to roll things over.
Now we hear that the banks are demanding real business plans showing a real likelihood of repayment.
In other words, the problem is not bank liquidity; it is that a lot of lending has not been done in a method that would traditionally have been considered prudent.
The Pundit’s family once had a substantial produce business, advanced millions to growers, provided millions more in credit for export customers and used a bank to help finance the operation. The bank was typically willing to lend but they had one rule: One day a year, they wanted us to owe them zero. We don’t sense that a lot of growers, tree fruit and others, could really meet that test.
The bright side is a little tough because it means hardworking growers will go broke. If the problem is oversupply, banks not lending to those unable to establish a prudent likelihood of repayment will cause weak players to exit the business. This will leave strong ones in a better position to charge what they need to if they are to make a profit.
It is a tough outcome, but what, really, is the alternative?