Vertical Coordination In Malting Barley

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Vertical Coordination In Malting Barley

• A Silver Bullet for Coors?

Lindsey Higgins Pablo Ramirez
Texas A M University College Station, Texas
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Coors Strategic Decision

• How can our supply chain management structures
  withstand the economic threats of a dynamic world
  market?

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Case Objectives

• Determine the theoretical framework that best
  describes Coors Brewing Companys decision to
  contract their malt barley input needs
• Determine how the resulting analysis will apply
  in Coors attempt to capture more market share in
  the changing world economy

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Theoretical Framework

• Transaction Costs Theory
• Agency Theory
• Contractual Incompleteness
• Key Aspect These 3 theories are not
  mutually exclusive and to a large extent
  intertwined

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Continuum of Theoretical Framework
Low Asset Specificity Low Quality Requirements
High Asset Specificity High Quality Requirements
Transaction Costs theory
Agency theory
Neo-classical
Vertical Integration
Complex contract relationship
Verbal contract/ agreement
Simple legal contract
Spot Market No contracting
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Theoretical Framework

• Transaction Costs Theory
• Agency Theory

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Three Primary drivers
Transaction Cost Theory

• Uncertainty
• Asset Specificity
• 3. Measurement Costs

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Uncertainty of Barley Prices
Source Data obtained from USDA
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Uncertainty of Barley Prices
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Three Primary drivers
Transaction Cost Theory

• Uncertainty
• Asset Specificity
• 3. Measurement Costs

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Comparison of Standards
Coors Coors USDA Grade 1
Min Max
Plumpness1 80
Plumpness2 75 79
Color points 40
Protein 8 13.5
1 Base price screenings 2 Thin Price Screenings
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Graph of Transaction Costs Theory
Spot Market
Contract
Vertical integration
Transaction costs
0
Asset Specificity
Source Williamson 1991
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Three Primary drivers
Transaction Cost Theory

• Uncertainty
• Asset Specificity
• 3. Measurement Costs

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Relationship of average costs between externally
and internally coordinated markets.
Price
Average Total costs
Average Transaction costs
Average cost of grains
Average cost of measuring quality
0
Quantity
Internally
Externally
Source Barkema 1993
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Transaction Cost Theory

• Additional costs in a contractual agreement
• Legal fees
• Agronomic costs
• Negotiation costs
• Selection of growers
• Costs associated with the transfer of risk from
  producers to Coors via contracts

Yet, Coors determined that the transactions costs
on a spot market basis outweigh these additional
transaction costs associated with contractual
agreements.
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Transaction Cost Theory

• High uncertainty associated with
• Barley prices and quantities
• Highly specific needs for quality inputs
• Implications associated with measurement costs
• Therefore Transaction Costs is the primary
  theory that best describes Coors malt barley
  contracting program

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Agency Theory

• Coors addresses the issues associated with agency
  theory through
• Unique barley variety seed purchased from Coors
• Strict specifications
• Contracts not renewed if quality standards are
  not met
• Improved information technology

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Contractual Incompleteness

• Concepts of Contractual Incompleteness will
  always be present
• Bounded by rationality
• Doesnt specifically motivate their decisions,
  nor does it best describe their structure

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Prospects for The Future

• Tougher competition and tighter margins
• Changing legal requirements
• GMO
• Traceability
• ISO 9000
• Food Safety
• Beer is a mature industry
• Need to find new markets

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Coors in a Global Future
Strengths Weaknesses
Mergers in Canada and UK Single site brewery
Experience with contracts gives them the ability to trace back to the farm level Difficult to implement the same level of coordination in multiple countries
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Coors in a Global Future
Opportunities Threats
Growing markets in other countries Different tastes and preferences in other countries
Trend for differentiated premium beers Low growth in the US
Microbreweries market is exploding
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Summary

• Quality specifications motivate the use of
  contracts
• Economics of supply chain structure leads to the
  minimization of transaction costs
• Thus, adverse selection and moral hazard concepts
  are addressed in the arrangement of the contracts
• Their ability to meet traceability and other
  protocols will allow them additional market access

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Selected Sources

• Barney, J. Gaining and Sustaining Competitive
  Advantage.
• Cook, M. and Peter Barry. Organizational
  Economics in the Food Agribusiness, and
  Agriculture Sectors. Amer. J. Agr. Econ
• Martinez, S. Vertical Coordination of Marketing
  Systems Lessons from the Poultry, Egg, and Pork
  Industries. United States Department of
  Agriculture, Economic Research Service
• Jones, E. The Role of Information in U.S. Grain
  and Oilseed Markets. Review of Agriculture
  Economics.
• Williamson, O. Transaction-Cost Economics The
  Governance of Contractual Relations. J. Law and
  Econ. 22(1979)233-61
• Grossman, Sanford and O. Hart. The Costs and
  Benefits of Ownership A Theory of Vertical and
  Lateral Integration. J. of Political Economy.

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Other Theories

• Increase profits in noncompetitive markets
• Price discriminate
• Create barriers to entry
• Shift price and production risk to firms that can
  manage risk more efficiently
• Ensure input supplies
• Sustain a strategic competitive advantage

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Cumulative Distribution Function (CDF) graph