Calculating the business risks of converting to organic is a challenging but essential task if we want to encourage more farmers and processors to switch to organic. Johan Cejie has been crunching the numbers
Converting a farm, a processing line, a product or a restaurant from conventional to organic production means the organisation has to make an investment in time, money, loss of production and so on. In making this investment decision, you would have to assess the risks. One of the most important factors is what kind of market growth you could expect. Looking at the Swedish retail market, the time span you choose to look at decides the volatility. Over the last ten years, the annual growth rate has varied between -4% and +41%. However, aggregating the annual years, it seems the market is developing steadily at CAGR +13%.
Converting farms, processes and/or products to organic always includes a business risk. We may consider the business risk to be the product of the possible size of a loss and the likelihood that this loss actually occurs. The size of the possible loss is relatively easy to calculate. For a farm it would be fairly well known how much your harvest will drop the first years, but also what support is available from governments etc. For a processing business, costs for developing a new product, adjust production facilities, etc would also be quite possible to calculate. As these costs are to be considered an investment, you would have to decide what time span you accept before you get a return on your investment. In other words; how many years of organic price premium do I need to cover investments for organic conversion, and become more profitable than I was using my resources for conventional production?
“Looking at the Swedish retail market, the time span you choose to look at decides the volatility. Over the last ten years, the annual growth rate has varied between -4% and +41%. However, aggregating the annual years, it seems the market is developing steadily at CAGR +13%”
Price as such is of course very difficult to predict. It depends on what type of product you are selling and on what market. Naturally it also depends on supply and demand. Speaking to farmers who are considering converting to organic, I have often met two concerns regarding supply and demand: How do I know how the market is going to develop over time, and how do I know if heaps of other farmers of my kind are also about to convert? The last question is usually not too difficult to get a grip on; farmers are usually well informed regarding this kind of information. Conversion data is also often available from government agencies and NGOs. As for the other question – what we know about long-term market development – here, I have been missing data.
For a farmer, a lot of decisions are made with considerably longer time horizons than other businesses. A crop rotation plan, for example, is usually between five and ten years. An investment in a stable may have a depreciation time of 15 to 25 years. When you look at annual growth rates for the sales of organic food in Swedish retail, the market looks very volatile. The growth ranges from -4% (2012) to plus 41% (2008) per year.
The one-year horizon is interesting to operations closer to the consumer market; retail need to be responsive enough to cope with drastic changes in demand, as do suppliers of fresh food and other perishables. This creates a difficult situation for dairies, for example. For a grain farmer, however, longer periods of time are more interesting; what’s the average growth rate over a longer period of time? The relevant term appears here being Compound Annual Growth Rate, CAGR (neatly defined here). Looking at it over a longer period of time (of course) makes the developments smoother. Looking at 3 year CAGR starting at sales year 2008, the range is 6% to 18% which means that over a three year period, the market has grown on average no less than 6% if you look at the last ten years. But the volatility is still significant. Analyzing EkoWeb’s market data over a seven-year period however, evens out the CAGR to between 13% and 14%.
Taking this one step further, the CAGR for nine years is 13,1% when it comes to sales of organic products in Swedish retail. Since the seven-year CAGR and the nine year CAGR seem to agree, this may be a relevant way of describing the market development to a farmer. So when calculating risk, at least there seem to be data to support that taken over a seven-year period, annual market growth has been about 13% for the last decade.
The big question, of course, is if this will continue? It seems that organic market in Sweden has cycles with booms every seven to nine years, with slow or even slightly negative growth in-between. There seem to be a growing group of consumers looking for organic, and there is considerable awareness that we need better food for us and the planet. It seems to me that it is quite possible we will see a similar pattern in the coming decade.
Sources:
I have used information gathered through almost two decades of working in the organic industry. Specific data in this article is mostly sourced from EkoWebs annual market reports and KRAV’s annual market reports.
• This article originally appeared as a LinkedIn article.