The Business of Tomatoes
CAB CS 06.1
Hageman’s Tomato Farm1
Maud Roucan, Dr. Allan Gray and Dr. Michael Boehlje 2
January 2006
Center for Food and Agricultural Business Department of Agricultural Economics Purdue University 1145 Krannert – Room 781 West Lafayette, Indiana 47907-1145 Phone: 765.494.4247 Fax: 765.494.4333
1 Copyright 2005, Purdue Foundation, West Lafayette, Indiana 47907. All rights reserved. Unless permission is granted, this material shall not be copied, reproduced or coded for reproduction by any electrical mechanical or chemical process or combination thereof, now known or later developed. Note: this case was prepared as the basis for class discussion rather than to illustrate either effective or ineffective handling of an managerial situation.
2 This case was developed by Maud Roucan (Research Associate, Center for Food and Agricultural Business, Purdue University), Allan Gray (Associate Professor, Center for Food and Agricultural Business, Purdue University) and Mike Boehlje (Professor, Center for Food and Agricultural Business, Purdue University).
1 The Business of Tomatoes
HAGEMAN’S TOMATO FARM Maud Roucan, Allan Gray and Michael Boehlje
1 Introduction
Philip Hageman’s fingers are green with the pigment of tomato plants. A craggy-
faced man with a passion for his work, Philip has been growing tomatoes since 1970.
Earlier today, Philip’s kids were all gathered for the traditional Thanksgiving meal. As always, there was lots of talk about the farm and the future. Melissa and Matthew were
particularly vocal. Melissa (Philip’s daughter) expressed her interest in joining the farm.
She was a strong believer in diversification and thought the family farm should diversify into the dairy business where she had been working for the last few years. But Matthew
(Philip’s son) still believed in a future for tomatoes. In his opinion, the solution was to grow the tomato business and get bigger to be more attractive to a processing company.
Philip had been working hard over the past 35 years to create a viable business.
Matthew expressed an interest in joining the family farm business 10 years ago. Philip and Matthew had to work hard to make the farm viable for two families. Today, Philip is unsure. Can the farm make enough money to allow another member to join? Philip is also torn between his children’s different ideas for growing the operation. On one hand, the dairy would be a good diversification opportunity particularly since the dairy industry is expanding in California. However, Philip does not have the first clue about raising and selling livestock. On the other hand, the tomato industry is facing a number of important challenges. Prices have declined for several years, contracts have been hard to acquire and fulfill, and growing tomatoes is a risky business. But, tomatoes are what Philip
2 The Business of Tomatoes
knows -- he understands the supply chain, he has established contacts with processors and he has been growing tomatoes his whole life.
From a strategic and financial standpoint, Philip knew that the farm could not afford to pursue both opportunities -- the dairy diversification and the expansion in tomatoes. So, it was obvious that just one growth opportunity could be selected. Philip was confident Melissa would join the farm whichever opportunity was chosen. However, he knew that if he chose Matthew’s idea, Melissa would be really disappointed and ask for sound reasons. On the other hand, if he chose Melissa’s idea, Matthew may not understand why his dad would support Melissa’s view since she had never really been involved in the farm business. In short, Philip knew they would have to a make a well reasoned decision and everyone would have to agree on the future path of the business.
It was getting dark outside and Philip’s wife was watching a movie so he decided to seriously begin evaluating the two alternatives. Whichever opportunity was chosen would depend on the farm’s investment capacity, the sustainable profitability of each opportunity, the industry’s prospects, and the fit with the farm and family’s strengths.
Melissa and Matthew had given Philip a set of numbers to look at, so Philip decided to start with those and begin his analysis.
Farm Description
Located on the west side of the San Joaquin Valley near Fresno, the Hageman’s current farming operation has 12,000 acres of farmland. About 80% of the land is owned and the rest is cash rented. All of the acres are fairly contained around the Fresno area, and a limited amount of time is lost in transportation. Philip and Matthew typically grow about 3,000 acres of tomatoes, 2,100 acres of alfalfa, 5,000 acres of cotton and 1,900
3 The Business of Tomatoes acres of almonds (in full production). The financial statements for the operation are summarized in Exhibit 3.
Philip and Matthew are partners and have been sharing the managerial responsibilities for the last 10 years. Philip is more involved in the financial aspect of the business and Matthew’s focus is on operations. Over the last 35 years, Philip has developed excellent relationships with the processor, Morning Star. When Matthew joined the farm, the tomato acreage was increased by about 1,000 acres. Philip and
Matthew decided at that time to contract part of the additional production with Hunt’s.
This decision was motivated by two reasons. First, Morning Star was hesitant to increase their acreage under the contract so drastically right away. Second and more importantly,
Philip and Matthew wanted the farm to gain some bargaining power relative to the processor. Today, all the Hageman’s farm production is under contract; about 75% with
Morning Star and 25% with Hunt’s.
The Three Growth Opportunities
Horizontal Integration
Matthew, 34 years old, has a B.S. in Agricultural Economics from the University of California Davis (UC Davis). After graduating, Matthew decided to work internationally to broaden his horizons. He spent two years in Mexico working as an operations manager for a large tomato farm that was growing their own transplants and packaging their own tomatoes. During that time, he learned a lot about large scale farming and perfected his Spanish. After two years, he felt ready to come back to Fresno and joined his dad in the family business. Since then, they’ve increased the tomato acreage, have improved yields and have strengthened the relationships with their
4 The Business of Tomatoes
Mexican workers. Matthew strongly believes the farm is in good financial position and has a future in tomatoes.
For several months, Matthew has been seriously considering a major expansion.
Since water is limited in Fresno County, he feels an expansion is not possible in the neighborhood of the farm and has been contacting bankers in Northern California for some leads on possible properties. About one month ago, one of the bankers came back with a great business opportunity. A tomato farmer, under financial pressure, in Yolo
County is looking for a partner. He is willing to sell up to 51% of his interest in the
business and let someone else take over management of the farm. The farm includes
8,000 acres (about 25% of the land being owned) which is somewhat smaller than their farm in Fresno county. It has about the same crop mix: 2,000 acres of tomatoes, 2,000 acres of alfalfa, 3,700 acres of wheat and 300 acres of almonds (in full production).
Matthew has visited with his wife. He is aware that growing tomatoes in Northern
California is somewhat riskier than in the South. However, he and his wife are prepared to move to Northern California to run a farming operation in that area – if Melissa wants to come back to the base farm to help their father. But, the numbers will have to be attractive to convince Philip and Melissa that this is the most profitable new investment for the family farm.
Matthew has been gathering some information about the opportunity in Northern
California. His initial estimates, assuming a 51% interest share, suggest that they would have to invest approximately $7,500,000 based on the following:
153 acres of almonds at $9,000/acre = $ 1,377,000
982 acres of crop land at $3,500/acre = $ 3,437,000
5 The Business of Tomatoes
Machinery, buildings = $ 2,600,500
Total = $ 7,414,500
Matthew has also estimated production costs for the farm in Northern California (see the following table and Exhibit 1 for the detailed table). He knew the farm was producing yields about 10% higher than county average. He also expected lower costs than average thanks to his expertise. A look at the current financial statements led Matthew to believe that overhead costs could be lowered by taking advantage of the economies of scale provided by having the home farm and the new farm buy inputs together. He expected operating and overhead costs to grow at 2% per year and based his projected yields and prices mainly on historical evolution. Matthew was concerned about the profitability of
the farming operation alone so when he thought into the future, he resisted adding land
appreciation into his assumptions of profitability.
Item Per acre Acres Total
Gross Revenues $1,142 4080 $4,657,427.10
Overhead Costs (not including depreciation) $144 4080 $587,214.00
Operating costs (not including operating interest) $675 4080 $2,753,184.00
Operating Interest $16 4080 $66,810.00
Depreciation $56 4080 $228,633.00
Total Cash Expenses (Operating Costs + Overhead Costs) $819 4080 $3,340,398.00
Profit (Revenue - Cash Expenses - Depreciation) $267 4080 $1,088,396.10
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Diversification
Melissa is 27 years old. When she was 18, she surprised everybody by announcing she
would get a degree in animal science at UC Davis. Her dad was very proud but amazed;
Melissa had never shown that much interest in the farm business. During her four years at
Davis, Melissa visited and helped on the family farm extensively. At 22, she received her
B.S. with a specialty in dairy. She then decided to go on for her M.S. degree in
agricultural economics at Purdue University. Her thesis was a NPV (Net Present Value)
analysis of the potential profitability of a large dairy operation under the supervision of
Drs. Boehlje and Gray. Since graduation, Melissa has been a farm manager for a dairy
operation in Tulare County.
Melissa’s boss and owner of the dairy is about to retire. He has no heirs interested
in the dairy and has been contemplating what to do with the farm. He is pleased with
Melissa’s performance on the job, her work ethic and her business sense. Two weeks ago,
he asked her if her family would be interested in buying his farm. Melissa loves her job at
the dairy, strongly believes that there is money in that business, and would like to be her own boss. However, she knows that she needs to convince her family that this would be a
good direction for the family farm to grow. So, for the past two weeks, Melissa has been
gathering the numbers to convince her dad and brother that the dairy is a good investment
for the family farm. The dairy farm has about 1,400 cows, 25 acres of land around the
building, and fairly new and modern facilities and equipment. Upon further analysis and
phone calls, she expects the purchase to require the following investment:
25 acres of “rangeland” at $1,500/acre = $ 37,500
Machinery, Equipment, Buildings at $3,000/cow = $ 4,200,000
7 The Business of Tomatoes
Livestock at $2,000/ cow = $ 2,800,000
Total = $ 7,037,500
Her current research suggests that the profitability of the operation breaks down as follows (see Exhibit 2 for projected numbers):
Gross Revenues Price Quantity Total Milk $0.13 /lb 31,483,328 4,092,833 Cull cows $0.53 /lb 646,800 342,804 Calves $302.50 /head 980 296,450 Total Gross Revenues 4,732,087
Costs Cost Quantity Total Operating costs $8.72 /cwt 314,833 2,745,346 Overhead costs $250.00 /cows 1,400 350,000 Total Cash Expenses (Operating Costs + Overhead 3,095,346 Costs)
Operating interest $0.20 /cwt 314,833 62,967
Depreciation $103.00 /cows 1,400 144,200
Profit (Revenue - Cash 1,492,540 Expenses - Depreciation)
Vertical Integration
Several years ago, Matthew and Philip had investigated the possibility of building
a transplant house and producing transplants for their farm as well as supplying
neighboring farmers. Since the farm is now at a crossroad, Philip believes it’s time to
revisit this opportunity. More and more, farmers are switching to transplanted tomatoes.
Additionally, Fresno is the major tomato producing county and Philip and Matthew have
very good relationships with their neighbors. Philip believes they could produce
transplants for about 15,000 acres including his own farm. Philip contacted the
8 The Business of Tomatoes
greenhouse builder he and Matthew had selected a couple of years ago to check the investment price and made some calls to check equipment prices. He expected the following investment would be needed:
20 acres at $3,500/acre = $ 70,000
Buildings = $ 5,350,000
Buildings and equipment = $ 1,250,000
Total = $ 6,670,000
As to revenues and costs of production, Philip estimates the following (see following table and exhibit 3 for detailed information):
Gross Revenues Quantity (in thousand) Price/thousand Total Transplants 112,500 26.500 $2,981,250
Costs Cost per thousand Quantity (in thousand) Total Operating costs $10.90 112,500 $1,226,250 Overhead costs $5.74 112,500 $645,750 Total Cash Expenses $16.64 112,500 $1,872,000 (Operating Costs + Overhead Costs)
Operating interest $0.20 112,500 $22,500
Depreciation $2.64 112,500 $297,000
Profit (Revenue - Cash Expenses - $812,250 Depreciation)
Philip is hoping to have Matthew and Melissa give a presentation on their
alternatives at the next monthly management meeting and he will present his analysis of
the transplant house project. Philip is hoping to have the whole management team bring
their perspectives to all of the projects and to have an open mind to considering projects
9 The Business of Tomatoes
other than their own. Philip also asked the accountant to be there and is hoping that his
wife will facilitate the meeting and the discussion between Matthew and Melissa.
Discussion Questions
1) What are the strengths and weaknesses of each of the expansion opportunities? 2) Of the three alternatives, which makes better sense from a strategic standpoint? 3) What does the Net Present Value analysis indicate about each of the three alternatives? 4) What are the risks associated with each of the expansion alternatives?
10 The Business of Tomatoes
Exhibit 1: Price and Yield Projections for Expansion to Northern California Operating and overhead costs are expected to have an annual growth of 2% and 1.5%, respectively. Price and yield projections for alfalfa are based on historical behavior in the county/state. Fapri projections (http://www.fapri.iastate.edu/outlook2005/) are used for wheat, tomato and almond.
Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Tomato Production Acres 1020 1020 1020 1020 1020 1020 1020 1020 1020 1020 Yield (in ton) 39.60 39.10 39.60 40.10 40.60 41.10 41.10 41.10 41.10 41.10 Price (in $/ton) $ 58.05 $ 57.83 $ 57.97 $ 58.00 $ 57.94 $ 57.80 $ 57.69 $ 57.84 $ 58.30 $ 59.03
Alfalfa Production Acres 1020 1020 1020 1020 1020 1020 1020 1020 1020 1020 Yield (in ton) 7.20 7.50 8.80 7.20 8.20 7.60 8.00 8.30 7.80 7.32 Price (in $/ton) $ 131.00 $ 126.72 $ 153.64 $ 122.07 $ 103.48 $ 112.37 $ 135.91 $ 117.79 $ 102.55 $ 136.50
Wheat Production Acres 1887 1887 1887 1887 1887 1887 1887 1887 1887 1887 Yield (in bu.) 86.00 82.80 83.80 84.40 85.00 85.80 86.40 87.00 87.60 88.20 Price (in $/bu) $ 3.75 $ 3.59 $ 3.63 $ 3.71 $ 3.76 $ 3.83 $ 3.88 $ 3.93 $ 3.99 $ 4.03
Base Acres 1887 1887 1887 1887 1887 1887 1887 1887 1887 1887 Government Payments (in $) 57,550 57,550 57,550 57,550 57,550 57,550 57,550 57,550 57,550 57,550
Almond Production Acres 153 153 153 153 153 153 153 153 153 153 Yield (in lb.) 2500 2500 2500 2500 2500 2500 2500 2500 2500 2500 Price (in $/lb) $ 1.94 $ 1.95 $ 1.98 $ 2.00 $ 2.02 $ 2.03 $ 2.05 $ 2.06 $ 2.08 $ 2.09
11 The Business of Tomatoes
Exhibit 2: Price and Yield Projections for the Dairy Operation Operating and overhead costs are expected to have an annual growth of 2% and 1.5%, respectively. Milk production is based on record of good performing dairies located on the western coast. Price and yields projections are based on fapri publications. Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Income Assumptions Milk Production lbs/milking Milk produced cow 22,488 22,583 22,698 22,826 22,964 23,104 23,249 23,404 23,557 23,709 Price of milk $/lb $0.13 $0.13 $0.12 $0.12 $0.12 $0.12 $0.12 $0.12 $0.12 $0.12 Cull Cow Sales Number of cull cows Head 420 420 420 420 420 420 420 420 420 420 Weight of cull cows lb. 1540 1540 1540 1540 1540 1540 1540 1540 1540 1540 Price $/lb $0.53 $0.51 $0.50 $0.49 $0.46 $0.45 $0.43 $0.42 $0.42 $0.43 Cattle Sales $/cwt $0.50 $0.50 $0.50 $0.50 $0.50 $0.50 $0.50 $0.50 $0.50 $0.50 Number of calves Head 980 980 980 980 980 980 980 980 980 980 $302.5 $296.3 $285.5 $272.8 $260.8 $250.1 $241.4 $242.2 $246.9 $248.7 Calf price $/head 0 6 7 3 5 6 8 3 0 1
Expense Assumptions Operating Costs $/cwt $8.72 $8.89 $9.07 $9.25 $9.44 $9.63 $9.82 $10.02 $10.22 $10.42 Overhead Costs $/milking cow $250 $254 $258 $261 $265 $269 $273 $277 $282 $286 Depreciation $/milking cow $103 $103 $103 $103 $103 $103 $103 $103 $103 $103
12 The Business of Tomatoes
Exhibit 3: Price and Yield Projections for the Greenhouse Project Operating and overhead costs are expected to have an annual growth of 2% and 1.5%, respectively. Transplant production is assumed to stay constant over time while price is based on tomato price trend (from Fapri projections).
Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Income Assumptions Transplant Production Number of Transplants thousands 112,500 112,500 112,500 112,500 112,500 112,500 112,500 112,500 112,500 112,500 Price of Transplants $/thousand $26.50 $26.40 $26.30 $26.20 $26.10 $26.00 $25.90 $25.80 $25.70 $25.60
Expense Assumptions Operating Costs $/thousand $10.90 $11.12 $11.34 $11.57 $11.80 $12.03 $12.28 $12.52 $12.77 $13.03 Overhead Costs $/thousand $5.74 $5.83 $5.91 $6.00 $6.09 $6.18 $6.28 $6.37 $6.47 $6.56 Depreciation $/thousand $2.64 $2.64 $2.64 $2.64 $2.64 $2.64 $2.64 $2.64 $2.64 $2.64
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Exhibit 4: Hageman’s Farm Financial Statements
Income Statement
Revenue All Crops $ 22,946,490 Expenses Operating Expenses $ 16,049,400 Depreciation $ 1,365,076 Operating Interest $ 354,400 LT Interest debt $ 621,697 Total $ 18,390,573
Net Income $ 4,555,917
Balance Sheet
Assets Liabilities
Current Assets $ 11,822,442 Current Liabilities $ 3,940,814 Noncurrent Assets $ 28,944,601 Noncurrent Liabilities $ 8,289,298 Total Assets $ 40,767,043 Total Liabilities $ 12,230,112
Owner's Equity $ 28,536,931
Total Liabilities and Equity $ 40,767,043
14 The Business of Tomatoes
Exhibit 5: U.S. Processed Tomato Industry Tomatoes are grown in every state in the U.S., excluding Alaska, and are the second most important vegetable crop (next to the white potato) in the United States. More than eight million tons of tomatoes are produced annually in the United States. Of that, about one million are hand-picked and sold as fresh tomatoes3 and the rest are machine-harvested and processed. While fresh tomatoes are typically valued at 25-35 cents per pound, processing tomatoes are valued at about 3 cents per pound. As a result, processed tomatoes account for only one-third of all tomato cash receipts despite a crop size that is five to six times greater than fresh market tomatoes. The U.S. is able to compete in the global tomato market because of its high productivity with yields of 28.5 tons per acre. These yields are second only to Israel (50.9 tons/a) where most of the production comes from greenhouses. The production in Western Europe is also increasing because of the improved productivity (23.25 tons/a). However, the region that appears to be the largest threat to the U.S. is Asia with 6.4 million acres harvested in 2004 which represents 58% of the global area devoted to tomato production. However, yields in Asia are still low: 9.16 tons/acre.4 For several years, the United States has been the second largest producer of fresh and processed tomatoes, behind China (2.5 million acres vs 0.4 million of acres); U.S. growers are significantly more productive than those in China. Over the past several decades, the U.S. processing tomato industry has been moving westward. California accounts for about 95 percent of today’s processing tomato area harvested in the U.S. Texas, Utah, Illinois, Virginia, and Delaware once harvested thousands of acres of tomatoes, but today they have little or none. U.S. per acre yields for processing tomatoes continue to trend higher, moving from 14.5 short tons per acre in 1961 to more than 37 short tons in the early 2000s. Improved production and harvest technologies (including improved seed varieties), plus the shift of production from low-yielding states to California (where yields are high) are the reasons for much of the gain in yields.
3 In 2002, 30% of the tomato acreage were harvested for fresh tomatoes. 4 In 2004, the US harvested 434,720 acres, Western Europe 657,510 acres and Israel 7,660 acres.
15 The Business of Tomatoes
Relatively high prices for tomato products in the late 1980s motivated significant new investment in tomato-processing facilities and increased production in California. This created an oversupply, causing prices to decline and forcing several processors to close in the early 1990s. These challenges continue today. Growers contract with processors to process red-ripe tomatoes. Contracts often specify the acceptable varieties, and the contracted price is based on tonnage and fruit quality. Many firms manufacture pulp-based products, such as stewed and diced tomatoes, but the initial processing is done by firms that manufacture tomato paste. This raw ingredient is distributed under contract or sold to remanufacturing firms that add water, spices, etc. to make retail and foodservice packs of soups, sauces, catsup, and paste. After the mid-1970s, U.S. consumption of processed tomatoes began a steady climb that accelerated in the late 1980s with the rising popularity of pizza, pasta, and salsa. Economic Research Service estimates suggest the largest use of processed tomatoes is in sauces (35 percent), followed by paste (18 percent), canned whole tomato products (17 percent), and catsup and juice (each about 15 percent). Domestic use averages 75 pounds per capita (fresh-weight basis). Reflecting a weak economy, consumption during the 2000s has remained below the average of the 1990s. Processed tomatoes are most popular in the West and Midwest and less in the South. Black consumers have the highest per capita consumption of tomato paste and catsup, while Caucasians lead in the consumption of tomato juice. Processed tomatoes tend to be accepted by people at a younger age than fresh tomatoes. About one-third of all processed tomato products are purchased away from home at various foodservice outlets (pizza parlors, for example). Since the early 1990s the United States has been a net exporter of processed tomatoes. The main destinations are Canada (about half of the volume), Japan, Mexico, and South Korea. Generally, tomato sauces account for the largest share of exports followed by paste, catsup and canned whole products. About 6 percent of the processed tomatoes coming to the U.S. are imported with Canada being the largest supplier (about a quarter and mainly catsup). Other suppliers are Chile, Mexico, Italy and Israel.
16 The Business of Tomatoes
Brunke, Henrich. “Commodity Profile: Tomatoes, Fresh.” Agricultural Marketing Resource Center, University of California. Prepared November 2003.
Hartz, Timothy K. and Gene Miyao. “Processing Tomato Production in California.” University of California, Division of Agriculture and Natural Resources. Publication 7228.
Lucier, Gary; Lin, Biing-Hwan; Jane, Allhouse and Linda Scott Kantor. “Factors Affecting Tomato Consumption in the United States.” Vegetables and Specialties. VGS 282 (November 2000).
VanSickle John J. “Outlook for Florida Tomatoes under FTAA and Future Marketing Issues.” http://www.ers.usda.gov/Briefing/Tomatoes.htm
17 The Business of Tomatoes
Exhibit 6: Tomato Production in California California is the leading producer of all tomatoes in the United States. Accounting for 95 percent of U.S. processing tomato output, California is also the leading state for processed tomato production. California ranks second (behind Florida) in fresh tomato production, producing one third of the US production. Fresh tomatoes are produced across many counties in each season except winter, with San Diego (spring and fall) and Fresno (summer) counties accounting for about a third of the crop. California's share of national fresh-market output has remained between 25 and 32 percent over the past 20 years. Most of California’s processing tomato acreage is in the San Joaquin and Sacramento Valleys, with more than 80 percent of statewide production in Fresno, Yolo, Solano, San Joaquin, Colusa, and Stanislaus counties. Small acreages can also be found in the Imperial Valley and along the central coast. Imperial Valley fields are planted in late January through February for harvest in June. Elsewhere in the state, fields are planted from late January through May. Harvest goes from July into October (with most of the activity from August to September) to meet contracted weekly delivery tonnage schedules. Most tomato fields are direct seeded, but transplanting is increasing. Transplanting enhances earliness and provides a better plant stand in difficult field conditions or where weed control would be difficult and expensive with seeded tomatoes.
Hartz, Timothy K. and Gene Miyao. “Processing Tomato Production in California.” University of California, Division of Agriculture and Natural Resources. Publication 7228. (http://anrcatalog.ucdavis.edu/pdf/7228.pdf) http://www.ers.usda.gov/Briefing/Tomatoes/background.htm
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