Learnings from a Comedy of Arrogance
Larry Martin, Ph. D.
Dr. Larry Martin & Associates and
Agri-food Management Excellence
On June 28, 2016 the Ontario Farm Products Marketing Commission (overseer of agricultural marketing boards in the province), apparently with limited and selective industry consultation, announced its intent to amend Regulation 440. The amendment would remove the ability of The Ontario Processing Vegetable Growers Board (OPVG) to negotiate minimum contract prices and terms and conditions for Ontario processing vegetable growers with their processor customers. Negotiation power would be replaced by an industry advisory committee. The Commission also promised to identify options that would help the processing industry grow, and provide a “modernized” pricing system between growers and processors. All this was in “support of the Premier’s Agri-Food Challenge” which is to double the sector’s annual growth rate and create 120,000 jobs by the year 2020. None of it is spelled out in any detail in the announcement.
Comments on the Commission’s intention were to be made by August 12 and the change would be implemented before the normal period of negotiation for the 2017 crop.
For anyone familiar with the processing vegetable industry, it comes as no surprise that this sudden announcement, the process with which it was made, and a six week comment period in the middle of the industry’s busiest season resulted in significant push back from OPVG, individual producers, and some politicians.
Agriculture Minister Leal intervened in the Commission’s process around August 15, as will be explained below.
This paper has a number of objectives:
- To provide an assessment of OPVG’s historic performance
- To review and evaluate the series of events in this little drama
- To provide perspective on some strategic issues in the industry
- Provide suggestions that may improve the outcome of the Minister’s altered process.
2.0 The Pricing System for Processing Vegetables
OPVG has negotiated contracts on behalf of processing vegetable growers for the past 70 years. OPVG covers commodities such as tomatoes for paste, tomatoes for canning and dicing; sweet corn for canning and freezing, peas, beans, carrots, cauliflower, etc, all for canning and freezing and cucumbers for pickling. Varieties for preserving are usually different than those for fresh consumption. So, OPVG has no responsibility for the summer fresh beefsteak tomatoes, or greenhouse grown tomatoes, but they do negotiate prices for the tomatoes that go into ketchup, juice, soup, or cans of diced tomatoes that are used in cooking. The same applies to the other products under OPVG’s jurisdiction.
This annual pricing process begins in the late fall each year as a committee of producers for each product negotiates price and other contract terms for the following crop year. If an agreement is not reached (which they usually are) by a given date negotiations stop. There can be mediation to try to come to an agreement and, if all else fails, the final outcome is settled by an arbitrator, using final offer arbitration. Final offer arbitration means accepting one or the other of the parties’ final offers. This system is intended to restrain the parties from wildly unrealistic positions, and to encourage them to settle. In the majority of cases, this is accomplished.
This type of contracting system is rather unique to the processing vegetable industry. It evolved out of the desire by both parties for pre-plant contracts and because most processors traditionally priced their products for six months to a year forward to their retail customers, usually before harvest. This means processors must carry large inventories of either raw material or finished product from harvest throughout the year. Having price assurance removes risk from the value of inventory, gives processors a good basis for planning, thereby facilitating financing by lending institutions. For example, after contract prices are confirmed each year, processors then determine the amount they will contract, presumably based on their sales forecast at the resulting wholesale prices. This gives them a basis for budgeting and a clear plan to present to lenders.
The Ontario industry is in direct competition with the US industry. Much of North American processing tomato production and paste manufacturing is in the Central Valley of California, and some canning production is in Indiana and Ohio. Peas, beans and sweet corn are mainly produced in Quebec, Wisconsin, Minnesota and New York. Canadian retailers can buy finished products from US processors, and vice versa.
In the US, processing companies also establish annual contracts with growers. The means by which this is accomplished can vary widely; from grower Associations that negotiate collectively to one on one negotiation.
Canadian processors can buy raw vegetables from the US and vice versa: there are few barriers to trade since NAFTA was implemented. Because of this competitive structure, the OPVG has long recognized Canadian product and raw material prices have to be competitive with those in the US.
At the same time, Ontario growers have the opportunity and necessity (because of crop rotation concerns) to grow other crops such as corn, wheat, soybeans, edible beans, etc. Processing vegetables may require more labour, specialized equipment, and production knowledge than the more traditional grain and oilseed crops. It is relatively easy to switch to these traditional crops, so processing vegetables also need to be priced to compete with them for land (as is the case in the US). A corollary to the foregoing statement is that, because of relatively large investment requirements for specialized machinery and equipment, vegetable growers need to have some assurance of an ongoing market for vegetables before they make the investments.
3.0 Assessing the Performance of OPVG
OPVG is and has been aware of the foregoing statements about competition with the US and other crops.
I have had opportunities to work with OPVG and this industry several times over the years. I arbitrated tomato prices; mediated several times on various disputes; arbitrated a cauliflower dispute; headed a study commissioned by OPVG that examined the feasibility of developing a “green shipper” capability for pickling cucumbers aimed at enhancing competitiveness of the Ontario cucumber industry; worked with OPVG to find ways to encourage a major food company to expand investment in a processing plant; led a study to determine the competitiveness of Ontario’s pricing for peas, beans and sweet corn industries; worked with OPVG and a number of processors to head off an extremely wrong-headed study of the industry’s competitiveness by consultants for a federal government agency. Most years I’m very much aware of concerns and progress in negotiations either through OPVG and/or individual farmers.
With this background, a number of observations can be made.
3.1 OPVG’s Goal is Competitiveness
As indicated above, OPVG understands the competitive environment of its industry: they know that their raw products need to be priced competitively with other regions. In almost all of my dealings with OPVG around pricing, the central question is, “what price in Canadian funds will be competitive with expected US prices?” In most cases, the question is what will be the price in Canadian dollars in the competing US region?
These were the central elements of my tomato arbitration and OPVG provided considerably more information on the subject than did the processors’ organization. Casual observation is that pricing most years for most products meets the economists’ test of comparable raw product pricing. When it has differed, it’s largely because there was too little knowledge of US prices or, most frequently, because the exchange rate changed – either positively or negatively. The latter would be an issue with any forward pricing system. And it can be managed by currency hedges, or by fixing rates with processors’ bankers.
Beyond the rather obvious conclusion that processing vegetable prices are seldom out of line with US prices, there are several other observations that support the conclusion that OPVG’s goal is competitiveness.
- Price incentive programs have been offered when there is a desire to encourage strategic investment. That was the point of the work we did to get Heinz to expand their plant in Leamington (or to encourage other investors into tomato processing). Heinz long followed a strategy in North America of exiting tomato paste manufacturing, opting to buy paste from efficient primary processors and focusing on manufacturing finished products in Heinz’ own facilities. OPVG tried very hard to convince Heinz to not make that decision in Canada and to expand investment in its plant. The strategy was partially successful as the Leamington plant was kept open long after all Heinz’ US paste plants were closed. But, as we know, Heinz finally closed in 2014.
It is my understanding that OPVG offered a similar price incentive to all Ontario tomato processors this past year, in continued efforts to stimulate Ontario production.
- Productivity pricing. After the Canada/US Trade Agreement (CUSTA) was signed in 1989, the processing vegetable industry was in line to lose a huge amount of border protection: eg. Canadian tariffs on tomato paste were 13% before CUSTA and tariffs on finished goods such as ketchup and sauces were over 25%. They were all scheduled to be removed completely over five years.
The processing tomato industry in Ontario was clearly at a disadvantage with average yields of 19 tons per acre compared to California’ 30 plus. At similar operating costs per acre, this meant Ontario’s costs per ton were roughly 50% higher, a fact that the tariffs masked. But removing the tariffs would remove the mask.
The mask also covered up a series of supply chain inefficiencies that occurred because the industry was operating with this very high level of protection. A number of practices that, in part, were put in place to assure certainty of supply to processors evolved that were quite costly, eg over contracting acreage in case yields were impaired and then cancelling contracts when yields were good. Removing the mask revealed these issues also.
An interesting aspect of the contracts in Ontario is that the processors choose the varieties of seed stock to be grown on their contracts. Much of the yield difference with California resulted from the genetics the processors chose for their growers.
Faced with the likely loss of the industry as Ontario prices moved down relative to California’s, OPVG offered the processors a progressive discount for increasing their yields. To illustrate, if the base price was $100/ton, that would be the price processors paid if their contractees’ yields were the average of 19. But if their averages increased to 21 tons, then the price paid might drop to $98, and to $96 if yields were 22 tons, etc. This proved to be a significant incentive and in only a few years, Ontario’s yields were equal to or better than California’s, thereby helping to ensure the continuation of the processing tomato industry. A number of producers now have yields in the 50 ton range.
At the same time, other terms of the contracts were changed to improve supply chain inefficiencies, all of which has allowed processing tomato production in Ontario to continue for another 25 years.
The point is that this creative idea and the leadership for its implementation (it wasn’t warmly supported by a number of growers at the outset, so there was political risk) came from OPVG in an effort to improve the industry’s competitiveness under CUSTA/NAFTA.
- Another initiative to improve supply chain efficiency and product quality occurred in the early 2000’s when a government program was announced. For a number of other agricultural industries, it was turned into the usual government cheques sent directly to individual farmers, accomplishing little beyond increasing the price of land or Air Canada’s revenue with extra trips to Florida or Arizona, as many such programs do.
However, OPVG observed that one of Ontario’s competitive issues was that its yields and quality were far more variable than in the US again, especially for tomatoes. This made it difficult for processors to forecast how much finished product they would actually acquire from their contracts. In turn it was difficult to forecast to processors’ customers how much they would have because there was risk that drought would impact both yields and quality.
OPVG reasoned that existing government programs provided an excellent opportunity to ameliorate this problem and to improve industry competitiveness. Their solution was an agreement with government for a program that would provide a 50% grant to processing vegetable producers to invest in irrigation equipment.
Yield and quality variation have been reduced markedly since, thereby providing more consistent supply to processors.
- The tomato, cucumber and peas, beans, sweet corn studies in which I participated were all initiated by OPVG in an effort to answer the question, “what can we, as a group of growers concerned about the long term viability of our industry, do to make it easier for processors to be successful in this province”?
My experience was that OPVG was quite serious in all cases and was willing to go to considerable lengths to create solutions to encourage the processing industry in Ontario.
3.2 OPVG is Well Informed
I’m treating this as a slightly separate concept from the foregoing because one of the precepts in evaluating whether a market is competitively structured is whether there is good information about market conditions.
As indicated earlier, OPVG had excellent information in the tomato arbitration that I conducted. In other studies it was very clear that OPVG had great relationships with growers in other jurisdictions which allowed for obtaining often confidential pricing data from growers in competing US regions. OPVG’s ability to network with producers in other jurisdictions to understand market conditions seems quite remarkable.
In contrast, the processors seldom provided good information and sometimes resisted sharing what they did have. In particular, their association that was responsible for negotiations appeared to have little financial ability to conduct market research either because the processors were unwilling or didn’t see the point in having a deep understanding of market conditions. Having said that, it does appear, since the entry and expansion of Bonduelle into North America, they in particular have more information than used to be the case.
4.0 The Comedy of Arrogance
Given the impressions above, it was quite surprising when the Commission announced without forewarning in late June that it would remove OPVG’s power to negotiate contracts and replace it with an industry advisory committee. Not only was the announcement sudden, but a six week comment period during the busiest time of the year for the industry, and the intention to make it effective before the 2017 negotiations meant that, in the Commission’s mind, it was a fait accompli. This was all done without obvious consultation, certainly not with OPVG, though it’s apparent that someone was talking to someone, and without publicly available analysis to support it or to justify why the recommendation will improve the industry’s future.
The most comprehensive explanation of the reasoning behind the decision to date is a letter to MPP Rick Nicholls from Chatham-Kent, where many of the vegetable growers are located. Mr. Nicholls sent a letter to Geri Kamenz, Chair of the Commission in which he asked five questions. Paraphrasing, they are:
- What are the reasons for removing OPVG’s negotiating power?
- What power and responsibilities will the Industry Advisory Committee have?
- Will growers have an opportunity to vote on the changes?
- What analysis was completed to justify the change?
- How will the change meet the Premier’s challenge?
Kamenz said in his response that he was responding to each of Mr. Nicholls’ questions. The points he made are:
- The reason for the decision is that the industry has been in continuous decline. He cites that there are fewer producers and fewer processors and cites several recent plant closings. He says that processors invariably cite the current marketing system as being rigid and inflexible, leaving them uncompetitive internationally. (So, obviously he did consult with someone before making the decision).
- Kamenz says that industry advisory committees have been extremely effective in identifying and resolving supply chain issues in other commodities and cites dairy and chicken as two shining examples.
- He says the six week comment period is producers’ chance to show their responses to the decision. (Which I take as, no, there will be no vote.)
- The Commission has reviewed industry reports as far back as the 80’s and reviewed trends since the 60’s, as well as talking to a number of industry insiders to come to its decision.
- Kamenz reiterates the decline in numbers of producers since the 1960’s and says that the proposed change will allow both producers and processors to innovate and choose who they want to do business with.
For anyone familiar with agriculture in general, and this industry in particular, the shallowness of most of these responses is breathtaking. They are addressed below:
- In the first and last points, the decline in the number of farms and processors is cited. The fact is that the number of farms and processors has declined markedly in nearly all agricultural industries because of changes in on-farm and in-plant technology that allow economies of size, improved efficiency, better process control, and reduced costs. In short, almost all agricultural and food industries have become more efficient through technologies that incented economies of size and substituted capital for labour. Look at what has happened to the number of dairy, poultry, hog and beef finishing farms. One can only conclude that the pace of consolidation has little to do with the degree and nature of regulation in an industry, but rather with economic conditions within that industry.
- Kamenz’ response also implies that all the plant closings in Ontario are due to OPVG’s inflexibility and one would assume, because of the relative price of raw materials. As indicated above, that does not square with my experience, but if reviewing all these reports and trends since the 1980s do say that, why are they not being shown publicly? Why is there no analysis of the industry’s competitiveness, instead of or in addition to the out-of-the-blue announcement of a major change?
Part of my skepticism about the claim that OPVG is the problem is that it’s just too easy. Raw products represent only a portion of any processor’s total costs, sometimes a relatively small portion. There are also costs of labour, energy (especially high in an industry that heats and cans or freezes products), and capital. Ontario now has the highest cost of hydro in North America and also the highest minimum wage. Do you think, Mr. Kamenz that these factors might be a problem for some processors? Especially when Ontario’s processing plants are relatively small and do not have economies of size in their capital bases?
Four things make me extremely skeptical about the implication that processing plant closures are all about the inflexibility of OPVG and raw product prices:
- The work cited above in which OPVG searched for ways to improve the supply chain met with limited cooperation from processors. An example is the number and size of tomato contracts. Ontario growers have mechanical harvesters and other machinery that often is made for much larger California farms. One of the suggestions we made in the tomato study was to decrease the number and increase the size of tomato contracts. This would reduce collection costs for processors, and reduce overhead costs for growers, thereby making the supply chain more efficient. Obviously, some smaller growers were not happy with the suggestion, but processors were reluctant to take up the suggestion. It died.
- Kamenz specifically cites the closing of Bicks and Strubs as examples of the results of OPVG’s inflexibility. What he does not say (maybe he doesn’t know?) is that since those plants closed, Ontario is now producing more acres of cucumbers than before. The Ontario growers are now part of a US supply chain that ships cucumbers to US plants and then ships finished products back to Canada. This fact makes me think there’s something more than raw product prices and OPVG inflexibility at work here. Put quite simply, if the cucumbers are still being produced here but the processing is occurring elsewhere under contracts negotiated by OPVG, it’s hard to blame processor closure on raw product pricing or OPVG!
- It is also my understanding that, despite the major blow to the tomato industry when Heinz closed the Leamington plant, as of 2016 there are now more acres of tomatoes contracted than there were before the closure. Something positive must have occurred in the past few years.
- I was involved in a study a few years ago for OMAFRA to try to understand the reasons for the failure of Canada’s only peach processing plant at St David’s. The situation was a bit complex because of the supply chain relationship that had been negotiated with peach growers, and it was an older relatively inefficient plant, even with many attempts to modernize it. But a major immediate cause of its finally closing was an increase in minimum wages by the province.
There may be problems in the system and some may or may not be caused by OPVG. But if they are, more needs to be made clear about the contents of the “reports since the 1980’s”. Market conditions have changed since then. In those days, among other things, Ontario had some of the lowest electricity prices in North America, and total labour costs were lower. Those things don’t apply now.
Moreover, it would be enlightening to discover with much more specificity what all the alleged barriers are that are created by OPVG. In Kamenz’ letter to Mr. Nicholls, there are only vague generalities that certainly do not square with my experience. The letters of support for the Commission’s changes from the Ontario Processing Vegetable Processors’ Association (OPVPA) and Food and Beverage Ontario (FBO) are equally vague. OPVPA does argue that the most efficient producers are being restricted by OPVG regulations, but don’t explain how. They argue that OPVG supports profitability for the least efficient producers, but don’t explain how, especially given my understanding that processors can remove inefficient producers. Also, in none of my experience with OPVG’s focus on competitive pricing was there ever any discussion or acknowledgement of any individual grower’s costs.
The processors’ major argument seems to be that OPVG’s concept of “sustainable” pricing will not lead to growth or investment. This is the most specific point that’s been made, but it would be critically interesting to understand what the argument means. The clear implication is that processors believe they would be able to obtain lower prices with one-on-one negotiations.
- One of the more interesting aspects of Kamenz’s letter is the assertion that an industry advisory committee (with no identified role or powers) would be key in solving the industry’s problems after the removal of OPVG’s regulatory powers. As evidence he cites the chicken and dairy industries!
Huh? How does an industry advisory committee in two of the most highly regulated industries lead to a conclusion that an industry advisory committee in an industry with almost no regulation will be a solution? This smacks of a conclusion searching high and low for a justification.
An industry advisory committee might be a great thing, (I’ve supported the idea for a number of years, depending on its role and powers) but Kamenz’s justification is baseless.
Provincial Agriculture Minister Leal showed considerable leadership in bringing a stop to this comedy of arrogance, while implementing a better process. His letter to Kamenz is quite clear. He says “Without a more open and transparent dialogue on this proposal, it is not clear to me how it may serve the broad policy objectives of the Government of Ontario”.
The Minister directed the Commission to develop a new process that:
- Engages in consultation with all interested parties and stakeholders
- Develops a plan that will be in the interest of both producers and processors and that will be consistent with the government’s policy of supporting regulated marketing and increasing the number of agriculture related jobs in Ontario.
At a minimum any process and plan shall include:
- A detailed analysis of the industry’s competitiveness and its opportunities for growth
- Opportunities that will facilitate more informed participation of interested parties and stakeholders in the decision making process
- Any recommendations will be posted with at least a 60 day comment period, and in enough detail to ensure that any policy and economic objectives are clearly articulated.
For The Processing Vegetable Industry
Minister Leal is very clearly on the right track.
My impressions about this industry and OPVG are clearly biased. But my bias results from considerable information obtained and observed over a number of years. I admit that I’m not involved all the time, and I do observe that relationships are sometimes characterized by a high level of testosterone on both sides, so there may be more issues than I realize. But the Commission’s edict and Kamenz’ explanation simply don’t reflect what I’ve seen over more than 20 years.
One of the frustrations in working with this industry is that senior managers who make strategic decisions for the processing companies tend not to be involved in either the annual price negotiations nor in other strategic discussions about the direction of the industry. Price negotiations are left to local field personnel who may or may not have a clear grasp of the bigger picture. With a few exceptions, higher level managers tend to become involved when there is conflict or unhappiness with decisions. No forum has ever been established that facilitates the provision of hard information on competitiveness and opportunities for growth.
As a result, there have long been vague statements about OPVG being a barrier, but with too little specificity to evaluate their validity. As indicated here, my experience does not reflect these statements, but since there is little information beyond what OPVG provides and little strategic engagement from the processors, it is very difficult to evaluate them.
What is clear is that the Commission’s process was initiated as a result of conversations that were not open and transparent and that the analysis supporting it was not made public, at best. The Commission essentially extended the poor communication and analysis that dominated in the past. There is no doubt that an open discussion with relevant data and analysis would go far toward understanding whether, and if so, why this industry has lost competitiveness. At a minimum, there needs to be a thorough analysis of:
- Relative prices in Canada and the US
- Differences in costs for farmers and processors
- Where there are differences, there needs to be thorough investigation of the causes Suggestions were made above about labour and energy, but technology and economies of size also need to be investigated, as well as product development for a full understanding of competitiveness. This is not a simple analysis and it needs to be done correctly, including at least the variables identified here.
Minister Leal also refers to an analysis of opportunities for growth. This is extremely key and extremely sensitive. Individual companies have opportunities that they have developed themselves and don’t deserve to have them shouted from the rooftops so their competitors can take advantage. Whoever is in charge of the study needs to ensure that there is sufficient evidence to prove that there are opportunities, but that the information is provided in ways that protects competitive intelligence.
For the Agricultural Sector in General
For years the agricultural sector has been worried about its diminishing share of the population and the potential for diminished political influence.
This process was a clear manifestation of that fear. Left to its own, a government bureaucracy was persuaded by unknown political influences, based on Trump-like economic analysis, to remove regulatory powers from an agricultural marketing agency. It confirms fears of an irresponsible government organization, which knows better than the industry what’s good for it, taking the industry down a path with ideas driven by people outside. This is the very nightmare conjured by those concerned about losing political power and influence.
It underlines that agriculture’s political risks are not imagined. They are real. It is increasingly important that organizations like the FPMC use good objective information in the exercise of their authority, and that agricultural industries ensure that appropriate analysis is done.
The other side of this is that OPVG clearly did some things right and it has its defenders. These facts clearly filtered to the Minister of Agriculture who firmly intervened, stopped the process, and put it on a much better track, thereby illustrating the need for good analysis.
The warning to all agricultural organizations is clear. Society granted organizations in the agricultural sector a great deal of power to regulate their markets. But society today is much less informed and sympathetic than it was in the 1940’s, 1950’s and 1960’s when these powers were delegated. Society gives and it can take away. Therefore, while it looks like the Minister has correctly intervened in this instance, it underlines the need to ensure that regulation be done in the public interest going forward.