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Supply Chain Models for Small Agricultural Enterprises

W. Jang and C.M. Klein


Department of Industrial and Manufacturing Systems Engineering
University of Missouri
Columbia, MO 65211
USA
Abstract
Small agricultural production enterprises have been under immense economic pressures for many years. Many
public policies have been suggested to alleviate the problem but no one has taken a look at the problem from a
managerial or operations point of view. In this paper we develop models for supply chain issues facing small
enterprises, solve them, and suggest their uses and future considerations.
Keywords : Supply chains, optimization, e-commerce, agriculture

1.

Introduction

Agricultural production is one of the largest segments of our economy. It is a leading exporter and one of the areas
that most often embraces and uses new technologies to increase production. One area of agricultural production that
is struggling is the small farm enterprise. The small farm enterprise has continued to decline and face economic
hardship as industrialized agriculture grows and dictates the traditional markets. According to USDA statistics,
there are 350,000 large farms that consume 95 percent of inputs and produce 95 percent of the outputs. The
decline in small farm enterprises has been alarming. There has been a 63% decline in farm ownership over the last
several decades. What is most alarming though is that this decline has been even more significant for minority
farmers. During the same time period 97.5 percent of black-operated farms were lost. It is estimated that at least
1000 acres is needed just for a farm to break even under current practices. This, with changes in agricultural policy,
make it almost impossible for minority farmers to even enter agriculture as producers. If the trend continues,
minority populations will control almost no agricultural land by 2010 [15].
There have been and are many initiatives proposed to save the family farm. However, almost all of these initiatives
have been from a policy standpoint, not a production standpoint, and do not necessarily help those they are intended
to help. An example of such policy is federal farm subsidies. Last year almost two-thirds of the $27 billion spent
went to just 10% of farm owners, most of whom owned large farms, and to multi-million dollar corporations
(Associated Press, Sept. 10, 2001). It is our belief that a favorable impact can be made on small farm enterprises
through the development and implementation of models that address their basic needs and open new markets and
production initiatives. In addition, this basic research and modeling of an application area that has great variability
and is very dynamic should also yield insight and methodology for other non-agricultural based enterprises
struggling with many of the same issues.

2.

The Small Farm Enterprise

When discussing farming as a production process one must realize how unique this process is and how minor
savings in the process can be critical. For example, consider the frighteningly small margins in farming. U.S.
farmers spend a total of $185 billion annually on inputs such as chemicals, seeds, land, supplies, etc. and in return
they sell $210 billion worth of outputs [14].
In order for the small farm enterprise to be viable it must be able to respond quickly to product differentiation and to
establish niche areas of product. As stated by Kinsey and Senaur [11] farmers will increasingly be producing
commodities with specific attributes called for by food processors who are responding to retail demand. Traditional
patterns of farming will change; more products will be produced for niche markets and for international tastes.

There will be higher pay-off for the entrepreneur on the farm. In concert, Baumel [1] also states market
segregation may provide niche opportunities for producers who are willing to keep their product segregated and sell
based on specific attributes rather than in bulk. One approach to accomplishing this for the small farmer is through
the use of e-commerce and the development of appropriate supply chains and supply chain strategies as well as
decision making strategies for the development and running of co-ops and partnerships.
Agricultural supply chains and their application through electronic communications as applied to small farms and
micro -agricultural enterprises is an area that has received virtually no attention. However, there is a fair amount of
literature related to supply chains and e-commerce for industrialized farming [2, 4, 5, 8, 12, 16].
Agricultural production has some similarities to standard production systems and many aspects that are unique to
farming. Like any company that manufactures, a farming enterprise must make many decisions on how to run its
operations. This includes such things as how to distribute, transport or store inventory. However, unlike traditional
manufacturing, it may be advantageous to hold on to inventory if the price of grain will go up or if there are certain
types of shortages. At the same time if what you have produced is highly perishable then the concern is to get it to
market. These and many other decisions such as planting times, fertilizer usage, etc. are operational. In a
nonagricultural setting these operational decisions are made based on the assumption that very little in the overall
situation changes on a daily basis. The exact opposite is true for an agricultural producer.
Another type of decision that must be made is a tactical decision. These decisions do not rely on the same kind of
assumptions as do operational decisions, but they are related. The tactical level addresses issues such as deciding
how many acres to plant of each product, the choice of product to be planted (genetically enhance or not, etc.),
scheduling applications of pesticides, fertilizers, irrigation to meet production goals or choosing the mode of
shipment from the farm to an elevator or market. For tactical decisions, it is assumed that core structural components
of the network, such as products and sites, are fixed.
Neither of these levels though can truly be considered until the strategic planning decisions have been made. For
strategic planning decisions, however, anything can be changed except, of course, the external market demand.
The goal of strategic planning is to arrive at the most efficient, highly profitable supply chain system that serves
customers in a market. This is an area that has not been studied at all for small agricultural enterprises and only to a
marginal degree for industrialized agriculture [8].
In reviewing the literature for agricultural supply chain management there are no papers related to strategic
decisions or modeling. In the nonagricultural literature the majority of supply chain models lack practicality and
would be difficult to implement in practice. Cohen and Mallik [3] and Ganeshan et al. [7] review the state of
knowledge and practice especially in global supply chain management. From these reviews it can be observed that
little attention has been paid to strategic planning in this area as well. Therefore, there is a need for models and tools
to help in strategic decision-making and for assessing and developing the use of information technology within
supply chain systems and its impact.

3.

Proposed Models

This research will develop strategic planning models and supply chain models that integrate electronic
communications and e-commerce, and integrate them into a complete enterprise model. These models will allow
small farmers to predict the benefits and the return on investment of initiatives in supply chain management and ecommerce.
3.1. Strategic Planning and Decision Making
In the development of small farm enterprises there are many strategic decisions that must be made. Such decisions
include whether to form or join a co-op, what type of product to produce and how much, determination of when to
take a product to the market, capacity decisions, etc. One of the more important of these decisions is whether to
form cooperative agreements with other farmers and if so, how large to make the cooperative. The value of co-ops
especially for small farmers can be very significant in many situations. However, there are a variety of issues that

arise in maintaining and operating co-ops such as the optima l size of a co-op, when and whether to join a co-op, and
contracting and pricing policies. The solution to these strategic decisions is not clear at all. To give a feel for what
can be modeled and analyzed we present mathematical models that address some of these issues under simple
assumptions such as homogeneous farmers, deterministic demand, and a single product type. The following
mathematical development for specific cases shows that our approach will be applicable to more general and
complex problems.
The co-op system under consideration can be briefly described as follows. Consider multiple homogeneous farmers
producing one specific product. Their production quantity is assumed to be equal to Q. Each farmer faces local
demand X, which is stochastic and has probability density function ( x ) and cumulative distribution function

( x) . The price of the product for the local and direct farmer-consumer sales is equal to p1 . We further assume
that this local demand and price is not affected by outside factors such as other co-ops and grocery stores. Without
joining a co-op, small farmers have to sell their products individually and directly to actual consumers. They usually
do not have accesses to wholesalers, large supermarkets, and institutional customers such as hospitals, schools, and
hotels because of their small production quantities. However, a number of farmers may form a co-op so that they can
have more stable demand with larger customers. Suppose that the demand from wholesalers and institutions is
expected to be D, and the sales price per item is p2 , where p2 < p1 . That is, farmers may access larger stable
markets but with a lower price too compensate for the uncertainty of local direct markets, which pay more. If n
farmers form a co-op, total production quantity nQ should be larger than D. We also assume that each farmer sells
D/n items through the co-op and the rest, Q-D/n, to local customers.
We would like to first see whether forming a co-op is a viable and profitable decision for small farmers. If it is, we
are also interested in deciding the optimal size of the co-op for a given demand D. If a farmer only sells products
directly to local customers without using a co-op, then the revenue given by f (0) is

f (0) =

p1 x( x) dx + p1 Q( x ) dx
Q

If a farmer is a member of an n-farmer co-op, then the revenue is given by

f ( n) = p2 D / n +

Q D / n

p1 x( x )dx +

Q D / n

p1 (Q D / n )( x ) dx

f (n) is an increasing function in terms of n 1 , when Q 1 (1 p 2 / p1 ) . If


Q > 1 (1 p2 / p1 ) , f (n) becomes unimodal with a unique interior value of n that maximizes the function.

It is possible to show that

Therefore, it is always possible to decide the optimal number of participating farmers, or equivalently, the optimal
size of a co-op.
Using this model, a farmer can also decide whether joining a co-op is beneficial or not. By comparing

f (n) , we can show that there exists a Q and n , which satisfy;


1
If Q (1 p 2 / p1 ) ,
f (0) > f ( n)
n
f ( 0) f ( n)
1
If (1 p2 / p1 ) < Q Q ,

f ( 0) < f ( n)
If

Q >Q ,

f (0) < f ( n )

f (0) and

nn
n >n
n

The condition Q (1 p 2 / p1 ) can be rewritten as p1 Pr X Q p2 . In other words, a farmer should


not join a co-op if the expected marginal price of direct selling is larger than the price obtained through the co-op
participation. A farmer should always join a co-op if his production quantity is larger than a certain threshold value.
1

Otherwise, the farmers decision should depend on the size of a co-op. Because the values of Q and n can be
explicitly computed, our model may assist individual farmers who try to measure the value of forming and/or

joining a co-op. The model presented here is based on simple assumptions and will be extended to include
heterogeneous farmers, stochastic production, and uncertain wholesaler demand.
3.2. B2B and B2C Supply Chain/E-Commerce Models
Consider B2C and B2B aspects of an overall enterprise model. A B2C model should investigate whether direct
producer to consumer sales in retail markets is a profitable option for small farmers or not. The model should also
compute the conditions and amounts of such profitability as well as operational decisions such as quantity and
pricing strategy to optimize framers profits.
Farmers often sell their products directly to consumers for a price higher than the wholesale price, but there are
additional costs associated with transportation and other operations. Moreover, the customers price sensitive
demand, which is certainly random and dynamic, is often very difficult to estimate accurately. Some products can
perish and require additional costs to be removed. In other words, farmers have to take risks for potential higher
rewards. One of the key objectives of this research is to identify conditions that make it worth taking such risks
using mathematical and experimental modeling techniques. We conjecture that the direct sales will be valuable
especially in situations when the demand is easy to forecast, when the demand is highly sensitive to the price, and/or
when the costs and issues associated with logistics are fairly small. The next step is to decide the quantities and price
of products which the farmers would like to sell directly to customers. Because many products are perishable,
farmers need to find balances between lower yet certain profits and higher profits with uncertainties. Our analytical
models will provide operational decisions so that farmers overall expected profits are maximized.
In the past, companies have concentrated their efforts on coming up with effective decisions within a facility. With
today's market globalization and increased competitive pressures, companies are forced to move from making
decoupled decisions to coordinated and integrated decisions [6, 13]. The same concept can be applied to small
farmers and wholesalers, who purchase products from farmers. This research investigates B2B supply chain models
especially under a cooperative structure.
This research investigates supply contract and pricing decisions, which are very important for a co-op to optimize
their operations. Similar studies in a manufacturing and distribution channel can be found in [9, 10]. Our model
below presents an optimal pricing strategy, which achieves the maximal coordination of the supply chain, under an
information- sharing scheme.
Suppose that a co-op suggests the sales price ( p2 ) for its products to wholesalers. A wholesaler decides on an order
quantity (D) based on the estimated demand and cost parameters, along with the given price, so as to minimize the
total cost. The co-op delivers the ordered quantity to the wholesaler, and members of the co-op sell their remaining
products individually and locally. The wholesaler faces random demand (pdf: ( x ) , cdf: ( x) ) later from
retailers and may need to pay either a holding cost (h) or a shortage penalty (s).
Under this scenario, we can derive the profit function of a supply chain. This function is equal to the revenue of the
wholesaler minus the wholesalers holding and shortage costs minus the co-ops production cost. Observe that the
revenue of the co-op and the purchasing cost of the wholesaler cancel each other out. Hence, the profit of the supply
chain can be written as a function of order quantity as follows.

f ( D) = p x( x) dx h ( D x)( x )dx s ( x D)( x) dx v( D)


0

p is the sales price of the wholesaler. If the wholesaler follows an optimal ordering policy based on the
1 s p 2
well-known Newsboy problem, then D =
and the profit function can be rewritten as follows.
h+s
Where

1 s p2


x ( x) dx
h+ s

s p2
s p2
s 1 s p 2 x 1
( x) dx v 1

h
+
s
h
+
s

h +s

f ( p 2 ) = p 0 x( x) dx h0

s p2

h +s

Therefore, one of the objectives of co-op operation is to decide an optimal transaction price

p2 between the co-op

f ( p 2 ) is maximized. After some analysis, we can show that the optimal


s p2
1
transaction price satisfies (( v ' ) ( p2 ) ) =
. More interestingly, the results show that the optimal price p2
h+ s
is decreasing in demand if the production cost v (D ) is strictly concave while the price is constant if the production
and the wholesaler so that above function

cost is linear. That is, if a product has, in nature, concave production cost, a larger co-op can offer the product at a
lower price. This will entice more wholesalers to the supply chain, and the addition will provide a profit increase for
all existing members. We can conjecture that eventually only well-coordinated large co-ops will survive. Therefore,
it is necessary for a co-op to be aggressive in increasing demand, especially at the beginning stage of the supply
chain. On the other hand, in the linear cost case smaller co-ops can compete because the optimal transaction price
should be the same regardless of the size. Thus, the operation of a co-op should focus on other issues such as quality
and customer service rather than becoming large.
While this phenomenon is likely true, we need to carefully study the value of a larger supply chain from many
different views. Further investigation needs to be done in the pricing strategy of a supply chain when multiple
products and multiple co-ops are involved with different types of customers.

4.

Conclusions

The development of an effective supply chain management/e-commerce strategy is a problem common to many
industries including agriculture. In particular, the small farm enterprise is very susceptible to losing financial
viability due to poor practices. The models presented here are a first step in developing the strategic planning tools
necessary to allow small farm enterprises to compete and remain viable. If small farm enterprises are able to model
their supply chains and make strategic decisions based on scientific approaches they will be able to reduce costs,
improve service, and maintain a competitive position in a variety of markets.

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