The three-legged stool: A feasibility analysis for starting a CEA farm

Editor’s note: Peter Tasgal is a strategic consultant to the food and agriculture industries and co-founder of the Farmbook Project, based in Boston, US. The views expressed in this guest article do not necessarily represent those of AFN.

Controlled environment agriculture (CEA) — predominantly consisting of greenhouses, vertical farms, and container farms — has been gaining ground.

Two trends contributing to this increased popularity are technological advancements and renewed customer interest in where food is grown. With regards to the second of these, while Covid-19 has been devastating on many counts, a bright spot is that individuals and families are taking more time to understand where, and how, their food is being farmed.

AppHarvest is an example of a CEA company which has attracted significant attention from both agricultural and mainstream media. Its 60-acre tomato greenhouse in Morehead, Kentucky is close to its first seeding. The company has received national press for adding celebrity cook Martha Stewart to its board. It also recently announced that it’s becoming a publicly traded company through a SPAC merger.

Equilibrium Capital, a private equity firm which was an early investor in AppHarvest, has also backed Revol Greens. This Minnesotan CEA startup just announced it has raised an additional $68 million, bringing its total funding to date to over $200 million.

While interest in building CEA farms is clearly there, the pathway to actual development is not as clearly plotted. I posed this question to leading industry experts. To paraphrase, each of the experts cited three factors of a successful CEA farm’s creation:

1. Operational expertise
2. Distribution
3. Capital

In my opinion, a prospective CEA farmer is well positioned with each of those factors in place. If you have two of the three you have a good chance. However, one out of three poses a great challenge for the chances of success.

One example of ‘3 out of 3’ is AppHarvest:

1. Equilibrium Capital and the CEO of AppHarvest, Jonathan Webb, have previous CEA expertise
2. Mastronardi Produce (otherwise known as Sunset) will be providing distribution
3. Multiple investors on board including Equilibrium-led consortium, plus SPAC deal

After discussions with industry experts, I researched these three factors and the requirements for each. Here’s my analysis:

1. Operational expertise

Does the team have the competence and ability to cost-effectively develop and operate a CEA farm? There are a limited number of individuals with the skillset to both develop and operate. Adding a management team, if required, may hinder the ability to operate a profitable farm.

The first decision becomes: build a greenhouse or a vertical farm?

Greenhouse vs vertical farm

Factors to consider:

• Stage of industry. The greenhouse industry is more developed and has more surrounding infrastructure than the vertical farming industry. Specifically, there are more choices of factory-built structures for greenhouses.
• Land efficiency. Vertical farms, by definition, require less land per unit of output than greenhouses. In areas where land is costly, vertical farms may be a preferred option.
• Demand. Forecasting demand is a critical part of this decision-making process. If demand exceeds the capacity of a single-level grow structure (greenhouse) then a vertical farm may be necessary.
• Cost of power. Electricity is one of the largest costs in a vertical farm or greenhouse. Typically, kilowatt-hours of electricity to run a vertical farm are higher per unit of output than in a greenhouse. The quantity and cost of electricity required in the region the farm is located will affect the decision process.
• Cost to build, purchase equipment, and purchase systems. The cost to construct a greenhouse or vertical farm will vary dramatically.

After deciding on a vertical farm or greenhouse, a prospective farmer can begin to think about capacity.

How to determine capacity

Capacity can be worked out using the following equation:

(Plant sites per level based on horizontal grow area) x (number of levels) x (turns per year)

Greenhouses have one grow level. In addition to the horizontal growing area, space is required for a range of non-growing requirements. These include space for packing, preparing, people, shipping, and administration.

Capacity variables include:

• Product offering
• Technology usage
• Plant cycles
• Produce dimensions
• Required downtime
• Loss rates

A sample calculation is depicted below:

([3,000 square foot grow area] x [2 plant sites per square foot]) x (5 levels) x (10 turns per year)

= 300,000 plants per year

Site selection and development

After making a decision as to vertical farm or greenhouse and then determining capacity, the next thing to do is to select a site. Frequently a prospective farmer has a site in mind; they may own the land, desire to live in a certain area, or see a particular opportunity there.

Critical to the site selection process, in addition to the above, are the attributes of the site and the region it’s in. Attributes to consider during due diligence of a site include:

• Zoning and codes
• Utilities and utility access
• Ground and water
• Accessibility
• Community impact
• Skilled workforce – ability to assemble a strong team

Regulatory frameworks for CEA farms can vary significantly depending on state, county, and municipality.

2. Distribution

Distribution is a function of capacity, farm location, and price.

Distribution capacity

Distribution begins with relationships – knowing your customer. A farmer needs access to potential customers who are a proper fit for their farm’s offerings. Discussions with potential customers should focus around product demand and price.

When working with retailers, it is beneficial for farmers to be practical around demand forecasts. Retailers have an incentive to over-estimate demand, to avoid product shortages. However, over-growing will leave a farmer with excess product. Many farmers prefer purchase agreements where the customer agrees to buy a specific quantity at a specific price.

Additional considerations of distribution capacity:

• Amount of capacity concentrated with a limited number of customers.
• Optimal excess capacity for increased demand requirements of existing customers.
• Optimal capacity retained for new customers.

Capacity utilization requires a delicate balance between just enough flexibility, while using just enough capacity, to operate a profitable farm.

Farm location

Customer proximity affects each of the following:

• Distribution
• Product marketing (retailers command a premium for local)
• Labor access

Price

Understanding demand requirements and goal clarification is pertinent to price determination. If the goal is maximizing short-term revenue, a contract to maximize capacity may be the best alternative. If the goal is to maximize mid to long-term profitability, entering into smaller contracts with a range of customers will be beneficial.

Realism and conservatism are critical when pricing product. This is especially true when selling into retail. When I discuss pricing with CEA clients, in most cases I advise them to price somewhere between the price of conventionally grown product and organic product. There may be space to price higher in certain sections of retail outlets or with distinct packaging, but this is my general finding.

3. Capital

Despite the recent news of large fundraises across the industry, capital isn’t infinite. In almost all cases the crucial decision is where and when to invest capital. Even where capital seems to be almost ‘infinite,’ all investors require acceptable returns.

Capital trade-off decisions

• Buy or build? Buying a successful CEA farm will have a cost; but will also reduce time-to-market. Included in an acquisition is a structure, system, and customer and employee base.
• Technology. It can provide efficiency and quality benefits. However, it can also limit diversification of a product set and product packaging.
• Optimal location. Generally, land ownership is considered a given and not a variable. However, the value of the land and the benefits of the location need to be considered as compared to alternative locations.
• Optimal grow area. Generally, building to maximum capacity generates the most revenue. However, it may not produce the most total profit or return on invested capital.

Sources of capital

A wide range of capital providers are investing in the CEA market. The exception to this is senior-level debt providers, such as banks and other finance companies. Bank debt has historically been available exclusively to highly seasoned operators; and those whose funding is guaranteed by government or other highly-rated entities.

Sources of capital include:

• Individuals and private family offices
• Venture capital and private equity investors
• Junior capital arms of financial institutions
• Investment arms of corporations
• Vendor financing
• Lease financing

Supply and demand

The importance of the three factors — operational expertise, distribution, and capital — and the interplay between each cannot be underestimated.

For example, limited access to capital could require a reduction in footprint and therefore affect the number of customers it’s possible to serve. Decisions made with one factor in mind necessitate a review of decisions made with regards to each of the other factors. This fluidity continues throughout the life-cycle of the farm.

As with all businesses, there are trade-offs to each decision. Focusing on customer demand is the first priority. However, too frequently the focus is on operational efficiency. Ultimately, the consumer needs to be willing to buy the product at a price which is profitable to the farm. This requires the end consumer to be aware of the product and its key attributes. Running a farm requires focus on both supply and demand.