Cross-Linking Supply Chains & Establishing New Value Allocations
April 13, 2010
Case categories include: Operations Strategy & Planning
By Robert Sher
It takes special conditions for success in starting a business that can grow to a grand scale. Many CEOs find it’s easier and less risky to take an existing business and tune it up, reducing costs or improving quality to grab a bigger piece of the value chain. We CEOs look at our suppliers on one hand and our customers on the other.
But what if there are no suppliers or customers yet? If the supply chain hasn’t been formed? If the flow of transactions has not yet begun? Then you’d have to create the entire supply chain. Not unlike starting a new business, special conditions would need to exist, and a wide variety of players and processes would need to start at the same time to have a sustainable, ongoing system. CEO Neal Gutterson of Mendel Biotechnology (Group 110) is building a new supply chain by cross-linking three existing supply chains in new and unique ways. And what fun it is!
Here’s the three existing supply chains:
- Coal miners start a supply chain that feeds the steady demand for electricity.
- Oil explorers start a process that feeds refineries which produce fuel for our vehicles.
- Farmers produce crops that we eat.
Neal Gutterson would tell you that the farming supply chain begins with the development of better seeds that produce a higher and more reliable yield per acre. Since 1997, Neal’s PhD scientists worked in the lab, supplying companies like Monsanto with optimized seeds that help feed a hungry world.
Then, in 2007, British Petroleum (BP) called. Yes, the global fuel company. They foresaw the need to grow fuel. Not ordinary corn, but a crop optimized for sustainably produced energy. BP had made some strides in understanding the refining of this type of biomass. But their big worry was that no supply chain would exist to produce and deliver biomass when they needed it in the future. The best crops had not yet been identified. No optimized seed had been developed. No farmer had grown them. No equipment to harvest or transport the resulting biomass had been built. No one knew what it might cost. But BP knew that when it needed to add sustainably produced biofuels to their fossil fuel-based products, an entirely new supply chain had to be in place.
In mid-2007, BP made a sizeable equity investment in Mendel Biotechnology and funded a five-year program to develop dedicated energy crop varieties, initiate supply chain development, and formulate a plan for the following five years to commercialize the growing of feedstock and create an ecosystem of suppliers. Mendel had been an R&D company, but would now build out an entirely different business unit, Mendel BioEnergy Seeds, focused not just on seed biology, but on creating a feedstock-producing supply chain. Not just an ambitious goal, but a “Big Hairy Audacious Goal”: Cross-linking the food supply chain with fuel or power supply chains.
My first reaction when small companies talk about pioneering is the old phrase, “You can tell a pioneer by the arrows in their backs.” Pioneering is high risk work, and most efforts fail. Too many such efforts are based on a dream, not on a well-founded forecast of future demand, nor on a realistic appraisal of the challenges, nor on a strategy for crossing the large chasm to a profitable enterprise. In Mendel Biotechnology’s case, the trend away from fossil fuels and government support for renewable power were strong arguments in favor of future demand. Neal ensured that strategic mapping was an initial focus, led by new hires getting help from experts in the agriculture and energy industries. And Mendel was smart to not try and go it alone. They had a big, well-heeled partner willing to fund much of the effort.
To start, they had to envision what a functioning supply chain would look like. The first surprise came when market indicators suggested that the first viable market for bio-feedstock would be coal burning power plants supplying electricity, rather than biorefineries. It appeared that the seed, farming and harvesting processes for fuel conversion or power generation supply would be largely identical. But the processing of the plant material would surely be different, as would some of the transportation issues.
It was fortunate that in this case, there were two ways to win, and two potential markets: Conversion of the feedstock to fuel, or to electricity. Within 18 months, the original market—fuel—had become more distant and less attractive. Fortunately the power generation market took its place. So in addition to having a big partner and a forecast of good demand, having multiple opportunities to succeed further mitigated the risk.
Mendel already had plenty of PhDs to work on seed genetics, and the selection of Miscanthus—a type of grass—as the ideal crop was determined back in 2007-08. The pace of research quickened immediately. Neal’s first hire was a VP of business development to begin defining the company’s strategy and its most critical business objectives. Then came a general counsel, a VP of human resources, a high level CFO, and finally a senior VP of Seeds – a farming-savvy, operations-focused executive. The needs of the new business unit were much greater and more dynamic than those of a pure research company.
Creating the right team for the effort is critical. Pioneers have different personalities than settlers. Both face challenges, but pioneers are comfortable with failure, surging ahead with imperfect information, and experimenting real-time. Most members of the top team at Mendel who were ideal for the original business were not suited for the company going forward. Additionally, the new team needed to understand the supply chains they would be working with. Neal was very clear about his criteria for hiring the new team.
Mendel decided that it would have to be the facilitator-architect of the entire value chain, and began by opening up conversations with everyone from the power plants and biorefiners down to the farmer. They quickly planted very small plots of land with a range of initial potential product lines in collaboration with university scientists, and then larger plots of land with advanced candidate product lines with a few key growers to start to prove out the process. The farmer was guaranteed a fair return on the acreage employed. The resulting quantity of Miscanthus is being used to test all the assumptions and to help answer questions about the subsequent processes. Would the yield per acre on marginal farmland be acceptable? How could these grasses be harvested – particularly since they can grow up to 13 feet tall? Would processing them into pellets for power plants to burn be the best course of action? Would they produce an appropriate amount of energy, and would they burn properly?
The first trial growing and harvesting yielded many lessons and validated the premise that Miscanthus could be an excellent feedstock for the production of electricity. The progress of refiners (for fuel) in building commercial scale operations was much slower. They weren’t able yet to do their part to complete the full supply chain from feedstock to fuel. Mendel focused on where the demand was stronger.
But comparing Mendel Biotechnology with Hewlett Packard—or Leland Stanford and the Big Four who built an empire as the railway grew in the West—would not be fair. Those innovators were building an entirely new industry and supply chain. In this case, Mendel is building upon three pre-existing supply chains. Most of the participants will be existing companies in those supply chains. This meant less risk, more incremental growth, and a better chance of success.
With success at a small scale in hand, the team at Mendel has begun to romance all the partners they would need to scale up. Some come from the agricultural supply chain and others from the power generation supply chain, such as from the supply of woody biomass (e.g., trees). Larger tracts of land are now being planted to better study the effects of weather and to hone growing techniques. The availability of increased amounts of planted acres offered harvesting equipment manufacturers an opportunity to test their current machines and to adapt them for harvesting Miscanthus. Collaboration with processors began as well. And the industrial customer—power plants—were drawn in to stoke the fires of demand. Neal intentionally reduced risk by scaling up in several trials.
The battle was on to:
- Understand the cost of each step in the value chain and to understand where there would be efficiencies of scale.
- Understand the relative value for each participant in the new value chain versus the traditional business activities that were the mainstay of each of their businesses. How much profit would they need to earn to pay attention to the new opportunity?
- Prove that growing feedstock for power generation was truly commercially viable and could compete with coal, given government subsidies for renewable energy production and greener power generation. (Burning Miscanthus is carbon neutral.)
- Create market conditions that bring on steady, consistent demand sufficient for all the participants in the supply chain to invest significant resources.
Then and only then would BP’s vision be realized – a healthy supply chain ready and in place to supply a new source of energy. Mendel’s vision is to be embedded in that value chain, earning a share for themselves at each step as their seed turns into energy, first stored in the form of plant biomass and then converted into more useful, everyday forms such as electricity or transportation fuel. Their return for their seed development work is one thing, but the return for their entrepreneurship in shepherding the development of a new supply chain is additive. The specifics of cost, pricing and profits are still being determined, since the economics of production are still being discovered.
At present, nearly 200 acres of Miscanthus have been planted, and several power companies have agreed to do a mid-sized trial of the pelletized feedstock. The plan is to mix coal and Miscanthus (co-firing), with a first test already done, and others to occur later this year. By 2013, Neal forecasts that the supply chain will be fully defined, that Mendel’s royalties/income stream from the effort will be clear, and the foundation will have been laid to meet renewable electricity mandates from biomass that could displace perhaps 25% of coal power generation in the next couple of decades, a titanic shift in energy sources.
I can see the discussions happen in board rooms and Alliance of Chief Executives groups. Leaders taking stock of all the adjacent supply chains and mapping out all trends, new needs and opportunities where cross linking supply chains could create added value. What an opportunity to be the first company in your domain to envision a new supply chain, to decide how much of it you can own, to discover how much you can dominate, and to do what it takes to bring it to life. Tuning up operating companies is essential work, but think of the fun you could have cross-linking supply chains – if the required special conditions are present.
Robert Sher is an Alliance Director and principal of CEO to CEO. He may be contacted at firstname.lastname@example.org.