Vertical Coordination in The
Malting Barley Industry: A
‘Silver Bullet’ for Coors
Brian C. Briggeman
Joshua D. Detre
Case Study prepared for the 2004
American Agricultural Economics
Association Denver, CO
Background
• Adolph Coors founded Coors Brewery in Golden, CO
(1876)
• Growth
– 2002 acquisition of Bass Brewers (UK)
– Increased net income by 8%
• 2002 net income $161.8 million
• 2003 net income $174.7 million
– 9th largest brewer in the world
– In discussions with Molson
• Competitive Advantage
– Rocky Mountain Fresh
Production Contracts
• Secure supply of high-quality barely
• Strict Standards
• Price premium to barley farmer
– Idaho Barley Commission
• 2002 Malt Barley: $5.67/cwt
• 2002 Coors Production Contract: $6.75/cwt
• How does this affect costs in the value
chain?
Agency Theory
• Principal and agent
– Farmer pursues goals that differ from Coors
(moral hazard)
• Shirking results
– Asymmetric information (adverse selection)
• Farmers may have hidden information-knowledge
– Production history
– Production costs
– Risk sharing
– Use financial incentives to motivate workers
• Farmer must be willing to accept the contract
• Farmer must take efficient actions
Agency Theory
• Why Agency Theory is not the whole
story
– Little difficulty of performance
measurement in contracted barley
• Occurs because Coors pay the farmers on the
value they create
• Residual returns to barley production go to the
farmer therefore there are incentives to pursue
efficient actions
– Multiperiod relationships limit the
existence of hidden information
Transactions Costs
• Firms are designed to minimize the
total costs of transacting
– Farmers may be able to exploit learning
and scale economies
• Farmers are specialists who make necessary
investments to develop expertise and exploit
scale economies
– The market provides intangible benefits
• Integration may give rise to additional costs
– Agency
– Influence
Transactions Costs
• Why Transactions Cost Are Not The Whole
Story
– Problems
• Costs of transactions indistinguishable from other costs
– Technical efficiency gains from contracting outweighs the
agency efficiency (minimization of transactions costs) of
vertical integration
• Efficiency does not always imply cost minimization
– Coors does not force the farmers to bear all risks
• Repeated relationship between Coors and the farmers
– Reduces uncertainty
– Makes investments in assets more profitable
Why Ownership and Property
Rights Work for Coors
• Incomplete contracts, bargaining costs,
moral hazard, and influence costs are
sources of inefficiency in business
relationships
– Assignment of ownership rights affects
the magnitude of each of these problems
and possibilities of creating value
Why Ownership and Property
Rights Work for Coors
• Farmer ownership accompanied by
secure property rights
– Effective institution for providing
incentives to maintain a supply of quality
barely
– Without them there are dulled incentives
for farmers to make the investments
necessary to ensure quality barley
Coors Not Buying The Farm
• Objective for the law of property rights
is to assign them in a way that creates
value
– Important rights be assigned properly
initially
– Coase states if transaction costs are low
and rights are assigned, secure, and
transferable, there will be efficiency
– Contract arrangements between Coors and
the farmers have evolved towards an
efficient arrangement that allow both
parties capture mutually available gains
Coors Not Buying The Farm
• Difficulty of performance measurement
in barley production
• Coors wants the farmer to have
possession of residual decision rights
and residual returns.
– Decisions regarding the use of the assets
that are not explicitly covered in the
contract
– Will make efficient decisions because he
will want to maximize returns
Coors Not Buying The Farm
• Coors has multiperiod relationships
with key barley suppliers
– Provides an incentive for fair treatment
– Reputation is an effective control
mechanisms of the contract
• Arms length transactions are preferred to
ownership
– Consequences for performance when
contracts are granted for the next year
– Presence of a learning curve, which means
long-term relationships are valuable
• Very difficult to transfer knowledge and
experience
Value Chain affects on Property
Rights
• Supply Chain Management Activities
– Contract standards ensure high quality barley
• Creates a benefit position relative to competitors
• Accomplished through property rights
• Operations
– Production processes for Coors are higher
– Predictable costs (COGS per Sales ≈ 54%)
– Affect on contract bidding
Value Chain affects on Property
Rights
• Distribution
– Economies of Scale
• Minimum Efficient Size
• Sales and Marketing
– Building product image through
• Branding, pull advertising, and product promotion
• Breadth of product line
• Service
– Savings due to recycling can be passed onto the
production contracts
Value Chain affects on Property
Rights
• Profit Margin
– BOTTOM LINE
– Willingness to pay for Coors’
products
– Why? Competitive advantage
attributed to our differentiated barley
1999 Beer Industry
Leaders
Operating profit
Operating margin
Anheuser Busch
Coors
Miller
$23.51
$6.73
$12.47
25%
7%
15%
Source: Sanford C. Bernstein & Co., Inc. April 17, 2000
Beer Naturally
• Production contracts via property rights are
the most efficient form of organization for
Coors
– Source of Competitive Advantage in the “Value
Chain”
• Where to go from here…
– Economies of scale in operating expenses
• Continued selective acquisitions, mergers, and ventures
– Product proliferation
– Co-branding
– Capture cost advantages while maintaining benefit
advantages
• Thank you for your time and
attention
• Please feel free to ask any
questions you may have
about our presentation
Table 3. Income Statement Data for the
Adolph Coors Company, 1998 to 2002
(millions of dollars)
Gross Sales
Beer Excise Taxes
Net Sales
Cost of Goods Sold
Gross Profit
Other Operating Expenses
Marketing and Administration
Special Charges
Total Other Income
Operating Income
Interest Income
Interest Expense
Other Income, Net
Net Income Before Taxes
Income Tax Expense
Net Income After Taxes
Net Income Per Common Share
2002
4957
-1181
3776
-2415
1361
2001
2843
-413
2430
-1538
892
2000
2842
-427
2415
-1526
889
1999
2643
-406
2237
-1397
840
1998
2464
-392
2072
-1333
739
-1057
-6
-1063
298
21
-71
8
256
-95
161
4.47
-717
-23
-740
152
16
-2
32
198
-75
123
3.33
-723
-15
-738
151
21
-6
4
170
-60
110
2.98
-693
-6
-699
141
11
-4
3
151
-58
93
2.51
-616
-19
-635
104
12
-10
5
111
-43
68
1.87
Table 4. Other Performance
Information, 1998 to 2002
2002 2001 2000 1999 1998
Barrels of Beer Sold, millions
31.8 22.7
23
22 21.2
Divdends Per Share of Common Stock
0.82 0.8 0.72 0.65 0.6
Depreciation, millions of dollars
230.3 121.1 129.3 123.8 115.8
Capital Expenditures, millions of dollars 246.8 244.5 154.3 134.4 104.5
Table 5. Scale Advantages Are
Key In Beer Industry 1999
($/Barrel)
U.S. Revenues, net
COGS
Gross profit
Gross profit
Operating Expenses
Operating profit
Operating margin
Share
Anheuser Busch
$93.37
55.88
37.49
40%
13.99
$23.51
25%
47%
Source: Industry sources, Bernstein
Coors
$93.68
55.39
38.29
41%
31.57
$6.73
7%
11%
Miller
$82.39
53.99
28.41
34%
15.94
$12.47
15%
21%
Table 7. Yahoo Beer Industry
Statistics
Description
Beverages (Alcoholic)
Adolph Coors Company
Allied Domecq PLC (ADR)
Anheuser-Busch Companies,
Big Rock Brewery Income T
Boston Beer Company
Brown-Forman Corporation
Chalone Wine Group, Ltd.
Companhia de Bebidas das
Constellation Brands, Inc
Consumer Non-Cyclical
Diageo plc (ADR)
Heineken N.V. (ADR)
Kirin Brewery Company, Lt
Quilmes Industrial S.A.
Robert Mondavi Corp.
Todhunter International,
Market Cap
143.65B
2.55B
9.18B
41.74B
54.86M
280.97M
5.64B
127.83M
7.59B
3.96B
1214.44B
39.15B
15.43B
9.53B
5.25B
559.21M
74.24M
P/E ROE % Div. Yield % Debt to Equity Price to Book Rev Qtr vs Yr Ago EPS Qtr vs Yr Ago
19.95 64.10
1.69
2.33
12.88
7.44
15.06
14.64 14.30
1.19
NA
NA
4.57
-8.95
10.21 205.74
3.16
5.09
11.35
-2.01
124.32
20.13 79.19
1.70
2.77
15.35
5.99
17.54
12.61 23.22
7.40
0.19
2.77
26.52
152.63
21.49 22.70
NA
0.00
4.57
10.12
85.00
21.90 27.68
1.84
0.63
5.19
8.93
7.33
182.40 0.73
NA
0.80
1.32
-8.57
NA
19.79 27.92
4.68
1.43
5.34
19.41
-39.24
17.93 10.97
NA
0.90
1.71
19.99
8.78
20.60 33.57
2.43
1.14
8.29
12.79
19.07
15.02 32.49
3.06
2.16
7.08
-5.12
NA
32.08 27.57
0.83
1.72
8.07
12.89
-14.71
32.87
4.13
1.09
0.35
1.31
110.41
869.20
14.86
9.17
1.06
0.39
7.08
40.74
2675.00
25.16
4.82
NA
0.80
1.17
6.49
NA
13.71
7.75
NA
0.50
1.02
0.98
-23.14
Table 8. Dunn & Bradstreet
Industry Quartiles
Industry
Quartiles
2003
2002
2001
Solvency
Statement Sampling: 28
Upper
Median Lower
Statement Sampling: 139
Upper
Median Lower
Statement Sampling: 146
Upper
Median Lower
Quick Ratio
(times)
1.5
0.9
0.3
1.5
0.8
0.3
1.7
0.8
0.4
Current Ratio
(times)
3.1
1.9
1.3
3.2
2
1.2
3.3
2.1
1.1
Current
Liabilities /
Net Worth (%)
26.6
53.7
105.9
23.2
50.9
104.6
22.2
46.2
128.6
Current
Liabilities /
Inventory (%)
85.7
140.8
183.1
83.1
123.6
197
75.3
128.3
204.9
Total
Liabilities /
Net Worth (%)
40.1
104
270.7
35.2
91.5
228.1
30
109.3
244.2
Fixed Assets
/ Net Worth
(%)
16.4
52.4
86.8
23.6
42.6
80.4
22
48.8
88.5
Table 8. Dunn & Bradstreet
Industry Quartiles
Industry
Quartiles
Statement Sampling: 28
Efficiency Upper Median Lower
Collection
Period (days)
Sales /
Inventory
(times)
Assets /
Sales (%)
Sales / Net
Working
Capital
(times)
Accounts
Payable /
Sales (%)
2002
2001
Statement Sampling: 139
Upper Median Lower
Statement Sampling: 146
Upper Median Lower
2003
1.5
5.1
22.3
1.8
4.8
19.6
2.2
11.7
23
22.5
16.6
13.3
33
19.8
14
32.1
19.3
13.2
19.4
33.7
40.2
19.3
27.1
35.7
19.5
27.7
35.9
34.2
16.7
13.1
26.6
15.5
8.2
26
12.6
7.4
2.1
3.1
4
1.1
2.4
3.5
1.6
2.5
4
Table 8. Dunn & Bradstreet
Industry Quartiles
Industry
Quartiles
2003
Statement Sampling: 28
Profitability Upper Median Lower
Return on
1.8
0.6
Sales (%) 3.2
Return on
5.7
1.7
Assets (%) 8.4
Return on Net
Worth (%)
18.9
11.9
5.4
2002
2001
Statement Sampling: 139
Upper Median Lower
Statement Sampling: 146
Upper Median Lower
4.2
2.2
0.8
3.5
1.5
0.4
13.9
8.7
2.6
14
5.6
1.6
30.5
20.2
6.1
30
11.7
4.3
Table 8. Dunn & Bradstreet
Industry Quartiles
Median
Variance
Solvency Median
2003
2002
2001
2002
2001
Median
2003
2001
Median
2003
2002
Quick Ratio
(times)
0.9
12.5
12.5
0.8
-12.5
0
0.8
-12.5
0
Current Ratio
(times)
1.9
-5
-9.5
2
5
-4.8
2.1
9.5
4.8
Current
Liabilities /
Net Worth (%)
53.7
2.8
7.5
50.9
-2.8
4.7
46.2
-7.5
-4.7
Current
Liabilities /
Inventory (%)
140.8
17.2
12.5
123.6
-17.2
-4.7
128.3
-12.5
4.7
Total
Liabilities /
Net Worth (%)
104
12.5
-5.3
91.5
-12.5
-17.8
109.3
5.3
17.8
Fixed Assets
/ Net Worth
(%)
52.4
9.8
3.6
42.6
-9.8
-6.2
48.8
-3.6
6.2
Table 8. Dunn & Bradstreet
Industry Quartiles
Median
Variance
Efficiency Median
Collection
Period (days)
Sales /
Inventory
(times)
Assets /
Sales (%)
Sales / Net
Working
Capital
(times)
Accounts
Payable /
Sales (%)
2003
2002
2001
2002
2001
Median
2003
2001
Median
2003
2002
5.1
-6.2
56.4
4.8
6.2
59
11.7
-56.4
-59
16.6
-16.2
-14
19.8
16.2
2.6
19.3
14
-2.6
33.7
6.6
6
27.1
-6.6
-0.6
27.7
-6
0.6
16.7
7.7
32.5
15.5
-7.7
23
12.6
-32.5
-23
3.1
0.7
0.6
2.4
-0.7
-0.1
2.5
-0.6
0.1
Table 8. Dunn & Bradstreet
Industry Quartiles
Median
Variance
Profitability Median
Return on
Sales (%)
Return on
Assets (%)
Return on Net
Worth (%)
2003
2002
2001
2002
2001
Median
2003
2001
Median
2003
2002
1.8
-0.4
0.3
2.2
0.4
0.7
1.5
-0.3
-0.7
5.7
-3
0.1
8.7
3
3.1
5.6
-0.1
-3.1
11.9
-8.3
0.2
20.2
8.3
8.5
11.7
-0.2
-8.5
Factors in Coors Organizational
Structure
•
•
•
•
•
Specificity
Frequency and Duration
Complexity and Uncertainty
Difficulty of Measuring Performance
Connectedness
Coors Not Buying The Farm
• Difficulty of performance measurement
in barley production
– Since care is especially difficult and/or
costly to measure for Coors, the solution
would be allow the farmer to be the owner
• He has residual control and is the residual
claimant
• The farmer will have the proper interest in
maximizing the residual value of the asset