The canning of Tri Valley

What went wrong at Tri Valley Growers,
and what can other co-ops learn from it?

By Richard Sexton, Professor
Agricultural and Resoures Economics
University of California, Davis
Himawan Hariyoga,Ag Economis

Editor’s note: Many questions have been
raised regarding the causes of the demise of
one of California’s leading food processing
cooperatives. A recently completed study
conducted for the University of California
Giannini Foundation provides some
answers. USDA Rural Development provided
support for the study under a cooperative
research agreement.

ri Valley Growers (TVG) was a California agricultural cooperative owned by more than 500 member- growers and was California’s largest fruit canner, with $782 million in sales during 1998. Members -- who delivered primarily tomatoes, peaches, pears and olives to the cooperative for processing and marketing -- held $125 million of equity in the co-op in 1998. TVG was also a major Central Valley employer, with more than 9,500 seasonal and 1,500 annual employees.

But severe financial difficulties forced TVG to file a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code in July 2000. Its assets were subsequently sold to various buyers. Although a number of factors contributed to its downfall, perhaps the major one was the cooperative’s failure to adequately position its tomato processing operations to reflect the restructuring the industry had undergone. Weakness in the tomato operation -- including under-utilization of plants and failure to meet the explosion of demand for pasta sauces and Mexican food salsas -- led to tomatoes being subsidized by the coop’s much more successful fruit canning operations, to the detriment of the latter. Other negative factors included lack of strong membership contracts requiring crop delivery, a high debt-to-assets ratio and poor management decisions, ranging from over-paying members for crops in some years to the termination of too many experienced plant supervisors when new management took over the co-op in the mid-1990s.

A noteworthy finding of this study is that Tri Valley’s business structure as a cooperative did not contribute to its failure.

Essentials of TVG’s operations
TVG was formed in 1963 when two existing co-ops, Tri Valley Packing Assn. and Turlock Cooperative Growers, merged. In 1964 Oberti olives joined TVG, while in 1978 TVG purchased S&W Fine Foods. TVG also grew through acquisition of the assets and members of other financially distressed or failed processing cooperatives. This list includes Glorietta Foods in 1981, Cal Can in 1983, and Sacramento Growers Co-op in 1993.

By the mid-1990s, TVG operated 10 processing plants -- nine in California and a tomato reprocessing facility in New Jersey. TVG procured raw products from growers on both a membership and a cash-contract basis and converted them into a wide variety of processed products. As time passed, the percentage of product, especially tomatoes, procured through cash contracts increased. For the products it acquired on a membership basis, TVG returned revenues to growers through commodity pools. Prior to 1983, TVG operated a single pool, whereby all revenues and costs flowed into a single account, and surplus in excess of each commodity’s "established value" was returned to members in proportion to their patronage with TVG. Established value, in turn, was usually set in accord with industry prices that were discovered through bargaining between the commodity bargaining associations for tomatoes, peaches and pears, and the major independent processors of those commodities.

In 1983, TVG established the "50/50" pooling concept, whereby commodity-specific pools were established, and 50 percent of revenues derived from each commodity flowed into its own pool, while 50 percent went to the general pool. In 1996, TVG restructured itself as a "newgeneration cooperative," wherein members’ equity was converted to capital stock, and the 50/50 pooling concept was replaced by a complicated alternative that essentially represented a return to the single-pool concept.

TVG’s tomato operations
Tomatoes comprised about 40 percent of TVG’s revenues in the 1990s. The industry had undergone major structural changes by then. Production had relocated from coastal areas to the Central Valley, causing a mismatch between production and processing capacity, and the processing technology had come to emphasize low-cost, bulk-paste manufacturing undertaken in the producing areas, with remanufacturing into specific products done elsewhere.

Processed tomato products sell in a global market, and prices are subject to wide fluctuations and are strongly influenced by inventories carried forward from the prior crop year. On both a nominal and a real basis, prices declined on average from the period 1974-2000.

TVG joined the paste revolution in 1974, when it built a paste manufacturing facility near Volta and secured a favorable 10-year, cost-plus paste contract. In 1984 TVG acquired a paste remanufacturing facility in New Jersey. However, TVG also adopted a nonstrategic approach to expansion in the 1980s through acquiring the membership and facilities of two failed co-ops, Glorietta and Cal Can.

The result was that TVG’s tomato facilities were not well aligned geographically with its production, causing it to have higher shipping costs than the competition and, in some cases, its facilities lacked state-of-theart technology. Its production capabilities were also not well aligned with the market’s needs, as then-CEO and board chair James Saras himself noted in 1993.

These circumstances suggest that TVG needed to make investments in plant modernization and relocation, but it was constrained during the late 1980s and 1990s from doing so because it was already carrying a high debt-to-equity ratio, and its members were themselves suffering from adversities in the raw-product market, making it difficult to collect more equity from them.

TVG’s inability to compete in the growing but cost-driven bulk-paste segment of the market caused it to refocus on producing peeled products and branded product sales in the 1990s, but this strategy was constrained because TVG’s brands were weak and the value-added strategy brought it in to direct competition with larger, financially stronger rivals. TVG’s major market channels were retail (mostly private label), 44 percent; food service, 30 percent; and contract, 12 percent.

Overall, TVG produced a wide variety of low-value and/or low-margin products. During this period, it manufactured 435 tomato product items or labels, including 154 peeled products, 148 remanufactured products, 61 paste items, 22 sauce products and 17 puree items. For the most part, TVG missed the explosion in demand in the 1990s for pasta sauces, Mexican salsas and barbeque sauces.

Very low raw product prices in 1991-92 caused reduced grower shipments to TVG in subsequent years, leading to underutilization of plant capacity -- tomatoes processed in five plants could have been consolidated into three. Poor alignment of production with processing capacity, inefficient technology and under-utilization of plant capacity combined to make TVG a high-cost tomato processor relative to most competitors. Stagnant processed product sales in the early 1990s also led to high inventory costs.

Indeed, tomato market adversities led to low grower returns and persistent subsidization from fruits to tomatoes under the 50/50 pooling arrangement. Most TVG growers were multicannery growers and lacked loyalty to TVG. TVG lacked strong membership contracts that would have required delivery and instead was forced to offer tomato growers special deals cash contracts, accelerated payments and low rates of equity retention -- to retain the patronage of tomato growers in the 1990s. Only 54 percent of tomatoes were acquired on a membership basis in 1996.

Tomatoes were a growth industry relative to canned fruits and TVG gained marketing synergies by selling both tomato and fruit products. But the co-op was not competitive in the bulk-paste market, lacked strong brands and resources to compete with major branded-product producers and faced stiff competition and increasingly powerful retail buyers for private-label sales. Its severe problems and limitations in the tomato market caused TVG to actively contemplate an exit strategy from tomatoes in 1994. But a new board and management team took over soon thereafter and recommitted TVG to the tomato market.

TVG’s fruit and
olive operations
Fruits comprised about 53 percent of TVG’s revenues in the 1990s, with canned peaches and fruit cocktail representing the lion’s share. Prior to its bankruptcy, TVG was the largest fruit processor in California, with about a 40-percent aggregate share of the market. TVG had its own brands, such as Libby and S&W, but sold a majority of its product under private labels.

On balance, TVG was better positioned in fruits than tomatoes, and fruit products on average generated a higher margin than did tomato products. On the downside, per capita consumption of canned peaches and pears declined rather consistently from 1970 through the 1990s, as fresh fruit alternatives became increasingly available. Despite its large share of California production, TVG lacked large national market shares or dominant brands for any of its processed products and was essentially a price taker in these markets.

Things were also more favorable on the membership side for fruits than for tomatoes. Most of TVG’s fruits were procured on a membership basis and -- perhaps because they had fewer selling options than the tomato growers -- TVG’s fruit growers were generally loyal to the coop. However, the persistent subsidies from peaches to tomatoes through the 50/50 pooling arrangement from the mid- 1980s through the mid-1990s caused discontent among the peach growers.

Although olives were a high-margin item for TVG, they caused many problems. Movement of olives as a percent of production was consistently the lowest of any TVG commodity, the percent of non-member purchases increased rapidly to 71.5 percent in 1996, and costs in excess of $10 million were incurred due to environmental contamination of the olive processing plant in Madera.

As with tomatoes, acquisitions and joint ventures involving TVG’s fruit and olive operations appear to have been happenstance (such as the acquisitions of failed cooperatives), not strategy. Unlike its major competitors, Pacific Coast Producers, a pear co-op that focused on low-cost, private-label production, and Del Monte, which focused on value-added brands, TVG tried to perform in both market segments. However, despite many problems, TVG’s fruit operations (excluding olives) were competitive to the very end.

"New-Generation" restructuring
In April 1995, Joseph Famalette was hired as CEO and president of TVG. Famalette had been the architect of a restructuring plan for his previous employer, American Crystal Sugar, and presented a similar plan to TVG members in June 1996. TVG’s equity base was hemorrhaging at this time due to loss of members and increased use of cash contracts, which presented no opportunity for a retain.

The restructuring plan included converting existing equity to a capital stock issued by commodity class. The capital stock conferred both a delivery right and obligation and could only be transferred, with board approval, to another California producer of the commodity. For example, 1.8 million shares of tomato stock were authorized, implying delivery of 1.8 million tons, but less than 800,000 shares were issued.

The 50/50 pooling concept was replaced with a "profitability target" concept that was closely akin to the old, single-pool concept. The restructuring was also accompanied by a purge of many employees from the pre-Famalette era who were replaced with executives who had little prior experience with cooperatives or food processing. A retired TVG executive noted wryly, "They fired everyone who knew where the light switch was at."

Final downward spiral
In 1996, TVG changed its definition of operating income and redefined its fiscal year. The new management also raised prices after the 1996 pack, in market conditions that were not supportive of higher prices. This move resulted in declining sales and rising inventories. Long-term debt rose from $30.1 million in fiscal 1995- 96 to $145.6 million in fiscal 1996-97.

In August 1997, TVG’s auditor, Deloitte & Touche, warned TVG of an increased risk of inaccurate financial reporting, in part because the position of chief financial officer had been eliminated in the downsizing. In August 1998, TVG announced a net loss of $78 million and fired CEO Famalette. About 50 percent of this loss resulted from paying growers 129 percent of the established value vs. the 90 percent that was guaranteed. TVG ended fiscal 1998-99 with a loss in excess of $120 million. These losses were carried forward on TVG’s books, effectively depleting the cooperative’s equity, and making it functionally bankrupt even before the official filing in July 2000.

Analysis of TVG’s demise
The seeds of TVG’s demise were in place prior to the 1990s in the form of high inventories, low productivity of assets, high operating and transportation costs relative to the competition and a high debt-to-equity ratio, which inhibited needed investments in modern plant and equipment. TVG was competitive in fruit processing, but not in tomato processing. TVG needed to become competitive in tomatoes by either finding a market niche where it could thrive, or else jettisoning its tomato line.

Using fruit revenues to cross subsidize tomatoes was not a viable longterm strategy. It will never be known whether TVG could have survived as a fruit processor, if it had divested its tomato lines in advance of the disastrous last years of its operation.

The new-generation cooperative restructuring was largely unsuccessful, in that it failed to stabilize either the equity base or the base of raw product. However, this move had little, per se, to do with the bankruptcy. Rather, the restructuring was a desperate response to severe problems that were already in place. The cost-reduction measures implemented at this time were counterproductive because they were too radical and ill-targeted, so as to negatively impact TVG’s ability to generate revenues. The long-standing problems of poor internal controls and lack of a centralized information system were never addressed.

Some have viewed TVG’s bankruptcy as a sign that co-ops are illsuited to succeed in 21st century markets. One way to address this concern is to ask which of TVG’s problems were due to its cooperative structure vs. being due to market conditions or internal problems.

We view the acquisition of inefficient capital from defunct co-ops as both a co-op (due to a sense of obligation to help fellow co-ops) and a management problem. The high debt-toequity ratio that TVG experienced is common among cooperatives, and is due to the limited pool from which they can draw equity (namely, the members), and members’ reluctance to contribute to long-lived projects, known as the "horizon problem." The unwillingness to terminate growers who were no longer viable producers for the cooperative and the dramatic grower overpayments in the final years probably also trace to the grower-ownership dimension of a cooperative.

Market problems were fundamentally twofold, but neither was insurmountable. The tomato market, though growing over time, was very volatile, and the canned fruit market was in decline.

There were several internal problems related to management and the board. Non-strategic acquisitions of failed competitors has already been noted, and failure to adopt an integrated management information system was a critical error. So, too, was the Famalette-era purge of employees who were knowledgeable about the food processing business.

Other internal problems attributable to the co-op’s leadership include failure to come to grips with the grower end of the tomato business, including overreliance on cash contracts. Finally, TVG had a persistent lack of focus on the selling side -- for example, whether to emphasize brand or private label sales and whether to emphasize paste or value-added products in tomatoes.

Ultimately, we do not think that TVG’s cooperative structure was the major factor in its bankruptcy. The fact that peer cooperative Pacific Coast Producers continues to experience success supports this view. We do think the TVG experience offers lessons for cooperatives.

A multi-product marketing co-op is desirable in the sense that modern markets prefer "full-line" suppliers. But marketing multiple products has the potential to create significant internal problems in terms of pooling and director loyalty and responsibility. TVG’s experience with its tomato growers emphasizes the importance of long-term grower contracts to encourage member loyalty. However, loyalty to other cooperatives should not replace sound business judgments.

Finally, TVG was probably slower in responding to changing market forces than its competitors, perhaps due to a cumbersome cooperative decision-making process.


What went wrong? Some opinions


General conclusions about co-op’s downfall



September/October Table of Contents