Farmer-owned ethanol and the
role of information technology
Anthony Crooks and John Dunn,
Agricultural Economists
USDA Rural Development
Editor’s note: This is the first of a two-part
article looking at the impact evolving
information technology is having on the
nation’s rapidly expanding ethanol industry.
In part two, we will take a closer look
at the various factors that have converged
to spark the industry’s growth, as well as
the impact of information technology on
production and commercialization of
ethanol products.
dvanced information
technology (IT) and an
increasingly transparent
financial sector have
become key driving business
forces in recent years, having
major impacts on operations, strategies,
structures, ownership and performance.
These forces cut across many industries
to force changes which, in turn, have
had significant economic and social
impacts in rural communities.
Recent writings underscore the
depth and extent of the impact of IT on
business and industry. Consider just a
few:
- Are the impacts of IT adoption any
more profound or far reaching than
that of other technologies? In his
book, Does IT Matter? Information
Technology and the Corrosion of Competitive
Advantage, Nicholas Carr
seems to think not. Carr asserts that
IT, as with earlier technologies —
railroads, electric power and telephones
— is steadily evolving from a
profit-boosting, proprietary resource
into a simple utility/commodity and
another cost of doing business. Carr
contends that the strategic importance
of IT has actually eroded as its
core functions have become widely
available and affordable. Carr’s views
were roundly contested.
- In IT Doesn’t Matter, Business Processes
Do; A Critical Analysis of Nicholas
Carr’s IT article, published in the
Harvard Business Review, Howard
Smith and Peter Fingar suggest that
Carr was only half right. They say
Carr’s article is about technology as a
business (the IT industry), not the
business use of technology for competitive
advantage. In other words,
Carr has intermixed information
technology as a business with the act
of using information technology to
conduct business. Carr’s article examines
the first 50 years of IT and business
automation, when the focus was
on data function, storage, processing,
and transport. In the next 50 years,
the core functions of IT are business
processes and their functions of storage,
processing, and transport.
- In The World is Flat: a Brief History of
the 21st Century, Thomas Friedman
takes off at a gallop, offering example
after example of just how correct
Smith and Fingar were. Friedman
asserts that it is precisely because of
IT and business process-processing
that the era of mainframe computing
— with its command-and-control
orientation and companies
and/departments organized vertically
— has given way to the era of PCInternet-
fiber optics computing and
new business practices which are less
about command and control, and
more about connecting and collaborating
horizontally.
- In The Only Sustainable Edge: Why
Business Strategy Depends on Productive
Friction and Dynamic
Specialization, John Hagel and
John Seely Brown assert that
businesses thrive when they take
full advantage of IT opportunities
to negotiate the “productive friction”
of their economic environment
and begin to coordinate the
activities of enterprises, companies
and specialties across dimensions
of time, space and form to
build and accelerate their capabilities.
Friedman and Hagel/Brown
emphasize the critical importance
of digitizing and decomposing
work so that it can be moved
around in time and space — to be
outsourced (or off-shored) for
competitive advantage.
IT leveling the playing field
for smaller-size businesses
It is precisely because of evolving
IT and business process-processing
that mid-sized firms from
all over the world compete now on
a more level playing field.
Suddenly, mid-sized and even small
businesses have access to the same
advantages that were once held
exclusively by the larger, vertically
integrated firms.
As the fuel ethanol industry ramps out
of its developmental stage into a more
established role within the U.S. fuels
industry, a substantial portion of investments
are being made in single plants
with annual capacities that range from
50-100 million gallons. Not all ethanol
ventures have succeeded. However, a
substantial flow of capital investment
into ethanol plants continues, unabated.
This emerging industry structure is
in sharp contrast with what is typically
observed in sectors that process bulk
agricultural commodities. Typically, a
commodity sector is composed of a few,
large multi-plant firms which achieve
relative prominence after attaining significant
economies of scale, size and
scope. These plants then work to capture
additional value through their
trading and financial operations. These
traditional industries are also characterized
by a high degree of vertical integration
and/or coordination.
The ability of traditional firms to
achieve competitive advantage is predicated,
in part, on their capacity to
develop efficient internal information
systems to provide market coordination
and links between their operations
and global commodity and financial
markets. However, the rapid and
widespread change in information
technologies has arguably eroded the
power provided to these global processing
concerns.
Objectives
Our hypothesis is that the knowledge-
based economy may be fundamentally
changing cost structures and
the competitive landscape faced by
firms in rural America. This became the
jumping-off point for this USDA-sponsored
study on the future ownership
and control of the ethanol industry.
The objective of out study was to discover
answers to four basic questions:
- Does the present ethanol industry
represent a stable structure
or a transitional step toward an
inevitable concentration of
ownership into the hands of a
few large processing firms?
- Have contemporary information
technologies fundamentally
changed the information flows,
scale of operations, access to
markets, conditions of vertical
and horizontal coordination,
sources of finance and the competitive
landscape for mediumsized,
independent processing
firms?
- To what degree have cost savings
associated with better
access to information and
financing offset the cost savings
traditionally associated with
horizontal and vertical integration
in processing industries?
- What steps do medium-sized
ethanol production entities need
to take to continue to survive in
this new information-based
market environment?
The fuel ethanol industry may very
well be in transition toward an
inevitable concentration of ownership
into the hands of a few large processing
firms. At present, however, there
seems to be a structural equilibrium
among the mid-sized and largest
firms. This equilibrium is supported
by an industry-wide adoption of contemporary
information technologies
that serves to enhance medium-sized
firms’ access to markets and inputs,
while simultaneously diminishing the
relative importance of vertical coordination.
The rise of the ethanol
plant “franchise”
In the early 1980s, a number of
people were exploring the idea of
small, portable on-farm stills and 1-
million-gallon-per-year plants. They
discovered that besides being expensive
to build, these plants have to be staffed
24 hours a day and that the job is
much more sophisticated than throwing
some corn in a vat, and then opening
up a spigot the next day to fill up a
tractor with ethanol.
Broin, Fagen/ICM and other engineering
firms designed “cookie-cutter”
ethanol plants with standard designs
that can be easily built in most locations.
They also provide the financing,
conduct feasibility studies and will
“hand-hold” producer-investors
through the entire process. They can
offer an entire package — from feasibility
to turnkey and beyond.
This prospect didn't exist in the
early ‘90s, when there were many
questions about the right way to build
a plant. Builders of a 30-million-gallon-
per-year plant had to follow a
more traditional construction route.
This involved hiring a process firm, an
engineering firm for the design and a
construction management firm, all or
some of which may have had no prior
experience building an ethanol plant.
Uncertainty added significantly to
start-up costs and, subsequently, to
each step in the process.
However, enough plants have been
built to develop a large body of knowledge
and experience which has reduced
the degree of uncertainty about such
projects. Time and expense have been
reduced for everything — from the
first planning meeting to pouring the
first gallon of ethanol.
The standardized designs and business
models were pioneered mainly by
Broin, Fagen/ICM and a few other
companies. These firms began with the
recognition that producer groups were
developing an investment interest in
these plants. They also understood the
operating point at which these plants
could be profitable — at that time, it
was around 40 million gallons per year.
Compared with 10 or 15 years ago,
standard design technology has cut in
half the costs of construction and the
non-energy portion of operations. And
while it’s unfortunate that higher natural
gas costs have wiped out much of that
savings, today’s plants are being built
for half the money and operate twice as
efficiently as those of the 1990s.
Several factors have contributed significantly
to lowering operating costs,
including greater corn-to-ethanol conversion
rates, which are now commonly
2.85 bushels per gallon, up to three
gallons (on a denatured basis) given the
right variety of corn. Reduced cost and
increased efficiency of enzymes mean
that enzymes cost only half of what
they did 10 years ago.
Distributed control systems
Prior to the mid-1980s, process
automation was comprised of analog
loop controls and complex pneumatic
controls with individual, large circuit
boards dedicated to each control loop.
These systems were normally located
in control rooms, so the sensors and
controller outputs had to be physically
connected to the control room.
This resulted in large cable runs full
of wires and tubing. Because the systems
were bulky and required direct
interconnections with the process,
there were often several satellite control
rooms for each part (or subpart) of
the process. These systems required
sophisticated maintenance by skilled
instrument technicians, and data-logging
was done on strip chart recorders.
Despite the awkward implementation,
these systems replaced hardwired relays
and manual controls for critical systems,
allowing plants to reduce labor
and improve consistency of operation.
But an even more significant contributor
to plant efficiency has been
the development of information technology
systems, the so-called
Distributed Control Systems (DCS),
and the electronic automation that's
evolved in the plant. DCS were introduced
in the late 1980s, enabling centralized
process monitoring and control.
DCS systems placed integrated
circuit board controllers close to the
processes that they controlled. Inputs
from field instruments and outputs to
valves and pumps were converted to 4-
20 milliamp signals to minimize signal
loss and noise.
They generally run short distances
to cabinets in the process area which
contained a manageable number of
control loops. Each DCS cabinet is
connected to a main control computer.
Process instruments, output to pumps
and valves, and controller settings are
driven from a computer console (dashboard)
located in a central control
room. This design also enables monitoring
and control from multiple (and
redundant) locations, such as local
control rooms, engineering offices or
even remote locations.
Expanding system capabilities
During the 1990s, these systems
grew in capabilities in step with the
geometric growth of information technology
applications and abilities. This
evolution reduced labor requirements
by more than 50 percent during the
past 15 years. As computer control,
process monitoring and laboratory
capabilities further improved, sophisticated
data warehousing and analysis
systems were adopted to convert the
ever-increasing volume of data into
useful information. These systems can
now monitor process conditions and
control settings, as well as laboratory
measurements when integrated with a
LIMS (Laboratory Information
Management System).
Whereas early systems could only
retrieve historical information, today’s
systems perform complex mathematical
manipulations, display graphical
results and project future outcomes all
in ‘real-time.’ Data manipulation and
extraction capabilities enable much
narrower process tolerances to further
reduce costs and simultaneously
increase yields and productivity.
The advantages of DCS systems,
data warehousing and analysis include:
A reduction in manpower by allowing
one operator to monitor and control
several processes at once; the ability to
see small changes in production variables
and correlate them to changes in
conditions, raw materials or ingredients;
and an increase in overall plant
efficiency, because operators can finetune
process parameters using realtime
data and sophisticated analysis.
Early on, plants scheduled several
maintenance shutdowns during the
year to prevent equipment failures.
With the data collection capabilities
of the DCS systems, preventive maintenance
programs came into a world
of their own, reducing downtime for
preventive maintenance. These
processes and technologies continue
to evolve and become even more significant.
Business/bio process
metrics & benchmarking
DCS plants all have the same production
and business processes and
share a data collection and analysis
protocol called "benchmarking.”
Benchmarking is an array of performance
measures that are monitored
daily, gathered weekly and summarized
monthly to be reported to management
and the board. If, for example, a
group of 10 plants of common design
are all linked together, the business
and biological process benchmarks for
this group are very well understood.
The manager of any one plant,
therefore, can adjust and refine the
process to improve his performance
and thereby raise the standard of the
whole group, in a stair-step fashion.
This business process is possible only
with today’s information technology,
and even now it’s time-intensive to
perform. But this would have been virtually
impossible 10 years ago.
Firms like Broin and Fagen/ICM
were able to expand to their present
capacity level because of the information
technology employed by the new
plants. Broin and Fagen/ICM each
direct the operations of some 20 plants.
The talent pool to manage and
operate these plants has grown with
the process. Both firms employ a cadre
of well-seasoned managers who
learned during the difficult years how
to run a plant efficiently. Both companies
provide management services,
marketing and procurement contracts
to mid-sized plants. This is a far cry
from the old days when managers were
still putting contracts out and doing
everything by hand.
Now — by using information technology
and business process technology
— a group has the ability to manage
about 20 plants as one plant. Fifteen
years ago, it would have been nearly
impossible to market the product for
that many plants and do a good job.
Now, an entire array of management
services is provided.
There is no way those plants could
be managed in this way without
improved information technology. The
plants themselves are physically too far
apart. It would be impossible to oversee
so many variables in different parts of
the country. The necessary staffing
wouldn’t be available because of the
expertise required at the control points.
Consolidated marketing partnerships
The rise of marketing firms was
instrumental in this trend. Ethanol is
not marketed at the processing plant.
Buyers (the refiners and blenders of
gasoline) don’t want to deal with all
these small plants. They demand bulk
purchasing — millions of gallons at a
time. Buyers want to sign contracts for
50-180 million gallons and want to
trade with someone marketing 500
million gallons per year.
The first impact of modern IT on
the ethanol industry was as a horizontal
coordinator. Many mid-sized firms
consolidated their marketing activities
out of necessity to bargain with the
handful of fuel ethanol buyers who
traded in quantities of hundreds of
millions of gallons at a time.
Successful consolidated marketing
efforts led to innovative applications of
these powerful new IT technologies to
coordinate other activities horizontally
— such as procurement and logistics,
risk analysis and eventually plant management
— among several plants
simultaneously. This horizontal coordination/
consolidation role across
enterprises, companies and time/space
is now performed by five or six firms.
Their services are contracted to a substantial
majority of the mid-sized,
farmer-owned plants.
Over the past few years, the market
share of the industry’s major producer
(ADM) has dropped from 60 percent
to around 30 percent. The balance has
been taken by marketing firms —
United Bio Energy, Ethanol Products
and a few others.
Because fuel ethanol is sold by a
dozen marketers and most of it is purchased
by a half dozen buyers, information
on prices and quantities may be
very good within that trading circle, but
it is unavailable to outsiders. There is no
mandatory reporting of ethanol prices.
Consolidation of
process management
It appears that a virtual consolidation
of ethanol processing is taking
place. Instead of consolidation through
ownership, management is becoming
more centralized and concentrated. A
number of companies — such as Land
O'Lakes and Purina, CFC, United Bio
Energy and even integrators such as
Cargill — are offering management
services to facilities other than their
own. IT has altered the ethanol
industry structure by shifting the
ownership and control emphasis
from the acquisition of physical
production assets to the aggregation
of information technology
assets. Economic power in the
industry no longer arises from
ownership of production capital
(plants and equipment) but from
the control and manipulation of
intellectual capital and property
rights.
Ethanol marketing/contracting
Ethanol plants typically forward-contract the sale of
their fuel twice each year. There is also a spot market,
but no real-time pricing exists. Daily prices from
Bloomberg, OPIS and Platt are published, but these are
reported too late to be of use to traders. Mandatory
reporting would be useful to plant managers and
boards of directors. Having accurately reported prices
would provide a basis of comparison for boards to use
in evaluating how good a job their marketing firm is
doing. Traders and ethanol plants get price quotes, but
no quantity information is available.
Plants want to lock in their corn price and sell their
ethanol on a six-month contract in an effort to set a
“crush margin.” Longer periods are unavailable
because their buyers (refiners and blenders) won’t
commit beyond six months. This is an interesting development,
given that energy traders are accustomed to
locking prices for up to 10 years in advance.
The marketing of dried distillers grains (DDG) — a
major co-product created in ethanol production — is
also done primarily by a few firms with a few buyers.
The traders on both sides are well informed, but the
price reporting is of limited use because the product
traditionally is highly variable in quality and there are
no specified trading standards. DDG quality varies
because of corn quality, the heating/drying process
and an inconsistent blending of DDG with solubles.
Each of these factors results in a highly variable analysis
of DDG. The market discounts the price of DDG for
this variability.
Universities provide excellent information on the
feeding of DDG to beef cattle, swine and poultry. Some
research indicates that DDG has a nutritional value
equivalent of 120 to 130 percent of corn, but it sells at a
much lower price.
However, while the potential to feed DDG is large,
the feed industry will not incorporate any ingredient
into its rations until there is ready supply in the amount
needed to serve their markets. A case in point is ConAgra
considering the use of DDG products in its poultry
division. It tested numerous products and was reportedly
pleased with the nutritional attributes and cost of
DDG and wanted to incorporate it into their rations.
Eventually, however, reliability was the restricting factor.
The whole exercise stopped dead when ConAgra
asked the simple question, “Can you provide us 3 million
tons of it?” Such a supply was not then available.
Distributed Control Systems (DCS) benchmarking
enables plants to standardize their distillers grain products
to the quality and consistency required by their
customers. DCS also gives opportunity for consolidated
marketing efforts among partnering plants to have a
presence in regional and (soon) national markets
because they now have a consistently reliable product,
available in sufficient volume and offered at an attractive
price relative to corn.
Corn procurement is not as concentrated as corn
marketing. Many plants have procurement alliances
with their ethanol marketing partners. These are supply
agreements and risk-management contracts that
work in concert with the marketing contract to provide
a reasonable assurance to the plant of a working
‘grind margin.’ However, corn trading/procurement
is more fragmented because it is not necessary
for a plant to align itself with a major grain-trading
company.
One reason for this is that the farmer-owned plants
have delivery agreements with their producer members
to source a significant portion of the required
feedstock locally. A more important reason is that
there is a trading history in corn and market transparency
because of the Chicago Board of Trade and
the futures markets. There’s a local corn “basis,” and a
historically well known set of transportation differentials.
So, it’s not necessary to align one’s self with a
major company to procure feedstock efficiently. However,
lenders offer incentives to new plants to contract
for risk management services as a way of mitigating
their own risk in the project.
By Anthony Crooks & John Dunn
