Jul 31, 2023
Striking a Balance: Are You a Technology Company or a Farming Company?
Welcome to the second edition of my newsletter! As I pondered the topic for this round, I felt drawn to delve into a significant hurdle frequently encountered by vertical farming companies. If you're exploring the intricacies of investing in, or developing this innovative method of agriculture, I hope to provide you with some insight into how these pioneering farms navigate the integration and innovation of technology.
This subject may sound familiar, as it's something I've touched on before, along with others in the field. However, in light of the recent and rather alarming trend of vertical farming ventures failing almost weekly, I believe it's a topic worthy of revisiting. This time, I aim to offer a fresh perspective on the question: are you a technology company or a farming company?
The accelerating trend of controlled-environment agriculture (CEA), particularly vertical farming and hydroponic greenhouses, has captivated investors, entrepreneurs, and journalists worldwide. They are intrigued by its promising attributes, including hyper-local, year-round production capabilities, reduced water use, and the potential to minimize climate change impacts on farming. However, this burgeoning industry isn't without its dilemmas, including whether an operation should identify itself primarily as a technology company or a farming company.
The complexity of the decision-making process in vertical farming regarding technology development holds considerable impact on budgeting, equipment choices, operational efficacy, and investment opportunities. Regrettably, many industry participants unintentionally muddle the two main approaches, which can lead to confusion. This can slow down development, distract from their primary mission, and even hasten the depletion of their hard-earned funds.
In this piece, I’m going to shine a light on the three main “camps” within the vertical farming industry in regards to technology development. Additionally, I'll delve into why having a clear identity is not just important, but essential for growth, nurturing investor relationships, and achieving long-term success.
Camp 1: The Technology Developers
The first camp comprises companies with a strong affinity for technology and innovation. These companies are often run by engineers and technology entrepreneurs who believe in the transformative power of technology to revolutionize the traditional agricultural space.
They devote substantial resources towards R&D to develop proprietary systems and cutting-edge equipment, aiming to minimize costs, enhance productivity, and streamline the vertical farming process.
In theory, this can be beneficial; the use of sophisticated sensors, robotics, and data analysis tools can provide greater control over plant health, growth rates, and crop yields, potentially reducing operational costs and enhancing profitability in the long term.
However, the reality often paints a different picture. The development of custom technologies involves significant upfront investments and presents a high-risk approach due to the unpredictability of new tech and its implementation at scale. Furthermore, these companies generally aim to sell their produce on a large scale to retail distribution channels, putting them in direct competition with traditional agriculture. To compete with traditional agriculture, these vertical farms must be hyper-focused on farming operations, not just technology.
Despite their grand ambitions, many such companies haven't achieved the scale necessary for profitability, leading to a significant cash flow problem. Companies in this camp often get lost in overengineering technology fantasies, investing in R&D, and raising money based on a vision of reinventing agriculture from the ground up. While this tech-first approach has led to companies in this camp raising the most money and having the highest valuations, investor patience is waning, and the once plentiful equity capital is drying up, increasing financial pressure on these technology-obsessed operations.
Examples from Camp 1: Fifth Season who developed robotized vertical farms, raised $75M in total and eventually ran out of cash and shut down its operations.
Camp 2: The Technology Integrators
The second camp, technology integrators, approaches the vertical farming industry from a more pragmatic perspective. Instead of investing heavily in proprietary technology development, they capitalize on established, proven technologies – often from industry-leading regions like The Netherlands.
These companies shoulder less risk, as the system manufacturers bear the development costs. Their approach is generally regional or local, and they often target specialty crops that benefit from rapid and local distribution due to their perishability.
Technology integrators prioritize sound farming practices and have shown impressive results with this business model. Those companies in this camp that focus on niche, profitable crops can achieve profitable unit economics more swiftly than their technology-focused counterparts. They are also more resilient to fickle capital markets as they don’t have massive R&D teams and budgets burning away their funding.
By building relationships with proven suppliers that spend money on R&D to deliver the best capex and performance in CEA, these companies can often find technology suppliers that grow with them, spreading risk and leveraging shared data and collaboration to improve operations. These relationships can be especially valuable when VF companies in this camp scale up.
Example: Vertical Harvest, which develops urban vertical farms focused on employing vulnerable communities and integrating proven Dutch CEA technology.
Camp 3: The Transformers
I call the third camp “transformers” because they begin as technology-focused companies and end up commercial-scale farmers. In fact, transformation is the objective of many from Camp 1, but only a few can succeed through the changes, as noted in a recent LinkedIn Post from Professor Paul Gauthier who shares that this journey typically unfolds in four distinct steps:
STEP 1: Proof of Concept
This initial phase necessitates demonstrating that your idea or technology is not only functional but viable. Although this generally happens on a small scale, a few hundred square meters suffice.
STEP 2: Scalability
This phase requires evidence that the farm can operate at a high scale with the selected technology. Your farm expands into the thousands of square meters range, testing the technology's scalability and your capacity to manage a larger-scale farm. Rushing into the next phase can amplify pre-existing errors, jeopardizing success. At this juncture, your agriculture team morphs into a grower team, and most Ag R&D is outsourced to academia or research specialists.
STEP 3: Expansion
Now, the company seeks to broaden its horizons into new markets or locations. This stage could mean an increase in the number of farms, diversifying the portfolio, or both. As the technology has proven effective, it becomes a tool to boost productivity. The primary challenge here is to keep up with order fulfillment. Consequently, your engineering team transitions into a maintenance team.
STEP 4: Profitability & Innovations
At this stage, the company is operating profitably at scale and seeks ways to reduce costs and boost profits.
Dr. Gauthier reminds entrepreneurs in vertical farming that they must resist the temptation to rush through or skip these crucial stages. Drawing parallels with Jean de Lafontaine's fable of the Rabbit and Turtle, patience and steadiness are critical.
Example: I wish I could think of more examples for this category, but there aren’t any that I can put forward confidently. Please share some if you have some. I suppose we can mention Square Roots who, according to recent news, are now shutting down many operations. They did the reverse, starting with Freight Farms containers and then developing their own container model based on in-house R&D.
Conclusion: Embracing a New Era of CEA Investing, Planning, and Development
The vertical farming industry stands at a crossroads characterized by uncertainty, complexity, and untapped potential. Amid these challenges, it's crucial not to abandon the promise of CEA but to adopt a more strategic approach to investing, planning, and development.
The choice between being a technology company or a farming company is difficult because farming companies will always have lower valuations than technology companies. On the other hand, farming companies are more likely to focus on optimizing operations which will lead to favorable unit economics and increased revenues. There is a delicate balance between leveraging technology for operational excellence and adhering to the tried-and-true principles of successful CEA. The winners in this space will be those who can effectively integrate technology while keeping their feet firmly planted in the foundations of good agricultural practice.
This balance is the key to sustainable, profitable growth in the vertical farming industry. It allows companies to offer a compelling value proposition to investors, who are increasingly scrutinizing business models, market positioning, and financial sustainability. By understanding whether they are primarily technology developers or technology integrators, vertical farming companies can ensure they are on the right path to realizing their vision and delivering on the tremendous promise of controlled environment agriculture. The bottom line is that with over a decade in existence, vertical farming technology works and its potential to grow diverse crops indoors are well-documented, so companies should focus instead on operations and growing something unique for the market, which is often a much less sexy job than R&D to “reinvent” agriculture.
One interesting question to ask is, “What other parts of agriculture does this ‘invent VS integrate technolgy’ conflict exists?” For example, do we see outdoor commercial farms powered by in-house developed robots that are raising money as technology companies rather than as farms? I can think of some examples in aquaculture, but I am curious if you have any other examples of this in other areas of agriculture.