August 14, 2018
Kenneth Scott Zuckerberg, AIF® AFA®, Wells Fargo Sector Manager, Agrifood Technology and Packaged Foods
Indoor production of fresh fruits and vegetables leveraging aeroponic and hydroponic growing techniques has gained meaningful investor momentum in recent years. The simplistic bull case for sector investment is that indoor farming operations provide direct exposure to a growing consumer demand for healthy, local, farm-fresh produce. Unfortunately, the defendable bear case is that indoor farms are expensive to build and operate, lack full automation, and do not command a pricing premium over outdoor-grown, organically produced crops.
In my opinion, the path to greater value creation lies in the partnership between indoor farms and food retailers. I think this can be accomplished by: 1) creating a branded ultra-premium offering; 2) creating private-labeled products leveraging the retailer’s brand name; and/or 3) installing living breathing vertical farms inside the produce section of the grocery store. Can anyone say craft produce?
I commenced a deep-dive into indoor farming prior to moderating a panel at the Indoor AgTech Innovation Summit sponsored by Rethink Events, Ltd., this past June. The event afforded me the opportunity to gain perspectives from the leading players in the space, including AeroFarms, Bowery, Bright Farms, 80 Acres Farms, Gotham Greens, Plenty, and Uriah’s Urban Farms, as well as greenhouse data service providers such as iUnu, and academic experts from Cornell University. The knowledge gained augments existing Wells Fargo Food and Ag Industry Advisor subject matter expertise.1
Defining indoor farming and Controlled Environment Agriculture
Indoor farming is actually a sub-segment of a much broader segment of farming called Controlled Environment Agriculture. The New York State Energy Research and Development Authority’s definition reads as follows:
Controlled Environment Agriculture (CEA) is the combination of engineering, plant science, and computer managed greenhouse control technologies used to optimize plant growing systems, plant quality, and production efficiency. CEA systems allow stable control of the plant environment, including temperature, light, and CO2, and provide separate control of the root-zone environment.
In simple terms, indoor farming can be seen as an innovative, conservation-oriented method of growing high-quality produce such as lettuces, microgreens, tomatoes, and other fruits and vegetables on a year-round basis in local communities. Currently, a large amount of the fresh produce consumed in the U.S. is grown on the West Coast and shipped cross country, or imported from other farming regions such as Mexico.
To be clear, CEA is not a new concept as evidenced by the fact that mushrooms have been grown indoors in the U.S. for approximately 100 years, and edible plants and decorative flowers have been grown in greenhouses and nurseries in Holland for approximately 50 years. Tomatoes are another important crop grown in greenhouses. Additionally, NASA has claimed to pioneer the process of growing plants utilizing LED lights as far back as the 1980s. What is new, however, is the combination of more powerful and energy efficient LED lights coupled with improved controls on temperature, humidity, and sensors, tied into a plant growing system on warehouse vertical racks, in shipping containers, or on rooftop farms.
Investor interest in indoor agriculture
In recent years, more than $500 million of capital has been deployed by investors in indoor AgTech startup companies based on the simple thesis of high-return potential resulting from the intersection of declining prices for LED lighting technologies and the growing consumer demand for fresh produce grown with limited use of traditional crop inputs. The capital has come from socially responsible funds and others seeking returns from companies that use clean technology and emphasize sustainable business practices.
The following table presents a snapshot of the competitive landscape for the indoor AgTech Industry. It should be noted that this snapshot excludes traditional nurseries and greenhouses along with certain technology robotics companies. (The latter happens to be a very interesting category, including startups such as AgriLyst, Arable, FoodLogic, Harvest Automation, and iUnu, that I’ll cover in a future blog.)
A theory on how indoor Ag retailers and consumers can all win
To recap several of the points above, produce grown in indoor farms provides an interesting alternative to outdoor-grown fruits and vegetables. That being said, I struggle with the notion that indoor farming will fully disrupt the existing outdoor growing regions and seasonal migration of growing operations between central, coastal, and desert valleys in the Western U.S. and Mexico. My reasoning is as follows:
- Many, not all, business models are capital intensive, and could be challenged to scale profitably in local regions.
- Local indoor farms typically offer high-quality produce delivered to grocers more quickly than many Californian or Mexican producers can, however the industry is not achieving additional compensation for this perceived competitive advantage.
- Existing industry players are generally low-cost, high-efficiency operators with long-established relationships with food distributors and retailers. Without a large scale national player, the incumbent players will remain in control of the terms of trade.
- Indoor farming operations have not yet proven they can fully insulate themselves from a disease outbreak such as the recent outbreak of the E.coli virus in Romaine lettuce, even though growing in a controlled environment.
- Indoor-grown lettuces, microgreens, arugula, and tomatoes lose flavor and remain highly perishable once harvested, packaged, and shipped to product sellers.
Notwithstanding this backdrop of challenges, I remain intrigued by the idea that closer alignments and joint ventures between indoor farmers and food retailers can create and deliver significant value. How can this be accomplished? Here are a few tactical ideas:
- Creation of an ultra-premium line of produce – Working directly with retailers, indoor farming operations can better message key product attributes: high-quality consistent products, year-round availability, and local/sustainable production. Wendy’s recent announcement to eventually source 100% of its tomatoes from indoor greenhouses would seemingly provide a positive tailwind for marketing indoor-grown produce.
- Installation of vertical farms in or on top of the grocery store – The difference in quality is noticeable between produce harvested immediately prior to consumption as compared to packaged, post-harvest produce. Again, the taste and quality attributes need to be properly marketed to achieve better pricing, however, the idea of produce harvested on-demand should theoretically de-risk the stand alone indoor ag business model from the perspectives of efficiency and waste reduction.
Personally speaking, nothing makes me happier than starting a meal with a healthy salad filled with fresh, peppery arugula, leafy spinach, and flavorful, red tomatoes, and cucumbers. Based on ongoing sector research and visits to several indoor farming facilities, I believe that indoor AgTech offers a compelling method to extend the seasonality of domestically-grown produce to 12 months of the year. I look forward to further exploring the issues raised in this blog in a future webinar on indoor farming and Controlled Environment Agriculture.
1. Article input provided by David Branch, Wells Fargo Sector Manager, Specialty Crops, Matt Dusi, Wells Fargo Sector Manager, Fresh Produce, and Karol Aure-Flynn, Wells Fargo Senior Sector Analyst, AgriFood Technology and Packaged Foods
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