The coronavirus pandemic exposed numerous weaknesses in the food supply chain. In particular, the pandemic demonstrated how rigid the U.S. food supply system is. The United States is extremely efficient in producing food but lacks flexibility to adapt to major shocks.
In a previous post, I wrote about the advantages and limitations of local food supply chains to address some of the weaknesses in the national food supply system. While local food supply chains are generally more flexible than national food supply chains, they also typically lack economies of scope and scale.
A recent paper by Lauren Chenarides, Mark Manfredo, and Timothy Richards attribute the lack of resilience in the U.S. food supply chain to the combined effects of uncertainty, high fixed costs, and perishability. They suggest that underestimate the probability of a catastrophic event like the coronavirus pandemic, and thus undervalue flexibility.
High, fixed costs of committing to a single distribution channel combined with volatility in the marketplace leads to “real option” value. Real options come about when firms have the prerogative to make an investment but not the obligation. Consider, for example, a producer who is deciding whether to invest in distribution to the food service or retail channel. Costly investments include packaging, transportation, product design and labels, contract negotiations, and processing plants. Many of the up-front costs are sunk costs (e.g. costs that cannot be recovered). There is considerable uncertainty in both the food service and retail channels, suggesting that investment in either channel involves risk, and the decision to change channels has a valuable “real option” since the firm cannot recover investments already made in a distribution channel.
Chenarides, Manfredo, and Richards believe that prior to COVID-19, firms believed the probability of losing an entire distribution chain was close to zero. Nevertheless, the food service distribution chain practically disappeared overnight, and many produce farmers had to till their crops into the ground. Similarly, when several meatpacking plants temporarily shut down due to workplace COVID-19 outbreaks, many livestock farmers had to euthanize their animals.
The authors argue that the lack of resilience in the food supply chain is not so much a market failure as a lack of managerial imagination. They suggest that the coronavirus pandemic will expose firms that should not have existed. Capital markets will discipline firms that were too rigid to respond to shocks in the food service distribution channels. This is not an encouraging conclusion for firms that are struggling to survive the pandemic. However, it does suggest that structural adjustments in the food supply chain and in the greater economy that result from the pandemic will lead to more resilient supply chains and fewer catastrophic disruptions in the future.
