economic impact of storage and handling regulations on retail fertilizer and pesticide plants

Economic Impact of Storage and Handling Regulations on Retail

Fertilizer and Pesticide Plants Du,ane S. Rogers Jay I: Akridge

A budgeting model was developed to estimate the cost of retailing dry bulk fertilizer, liquid bulk jertilizer, anhydrous ammonia, and pesticides for three sizes of plants. Estimates were obtained of the cost to upgrade each of the model plants to comply with Indiana's regulations on the handling and storage of fertilizers and pesticides. Results suggest that there are sign&ant scale economies associated with the regulations and that smaller plants will have a more dificult time rationalizing the investment in containment facilities. The implications of these regulations for the retail

fertilizer industry are explored using Porter5 five-forces model. 01996 John Wiley & Sons, Inc.

.................................................... Reqursts for reprints should be sent to Dr. Jay 'r. Akridge,

Purdue University, Dept. of Agricultural Economics, 1145 Kran-

nert Building, West Lafayette, IN 47907-1 145, E-mail:

[email protected].

Increased government regulation has become one of the most important issues facing the retail fertilizer and pesticide industry. The ability to cost effectively comply with these regulations will play a critical role in firm success. Many of these new regulations deal with safeguarding the environment. And, a key component of safeguarding the environment is the maintenance of good stewardship practices, taking steps to prevent contamination, and correcting problems created by accidents and past abuses.' Many of the necessary steps to help prevent contamination by the retail fertilizer and pesticide industry in Indiana have been set out in a set of rules recently adopted by the Indi- ana State Chemist. The economic impact of these fertilizer and pesticide storage and handling regulations on Indiana retail fertilizer plants is the fo- cus of this study. Because the Indiana regulations are similar to those in a number of other states,

............................................................................................................... Funding for this project was provided by the Tennessee Valley Authority National Fertilizer und Environmental Research Center and Purdue Unioersity. The authors grat.f.lly acknowledge the helpful comments of Steven f! Erickson, Thomas G. Foster, Kenneth F: Hurling, John G. Lee, and Lee R Schrader. An earlier version of this article was presented at the Annual Meeting of WRCC-72 Agribusiness Research Emphasizing Competitiveness in L u s Vegas, NV, June 15, 1992. This article is Purdue University Agricultural Research Programs Journal Paper No. 13528. 8 Duane S. Rogers is an Agriculture Loan Oficer with The Farmers National Bank of Geneseo, Geneseo, tL, and a former Graduate Research Assistant at Purdue University

Jay 7: Akridge is an Associate Professor in the Department of Agricultural Economics and Associate Director of the Center for Agricultural Business at Purdue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Agribusiness, Vol. 12, No. 4, 327-337 (1996) 0 1996 by John Wiley & Sons, Inc.

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Rogers and Akrldge

the results of this study provide insights on a broader scale.

impact of storage and handling regulations on the profitability of Indiana retail fertilizer plants. First, the cost of retailing dry bulk fertilizer, liquid bulk fertilizer, anhydrous ammonia, and pesticides was estimated. Then, the costs associated with upgrading existing facilities to comply with regulations on storage and handling of fertilizers and pesticides were quantified. The impact of an increase in investment costs on the profitability of these plants was assessed. Two strategies-an increase in plant volume and an increase in price- that could be implemented to offset the added costs were evaluated. Finally, the impact of these rules on industry profitability was explored using Michael Porter’s five-forces model.2

The objective of this research was to quantify the

Regulation Review

There are two sets of rules on storage and handling of fertilizers and pesticides that were adopted by the Indiana State Chemist. These rules apply to any firm or individual storing bulk fertilizers and pesticides in excess of specified minimum amounts. For dry bulk fertilizer products, any location that stores more than 12 tons of dry bulk fertilizer in undivided quantities must comply with the rules.3 The term undivided quantities means

stored in a single ~onta iner .”~ For dry pesticide products, any location where more than 100 lb of dry pesticides are stored in undivided quantities will need to ~ o m p l y . ~ Any location that stores more than 2,500 gallons of liquid fertilizer in undivided quantities must ~ o m p l y . ~ And, any location where more than 55 gallons of liquid pesticides are stored in undivided quantities is subject to the rules.5

cus on keeping these materials in a covered area to prevent wind and rain from causing spillage. Most retail fertilizer plants have structures in place to prevent such damage and additional capital investment is generally not required to comply with the rules for these product lines.

i b

The rules for dry fertilizer and dry pesticides fo-

To bring existing liquid fertilizer storage facilities into compliance, two types of secondary containment facilities must be constructed. The rules state that there must be a facility (dike) ca- pable of containing any spill due to failure of the primary storage tank(s). In addition, an operational area containment (load/unload) pad is required to contain any spill (up to 750 gallons) that occurs during the loading or unloading of the storage tank.”

The regulations also state that the diked area around the storage tank(s) must be large enough to contain the volume of the largest tank plus the volume displaced by all tanks and equipment in- side the secondary containment area. An extra 6 in. (freeboard space) must be added to the height of the wall of this containment structure to accommodate rainfall. The load/unload pad must be constructed and reinforced to handle the maxi- mum gross load (including product) of any vehicle using the operational area. The load/unload pad must be curbed and paved and must be at least 10 feet wide and 20 feet long. The curbed surface and catch basin of the pad must be large enough to hold at least 750 gallons of discharge fluid.3

The guidelines for bulk liquid pesticide containment are similar to those adopted for bulk liquid fertilizer containment. A dike must be built that will contain 100% of the largest tank plus the volume displaced by all of the tanks and equipment within the diked area plus the 6-in. freeboard space.5 This pesticide containment dike must be separate from the dike for liquid fertilizer-that is, a single dike cannot be used for containment of both liquid fertilizer and liquid pesticides. A load/unload pad must also be constructed, but this pad can be shared with the liquid fertilizer facility.

The regulations also mandate new record keeping and administrative practices. The regulations state that a weekly inspection of the primary containment (storage tanks) and semiannual inspections of the secondary containment (dikes) must be per- formed. A semiannual inventory reconciliation, showing the amounts of dry bulk fertilizer, dry pesticides, liquid bulk fertilizer, and liquid pesticides that are lost or unaccounted for from each storage container at the end of each period must

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Regulations

be prepared and maintained on file at the storage facility. Finally, a discharge response plan must be developed.3.5

In addition to the facility and record keeping costs described above, there will be additional labor costs associated with the maintenance of the new containment facilities and with the increased security measures required. These costs include the labor necessary for the general upkeep of the diking facilities such as retrieving any spill, clean- ing the containment surfaces, and pumping out rainwater that accumulates in the dike. For security reasons, the rules indicate that each storage tank and building must be locked to deter un- authorized entry.

Procedure

A budgeting model was developed that details the cost of retailing dry bulk fertilizer, liquid bulk fertilizer, anhydrous ammonia, and pesticides to farmers/customers. Facility and equipment costs along with other operating costs were incorporated into this spreadsheet budgeting model to calculate cost estimates for each of the product lines. A 6,000 ton plant was used as the base model. Mod- els of two similar retail outlets, one smaller than the base model (3,000 tons) and one larger than the base model (9,000 tons), were also developed. These three plant sizes correspond to the average, bottom third, and top third plant sizes as reported in the 1990 Purdue University/Tennessee Valley Authority Fertilizer Retail Efficiency Data (FRED) Project.6 Data from the FRED study were used to specify the product mix for the models.6 The dry fertilizer product line accounts for 50% of total plant tonnage. Of the remaining 50% of plant capacity, 37% is allocated to the liquid fertilizer product line and the remaining 13% is anhydrous ammonia.

Product-line profitability and cost-volume relationships prior to investing in environmental compliance structures were evaluated using the three model^.^ The cost of the required containment structures for each of the model plants was then incorporated into the budgeting models. These estimates utilize concrete as the containment medi-

um." Estimates of additional costs not directly related to construction costs were then developed. The additional labor, new inspection routines, and increased record keeping required by the storage and handling rules will all increase the cost of operating a retail outlet. These costs were incorporated into the budgeting model to provide a more accurate assessment of the total cost of environmental compliance.

The cost model used in this study is a standard budgeting model. Common plant cost, fixed and variable plant costs associated with a particular product line, fixed and variable delivery costs, and the costs of products are deducted from revenue to arrive at plant profit. To estimate the delivery equipment operating costs for each product line, a cost model developed by Raikes and Heu- brock was used.8 Their model incorporates an assumption that plant market share is a linearly declining function of road distance from the retail outlet. Raikes and Heubrock assume that market share is 100% at the retail outlet and that it declines linearly with road distance from the outlet until it reaches zero at a specified distance from the plant. An adjustment factor was added to this model to incorporate the extra mileage that accumulates when a delivery driver fails to take the optimal route and also to account for mileage driven in the field and at the plant. (Details on the budgeting model are given in the Appendix.)

Much of the data on equipment and facility costs were collected by interviewing managers of retail facilities located in Illinois, Indiana, and Ohio. As- sumptions concerning product prices, buildings, equipment, and labor required to operate each of the model plants were developed.7 Estimates of salaries for the manager, secretary, and equipment operators were obtained from a survey conducted by Taylor and Akridge on labor costs in the retail fertilizer and pesticide i n d ~ s t r y . ~ This mail survey, sponsored by Dealer Progress magazine, collected salary, benefit, and bonus information for

aCost estimates were also developed using synthetic materials as

the construction medium for the containment structures. Synthetic

costs were roughly one-half the cost of using conerete, but there are

some disadvantages that will need to be considered before choosing

the synthetic rnedium.7

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Rogers and Akridge

eight management and labor positions in some 400 retail fertilizer plants across the United States.

The Raikes and Heubrock transportation cost model requires an estimate of the demand density for each of the product lines. Data from several sources were used in estimating this demand density. The model also requires an estimate of the labor costs directly related to distance traveled (variable labor coefficients) and the labor costs associated with each load, regardless of distance traveled (fixed labor coefficients). Variable labor coefficients were obtained by estimating the cost of delivering 1 ton of material 1 mile.I3 The constant labor coefficients were estimated by asking retail managers the average time it takes to weigh empty, load, weigh full a t plant, and off-load an average load of fertilizer for each type of delivery vehicle.

Data on the cost of compliance were obtained from consultants, construction companies, Tennes- see Valley Authority publications, and retail fertilizer and pesticide plant managers.7 Engineers were consulted on the appropriate size of structures and materials that were needed to upgrade each of the model plants. Estimates on the cost of constructing these structures were obtained from construction firms. To estimate record keeping and administrative costs, a telephone survey was conducted of retail managers from Illinois, Indi- ana, and

Cost of Retailing Fertilizer

Using the budget models, the cost of retailing fertilizer and pesticides for each of the model plants was estimated (Table I). Economies of scale are evident as per-ton costs decline from $285.17 to $269.66 to $258.80 as plant size increases from 3,000 to 6,000 to 9,000 tons, respectively. Econ- omies of scale also exist for each of the three product lines: dry fertilizer, liquid fertilizer, and anhydrous ammonia. As plant size increases, the per-ton cost specific to each product line declines.

Figure 1 shows average total per-ton costs associated with changing volume in each of the three model plants. Plant volume was increased and de- creased 10, 20, and 30Y~ from current plant tonnage to explore the impact of volume changes on

average total cost. Note that average total costs change substantially with changes in volume. For instance, a 20% reduction in small model plant volume causes average total costs to increase to $305.83/ton (7.2% increase), while a 20% increase in volume causes average total costs for the small model plant to fall to $271.41/ton (4.8% decline). This sensitivity analysis illustrates the importance of plant volume in the retail fertilizer and pesticide industry. Because a large proportion of investment, equipment, and operating costs are fixed, additional volume dramatically reduces per- ton costs.

Costs of Compliance

Based on storage tank sizes for each of the three model plants, engineering specifications for the appropriate containment structures and loadlunload pads were developed. Detailed information on these specifications is given in Rogers.? A summa- r y of the sizes and compliance cost estimates for each model facility is presented in Table 11. Other investment costs associated with the storage and handling regulations are shown in the lower portion of Table 11. The cost of the sump pit, rinsate tanks, plumbing used to connect the sump pit to the rinsate tanks, locks, and any other investment costs were estimated (Table 11). The total investment in compliance facilities for the small, base, and large model plants is $45,223, $51,232, and $78,844, respectively (Table 11).

The primary factor that drives the investment in compliance facilities is the size of the largest liquid fertilizer storage tank that must be contained. The total investment cost does not increase dramatically when plant size is increased from 3,000 to 6,000 tons, because the largest tank that must be contained does not change. But, when liquid fertilizer storage tank size was increased from the 20,000-gallon tank in the 6,000-ton facility to the 50,000-gallon tank required in the 9,000-ton facility, the size of the dike had to be increased dramatically, leading to the higher cost. Thus, the investment in containment facilities is likely to be lower for a plant with smaller tanks than it is for

Regulations

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Small Base

(3,000 tons) (6,000 tons)

~

Table 1. Summary of Small, Base, and Large Model Plant Cost Stroctnre Before Investment in Compliance Facilities. . . . . . ...........................

Large (9.000 tons) -

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Plant

Revenues $800,000 Var. costsb 620,026 Fixed costsr 235,487 Total costs 855,513 Net profit ($55,513)

Investmentd $42,152 Othere 123,291 Total costs $165,443

Investment $2 1,661 Equipmentf 15,549 Operatingg 9,061 Total costs $46,2 7 1

Investment $4,832 Equipment 11,403 Operating 5,224 Total costs $2 1,429

Investment $3,532 Equipment 12,437 Operating 5,369 Total costs $21,338

Common Plant Costs

Dry Fertilizer Costs

Liquid Fertilizer Costs

Anhydrous Ammonia Costs

Per Ton. Total . . . . . . . . . . . . . . . . . . . . . . . .

$266.67 $1,600,000 206.68 1,251,143

78.50 366,821 285.17 1,617,964 (18.50) ($17,964)

$14.05 $58,738

$55.15 $280,940 41.10 222,202

$14.44 $30,261 10.37 21,976 6.04 16,306

$30.85 $68,543

$4.39 $7,059 10.37 20,732 4.75 9,529

$19.51 $37,320

$8.83 $7,064 31.09 23,630 13.42 12,192

$53.34 $42,886

. . . . Per Ton. . . . . . . . . .

$266.67 208.52

61.14 269.66 ($2.99)

$9.79 37.03

$46.82

$10.09 7.33 5.44

$22.86

$3.21 9.42 4.33

$16.96

$8.83 29.54 15.24

$53.61

. . . . . Total

. . . . . . . . . . . .

$2,400,000 1,881,266

447,917 2,329,183

$70,817

$59,204 283,589

$342,793

$39,612 30,269 27,057

$96,938

$9,849 29,025 13,770

$52,644

$8,829 33,372 18,478

$60,679

. . Per Ton.

. . . . . . . . . . . . .

$266.67 209.03 49.77

258.80 $7.87

$6.58 31.51

$38.09

$8.80 6.73 6.01

$21.54

$2.98 8.80 4.17

$15.95

$7.26 27.81 15.40

$50.47

aPer ton costs expressed relative to total tonnage for total plant and common plant cost figures, and relative to product line tonnage

for each product line.

bVariable costs are those cnsts that change with changes in volume.

cFixed costs are those costs that remain constant with changes in volume.

“Investment costs are the fixed and variable costs associated with buildings and equipment located at the plant.

?Other common costs include management and sales person salaries, general utilities, advertising, etc.

fEquipment costs are fixed costs associated with delivery equipment.

GOperating costs are variable costs incurred in operating delivery equipment.

a plant with a few large tanks. Plant managers must weight this lower cost of compliance facilities against the higher storage costs associated with smaller tanks. Estimates of total investment costs were then

converted to an annual cost. Table I11 shows the annual cost associated with the containment struc-

tures and the increased administrative and labor requirements. Costs included under annual costs are the increase in insurance accompanying these structures, estimated repairs, and a provision for interest and depreciation. Taxes and insurance were calculated at 3% of the initial investment cost in compliance facilities, and repairs were esti-

0331

Rogers and Akridge

$320

::::I 1 $200

0 1 2 3 4 5 6 7 8 9 1 0 1 1 1 2

Thousand Tons

Pikre 1. Average total cost curves prior to compliance investment.

mated at 6% of the initial investment.’ Interest and depreciation were calculated using the capital recovery charge (CRC) procedure. The CRC formula annualizes the cost of depreciation and interest using the real rate of interest over the useful life of the asset. Using this procedure, the small model plant’s annual costs will increase by $10,921. For the base and large model plants, annual oper-

ating costs will increase by $12,249 and $18,285, respectively (Table 111).

Relative to estimated profit levels for the three model plants shown in Table I, these annual increases in costs due to compliance with storage and handling rules are clearly significant. And, comparing these costs to actual profit levels of industry plants also puts them in perspective. In 1990, a small (3,000 ton) FRED plant lost $1,198, while the medium (6,000 ton) and large (9,000 tons) plants generated $16,245 and $67,713 in operating profit, respectively. The annual cost of complying with storage and handling rules puts additional pressure on the abilities of plant managers to generate a profit at their facility.

Two Management Tactics

One tactic that might be used to offset these additional costs is to increase plant sales volume by improving marketing practices, holding prices constant. To evaluate this tactic, volume was increased in the budgeting models for each of the

. . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . Liquid Fertilizer Dike

Size cost

Size cost

Size cost

Other Costs Sump pit Rinsate tanks Plumbing, locks, etc. cost

Total Cost

Pesticide Dike

Load/Unload Pad

Table I I . Cost Breakdown for Investment in Compliance Facilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Small Base Large (3,000 tons) (6,000 tuns) (4,000 tons)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

37’ x 37’ $26,773

20’ x 20’ $10,375

15’ X 34’ $2,726

$939 2,120 2,290 5,349

$45,223

40’ X 40’ $30,954

21’ x 21’ $11,898

15’ X 38’ $2,986

$939 2,120 2,335 5,394

$51,232

57‘ x 57‘ $51,260

21’ X 29’ $15,123

30‘ X 50’ $7,032

$939 2,120 2,370 5,429

$78,844

Total construction and facilities costs to comply with storage and handling regulations.

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Regulations

Table 111. Annual Cost of Compliance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Small Base Large (3,000 tons) (6,000 tons) (9,000 tons)

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Common Plant Costs $2,816 $2,898 $3,806

Liquid Fertilizer 5,843 6,757 11,182

Pesticides 2,262 2,594 3,297 Total Annual Cost $10,921 $12,249 $18,285

Dry Fertilizer 0 0 0

Anhydrous Ammonia 0 0 0

Total annual depreciation and interest cost (estimated using capital recovery charge formula), maintenance and repairs, and record-

kwping costs.

product lines until the annual compliance costs were exactly offset by the contribution margin from this increased volume. Volume across all product lines would need to increase over current volume levels by 5.7, 3.2, and 3.2% for the small, base, and large model plants, respectively, to cover the annual cost of compliance. These volume increases assume that fixed costs will not change once volume has been increased. For small increases in volume like these, fixed costs should not change. But, fixed costs will eventually increase as volume increases because more delivery vehicles, full-time labor, and so on, will be needed to service the higher sales volume.

The increases in volume required for the liquid and pesticide product lines if each product line is forced to cover its own annual compliance costs were also calculated. For the liquid product line, volume would need to increase 8.3, 4.8, and 5.3% over current levels, for the small, base, and large model plants, respectively. Pesticide sales would need to increase 5.8, 3.3, and 2.8% over current levels for the three plant sizes. Thus, sales volume would need to increase moderately for both the liquid fertilizer product line and the pesticide product line, holding current prices and cost relationships constant, to generate an adequate contribution margin to offset the cost of compliance. However, it may prove difficult to increase volume without in- curring additional marketing costs that would increase these numbers even more. And, since con- sumption of fertilizer products has been steady to falling over much of the past decade, finding the

required additional volume for every retail plant in this industry will be nearly impossible.'"

The other management tactic evaluated was an increase in price. The increase in price, holding volume constant, that must be implemented to offset the annual compliance cost was calculated. Prices of all product lines would need to increase 1.4, 0.8, and 0.8% for the small, base, and large model plants, respectively, to cover the annual cost of compliance.

The percentage increase in price for liquid fertilizer was calculated when the liquid fertilizer product line was forced to cover all compliance costs that are directly tied to that product line. Prices need to increase 4.5, 2.6, and 2.9% for the small, base, and large model plants, respectively, to cover the annual cost of compliance.

The percentage increase in price for liquid fertilizer was calculated when the liquid fertilizer product line was forced to cover all compliance costs that are directly tied to that product line. Prices need to increase 4.5, 2.6, and 2.9% for the small, base, and large model plants, respectively, under this scenario. Thus, a retail fertilizer manager must decide if raising liquid fertilizer prices by 2 to 5% is a realistic tactic for recouping the annual compliance costs associated with this product line. Given the competitive conditions in the industry and the demand trends for fertilizer and pesticides, most managers will likely use a combination of these two tactics, as well as reducing costs in other parts of the business, to maintain plant profitability.

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Industry Impacts

Rogers a n d Akridge

Rivalry

What impact will these additional costs have on the competitive structure of the Indiana retail industry? To provide insight on this question, Mi- chael Porter’s framework for assessing an industry’s profit potential was employed.2 In Porter’s view, the strength and nature of the competitive rivalry in any industry depends on five basic forces: the threat of new entrants, rivalry among existing firms, the threat of substitute products, the bargaining power of customers, and the bargaining power of suppliers.’ The collective interac- tion of these five forces determines the ultimate profit potential in an industry. The impact of each of these forces on the profitability of the retail fertilizer and pesticide industry is considered below. In this discussion, only the impacts of the storage and handling regulations on industry competitive structure are explored. Hence, although these environmental regulations may work in a positive fashion through one of the forces, the force could still have an overall negative effect on the profitability of the industry due to other influences.

Threat of New Entrants

New entrants to any industry bring new capacity, the desire to gain market share, and usually sub- stantial resources.2 Because any new plants will be required to have containment structures, the threat of new entrants into the retail sector should be reduced. The investment costs associated with a new retail fertilizer plant are significant. The high costs of containment facilities will raise entry barriers further, likely deterring some potential new participants from entering the retail arena. In addition, environmental rules now bring even more government activity into this industry. Some potential entrants will be less prone to enter due to the more stringent regulatory environment. Be- cause the above effects help to deter new participants from entering the retail fertilizer and pesticide industry, the storage and handling regulations will likely have a positive effect on industry profitability through this force.

Rivalry among existing competitors is the second factor that helps determine industry profitability. To better understand this force, the profitability of the three model plants will be considered. Two of the three model plants show negative returns before compliance costs. After the three model plants are brought into compliance, the small and base model plants incur heavier financial losses, while the large model plant posts a lower profit. These results suggest a smaller plant will have a more difficult time rationalizing construction of the necessary containment structures. Smaller plants will face increasing pressure to close or consolidate with another plant to remain competitive.b With fewer plants competing for farmer/ customers, rivalry among the remaining competitors within a given geographical area may lessen. In this case, regulation’s impact on rivalry will have a positive impact on industry profitability.

However, in the shorter run the impact of rivalry on profitability may be different. The volume and price increases necessary to maintain current profitability were documented earlier. Plant managers focused on additional volume may pursue aggressive price strategies to build market share, depressing margins and reducing profitability. The net effect of this force on profitability is uncertain in the short run and will be highly dependent on competitive conditions in local markets. Over time, the storage and handling regulations working through the rivalry force may accelerate the exit of less efficient plants leading to a positive effect of this force on profitability.

Substitute Products

The third force that plays a major role in deter- mining industry profitability is the potential for ......................................................

bFor multiple plant operations, the storage function may be consoh-

dated at one location and containment structures built at only one site.

Other outlet5 might be used for storing equipment and servicing the

needs of the farmedcustomers. Plant managers must evaluate the trade-

off between lower containment costs and (potentially) hgher distribution

costs, as well as the impact of this strategy on customer service.

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R e g u l a t i o n s

use of substitute products. Substitutes limit the returns of an industry by placing a ceiling on the prices that can be charged for a particular product.2 How do these new regulations affect the ability of farmers to substitute for the products and services of a retail fertilizer plant? Currently, there are a number of farmers storing liquid fertilizer on their farms. Because the Indiana regulations pertain to anyone storing liquid fertilizer in quantities greater than the specified minimums, farmers will need to upgrade their own storage facilities. The high annual cost of compliance will force many farmers to reevaluate their on-farm storage pra~t ices .1~ Some farmers will undoubt- edly discontinue their on-farm storage program.

Given that some farmers will become more re- liant on their dealer for the storage function, gross margins may rise to reflect the additional value being added by the dealer. The increased importance of this service component should also help a dealer differentiate their business from other dealers. This shift may help dealers compete less on price and more on the quality of their service. The net effect of the regulations on industry profitability through the substitute force is positive.

Bargaining Power of Buyers

In this industry buyers possess significant bargaining power. The products a farmer purchases from the dealer represent a major portion of the overall cost of crop production. In 1990, fertilizer and pesticide expenses for corn production accounted for 44% of the total direct costs per acre.16 Be- cause these expenses represent a large portion of total input costs, farmers are willing to invest time and resources to locate the best possible value. Another reason farmers have bargaining power is because they are buying products that, for the most part, are standard or undifferentiated. If buyers know that they can obtain the same product from many suppliers, they have an oppor- tunity to negotiate, forcing the price down. However, bargaining power of buyers should be

lessened due to the new regulations. Support for this argument was presented in the discussions of the previous three forces. Higher barriers to

entry, and consolidations and withdrawals of dealers, along with fewer farmers storing products on the farm, should all help in reducing the bargaining power of the farmer. The net effect of the storage and handling regulations working through this force is positive for industry profitability.

Supplier Power

The last of the five forces is the degree of power a supplier holds over the retailer. This particular force should remain unchanged due to the new regulations. Basic manufacturing of pesticides and fertilizers is dominated by a few companies and is much more concentrated than the retail industry.17318 Some of these organizations are integrated forward into the retail sector. Although these manufacturing firms (suppliers) will need to comply with the same rules, this should not adversely affect their power over the retailer.

Five-Forces Model Summary

Figure 2 summarizes the effects of storage and handling regulations on the five-forces model. Pos- itive (+) signs have been inserted if the force has a positive effect on profitability in the retail fertilizer and pesticide industry. Negative signs (-) indicate that profitability is being limited by the force. An NIC indicates no change in the force as a result of the regulations. Overall, the storage

Substitute New Entrants

Industry Profits bility

Bargaining Power

of Buyers

Figure 2. Five-forces model after compliance investment.

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Rogers and Akridge

and containment regulations will likely have a positive impact on industry profitability through the five forces. The threat of new entrants, substitute products, and bargaining power of buyers will all become more favorable to industry profitability. Supplier power is not likely to be much affected by these regulations. However, the potential for more intense price rivalry does exist. On balance, while the new storage and handling regulations bring higher operating costs to the industry, the potential for additional profitability through changes in the industry's competitive structure does exist.c

Conclusions

Due to recently enacted regulations, retail fertilizer and pesticide managers have many decisions to make. Plant managers will need to decide whether to build the necessary structures to comply with these new rules or exit the retail fertilizer and pesticide business. If a firm decides to construct

these structures, other questions become important. A fundamental question arises as to what structures need to be built and what type of containment medium is best suited for their operation. The costs involved in building these structures must be evaluated in order to make the best possible decision. How these new costs impact the financial perfor- mance of the plant and how a plant manages these new costs will become a prominent issue.

The results of this study suggest that the costs of compliance with storage and handling regulations are significant. In addition, there are economies of scale with respect to compliance costs, although these economies may be dampened some by the use of larger storage tanks by larger plants. Managers will need to pursue a variety of marketing and cost control tactics to maintain profitability. De- spite these challenges, the storage and handling regulations may well offer long-term opportunities to those plants able to effectively manage the short run.

Appendix: Retail Fertilizer and Pesticide Plant Budget Model

A standard budgeting model was developed to estimate the cost of retailing fertilizer:

n n n

PROFIT = 2 REV, + 2 SERVi - c COGSi i= 1 i= 1 i= 1

W n n

- c CP, - 2 FPIC; - POCi j = 1 i = l i = l

" P

i=l k=I

where PROFIT is pretax profit; REV, is revenue for product line i; SERV, is service income for product line i; COGS, is cost of goods sold for product line i; CPj is common plant cost associated with cost item j ; FPIC, is fued plant investment cost for product line i; POC, is plant operating costs for product h e i; FDEIC,, is .....................................................

cFuture research may find the supporting arguments made using Por-

ter's five-forces model to be useful hypotheses for empirical analysis.

futed delivery equipment investment cost for delivery vehicle k in product h e i; DEOC, is delivery equipment operating cost for delivery vehicle k in product line i; n is the number of product lines; rn is the number of common plant costs; and p is the number of delivery vehicles. AU revenue and cost figures are expressed in dollars.

A modified version of the Raikes and Heubrock model was used to estimate delivery costs.8 Using their deciin- ing market share assumption, and modifying their model to accommodate the return trip from the field to the plant and the mileage driven at the field and in the plant yields:

P P c FDEICik 4- DEOCik = k = l k=l

[(NU& X DFC,,)

CCT, 4- (1.837)(VCTMik) DD,

( A 4

where NUM, is the number of delivery vehicles of type k in product line i; DFC, is the annual fixed cost for

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Regulations

each delivery vehicle of type k in product line i; CCTi, is the constant cost per ton associated with loading, unloading, a n d waiting for delivery vehicle of type k in product line i; the 1.837 is a constant i n the travel distance formula that has been adjusted for nonopt imal routes and travel at the plant and in the field; VCTM,, is var iable costlton-mile f o r delivery vehicle of type k in product line i; Q, is t h e total quant i ty of product line i sold (tons); DDi i s d e m a n d density (tons/sq.mi.) for product line i; and QD, i s the quant i ty delivered (tons) of product l ine i by delivery vehicle k.

el used in this s tudy: Combining t h e above equat ions gives the budget mod-

n n n

PROFIT = REVi + SERV, - COGS, i = l i = l i = l

rn n n

- 2 CPj - 2 FPIC, - C POC, j = l i = l i = l

- [ (NUM, X DFCi,) i = l k=l

1 /2 + [ CCT, + (1.837)(VCTMik) (&) ]

1

References

1. H.J. Parker, “Environmental Stewardship,” in Environ- mental Handbook for Fertilizer and Agrichemical Dealers, Tennessee Valley Authority, National Fertilizer and Environmental Research Center, Muscle Shoals, Ala- bama, TVAINFERC-91/11, Circular 2-303, October 1991.

2. M.E. Porter, Competitive Strategy-Techniques for An- alyzing Industries and Competitors, The Free Press, New York, 1980.

Regulations Under the Indiana Commercial Fertilirer Law, Agncultural Experiment Station, F‘urdue University, 1991.

4. Indiana State Chemist and Seed Commissioner, Questions and Answers Concerning New Rules for Containment of Bulk Fertilizer and Agricultural Chemical Storage, De- partment of Biochemistry, Purdue University, 1991.

and Regulations Under the Indiana Pesticide Registration Law, Agricultural Experiment Station, Purdue University, 1991.

3. Indiana State Chemist and Seed Commissioner, Rules and

5. Indiana State Chemist and Seed Commissioner, Rules

6. J . Bullerdick and J.T. Akridge, The 1990 FRED (Fertil- izer Retail Eff iency Data) Summary of Midwestern Re- tail Fertilizer Plants, Agricultural Experiment Station, Station Bulletin 618, Purdue University, August 1991.

7. D.S. Rogers, “The Economic Impact of Environmental Regulations on Retail Fertilizer and Pesticide Firms,’’ Unpublished MS thesis, Department of Agricultural Eco- nomics, Purdue University, May 1992.

hydrous Ammonia Fertilizer in North Central lowa, Ag- ricultural and Home Economics Experiment Station, Spe- cial report 76, Iowa State University, 1975.

8. R. Raikes and A. Heubrock, Costs of Retailing An-

9. W.J. Taylor and J.T. Akridge, “Bringing Home the Ba- con, Eighth Annual Retail Salary Survey,” Dealer Prog- ress, NovemberIDecember, 37 (1991).

US Department of Commerce, Bureau of the Census, Washington, DC, 1988.

port, Department of Biochemistry, Purdue University, Spring 1990.

12. J.T. Berry and N.L. Hargett, Fertilizer Summary Data, 1990. Tennessee Valley Authority, National Fertilizer and Environmental Research Center, Muscle Shoals, Ala- bama, TVAINFERC-91I6, Bulletin Y-219, May 1991.

13. C. Chambonnet, “Rationalization of the Cooperative Farm Supply and Grain Marketing System in East Cen- tral Indiana,” Unpublished MS thesis, Department of Ag- ricultural Economics, Purdue University, August 1987.

14. Economic Research Service, Fertilizer Use and Price Sta- tistics, Computer Disk 86012.

15. D.S. Rogers and J.T. Akridge, “Take Advantage of On- Farm Containment Costs,” Farm Chemicals, May, 36 (1992).

16. D. J. Pershing, Zndiana Farm Business Summary-1990, Cooperative Extension Bulletin, EC-658, Purdue Univer- sity, February 1992.

17. P.A. Andrilenas and H. Vroomen, “Fertilizer,” in Seven Farm Input Industries, Agricultural Economic Report 635, Economic Research Service, Washington, D.C., 1990, p. 14.

18. T.R. Eichers and P.I. Szmedra, “Pesticides,” in Seven Farm Input Industries, Agricultural Economic Report 635, Economic Research Service, Washington, D.C., 1990, p. 30.

10. US Bureau of the Census, 1987 Census ofAgriculture,

11. Indiana State Chemist, Indiana Fertilizer Tonnage Re-

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economic impact of storage and handling regulations on retail fertilizer and pesticide plants

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