GB570 Unit 7 Integration Case Analysis Example

Owning the Mill: A Unit 7 Integration Case Analysis of an Olive Oil Brand's Upstream Stake

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Purdue University Global

GB570: Managing the Value Chain

Unit 7 Integration Case Analysis

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[Date]

The company, the mill, the cooperative and every figure are composite and illustrative; the frameworks and sources cited are real.

Background

Alder Quay bottles single-origin Alentejo olive oil in Chicago and sells it to grocery chains. Its oil comes from mills in southern Portugal through a Lisbon exporter that stores, tests and ships it. Before the purchase, Alder Quay had no direct relationship with any mill. Its tasting panel chose among lots the exporter offered, and in the two harvests before the purchase, 9.4 percent of the lots reserved for Alder Quay were later downgraded from extra virgin to virgin grade after failing chemistry or sensory tests, forcing substitutions and twice delaying shipments.

The mill, which this paper calls Lagar da Ribeira, crushed olives for the growers' cooperative near Serpa, about 1,400 tonnes of oil in a typical year. It was profitable but short of capital, and at peak harvest its single processing line left fruit waiting up to thirty hours in the yard. Alder Quay bought 55 percent of it for about €1.3 million, roughly $1.42 million at the time, and the cooperative kept 45 percent.

The Rationale at the Time of Purchase

The board memo of three years ago gave three reasons, which this analysis reconstructs in the language of transaction cost economics.

A timing requirement specific to Alder Quay. Williamson (1985) argued that when an investment is specific to one trading relationship, contracting becomes costly because each side fears the other will exploit the dependence. Alder Quay's profile required olives crushed within about eight hours of picking during the first three weeks of harvest, when fruit is greenest. Meeting that requirement meant a second processing line that would sit underused once the early weeks passed. No mill would build it on a one-year contract.

Few mills able to do it. Of the mills supplying the exporter, only two could run separate early-harvest batches at controlled temperature, and both sold their best lots to other buyers.

Repeated dealings. Alder Quay buys every year, and each harvest would require a new negotiation over timing, batch separation and price. Williamson (1985) treats frequent, specific transactions as the case where ownership most often beats the market.

Outcomes

Each of the stated reasons can be tested against three harvests.

Supply. The mill now supplies about 520 tonnes of oil a year in lots nominated for Alder Quay, about 60 percent of its needs. The oil still passes through the exporter, which stores and ships it, but the lots are fixed at the mill.

Quality. Alder Quay financed a second processing line as part of the purchase. Fruit waiting time at peak harvest fell from up to thirty hours to under eight, and the share of Alder Quay's lots downgraded from extra virgin fell from 9.4 percent to 2.6 percent across the three harvests. Clodoveo (2012) shows that the time and temperature of malaxation, the mixing of olive paste before separation, strongly affect the compounds that give fresh oil its bitterness and pungency, and the mill's new temperature logs show that its early-harvest batches now stay within the range Alder Quay specified.

Return. Alder Quay's share of the mill's profit has averaged about $88,000 a year in dividends. In addition, the exporter passes on a nominated-lot discount of $0.25 a kilogram on the mill's oil, because Alder Quay now arranges supply that the exporter once had to find, worth about $130,000 a year. Together these come to about $218,000 a year, roughly 15.4 percent on the $1.42 million stake.

The stake paid for itself in quality before it paid for itself in money: downgraded lots fell by more than two-thirds in the first harvest.

Costs Acquired

Ownership brought costs the board memo did not list.

Harvest weather. The second harvest after the purchase followed a dry summer, and the mill's output fell by about a fifth. Alder Quay's dividends fell with it, and its nominated lots were cut by about 90 tonnes, which the exporter covered from other mills at full price.

A partner with different priorities. The cooperative's members are also the mill's suppliers, and they want the highest possible price for their olives. Alder Quay, as majority owner, wants the mill to earn a profit. The two sides have argued at each annual meeting over the price the mill pays growers, and the compromise reached in the third year ties part of the grower price to the share of early-harvest fruit delivered.

Management time and travel. A quality manager from Chicago spends about seven weeks in Serpa each harvest, and Alder Quay's chief executive sits on the mill's board. Alder Quay puts the combined salary share and travel for that time at roughly $60,000 annually.

Currency. The stake is valued in euros and its dividends are paid in euros, so Alder Quay now carries a currency exposure it did not have before. Over three years, a weaker euro reduced the dollar value of dividends by about 4 percent.

The Stage Still Out of Reach

The purchase gave Alder Quay control over the mill, but the oil still travels through the exporter's tanks, where it is stored alongside oil from ten other mills, filtered and shipped. Alder Quay's single-origin claim therefore still depends on the exporter's records of which oil went into which tank. Harrigan (1984) describes this as a form of tapered integration, in which a firm owns part of a stage and buys the rest, and notes that it combines some benefits of ownership with some dependence on outside suppliers. For Alder Quay, the remaining dependence sits at precisely the point where its label claims are hardest to verify.

Verdict

Measured against the reasons given at the time, the integration succeeded on quality and on supply, and it succeeded modestly on return. A 15.4 percent annual return is acceptable but not exceptional, and after management time and currency losses it falls to about 11 percent. The integration is incomplete on control, because the step between the mill and Alder Quay's dock is still owned by someone else. The partnership with the cooperative has also worked better than the board feared. Linking part of the grower price to early-harvest deliveries gave members a reason to pick green fruit, and the share of early-harvest olives reaching the mill rose from about a quarter to more than a third of the crop. That change came from the contract, not the steel, which suggests the stake bought influence as much as capacity. The next question, examined in Unit 8, is how much of what the label claims Alder Quay can actually prove through that step.

References

Clodoveo, M. L. (2012). Malaxation: Influence on virgin olive oil quality. Past, present and future: An overview. Trends in Food Science & Technology, 25(1), 13-23. https://doi.org/10.1016/j.tifs.2011.11.004

Harrigan, K. R. (1984). Formulating vertical integration strategies. Academy of Management Review, 9(4), 638-652. https://doi.org/10.5465/amr.1984.4277387

Williamson, O. E. (1985). The economic institutions of capitalism: Firms, markets, relational contracting. Free Press.