Feed Resource Recovery: Garbage in, Value out? 1. Restoring Natural Order. clean energy. nutrient cycle

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1 Feed Resource Recovery: Garbage in, Value out? 1 FEED RESOURCE RECOVERY: BRINGING NATURAL ORDER TO WASTE MANAGEMENT Restoring Natural Order clean energy energy cycle organic fertilizer farmer supermarket nutrient cycle feed INTRODUCTION Generations of managers and researchers have engaged in the pursuit of more efficient production methods for virtually all industries. The basic premise for efficient production focused on achieving the most economical methods for converting inputs into outputs. More recently, environmental concerns and social sensitivity are focusing increasing levels of attention on the methods and processes used in the disposal of these end products. The reasons for disposal include end of productive use (newspapers), replacement (batteries), obsolescence (computers) and over-production (food). Regardless of cause, the efficient, environmentally-sensitive disposal of unwanted production outputs has become both big business and a big business problem. The food industry is not exempt from these business and social pressures. The industry is under intense pressure to achieve more eco-friendly methods to produce, package and dispose of their various products. Many food processing systems are energy-intensive, inefficient and generate environmentally harmful by-products or waste. Food packaging in the supermarket and fast-food 1 Professor Paul Mulligan and Associate Dean Karen Maccaro of Babson College prepared this case for class discussion with the assistance of Paul Phadungchai, MBA Class of Copyright Babson College and the authors.

2 industries has long been a target of environmental groups. As if moving through the supply chain, many of these environmental groups are now focused on the food industry s practices for the disposal of excess food products. Industry estimates suggest that approximately 40 percent of all food produced in the United States goes to waste. In total, two hundred and forty-five metric tons of waste is created annually in the U.S. The economic cost associated with food waste is nearly $100 billion per year. Landfills are the final destination for 97% of food waste, resulting in dramatic environmental costs. These traditional cradle to grave disposal practices have generated accumulated waste levels that exceed the capacity of many local landfills. As a result, food purveyors are now paying increased fees to transport waste to regional or commercial disposal facilities adding to both the economic and the environmental cost of disposal by consuming additional resources, including energy. INDUSTRY SUPPLY/VALUE CHAIN A high-level industry value chain (Figure 1) demonstrates that waste generation occurs throughout the value chain. At the distributor and supermarket locations the majority of this waste follows a traditional waste disposal pathway. This disposal process includes on-site (temporary) storage of the waste, periodic pick-up by a waste management service provider, transportation to a landfill and bulk disposal at the landfill site. The waste management industry in the US encompasses over 10,000 companies with combined annual sales revenue of approximately $50 billion. Industry analysts stress that waste management has historically been a commodity service and the most services are sold based upon price. Profitability of individual companies is, therefore, largely a product operational efficiency 2. Three large national service providers, Allied Waste Industries, Waste Management Inc., and Republic Industries dominate the waste management industry, accounting for nearly 45% of industry revenues. Annual revenue per employee is $260k at these large companies, as compared to $125k at smaller ones, which is further evidence of critical scale economies Revenues Number of Employees 2006 Net Income 1-year sales growth 1-year net income growth Waste $13,363 48,000 $1, % (2.8%) Management Allied Waste $6,028 24,200 $ % (21.5%) Republic Industries $3,070 13,000 $ % 10.2% Table 1: U.S. Waste Management Big Three Key Statistics Waste service contracts generally last one to five years and are generated from bids where price is the primary differentiator. Fees are determined by market factors such as: collection frequency type of equipment furnished type and volume or weight of the waste collected distance to the disposal facility cost of disposal (usually landfill charges) 2 Hoovers Industry Profile,

3 Before the passing of strict federal waste management laws in 1976, the waste management industry consisted mainly of small, local companies. The industry became much more capital intensive during the resulting transformation from a dumping industry to a processing one. The emergence of sophisticated transfer stations that could quickly sort millions of pieces of waste drove many smaller players out of the market. Large companies began an intense period of consolidation and vertical integration, creating today s market structure where large hauling companies also operate landfills, transfer stations and recycling facilities (See Table #2). Landfills Transfer Facilities Recycling Facilities Waste Management Allied Waste Republic Industries Table 2: U.S. Waste Management Big Three Additional Statistics THE FOUNDING FATHERS AND MOTHER OF FRR A new player in this industry, Feed Resource Recovery (FRR or Feed), is bringing a different perspective to the waste disposal industry. The founders and start-up management team at FRR consisted of a mix of technical and managerial talent (See Table #3). Shane Eten, the Chief Garbage Person first encountered and developed an environmentally friendly business while working for a struggling family business, The Laurence Candle Company. Laurence Candle s struggles resulted from their inability to differentiate the company and its products from the more established Yankee Candle. The company needed a novel source of differentiation and Shane requested the opportunity to design a new candle line. Shane s Market research suggested that a customer segment existed for a more environmentally friendly product. Shane subsequently developed a line of soy-wax candles. Soy wax is all-natural, making this product one of the first commercially available candle products made entirely of renewable resources thus creating a sustainable product and process method within the candle industry. The soy wax candle line proved to be very successful. The social-environmental appeal of the soy candle, along with its longer burn times, allowed Laurence to charge a premium for the product, yet soy was less expensive than traditional paraffin wax, which created an attractive, high margin product. This experience led Shane to believe that environmentally sensitive solutions did not have to come at a higher cost triple bottom line was indeed achievable. 3

4 Table 3: Feed Resource Recovery Management team FEED RESOURCE RECOVERY: A NATURAL SOLUTION Feed Resource Recovery seeks to transform the cradle (seed) to grave (landfill) approach to food waste management to a more natural cradle-to-cradle ecosystem. An integrated, self-contained clean technology system that converts organic waste into power and a usable organic fertilizer is at the core of FRR s value proposition. FRR developed this alternative solution by creating a single modular waste processing system that incorporates: 1. A proven waste conversion technology; 2. A commercially available distributed energy generation unit; 3. A recently developed proprietary automation and remote management capability. The FRR team first explored the concept of a large centralized plant for natural processing of organic waste. The large plant design created many benefits for Feed management but also presented several challenges. From a benefits standpoint, the single location would be easier to monitor and service. The centralized plant would also create instant, scaled capacity. Of course, a plant of this scale would require a very significant capital investment who would provide this capital? The second option, and the one favored by Feed management, was a decentralized operating model. The decentralized model would utilize a smaller capacity processing unit that would reside on-site with the customer. These smaller units would require less capital per unit and allow Feed to scale incrementally. The new, critical questions then became: How (service design) can we bring the service, organic waste disposal, to the customer rather than the garbage to the disposal site? and who (market segment) would benefit most from a more local or portable waste management solution? Large scale food processors were already pursuing alternative solutions to waste management and disposal. These larger players also produced waste volumes that required relatively large scale solutions, making it difficult for a new entrant to secure market share. Feed management 4

5 believed that supermarkets presented an attractive opportunity (See Figure 2). The volume of waste produced by these markets was manageable, their location in densely populated areas required that waste (currently) be transported a considerable distance for disposal and they were looking for new ways to differentiate themselves from competitors, including branding in organic foods and positioning their operations as environmentally responsible. The FRR solution also posed no burden or significant modification to store operations. The supermarkets were already required to separate biodegradable from non-biodegradable waste prior to removal by wastehauling service providers. The market was attractive but Shane and his team also recognized that the supermarket industry operated at painfully low margins. An FRR-solution would have to be cost-neutral at best and preferably more cost efficient than current waste hauling services. The challenge was now design of a waste conversion system and service model that could profitably support on-location processing of biodegradable waste without raising customer costs. Existing conversion system producers were primarily designing and producing large scale systems. Their focus on large scale systems was a function of current industry demand and a widely-held belief that small systems were not economically feasible. The FRR team questioned these beliefs, based upon their research in new conversion technology and their observation that increasing transportation costs challenged prevailing industry doctrine as to profitability of onsite vs. transported solutions. Continued research and analysis led them to believe that the required product technology was available to support local digestion but their concerns regarding process technology (the service model) remained heightened. FRR PRODUCT TECHNOLOGY FRR s proposed modular unit, called the R2, is approximately the size of a large dumpster and will reside on-site at the customer location (See figure 3). Customer s will dispose of organic (food and paper) waste just as they do today sorting biodegradable from non-biodegradable and placing the waste in a receptacle behind their own facility. Existing service providers will continue to haul away the non-biodegradable waste. However, the biodegradable waste will be digested by the R2 unit through an anaerobic digestion process that facilitates the accelerated breakdown of organic material through the use of anaerobic microorganisms. The digestion process has only two outputs: 1) fuel (biogas) that feeds into a distributed electricity generation unit; and 2) an organic fertilizer that is suitable for direct application to farm land. This process occurs naturally (more slowly) in landfills but landfills do not segregate the organic byproduct (fertilizer) from other waste and the gases produced (polluting) at landfills are typically not captured for energy. The R2 unit incorporates several critical design features that allow the unit to operate safely and without significant, direct supervision. Automation is made possible through the use of an integrated control technology that drives a performance-optimizing ph-balancing unit. The gravity feed system eliminates the need for an operator to control system inputs and reduces both cost and complexity of system flow processes. The integrated solution would allow supermarkets and restaurants to more cost-effectively manage their waste stream, generate onsite energy and improve brand image. However the FRR team knew that being first to market with this industry changing solution would not likely be sufficient to achieve long-term market success. The goal for FRR management was to develop an operating strategy that built upon the first to market advantage by continuing to enhance their sources of competitive advantages. As stated by one member of the founding team, 5

6 We have all of the technology adoption issues that any new entrant would face. We also recognize that we re entering a mature market, so we need to focus on customer retention and incumbent (competitive) response at an earlier stage than most start-ups. The more effective we are as a company at aligning all aspects of our business model to support, complement and enhance the core competencies that create these competitive advantages, the better our barriers to entry will be at limiting the success of alternative competitive solutions. POTENTIAL DESIGN OF R2 SYSTEM 6

7 FEED RESOURCE RECOVERY S BUSINESS [MARKET FACING] MODEL The following information has been reproduced directly from Feed Resource Recovery internal documentation. This information describes critical attributes of the FRR business model that management believes provide critical sources of differentiation and sustained advantage. Customer Driven The ability to secure a customer before having a prototype will allow us to develop our beta system that better targets our specific market. There is a distinct advantage to involving a target customer from a products outset. Feedback from a vested customer will allow Feed to focus on customer s needs. Focal areas may include system automation, performance, usability, aesthetics, remote management, reliability, system footprint, cost and installation time. Small Footprint While other players in the industry scale their waste conversion systems up, Feed will continue to get smaller. Similar to the computer industry, Feed believes that smaller, faster and cheaper systems will be the future of waste management. The HSAD footprint is 1/10 th that of similar capacity low-solids anaerobic digesters because HSAD doesn t need water and the microturbine is the size of a conventional refrigerator. Allowing the first system designed for supermarkets to process up to 2,000 lbs./day in a compact footprint of 30 x 8 x 8. The second version aimed at Quick Service Restaurant chains will process around 250lbs. /day and be 1/5 the footprint and much cheaper. Some day Feed envisions every household with a PC will also be using our product. Plug & Play These compact systems are can be easily integrated into existing customer infrastructure built into a freight container, the system is easily transported to a customer location and, connected to their 3-phase power panel and, existing natural gas line. The system actually provides customers with a more reliable back up energy generator, mandatory for store operation. A reliable back up power system is important to supermarkets where large amounts of merchandise require cool temperatures. With a decentralized energy generation system, a store in essence has its own, constant back-up power system. Comparable systems that consume fossil fuels can cost tens of thousands of dollars and may only be used once a year. Just Add Waste Unlike many other batch anaerobic digesters the HSAD operates on a continuous flow process that takes four days to complete. We ve developed a completely automated system that enables our customers to process waste and generate energy onsite without changing current waste disposal behavior. The automation is made possible by our integrated control technology that operates our patented ph balancing unit and adjusts temperature and mixing rate to optimize system performance. Value Creation Distributed Installations These compact, easy-to-operate systems give our customers access to the valuable energy and nutrients stored in the system s organic waste output. Processing from 75 to 90 percent of a customer s waste stream on-site reduces waste volume and therefore the number of waste disposal pick-ups from twice a week to twice a month. Feed believes that the decentralized approach to waste conversion is the next logical step. Just like in nature each waste producer is responsible for and also benefits from managing their own waste stream. 7

8 Centrally Managed Our integrated control technology not only automates the system but allows us to remotely monitor system status and record system performance data. The system then transmits the real-time data to our servers, where we can then manage the unit remotely. This will give Feed the ability to provide preventative maintenance and ensure that all systems are operating at maximum efficiency. Deploying distributed systems that can be centrally managed will allow Feed to generate recurring revenue by offering services to our customers, while reducing the need to invest in and maintain a large servicing infrastructure and personnel. Network Effect - Historically waste management providers have only focused on providing disposal services for their customer. Feed takes into account the whole customer ecosystem by offering a solution that provides benefits to our customer s entire value chain. Feed will develop a web portal that will continually update the amount of liquid fertilizer each system is storing. A network of farmers, composters, landscapers, and state highway maintainers will have access to this information and choose when and where they can collect cost-effective fertilizer from our systems. Customer PR - Starting in year 2 Feed will also provide customers real-time environmental calculation information collected via our remote management capabilities. Customers will have access to an online portal platform with a unique set of tools that calculates the environmental impact of installed systems. Using a simple interface they will be able to publish the information for their consumers to view on their websites. This will allow our customers to demonstrate their socially responsible brand image. By improving our customer s brand, Feed will differentiate itself. FEED RESOURCE RECOVERY S ISSUES AND CHALLENGES Complemented by value-added services, Feed management believes that the FRR system has the potential to completely disrupt the traditional waste disposal model by giving customers on-site access to a valuable macrobiotic byproduct and energy, all generated from a customers own (biodegradable) waste stream. Feed management believed they had a strong value proposition: Cost neutral or cost saving solutions to waste management; Minimal disruption in current practices for the supermarket or restaurant; Environmentally responsible solution to a nagging industry problem; Enhanced brand development for FRR customers A sustainable financial model for FRR (See Appendix for financial projections) The management team knew that selecting the appropriate operating model was critical to the long term success of Feed. The team remained supportive of the decentralized operating model with smaller capacity processing units sited at supermarkets. However, they continued to encounter considerable resistance to this option from prospective customers. This led management to reconsider the centralized operating model with waste transported from the customer to a central processing location. Management also knew that a variety of key issues need to be addressed once they finalized the operating model decision. These decisions included defining a sustainable revenue stream and anticipating potential responses from current and potential competitors. 8

9 Case preparation questions: 1. What are the pros and cons of the two operation model options under consideration by Feed management? (you may wish to use the decision matrix located below feel free to introduce additional decision criteria) 2. Are there other operating model options that Feed management should consider? 3. How should Feed management structure their revenue model? 4. Who owns the end-products, fuel & fertilizer, and who captures revenues if they re sold? 5. What types of competitors might they anticipate? I.e. The response from traditional hauling companies and potential new entrants. 6. What is the end game - a financially sustainable business or eventual sale of FRR? Summary decision matrix: Pros and cons along multiple attributes Operating model Decision criteria Demand (input) flow Energy (output) generation Servicing complexity Scalability (short/long term) Financial implications Societal implications Environmental implications Decentralized Centralized 9

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11 Figure 2: Local (Massachusetts) customer-market assessment. the r2 system compact onsite waste conversion for supermarkets from provisional patent biogas generator system anaerobic digester effluent holding tank 27 - hopper feed input 28 - ph control system 29 - feed hopper 30 - biogas fueled electric generator 31 - interconnection panel 32 - feed holding tank Figure #3: FRR Product technology 11

12 APPENDIX: FRR FINANCIAL PROJECTIONS Income Sheet Projections: 12

13 Balance Sheet Projections: Cash Flows Projections: 13