Ethanol and sugarcane expansion in Brazil: what is fuelling the ethanol industry?

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1 Supplementary online material of International Food and Agribusiness Management Review DOI: TEACHING NOTE Ethanol and sugarcane expansion in Brazil: what is fuelling the ethanol industry? Ana Claudia Sant Anna a, Aleksan Shanoyan a, Jason Scott Bergtold a, Marcellus M. Caldas b and Gabriel Granco b a Kansas State University, Department of Agricultural Economics, Waters Hall, Manhattan, KS 66506, USA b Kansas State University, Department of Geography, Seaton Hall, Manhattan, KS 66506, USA Corresponding author: Ana Claudia Sant'Anna acsantanna@ksu.edu Statement of relevance This case study describes Brazilian ethanol industry and strategic issues faced by sugarcane farmers and processors as a result of recent industry expansion into the states of Goias and Mato Grosso do Sul. Managers of ethanol plants have to evaluate strategic implications of geographic growth on competitive dynamics and vertical coordination. Farmers have to decide whether to become a part of a growing industry and enter into sugarcane production or to continue with their existing production systems. The case provides a detailed description of the ethanol supply chain in Brazil from field to market and discusses market drivers influencing the industry. Change forces in the Brazilian ethanol industry are reshaping competitive dynamics in the sugarcane farming and processing sectors with important strategic implications for farmers and ethanol plant managers. Students will be expected to conduct an industry analysis and provide strategy recommendations to managers of ethanol plants and farmers. Shaped by government 1

2 regulations, market liberalization, globalization, and technological change, the Brazilian ethanol industry provides a rich context for learning and applying strategic analysis tools. Given the growing interest in renewable fuels and the position of Brazil as the world s leading ethanol producer and the primary competitor with the US, this case study can serve as an effective teaching tool with a potential to stimulate engaging classroom discussions. Target market statement This case was originally developed for a senior undergraduate level food and agribusiness management strategies course. It can also be used successfully in graduate courses and seminars focused on agribusiness industry analysis and strategic management. The specific teaching objective for this case is to refine and reinforce students understanding of market drivers and their effect on competitive forces in an industry. The learning objectives are realized by challenging students to: (1) assess how various market drivers are affecting the expansion of the Brazilian ethanol industry; (2) understand how these market drivers shape competitive forces within sugarcane farming industry and processing industry; and (3) identify implications for short-term and long-term growth strategies of sugarcane producers and ethanol mills in the states of Goias and Mato Grosso do Sul. The case study incorporates all of the essential information for students to understand the underlying economics of the ethanol value chain and how the external forces shape strategic growth opportunities. Teaching strategy statement Different teaching strategies can be used with this case depending on the class and instructors teaching style. The following is an example teaching strategy with suggested sequence of key questions and activities. The proposed strategy involves dividing the class time into three sections: first section will begin by presenting strategic problems faced by the managers of sugarcane mills and farmers and will proceed to identify and discuss in detail the market drivers and external forces influencing Brazilian ethanol industry; second section will focus on the discussion of how various market drivers affect competitive forces within sugarcane farming and the processing industries, as well as the implications for short-term and long-term strategies of sugarcane growers and ethanol mills; third section will be used to wrap up the discussion by highlighting the key themes and concepts. The focus of the analysis and discussion will be on addressing strategic questions faced by the managers of sugarcane mills and farmers. Specifically, managers of the mills have to evaluate strategic implications of geographic growth on competitive dynamics and vertical coordination. The first strategic decision faced by managers of mills as they expand into central part of Brazil is whether to install a facility in an area with established sugarcane production and, possibly, compete with existing mills for inputs or to locate in a new area and have to invest in establishing new procurement base. The second strategic decision is whether to procure sugarcane from farmers or to backward integrate into sugarcane production by renting or buying 2

3 land. Farmers in Goias and Mato Grosso do Sul have to reevaluate their strategy in the face of increasing competition for land and labor. Specifically, farmers have to decide whether to become a part of a growing industry and enter into sugarcane production or to continue with their existing production systems. Further, if they decide to join the ethanol supply chain, then they have to make a decision on whether to produce sugarcane and supply to the plant or to rent out the land to the plant instead. Depending on the class level, size, and objectives, the time allocated for each section can be adjusted accordingly to accommodate different teaching activities. For example, for the undergraduate level strategic management class the majority of the time can be spent on the second section using role assignments and group activities (e.g. student groups assume roles of sugarcane growers and managers of an ethanol plant to conduct strategic analysis of respective industries and to identify strategic implications for their businesses). Alternatively, for a graduate level industry structures course, more time can be allocated for the discussion of market drivers and competitive forces in the first section, drilling down into the impacts of economic, technological, political-legal, and sociocultural forces on supply and demand of sugarcane and ethanol. Activity statement Below is a list of questions and activities for the use in the classroom. To help in conveying how the class may be structured, each of the key questions and answers are outlined in two sections below. The instructor may also choose to provide some of these questions as a homework assignment to be completed prior to the in-class discussion. This will allow students to think critically about the case as they read it beforehand and may enhance the quality of in-class discussion. List of questions for Section 1: The discussion during the first section can be facilitated using a series of convergent questions which will help students to gain deeper understanding of the Brazilian ethanol industry, supply chain stages, market drivers, and external forces influencing the industry. The objective is to map out industry environment and help students think about underlying economics of the ethanol value chain and relationship between various market drivers fueling expansion of Brazilian ethanol industry. Ethanol supply chain Describe the stages in the ethanol supply chain in Brazil. Who are the key actors at each stage? o To answer this question students may refer to Section 3.1 and Figure 3 for information. What are the major differences between the ethanol supply chains in Brazil and the US? 3

4 o Some possible answer points may include: Feedstock: sugarcane vs. corn Vertical coordination between sugarcane producers and processors Sugar as a major co-product The instructor may create a list of answer points and ask follow up questions to expand on some of the points: e.g. what are the characteristic differences between sugarcane production and corn production? What are the characteristic issues associated with using sugarcane versus corn as a feedstock for ethanol production? How these might affect the nature of transaction between farmers and processors? Students may mention: the 5 year cycle of sugarcane production which brings up the issue of asset specificity; importance of geographic proximity and timely delivery to prevent losses in sugar content critical for conversion. All of this is bound to make the coordination between production and processing stages more difficult compared to corn-based ethanol production. This will be a good place to transition the discussion to industry analysis. Analysis of competitive forces in ethanol industry (using Porter s Five Forces framework) This analysis and discussion can draw from the information in Sections 2 and 3 in the case. Who are the suppliers to this industry and how much bargaining power they possess? o What is the relative size and concentration of the supplier industry vs ethanol industry? o How important the input for the cost, production process, and product quality of the ethanol industry? o What is the availability of substitutes for input supplied? How is this different between Brazil and US ethanol industries? o Can suppliers forward integrate? Can the mills backward integrate? How does this affect the bargaining power of suppliers? What is the intensity of internal rivalry in Brazilian ethanol industry? o What is the rate of industry growth? o What is the level of excess capacity and exit barriers? o What is the extent of product differentiation? Who are the byers from this industry and how much bargaining power they possess? o Is the buyer industry more or less concentrated compared to processing industry? o Are there any switching costs for buyers to switch to substitutes? o Can buyers integrate backward? How strong is the threat of new entrants? o Are there any barriers to entry into ethanol industry? o What is the new entrant s ability to access resources and establish procurement base? How strong is the threat of substitutes? o Are close substitutes readily available? 4

5 o Are they attractively priced? o How do performance futures compare? o Are there switching costs for buyers? What about complements? o What can be considered as a complement to this industry? o What are the trends in the complement industry? The instructor may also chose to ask students to conduct analysis of sugarcane industry (farming industry) using Porter s Five Forces framework. This will allow comparing and contrasting the intensity of competitive forces in sugarcane farming and processing industries. Change forces and market drivers affecting ethanol industry Here students are asked to identify and discuss the change forces affecting the sugarcane and ethanol industries in Brazil. This discussion can draw from the information in Section 4 of the case. Discuss the changes in long-term growth of ethanol market. o Which factors influenced growth of ethanol market in Brazil over last century? o Which factors are shaping current dynamics in ethanol and sugarcane industry in Brazil? o What are the most important factors that will influence long-term growth of Brazilian sugarcane and ethanol industries? Which major technological changes influenced ethanol industry most? o Which technological changes are likely to have a major influence in ethanol industry moving forward? o How will technological changes affect competitive forces in ethanol and sugarcane industries? Which major regulatory and government policy changes have influenced and continue to influence sugarcane and ethanol industry in Brazil? o How the changes in environmental, business, and land-use laws and regulations have affected and are affecting the ethanol industry in Brazil? What are the effects of increasing globalization on ethanol and sugarcane industry? How are these market drivers affecting competitive forces in ethanol and sugarcane industry? List of questions for Section 2: The second section can involve a group activity based on series of divergent questions to encourage students to identify and discuss implications for short-term and long-term growth strategies of sugarcane producers and ethanol mills in the states of Goias and Mato Grosso do Sul in light of changing market drivers and competitive forces. This section can begin with the 5

6 discussion of strategic issues faced by sugarcane growers and processors, and then the instructor can assign students into groups and ask them to formulate strategy recommendations for addressing these strategic issues. The objective here is to stimulate imaginative and creative thought drawing on the content of an entire course. There is no right or 100% correct answer or recommendation for addressing strategic issues. The good way to conclude the second section is a discussion of pros and cons of various strategies proposed by student groups. What are the strategic implications for sugarcane growers in Sao Paulo, Goias, and Mato Grosso do Sul? o What are the strategic implications for cattle and soybean growers in Goias and Mato Grosso do Sul? o What factors should farmers consider when deciding whether to switch to sugarcane production? o What factors would affect the decision whether to produce sugarcane and supply to the mill versus renting out the land to the mill? o What factors should farmers consider when making contractual arrangements with mills? What are the implications for growth and vertical coordination strategy in the processing industry? o What are the strategic implications for new and established ethanol mills in Sao Paulo, Goias and Mato Grosso do Sul? o What factors should managers of the mills consider when deciding where to locate the mill? o What factors would affect the decision whether to locate in areas with established sugarcane production versus locate the mill in new locations and incentivize sugarcane production? o What factors should the managers consider when deciding whether to enter into procurement arrangements with farmers or to backward integrate into establish own sugarcane production? o What are the pros and cons of backward vertical integration versus procurement from farmers? 6

7 Summary 1. This case study describes Brazilian ethanol industry and strategic issues faced by sugarcane farmers and processors as a result of recent industry expansion into the states of Goias and Mato Grosso do Sul. 2. The shift in sugarcane production to the Central part of Brazil as a reaction to market drivers has created unprecedented competitive dynamics in all stages of the Brazilian ethanol supply chain. The arrival of mills in new areas increased the demand for land and labor. 3. Farmers in Goias and Mato Grosso do Sul are contemplating a decision to enter into the sugarcane sector by reallocating land from their current economic activity. This warrants careful strategic analysis and consideration of various arrangement options with mills. 4. Given the inherent characteristics of sugarcane production and procurement, the management of the mills must decide on vertical coordination strategies for governing transactions between sugarcane production and processing stages of the supply chain. 7

8 Additional resources and information sources on ethanol industry Table S1. Other sources of data available online. Document Statistical Yearbook of Agrienergy 2014 Brazilian Ministry of Agriculture, Livestock and Supply Provides information on sugar, ethanol, sugarcane production, exports, consumption, and harvest, among others. Available at: International Energy Portal U.S. Energy Information Administration Provides information on ethanol and oil production and consumption in Brazil and other countries in the world. Available at: Brazil: Biofuels Annual USDA/FAS An annual report from the United States Department of Agriculture Foreign Agricultural Service with information on biofuel production in Brazil. Available at: Center for Advanced Studies on Applied Economics Provides statistics on ethanol, sugar, grains and cattle prices in Brazil. Available at: Ipeadata Provides data on Brazilian statistics such as inflation, GDP per capita, exchange rates among others. Available at: Profile of the Sugar and Alcohol Sector in Brazil (in Portuguese) - CONAB Publication, only available in Portuguese, with information on mills and sugarcane producers. Available at: 2.pdf 8