Beeronomics: External Economies of Scale

As if on cue, the always excellent John Foyston writes today in The Oregonian about Indie Hops and its new pelletizing plant to serve craft brewers specifically:

Indie Hops' shiny new $2 million hop-pelletizing plant in Hubbard is the most tangible evidence of CEO Jim Solberg's belief that it's time for the American craft brewers to move out of the shadow of the giants.

The plant has already proved that it can make hop pellets at 110 degrees and less -- 20 or 30 degrees cooler than current methods. The lower temperatures better preserve the delicate hop oils and aromas that craft brewers prize.

Hops are usually dried and baled after harvest in the fall and then sold as whole leaf, or processed into hop extract or pellets, which are hops that have been chopped and compressed into the size and shape of a pencil eraser. Pellets are easy to store and use, and produce more consistent results.

And now, Indie Hops' pellets will retain more of the volatile aromatics and aromas.

...

But there is a tradeoff: The plant runs slower than the pelletizing plants in Yakima -- about an acre an hour, Solberg said, or eight 200-pound bales of compressed hops. That fits in with the business plan devised a couple of years ago by Solberg and partner Roger Worthington, an Orange County attorney and longtime friend.

"We decided from the start to scale this to craft breweries and not the industrial brewers. Craft brewing has basically grown up on trickle-down from the mega brewers," such as AB InBev (Budweiser) and SABMiller, he said. "But craft brewers have come into their own."

Pelletizing is just part of the Indie Hops business plan, which aims to elevate Oregon's aroma hops to among the best in the world and provide the state with a processing and storage infrastructure that now exists mainly in Yakima. The U.S. grows about a quarter of the world's hops in Yakima, Oregon and Idaho. The 2008 crop was worth nearly $40 million to the state.

This is precisely the trend I was talking about in my recent Beeronomics post on economies of scale. This is an excellent example of external economies of scale: the fact that the craft beer industry as a whole has grown prompts or allows suppliers of ingredients to become more efficient and offer cheaper of better inputs which improves the costs and quality of all brewers.  Pellets are easier to ship, store and use but craft brewer worry about loosing some flavor.  Indie Hops has brought a new version that will allow craft brewers to be more efficient by using pellets but still retain the flavor that typifies their beer.

[Note: the picture is from The Oregonian's web page, but is unattributed]

Econ 101: External Economies of Scale

Note: I am back in the Oregon after a long trip home from Brazil. Much now to catch up on, but will try and keep the blogging active as much as possible because there is so much to talk about. Please be patient.

The New York Time's website this morning has a lead story with a fascinating headline: "Ford Says It Can Get By if Rivals Survive" Huh? Isn't being having bigger market share the goal of all auto manufacturers? If so, why not hope for your two domestic rivals to go away? Turns out, Ford is worried about something economist's call external economies of scale.

Scale economies are most often talked about as internal to the firm. As firms get bigger they can specialize workers tasks more more (a la Henry Ford) and make them more productive, they can get volume discounts on inputs, they can economize on warehousing and shipping costs, and productivity improving technology has a bigger payoff for bigger firms so they are willing to invest more in developing and utilizing such technologies (welding robots for example), and so on.

But there are also external economies of scale - efficiencies that occur when the entire industry is large. As the auto industry grows, suppliers of parts can also get bigger and exploit their own internal economies. So can the suppliers of raw materials for many of the same reasons listed above. Iron ore miners, steel manufacturers, stamping businesses can all become more efficient with greater scale that a large auto industry and the resulting large demand can provide. Also manufacturers of technologies like welding robots will have an increased incentive to come up with the next iteration of productivity improving technology because the payoff is bigger when there is a larger potential demand. Storage and shipping economies can also depend on the size of the industry.

So it is interesting that Ford believes that these economies will suffer if GM and Chrysler go under given the presence of many other manufacturers in the US (which would surely increase if GM and/or Chrysler went away). Ford also believes that the loss of these economies are more severe than the potential gain arising from market share - probably because the foreign competition is already fierce enough that it doesn't matter if GM and Chrysler are around.

Interesting times...