Vital Farms (extended): An Analysis by Cristian Velasquez
(For a condensed version, click here)
The Opportunity: Economies of Scale — Friend or Foe of the Food Industry?
“The problem of food is that it’s been a race to the bottom with price. We’ve spent less and less on food and at the same time healthcare costs have kept going up.” Matt O’Hayer, Vital Farms Co-Founder
Economies of scale have occurred by producing the optimal quantity of goods at the lowest possible price. Cost savings are passed onto consumers in the form of lower prices. Consumers have purchased products at commodity prices, but a negative externality has resulted from the mass production of food. Health, animal welfare, and the environment have felt this effect.
Companies face a new challenge, shifting consumer preferences. They are attuned to the health benefits of products and how they are made. Convenience, price, and taste are no longer the main determinants of why products are purchased. Moral and ethical standards influence product decision-making. People want to work with a company that cares about what they believe in.
The food industry is in the middle of a paradigm shift. Non-GMO, organic, cage-free, etc are the first buzz-words people look for on their food labels. Many of those words are complete bullsh*t. Cage-free means the birds are not kept in a cage. Can they still be confined in a closed environment? Yes. With a lack of sunlight? Yes. Pumped with hormones? Yes! The FDA gives recommendations on how food can be produced but the standards are minimal. Food-production companies produce at the minimum required standard at the cheapest price possible (economies of scale). Vital Farms looks at food production differently.
“Every hen is humanely treated, every egg is pasture-raised and we continue to elevate our (and the industry’s) standards, continuing Matt’s commitment to ethics over profits¹.”
(For a condensed version, click here)
The Products
Vital Farms sells products with standards, not buzz-words. Their staple product is pasture-raised eggs. In 2014, HFAC created the gold standard for pasture-raised egg production, the “Certified Humane® label. As seen on Vital Farm’s eggs cartons, they have met specifications by HFAC which include³:
- 1000 birds per 2.5 acres (108 sq. ft. per bird)
- Mandatory rotation of fields
- Hens must be outdoors year-round
- Protection from predators at night or inclement weather in the form of mobile or fixed housing
“Any product labeling terms that are important to consumers need to be clearly defined. The Certified Humane® labeling program is in place to assure a trusted product for consumers who care about how animals are raised and slaughtered for food.” Adele Douglass, HFAC’s Executive Director.
A healthier hen leads to a healthier egg. An experiment published in 2010 concluded that pasture-raised eggs had significantly higher concentration levels of Vitamin A (40%), Vitamin E, and omega-3 fatty acids than caged eggs⁴. For the same volume of nutrients, you are getting a more potent source from pasture-raised eggs.
Newer products include pasture-raised butter, ghee, and egg bites. Ghee, a butter substitute, originates from India and Pakistan and is gluten, casein, and lactose-free. Their newest product, egg bites, are microwavable eggs for those who don’t have time to cook eggs and need something on the go. The 3 products continue to grow Vital Farms’ revenue streams - combined they are 10% of total revenue⁵.
(For a condensed version, click here)
The Business Model
Vital Farms has become a middle-man of pasture-raised eggs by creating a network of pullet farmers, hatchers, brokers, and retailers of eggs.
The company began with a seasoned entrepreneur, 20 red Rhode Island Reds, and a goal to produce food in an ethical way¹. It has committed itself to animal welfare and a sustainable business model. In 2009, Whole Foods offered a $100,000 producer loan to them and became their first major retailer². O’Hayer eventually shifted Vital Farms from a producer to a middle-man for pasture-raised eggs. Family farms had an absolute advantage over O’Hayer in egg production, influencing the Executive Chairman and Director to begin partnerships with egg-producing farmers.
Family farm partnerships reduced the need for capital expenditures and quickly scaled the business. Today, the company and its 200+ family farms share a goal to produce eggs at the highest standard. Partnerships have enabled them to do more business while owning less, a similar strategy implemented by AZEK, a sustainable outdoor living products company.
“…we require these farmers to build and equip their farms to certain specifications, which requires a significant upfront capital investment, and any inability of farmers to obtain adequate financing on acceptable terms would impair their ability to partner with us⁵.”
Instead of creating a network of pullet farms (farms where day-old chicks are raised until 16 to 18-weeks old), Vital Farms has a single supplier who has created that network⁵. This shifts focus to building their laying-hen farm network. From pullet farms, hens are transported to the 200-plus family farms Vital Farms works with.
Vital Farms enters into forward-contracts with their farmers. Forward contracts are agreements to purchase specific amounts of goods at a specific date for a specified price. Working capital necessary to maintain the farm, produce the eggs, and purchase feed for the livestock are the farmers' responsibility, but Vital Farms is contractually obliged to purchase all of the eggs produced by them⁵.
Partnering farms must be within the Pasture Belt, a region in the Southeast with a preferable climate for year-round farming. The climate allows for field rotation and year-round grazing for the hens as they prepare themselves to lay eggs. The top 10 egg-producing states in the US account for 60% of all egg production, and Vital Farms partners with #6, 8, and 9 on that list⁹.
Upon purchase of the eggs, a third-party is hired to deliver them to Egg Central Station, Vital Farms’ 82,000 square-foot egg processing facility⁵. 3 million eggs are packaged daily at Egg Central Station, ready to be sold by brokers, who sell their eggs to distributors or retailers for the consumer to purchase from⁵. A broker-distributor-retailer network reduces the need for transportation and storage costs, which can lead to large inventory levels.
Vital Farms’ business model has influenced their ability to become the #1 pasture-raised egg brand and #2 egg brand based on retail dollar sales in the United States⁵. As their business continues to scale, Vital Farms will continue to dominate the egg market.
The Structure: Conscious Capitalism
“Our purpose is rooted in a commitment to Conscious Capitalism... Our business decisions consider the impact on all of our stakeholders, in contrast with the factory farming model, which principally emphasizes cost reduction at the expense of animals, farmers, consumers, crew members, communities and the environment⁵.”
Vital Farms operates as a B-Corporation, a newer corporate structure. As a B-Corp, they are legally required to balance the mission and profits when decisions are made, and those decision-makers are legally protected. Becoming one requires an assessment of what the company does and how it does so (day-to-day operations & business model). Information about the products/services they sell, tax practices, labor practices, animal testing, former penalties, sanctions or fines, etc must be disclosed¹⁰. Vetting can take months because of follow-ups, documentation, and on-site reviews to prove their claims. Scoring for Vital Farms can be found here.
In a recent Instagram interview, Matt O’Hayer boasted that his company received approval upon its first application, highlighting a commitment to benefitting everyone and everything involved with the business.
This foundation is further exemplified through their voluntary placement of Egg Central Station as an SQF “Select Site” member. Egg Central Station has an SQF Level 3 Certification, the highest possible accolade given by the GFSI⁵. Being a member shows they are always ready for an audit, a testament to their transparency in their food safety and quality practices.
Ovabrite — Vital Farms’ VIE
Name an industry as wasteful as the egg industry, where half of their products are deliberately discarded before going to market…go ahead…I’ll wait…
“We estimate the value of wasted eggs — male and infertile — to be at least $440 million annually, with an additional $70-plus million in labor and energy to incubate and sex those eggs.” Paul Knepper, President, Ovabrite
Every year, male chicks are killed through a process called chick culling. They don’t produce enough meat at maturity, so as a way to save feed for hens, they are killed upon hatching. This primitive method has been used for years but a solution is here.
Ovabrite, a variable interest entity (VIE) of Vital Farms, develops egg fertility and gender identification technology⁵. As a VIE, Ovabrite’s performance is influenced by the decisions Vital Farms makes on their behalf. VIE’s can be created as a risk-mitigation strategy. Similar to a subsidiary, losses do not put the controlling company completely at risk. Creditors going after the VIE cannot go after the controlling company.
Together with their partner Novatrans, they created TeraEgg¹¹. This proprietary technology detects gender in eggs before they are hatched, allowing the male egg to be used for consumption as opposed to being wasted¹¹. Couple Ovabrite’s technology with a consistent increase in household consumption of eggs in the United States, and you’ve created greater revenue streams for farmers using TeraEgg.
The Strategy
Well-timed (or coincidental) entrance into the market, proper positioning, and informative/entertaining advertisements have helped the company become #1 in pasture-raised eggs with an 80% market share and #2 in the market for egg retail dollar sales⁸.
“We intend to increase household penetration by continuing to invest significantly in sales and marketing to educate consumers about our brand, our values, and the premium quality of our products⁹.”
Premium products justify premium prices. Since inception, O’Hayer hasn’t budged with his pricing strategy, helping Vital Farms become #2 in retail dollar sales. This doesn’t imply they’ve sold the second-most eggs in the industry, instead, they’ve found a price point that matches demand. At nearly double the price of regular carton eggs, people have weighed the benefits and chosen to go with the more ethical, tasty, and healthy choice.
Interactive, informative, and entertaining marketing campaigns have helped justify the company’s price points and increase consumer awareness. “Bullsh*t Free,” a viral youtube clip surpassed 10 million views and their Traceability program gives you a live view of the farms your eggs come from. It’s this sort of transparency that consumers ask from corporations in today’s world.
The Channels
Vital Farms has surpassed 16,000 stores selling their products nationwide⁸, a majority of those stores being retailers. Retailers are their main revenue source, but long-term growth must go beyond retailers. Channels such as; convenience, drug stores, clubs, military, and international markets⁵ must be targeted. To capture and leverage this growth, they must continue to:
- surpass sales targets placed by their retailers
- increase product velocities (velocity = demand)
- achieve sufficient profitability for their products
Vital Farms also expects further growth through the foodservice industry.
“One example of our successful foodservice programs is with Tacodeli LLC, a popular chain based in Austin, Texas, which sells breakfast tacos made exclusively with our pasture-raised shell eggs across 11 restaurant locations and more than 60 points of distribution, such as coffee shops and farmers market stands, across Texas⁵.”
Foodservice partnerships are mutually beneficial relationships. Displaying the Vital Farms brand on menus will drive traffic and sales from health-conscious consumers familiar with the Vital Farms brand. Conversely, restaurants can help familiarize consumers unfamiliar with the Vital Farms brand, leading to future retail sales.
The Risk
Vital Farms’ risks are unique to their business structure. An overreliance on suppliers and co-manufacturers threatens their ability to maintain operations. The market for raw materials, having an elastic product, and COVID are risk factors affecting demand for their products.
A large portion of revenue comes from products made in facilities not owned by the company⁵. Of their 5 products (not including eggs), 6 different co-manufacturers are used⁵. Greater need for coordination of products and maintaining standards are needed as a result. This standard was put to test in December 2019 when their co-manufacturer for hard-boiled eggs conducted a recall for all of the hard-boiled eggs produced from their facility.
“In connection with the recall, our co-manufacturer elected to permanently close the affected production facility and move all production to a different facility, which did not have sufficient capacity to meet product demand. As a result, we were unable to supply customers with hard-boiled eggs for a period of time in the first quarter of fiscal 2020, which led to the loss of certain customer accounts for this product...⁵”
This threat is heightened by an absence of written contracts for 3 of their co-manufacturers⁵. A strain in the relationship, changes in the price of resources, or market conditions can influence their ability to manufacture the company’s products.
As a middle-man, Vital Farms must maintain long-term relationships with its suppliers, such as their sole supplier of pullet farm hens. This single-supplier has a network of pullet farms just as Vital Farms has with egg-producing farms, but there is no long-term contract guaranteeing supply. The 10Q states it isn’t efficient to contract directly with pullet farms, making their bargaining power over their supplier even weaker (lower bargaining power = lower profits).
A 10% increase in the weighted-average cost of feed materials could increase the cost of sales by approximately $2.6 million over a 39-week period⁵. To offset this loss, cost-saving initiatives and price increases to their customers would be initiated, but the latter is limited due to the elasticity of their products. Customers can choose cheaper alternatives despite the health benefits and values associated with purchasing Vital Farms’ products. In 2012, a drought lead to a volatile market for corn and soybeans which affected the company’s profitability.
“We may not be able to increase our product prices enough or in a timely manner to sufficiently offset increased commodity costs due to consumer price sensitivity, or the pricing postures of our competitors and, in many cases, our retailers may not accept a price increase or may require price increases to occur after a specified period of time elapses⁵.”
The Pandemic
The pandemic generated supply chain disruptions, but drove higher online sales, enhanced household penetration rates, and repeat customers.
Drops in demand and price for pasture-raised milk lead to a loss of several suppliers for the company, but no significant impact on its ability to supply ghee or butter products were experienced⁵. This risk was mitigated by working with their co-manufacturers to fulfill supply orders, but COVID will continue to be a threat to the supply chain.
COVID accelerated demand for e-commerce options in their retail channels⁸:
- Online fresh grocery sales at a key retailer increased 342% over the 24 week period ended Sept 5, 2020 (compared to 67% a year ago)
- “click & collect” sales at one national brick and mortar retailer surged 246% over the 26 weeks ended August 28, 2020 (compared to an increase of 69% for retail sales overall for that same period)
- last-mile delivery sales at a key partner have increased 206% year to date through the week ended September 11, 2020 (compared to an increase of 59% for retail sales overall for that same period)
Stay-at-home orders front the government meant a stock-up on essentials, resulting in new and repeat customers during the stock-up period. 440,000 new households purchased Vital Farm eggs during this 8-week period (“stock-up period”) ended April 19, 2020⁵. Over the next 20 weeks, 13,200 (30%) of the 440,000 made repeat purchases, with 72% of them purchasing various times⁵.
680,000 households that were new customers a year before made at least one purchase during the stock-up period⁵. 70% of them made at least one repeat purchase over the next 20 weeks and 69% of the 476,000 (70%) made multiple purchases over the period ended September 6, 2020⁵.
The pandemic resulted in about 337,680 repeat customers for Vital Farms. At a time when people were unsure about their financial status, job security, and health, they prioritized their health and values over convenience.
Recommendations
Here’s how Vital Farms will grow their business:
- Expand product offering
- Create new brand partnerships
- Expand further into the foodservice industry
- Expand suppliers/manufacturers network
Farmers choose to work with Vital Farms despite sacrificing income. Traditional methods of egg mass-production are more profitable but don’t align with the shared values of Vital Farms and their farmers. As they look to expand, they must continue to expand their product offerings. Farmers have other revenue sources besides pasture-raised eggs. Vital Farms has an opportunity to leverage the other products their farmers have access to (milk, cheese, meat, etc).
By working with the already existing partnerships, the company will benefit from:
- Expanded product-offerings from an existing partnership
- Use of existing transportation routes: Vital Farms or their shipping third-parties have trade routes already established, removing the need for new trade routes or partnerships to be created, lowering shipping costs.
- Shared shipping methods: A freight already picking up existing products from this facility can pick up other items in the same shipment.
New brand-partnerships should continue to be sought after by Vital Farms. Their bullsh*t free campaign surpassed 10M viewers at a time when Youtube was the most popular video website. Today, apps like TikTok appeal to viewers because of their short run-time and easier access through an app. Partnering with food influencers can reach up to 100 million monthly users in the United States, who range from the youngest to the oldest generations. Current food shoppers can be introduced to products they already shop for and younger shoppers can familiarize themselves with the brand as they grow and eventually become grocery shoppers.
As indoor dining restrictions alleviate, the foodservice industry’s traffic will rise. Partnerships with restaurants, hotels, and fast-food companies offer new revenue streams. McDonald’s announced a commitment to cage-free eggs by 2025. McDonald’s doesn’t have the same food-values as Vital Farms, but other food-retailers are following suit, opening a possibility to work with companies with aligned values.
Vital Farms has established itself as a successful middle-man for pasture-raised eggs. Their extensive network gets pasture-raised eggs from the farm to the consumer at a premium price. Relationships, contracts (and lack thereof), and third-parties are necessary but often are dependent on a single relationship to fulfill their supply chain. Growing the 3.6% household penetration rate for pasture-raised eggs will require a larger network, allowing them to become less dependent on singular relationships within their supply chain.
Conclusion
Market dominance will continue as they expand their products, operations, and as the market for food made more sustainably continues to grow. 2020 was a year of major growth for Vital Farms, experiencing over 49% growth compared to 2019⁸. Third-quarter of 2020 saw a $7.6 million gross profit increase and 2x operational from a year before ($1.2M to $2.4M)⁸.
Vital Farms has established several moats in its business model and has entered into a market at a time when it was needed. They have done so without deceptive business practices or scandalous behavior. Instead, they have established transparency in their business. Transparency — that’s the name of the game.
Check out my article on AZEK, a sustainable outdoor living product company.
Sources
[1] Vitalfarms.com
[2] SBJ Article https://sbj.net/stories/eggs-on-a-mission-vital-farms-leads-the-way-with-ethically-produced-eggs-from-springfield,62874
[3] Certified humane pasture-raised & free range defined
https://certifiedhumane.org/free-range-and-pasture-raised-officially-defined-by-hfac-for-certified-humane-label/
[4] Karsten, H.D., et al. “Vitamins A, E and Fatty Acid Composition of the Eggs of Caged Hens and Pastured Hens.” Renewable Agriculture and Food Systems, vol. 25, no. 1, 2010, pp. 45–54. JSTOR, www.jstor.org/stable/44490623. Accessed 27 Jan. 2021
[6] Forbes — O’hayer Interview
https://www.forbes.com/sites/chloesorvino/2020/08/01/vital-farms-blockbuster-ipo-proves-wall-street-has-an-appetite-for-sustainable-farming/?sh=534fc35b345b
[7] SQFI select site program
https://www.sqfi.com/why-get-certified/sqfi-select-site-program/
[8] Q3 earnings call
https://edge.media-server.com/mmc/p/snf53kcy
[9] United Eggs
https://unitedegg.com/facts-stats/#:~:text=U.S.%20table%20egg%20production%20totaled,produces%20294%20eggs%20per%20year.
[10] B-corp website
https://bcorporation.net/
[11] Ovabrite — Poultry times
https://www.poultrytimes.com/poultry_today/article_e7cdc252-b583-11e6-a1b3-83d7d5324b62.html
