May 2007 to April 2009 Update Over the past two years, AFC has faced more intense competition, particularly from aquaculturists in Chile. In addition, Chilean output has increased the supply of salmon and the Canadian dollar has strengthened in relation to the U. S. dollar. As a result, AFC has been unable to meet its budgeted revenue targets. Stocks of unsold harvestable fish have increased, as well as the corresponding cost of maintaining the fish, and the company barely made a profit in fiscal 2009.
In January 2009, AFC lost one of its largest retail customers, S&F Seafood, to a new salmon aquaculture firm, Nu-Farm Inc. This new competitor uses a sophisticated, computerized system for supply chain and product distribution functions. The system allows Nu-Farm to establish web links with customers, such as S&F Seafood, and to manage orders and deliveries directly for each of the customer’s retail outlets. This has eliminated the need for customers to make separate arrangements to receive and warehouse fresh fish, and to ultimately distribute the fish to their retail locations.
In February 2009, 2,000 kilograms of fish from Site 4 were rejected by three important customers, two of which are located in the United States. An internal investigation revealed that two employees at Site 4 had neglected to follow established procedures and failed to reject some fish that did not meet quality standards and were not certified by the staff veterinarian. In April 2009, employees neglected to secure some of the net-pens at Site 3. During a storm, more than 300,000 kilograms of young fish escaped from these net-pens and most were subsequently lost to predators.
Although the company’s property and liability insurance covers criminal theft of fish, it does not cover the loss of fish from disease, parasites, escape, or predators. In addition, there is no liability coverage with respect to food poisoning or diseases caused by the salmon, or environmental damage caused by the farm’s operations. The lost salmon had a book inventory value of $690,000, which was written off in fiscal 2009. The ultimate sales value of the lost fish had they grown to harvestable weight is approximately $1. 5 million.
It will cost $200,000 to repair the damaged pens. Domestic and Export Markets Guy Mills is dissatisfied with the company’s geographic sales distribution, which has not changed since 2006, and would like to increase overseas sales. He has requested Juliette Maise to investigate the possibility of opening an overseas sales office. Experts predict that demand for all forms of salmon will grow at a record pace in overseas markets, particularly in developing countries. It is expected that Canada’s international reputation for salmon and other fish will remain high.
A market analysis by a respected source, published in May 2009, indicates that the market for fresh salmon is maturing very rapidly in Canada and the U. S. , as consumer tastes become more sophisticated and demand begins to shift to shellfish and various exotic, imported fish. New packaging methods have been developed for mussels, which has enabled live fresh mussels to be exported to markets at greater distances from the farms.
The wholesale market price for Canadian mussels has remained stable at about $1. 40 per kg, but is expected to increase to $1. 0 over the next few years. In the past few years, global supplies of American oysters have decreased after hurricanes destroyed a significant percentage of the oyster farms in the southern U. S. At the same time, the popularity of these oysters by consumers in North America and Europe has been increasing. As a result, the market price for American oysters farmed in Canada significantly increased from $1. 80 per kg in 2006 to $2. 70 per kg in 2009. The re-established farms in the southern U. S. are expected to have their first new harvests in another year or two.
New Strategic Goals The board of directors met in May 2009 after receiving the financial statements for 2009. Guy Mills provided the board with a summary of selected site and segment data (see Appendix 1), and reported that the decreased profits in 2009 were caused by the Site 3 problems, the decrease in market value, the strengthening Canadian dollar versus the U. S. dollar, and the increased feed costs. He also indicated that he expected the four sites to yield an average of 3. 8 million kilograms (950,000 kilograms per site) of harvested fish per year, assuming that no further unusual losses were incurred.
Given the current market conditions and the risk of having to decrease prices or lose export sales to the U. S. , the board decided that the company should move into other markets and diversify into shellfish farming. No dividends would be paid for the next year or two to free up some cash to invest in new projects. The board directed Mills to investigate establishing shellfish aquaculture sites and develop a business strategy for increasing the profitability of the current salmon operations. They indicated that any proposed investment should generate a minimum after-tax return of 10% within five years.
Shellfish Aquaculture Opportunity Mills explored opportunities for diversifying into shellfish aquaculture. He found two potential opportunities (a mussel farm and an oyster farm) and wondered which one should be pursued or whether both should be pursued. A summary of the costs and yields for establishing these farms is provided in Appendix 2. Project Blue Wave Over the past two years, Dr. Lily Stern has been investigating what makes some salmon in an aquaculture environment grow more quickly than others, have better disease resistance, and develop higher-quality flesh.
Her studies have led her to submit a proposal for Project Blue Wave (see Appendix 3), which would use leading-edge genetic engineering to develop a strain of Atlantic salmon with superior qualities specifically suited to aquaculture. Dr. Stern insists that this is a new approach to finfish aquaculture and feels that it would revolutionize the industry. Executive Meeting – June 15, 2008 Mills suggested that AFC could increase revenues by pursuing overseas markets more aggressively. He also indicated that the company should find ways to decrease operating costs.
He presented the two options for expanding into shellfish aquaculture and Dr. Stern’s Project Blue Wave proposal for discussion and asked for any new ideas to achieve the board’s goals. Mills also reported that residents in the vicinity of Site 3 were investigating the possibility of launching a lawsuit against AFC if they could gather enough evidence to prove that the escaped fish were causing environmental damage and contaminating the wild fish. In the past, similar lawsuits have had a 10% success rate with damages amounting to $10 million.
Vanic questioned the wisdom of establishing a mussel farm in PEI. He indicated that many such farms become infested with an invasive parasite that attaches itself to the growing mussels. The parasites do not have a significant impact on the growth period or meat yields of mussels; however, maintenance, harvest and distribution costs are significantly increased (20% more variable production, 10% more fixed production, and 14% more variable distribution costs). Employees also dislike handling mussels infested with the parasite.
Egin indicated that only about 25% of mussel farms get infected with the parasite. He was more interested in the Project Blue Wave proposal and suggested that it had a very good chance of realizing greater than market returns. He indicated that the R&D department had been conducting some preliminary research on genetic engineering and the scientists believe they are on the brink of delivering results, if supported with a little more investment.
Jacques Dubois wondered whether the chances of successfully developing a fastergrowing salmon were much lower than Egin or Dr. Stern realized and that a much larger aquaculture organization, or the government, would be doing this research if it were a project worth pursuing. He felt that too much money had already been spent on R&D and not enough on operational efficiencies, supply chain management, and technologies. Dubois also wondered whether AFC should consider adopting IFRSs for financial reporting and, if so, what the major implications of the conversion would be. After the meeting, Mills directed Adam Rice, Controller, to review the company’s strategic options and operational issues.
Other Information Rice began by interviewing various staff members, and made the following notes: 1. The variability of the fishing industry has made banks very cautious. Consequently, the Eastern Bank of Canada would be willing to provide a loan of no more than $3 million at an annual interest rate of 8%, on the condition that AFC maintain a gross profit margin of at least 20%. 2. Maise has determined that Paris, France would be an ideal location for an overseas sales office.
Space could be leased for CDN$5,000 per month and a local salesperson could be hired for an annual base salary of CDN$20,000 plus a four percent sales commission. Maise estimates that this office could generate annual sales of up to 500,000 kilograms of fresh whole salmon. She also indicated that there is a strong market for oysters in France, if they could be transported in an economical manner. 3. Rob Vanic predicts that world fuel prices will continue to increase and that the risk of spoilage of fresh seafood shipped overseas will double.
In fiscal 2009, two percent of overseas shipments of salmon were lost or spoiled before reaching the customers. 4. An investigation of the variable cost variances at Sites 3 and 4 revealed that the employees were overfeeding the fish, resulting in an excess amount of feed falling to the ocean floor. At Sites 1 and 2, the employees are well trained and experienced. 5. In June 2009, an important, high-potential overseas customer asked an AFC salesperson to ship crates of fish purchased for US$6,000 with documentation that stated the value as US$2,000. Apparently, this request was for customs purposes.
The salesperson consulted Maise, who indicated that the company’s policy to please the customer applied in this and all other cases. The salesperson brought the matter to Rice’s attention. 6. Costs of preliminary research on genetic engineering have been expensed in the year incurred. 7. Genetic engineering is a common practice in the agriculture and livestock industries. Proponents of organic and natural foods have increasingly complained about the ethical issues surrounding genetic tampering. 8. A discount rate of 10% after taxes is used for evaluating capital investments.