The Limits of Operational Excellence in the Seed Industry Under Climate Change

Abstract

This paper analyzes the optimal production decisions of a seed manufacturer confronted by the increased likelihood of extreme weather events that amplify the volatility of the yield in the seed production process. We model the process as a discrete-time stochastic dynamic optimization problem where, in each period, the manufacturer solves an optimization problem with two stages: The planting stage, where the manufacturer chooses the quantity of hybrid seeds to produce through a network of outsourced farmers, and the allocation stage, where the manufacturer allocates the resulting yield from the planting stage to different markets with varying profit margins. We operationalize the effect of climate change through an increased probability of extreme events. We prove that, as the extreme event probability increases (a) the manufacturer’s expected profits decrease while the optimal planting quantity grows; (b) the expected total yield of the planting stage decreases, reducing the profit of the farmers who work with the manufacturer; (c) the expected allocation quantity to different markets decreases, and this decrease is more significant in low-margin markets. Finally, we present a simulation model calibrated to industry data. We find that even a small increase in the likelihood of extreme weather events can dramatically change optimal production decisions and have significant negative effects on the profitability of commercial seeds, on the availability of seeds in low-margin markets, on the profits obtained by farmers involved in the seed production process and, on the value of postponement strategy.