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Photo: NCE Seafood Innovation Cluster
DNB Insight Economic impact of innovation and
digitalization in salmon farming Intrafish/DNB Seafood Summit, London September 2017 Dag Sletmo, DNB Ocean Industries - Seafood
Mob +47 95286134, email: [email protected]
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DNB Ocean Industries, Seafood
Innovation will bring
back volume growth
The level of innovation within global salmon
farming is impressive. But innovation is also
necessary as the old approach to farming
has reached the end of the road.
What makes us say that the current farming
regime has reached the end of the road? The
most striking fact is that there has been no
volume growth since 2012. Cost per kg has
skyrocketed the last few years. And we have
seen a decline in production volume per
employee in Norway since 2007. In addition, the
current environmental situation is a strain on the
industry’s relationship with society at large. As a
result governments are hesitant to issue new
licenses.
Stagnant volume since 2012
Source: SSB, DNB
Hefty cost increase
Source: Fiskeridirektoratet, DNB
Declining labor productivity
Source: Fiskeridirektoratet
The common theme behind these challenges is
that the biological capacity of the coastlines is
essentially fully utilized in all major salmon
farming regions globally. The good news is that
this capacity limit is not a fixed number given by
Mother Nature but a function of technology,
farming practices and regulations. Hence
innovation along these three pillars can lift the
biological capacity for salmon production.
The Norwegian development licenses are an
example of a good regulatory innovation. This
regulatory innovation has led to an avalanche of
technological innovation. We don’t know yet if
the solution to the current challenges will be the
sum of many incremental improvements or a
paradigm shift. But the high level of activity and
the strong economic incentive for innovation due
to the high profitability make us optimistic that
volume growth will return to the industry.
The high innovation activity we currently see is
driven by:
High salmon prices
Low oil prices
Digital revolution
The high salmon price is caused by the
challenges mentioned. Zero supply growth in a
market with strong structural growth in demand
will inevitably lead to very high prices. Even if
cost has increased, price has increased a lot
more and led to stellar profitability – which gives
a strong economic incentive to find new
production methods which will increase volumes.
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Norwegian salmon exports, tonns (000s)52 weeks rolling
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Production cost (NOK/kg), Norway
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No growth = high margins = strong
incentive for innovation
Source: DNB
The low oil price has led to significant over
capacity and layoffs in the offshore oil industry in
Norway, which has caused many companies and
skilled engineers to look for new opportunities in
salmon farming.
The digital revolution as such is independent of
these developments. But the adoption of digital
technology will be accelerated by the industry’s
need to solve its challenges and will be enabled
by the industry’s current high profitability and
investment capacity.
Following the announcement of the development
licenses in Norway the rate of technology
development has increased substantially.
Spectacular engineering feats such as Marine
Harvest’s “egg” and Salmar’s offshore farm grab
the headlines. These may allow farming deeper
into the fjords and further offshore and hence
increase the sustainable farming capacity on a
national or global level. Digitalization is also an
important aspect – both independent of the
development licenses and also within them.
Salmar’s offshore rig contains 20,000 sensors for
example.
Salmar offshore rig: 20.000 sensors
Source: Salmar, DNB
Digitalization and new
technology
There is an avalanche of new buzzwords and new
technologies these days – an almost endless
string of so called «Gutenberg moments» (named
after the invention of the printing press which
went on to revolutionize society).
Buzzword fest
Source: DNB
Why do we get so many major new technologies
now, and why do they come simultaneously? MIT
professor Erik Brynjulfsson says it is because
Moore’s law has been at work for so long.
Moore’s law essentially says computing power
doubles every 18 months. Exponential growth is
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very powerful, but in the beginning the impact
can be limited if the starting point is very low. If
something tiny doubles, it is still small. Moore’s
law was coined in 1965 and since then computing
capacity has doubled 35 times. If you fold a piece
of paper a few times not much happens. But if
you fold it 35 times it becomes almost as thick as
the distance from New York to Los Angeles. A
handful more times and it would reach to the
moon. That is why “suddenly” artificial
intelligence, big data, cheap robots, self-driving
cars, 3D printing etcetera all came into existence
at the same time.
Moore’s law on a big base is powerful
Source: Intel
The three most relevant new technologies for
salmon farming are probably the following:
Internet of Things (IoT)
Sky computing & big data
Artificial intelligence.
These will help collect data from physical
operations, store the data in the sky where the
big data can be analyzed using raw computer
power, and artificial intelligence. This will help
optimize operations but more importantly it will
help us understand the fish and the environment
much better – and the interaction between the
two. The outcome of this should be improved
biological and environmental performance. A
prime example is the “AquaCloud” which we will
get back to later.
This doesn’t mean that other digital technologies
will not be important. Blockchain could be one
example. Most people associate blockchain
technology with the digital currency called
bitcoins. But it can also be used in optimizing and
documenting long supply chains, something
shipping company Maersk is working on. This
could also have potential for salmon feed’s long
supply chains which stretch from South America
to Norway. In addition to streamlining and
reducing cost related to the actual movement of
goods, blockchain could potentially be used to
document the origin of ingredients from a
sustainable sourcing and food safety perspective.
Advanced processing robotics can improve
quality and yield and cut cost. Such technology
has already enabled Norway Seafoods to export
cod processed in Scandinavia to Chinese
consumers, breaking the pattern of sending fish
from Europe to China for processing and re-
export to Europe. Electronic systems can replace
the old fashioned telephone based sales process
– the way electronic trading replaced most of the
old fashioned stock brokers years ago. And so
on.
Digitalization trends in
salmon farming
We see two major current digitalization trends in
salmon farming:
Increased instrumentation and data
collection
Increased biological focus
Increased digitalization focuses on
measurements of temperature, oxygen, salinity,
algae, etc. At the same time a candy box full of
exciting new tools such as ROVs, robots,
ultrasound, IoT, etc is available. The aim of the
increased instrumentation and data collection is
to improve specific operations. But over time the
consequences can be radical as improved
knowledge accumulates and data collection turns
into big data which can feed artificial intelligence
algorithms.
The driving force behind this instrumentation and
data collection trend is more mature technology
but also a more mature salmon farming industry
which is more willing to look at new solutions.
The main value driver in salmon farming is the
biology. Biology is complex with many
parameters. Big data and artificial intelligence
can contribute significantly to improving our
understanding of these issues. Examples can be
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the interaction between the fish, the environment
and feeding. Or how to breed a fish with high
resistance to sea lice. Maybe it can tell you which
combination of fish stock, vaccine and feed to
use for a specific region if a customer has
ordered a certain volume of a given quality for
delivery at some given point in the future.
This trend within digitalization of increasing
biological focus is driven by a need to better
understand the fish. A lot of the technological
development has been focused on engineering
rather than the fish as such. The influx of
engineers from the petroleum sector is very
advantageous for the farming industry in general
– but oil people are not used to working with
living creatures. And cost trends in recent years
have clearly shown that the dominant factor
driving production cost is biological performance
– not tweaking smaller cost items here and there
the way it is in many other industries.
A lot of the creativity within salmon farming
digitalization is driven by small start-ups. But we
also see big players getting more involved. The
NCE Seafood Innovation Cluster and DNVGL are
active in big data. We see IBM Watson and
Telenor in artificial intelligence. Public institutions
like SINTEF, Institute of Marine research and
Norwegian Veterinary Institute act as opinion
leaders. And leading companies within digital
manufacturing such as ABB and Siemens are
getting involved.
The AquaCloud project led by the NCE Seafood
Innovation cluster is a poster child example for
digitalization within salmon farming. The project
collects large amounts of data from farming sites
every day which is sent to the cloud. IBM Watson
analyzes the data and generates predictions and
strategies for sea lice treatments using artificial
intelligence. Data is provided by Lerøy, Marine
Harvest, Grieg Seafood, SalmoNor, Bremnes
Seashore and The Institute of Marine Research.
This project is built on the three key
technological elements we mentioned;
sensors/IoT, sky computing & big data, and
artificial intelligence.
The AquaCloud
Source: NCE Seafood Innovation Cluster
OptimeeringAqua is a small startup using big
data and artificial intelligence to make plans for
optimizing production. The company believes it
can boost production per license by as much as
10 percent, which would obviously be of
tremendous value. The people behind the
company used to make production plans for
hydropower companies and are now applying
that methodology to salmon farming instead. So
far they have partnered with Grieg Seafood and
Cermaq.
Optimeering’s license utilization vs manual approach
Source: OptimeeringAqua
Telenor has made a powerful IoT solution for
farmer Midt-Norsk Havbruk transferring data and
live video from the fish pens to a control room on
land. The company can then operate several sites
from one location where three people can do the
job which earlier required six.
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Full page newspaper ad for Telenor farming IoT
Source: Finansavisen, DNB
Startup company Sea Smart has developed a
drone which moves inside the pen without any
cables and collects relevant data on the
environment and fish welfare. The data transfer
to the net is wireless, and the data helps the
farmer make better operational decisions.
The SeaSmart drone
Source: SeaSmart
Former Tomra employees have started a
company called BioSort. They are working with
Cermaq on a concept called iFarm which can
identify each individual fish in the pen through
3D scanning and recognition technology. This will
allow individual treatment of each fish instead of
the current group treatment.
iFarm – treating each fish as an individual
Source: BioSmart
Digitalization is improving the genetic tool kit and
radically reducing the cost of analysis. The
improvement in such cost has even outpaced
Moore’s law.
Genetic revolution
Source: National Human Genome Research Institute
New gen editing techniques such as CRISPR
could have a major impact on improving
resistance to disease and parasites and also on
improving other key biological parameters. Such
methods can be controversial however even if,
unlike with gen modification, gene material is not
moved from one organism to another. But better
genetic insight could also improve traditional
breeding by enabling more precise selection of
which fish to breed and also help in the
development of vaccines and medicines.
Over time the most radical impact from
digitalization in aquaculture is likely to be related
to better understanding of the fish and its
interaction with the environment rather than the
optimization of single elements in the value
chain. In other words: doing the right things will
have a larger impact than doing things right.
Salmon farming executives sometimes sound like
the former US Defense Secretary Donald
Rumsfeld who spoke about “known unknowns”
and “unknown unknowns”. There is an increasing
consensus within salmon farming that there is a
lot we don’t know about certain issues – the
“known unknowns”. And also that as one
problem after another is fixed, new problems will
emerge – “the unknown unknowns”.
Digital technology increases speed and fluidity in
markets which means that most companies must
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become less hierarchical and delegate more
decision making further down in the organization.
Salmon farming may not fit this pattern and
actually see the opposite effect. A key value
driver in farming is decisions and actions which
happen at the actual site. These decisions must
be taken at the site in real-time, not delayed and
forwarded to headquarters. The fact that
Norwegian workers are generally able to make
independent decisions with little supervision has
been a cultural competitive advantage for
Norway. Most cultures are more hierarchical and
command based.
Digital technology could lead to knowledge
becoming less based on individual employees.
Remote real-time monitoring will reinforce this. It
is very difficult to replicate the craft of a master
salmon feeder for example. But if an algorithm
can learn the tricks the game will change and
operations can also be performed remotely.
Disruptive technology
New technology is exciting and positive for the
economy overall. But it is not beneficial for
everybody, there will also be losers. Digital
technology generally has more disruptive power
than other technology and consequently can
create more losers.
A McKinsey study states that the global gross
economic impact of disruptive technology will be
$30 trillion the next 10 years (double the current
US GDP). But the net will be “only” $10 trillion.
The reason is that there will be $10 trillion in new
value creation (captured largely by new players)
but also $10 trillion in destroyed value creation
(the hit taken by established players). Essentially
the gain of the new players is the loss of the old
ones. The reason the net gain is positive and not
zero is that the consumer will receive free or very
cheap services representing a value to them
equivalent to $10 trillion.
Disruption = creation & destruction of value
Source: McKinsey, TRK Group
Already back in 1992 Bill Gates famously said
“Banking is necessary, banks are not..». This is
keenly felt by many bankers today as new digital
players attack the traditional banking value
chain. Salmon farming is different however, and
salmon farmers will remain necessary.
One key reason is that salmon farming is a
biological production, not an abstract and
information based production like banking which
can easily be digitalized.
Another reason is that the product satisfies the
end demand. Unlike salmon many products are
intermediate and not the goal in itself. The
consumer never demanded newsprint as such –
the demand was for information. When
newspapers went online, the demand for
newsprint collapsed. The sharing economy is a
threat to many physical products we will continue
to demand such as vacation homes and cars.
Peer-to-peer sharing services like Airbnb and
Nabobil increase capacity utilization dramatically
and hence reduce demand in terms of number of
units which need to be produced each year. But
unlike your vacation home or your car, your
salmon dinner doesn’t spend 95% of its time
being unused. You will not want to share it.
Is there no black swan risk in salmon farming?
By definition we don’t know. But we can say that
the black swan risk should be lower than in many
other industries. One “outlandish” potential risk
is “cultured meat”. Researchers at Maastricht
University have made a 250 thousand euro
hamburger grown in the lab. The burger was
made from 20,000 muscle fibers from a small
cow stem cells sample. The cow lived happily on
after the sample was taken, and animal welfare
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considerations were what motivated Google co-
founder Sergey Brin to pay for it.
Bill Gates, Richard Branson and Cargill have
recently invested in a San Francisco start up,
Memphis Meat, which is working on producing
meat based on similar technology.
Cultured meat grown from stem cells
Source: Memphis Meats
Given consumer resistance to technologies which
are much less radical than cultured meat (and
much cheaper!) it is difficult to see this
technology becoming main stream in the coming
decades.
Anthony Scaramucci, who was the White House
communications director for 10 days, introduced
a new expression to the English language; “front
stabber”. A front stabber is someone who will
stab you in the front, i.e. you will see him coming
- as supposed to a backstabber. If the salmon
industry is hit by radical technological disruption,
we believe it would likely come from the front,
meaning the industry should be able to see it
before it is hit.
Spotting black swans in advance
Source: Anthony Scaramucci, Fox News, DNB
Why growth at all?
In this note we focus on how innovation may
bring back volume growth. A devil’s advocate
might have asked why we are so concerned
about restoring volume growth in the first place.
From a financial perspective sea lice and the
resulting the lack of growth since 2012 has been
a blessing in disguise for many farmers. The lack
of growth has pushed prices to new highs and
pulled profitability along with it even if cost also
has increased.
Zero volume growth has been profitable so far..
Source: Oslo Børs
Many salmon farmers would find that argument
offensive, even if that dynamic has helped make
them rich. Growth is part of their DNA.
But there is also a financial argument for growth.
A key factor behind the salmon success story is
the strong underlying demand. But demand does
not develop in a vacuum independently of
supply. A key demand driver is the growing
middle class in emerging markets. But if these
new potential customers are never introduced to
the product, they will not demand it – and hence
not be part of the global pricing equation. The
“demand destruction” many commentators fear
when prices are high, is a bit misplaced we
believe. The real danger is not that the shelf
space in European discount retailers contracts.
That is not destroyed demand, that is just a
movement along an unchanged demand curve.
At a high price demand is lower than at a lower
price even if demand as such is unchanged.
When the price comes back down, the shelf
space expands back to its original size. But if a
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lack of product means that new markets are not
developed, that is “destroyed” demand in the
sense that it won’t get developed. And it won’t
impact prices. The standard analyst assumption
that underlying demand grows by some 7% per
year would break down.
There is also the sustainability aspect. If a
natural resources industry generates obvious
super profits over time it is more likely to be hit
with resource rent taxes. And the industry is also
more likely to have problems gaining sympathy
for its cause from society at large. Hence it could
be better to make high profits on a higher
volume, even if return on capital employed would
be somewhat lower. And a larger invested base
means that the total economic value added could
be higher even if the return on capital was lower.
Economic implications of
digitalization
Digitalization of salmon farming will be good for
the world and the consumer. But will it also be a
good thing for the industry? It depends on how
you look at it. And it also depends on whether
you are a farmer or a supplier. For farmers
margin is the key value driver, for suppliers it is
volume. Digitalization and innovation should help
lift volumes, which is good for suppliers. For
farmers it is a trade-off between the positive
impact of higher value vs the negative effect of
lower prices.
One way to approach the issue of how
digitalization and innovation will impact the
industry is to ask ourselves these three key
questions:
1. What happens to cost per kg?
2. What happens to sustainability & “license
to operate”?
3. What happens to entry barriers?
Cost should drop
Digitalization should help reduce cost as it does
in all industries. It can simplify processes, reduce
the need for manpower, improve data quality and
volume, enable real time monitoring, and lead to
better decisions and better asset utilization. The
largest impact of digitalization is likely to come
from better biological insight which can lead to
better biological performance. Doing the right
things will likely be more of a cost driver than
doing things right.
Sustainability should improve
A better biological and genetic understanding of
the fish along with better understanding of the
interaction with the external environment should
allow for more sustainable farming and more
targeted regulations. This improved
understanding could also strengthen the insight
into how disease and parasites move with the
water streams and from site to site. This should
help reduce disease and reduce the
environmental footprint as sustainable production
capacity is a function of technology, farming
practices and regulations – not just the natural
environment. Good sustainability equals “license
to operate” (and license to grow).
Sustainability is not optional
Source: The New Yorker
Entry barriers should decline
While improvements in unit cost and
sustainability are positive for farmers, lower
entry barriers are not. Lice and sustainability
problems created an effective entry barrier.
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Market structure drives profitability
Source: DNB
A lifting of the sustainable biological production
capacity will lower this barrier again. An entry
barrier should give lower margins but on higher
volume. The net effect is not clear for the
farmers. For support industries that depend on
volume as their key value driver lower barriers to
entry in salmon farming should be positive. It will
likely be positive for the farmers also as a lack of
supply growth will impact long term demand
growth.
In business exit barriers are discussed a lot less
than entry barriers but they are still important.
Exit barriers are about how easy it is for capacity
to leave an industry. In hotels, shipping and
airlines the exit barriers are high. If capacity is
too high and prices drop companies may go
bankrupt – but the assets keep living for another
20-30 years under new ownership. New owners
got in at a bargain price and can hence live with
lower market prices, and the market can remain
weak for many years.
In salmon farming the exit barrier is very low.
This is why the down cycles in salmon farming
historically has been two years instead of the
10+ observed in many industries with high exit
barriers. If the salmon price is too low farmers
put fewer juveniles into the water, supply then
drops some 18 months down the road and the
market balance is reestablished. If large capital
intensive structures such as land based facilities
or offshore rigs become a substantial part of the
salmon farming market, a similar dynamic to that
of airlines or shipping could manifest itself in
salmon farming at some distant point in the
future. This would not be related to digitalization
as such however.
In the first half of 2017 the average EBIT/kg
margin for Norwegian farmers was some NOK 25.
With no entry barrier whatsoever, the margin
would have been some NOK 4. That would give a
normal return on the capital invested in biomass
and equipment but not on the licenses. Licenses
would have no value in such a scenario. We
believe the probability of such a scenario to be
extremely low however. Our assumption is that a
normal cross-cycle margin should be around
NOK/kg 10.
Conclusion & summary
The high level of innovation in the salmon
farming industry should help solve the current
challenges and bring back volume growth.
Digitalization will be a key factor behind this
improvement, initially through improved existing
operations but over time primarily through
improved biological performance. This will be
driven by big data and artificial intelligence. This
could help reverse the negative cost trends and
restore society’s faith in the industry and hence
the robustness of the “license to operate”. Entry
barriers will be reduced. This will have a negative
impact on farming margins but higher volumes
would compensate partially or fully. The net
effect could even be positive as over the long run
supply growth will impact demand growth.
Without growth in volume, new markets will not
be developed, and will hence not be part of the
global pricing of the product.
We believe the long term outlook for the salmon
farming industry is very strong. Very few, if any,
industries surf on such a high number of
megatrends. Demand can continue to grow at a
high annual rate for the rest of our lifetimes
fueled by these trends – an increasing and richer
world population being the most obvious ones,
but there are many others in addition. The main
challenge for the industry is to meet and develop
that demand. The high level of innovation we
currently see makes us optimistic that the
industry will be up for this challenge.
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The force is with us!
Source: DNB