Are scalability and CapEx issues killing vertical farms?

One thing that has bothered me for years has been the high level of investment in vertical farming. Don’t get me wrong — investment in a new industry is generally a good thing. Plenty received over $1 billion dollars; Bowery received $600 million, and Kalera received about $250 million.

The problem is that all these farms are now out of business, along with a host of others. The size and scope of the projects baffled me and seemed out of proportion to the product itself. What was driving this “irrational exuberance?”

This strategy continues to play out among the survivors, especially relative to the size and scope of the production facilities proposed or in operation. For example, 80 Acres built a $95 million vertical farming facility in Florence, Kentucky, in 2023 to accompany its facility in Hamilton, Ohio. Vertical Harvest just completed a 51,000-square-foot facility in Portland, Maine, that cost $88 million.

While I wish these vertical farms and others great success, I do not think this investment approach should be a blueprint for others to follow for a variety of reasons. The question is: How much money should a venture spend on a new vertical farm production facility growing fresh vegetables?

The case of the iPhone

To answer this question, it is useful to compare capital investments in high-priced versus low-priced widgets. Let’s assume we are investing $100 million in a new production facility. We will begin with a unit economic analysis of an investment in a facility that produces iPhones.

Assume we are selling iPhones through cellphone carriers and other channel partners. To keep this straightforward, we will focus on contribution margin as opposed to more complex measures, such as return on net assets (RONA) or net present value (NPV).

Also note that this analysis does not include overhead (SG&A); i.e., facility costs, salaries, sales and marketing, etc.

Assumptions: iPhone

CapEx = $100 million amortized straight line over 10 years = $10 million/year

Channel: Partner programs

Price ≈ $1,000 (average price across models)

Variable cost ≈ $700 (estimate of materials, direct labor, packaging, distribution, commissions, etc. based on a synthesis of various published iPhone teardowns)

Contribution margin = price minus variable costs: $1,000 − $700 = $300/unit.

Breakeven units/year = annualized fixed costs divided by contribution: $10 million ÷ $300 = 33,333 units/year.

Interpretation

Based on these assumptions, $100 million CapEx amortized over 10 years requires about 33,000 finished units/year to cover the annualized CapEx (before profit, taxes and corporate overhead). That’s about 91 units/day.

For context, Apple ships about 220 to 250 million new iPhones per year, so Apple only needs to sell less than 0.01% of its inventory to break even in a matter of weeks. In short, this is a worthwhile investment for the company with a short payback period.

It is an even better investment because: (1) Apple is an industry leader with built-in market demand (first mover advantage and bargaining power); (2) while there is competition, arguably the only real competitor is Samsung (competitive rivalry); (3) other players in this industry are playing the same investment game (comparables); (4) barriers to entry are high based on capital requirements, knowledge and technical requirements; (5) substitution effects are nominal; and (6) Apple has the knowledge, expertise and supply chains to reduce risk.

The case of lettuce

Now, let’s look at building a vertical farm production facility to grow lettuce with the same $100 million. We have the option of selling through various channels, from wholesale to distributor to retail to customer direct.

To achieve volume and higher margins, let’s assume we are selling premium loose-leaf 8-ounce bagged lettuce for $3 a unit to retail chains like Whole Foods or Walmart.

Assumptions: lettuce

CapEx = $100 million amortized straight line over 10 years = $10 million/year

Channel: Retail / Price: $3/unit

Variable cost ≈ $2.50 (materials, direct labor, packaging, distribution, commissions, etc.)

Contribution margin = price minus variable costs: $3 − $2.50 = $0.50/unit.

Breakeven units/year = annualized fixed costs divided by contribution: $10 million ÷ $0.50 = 20 million units/year.

Interpretation

A vertical farm needs to produce 20 million units per year for 10 years to cover the same $10 million/year fixed charge, which is roughly 54,795 units/day. Is this doable? Well, only if the following conditions are true.

Reality check

First, how does this compare to the overall size of the market for leaf lettuce? Leaf lettuce production in 2023 totaled about 1.6 billion pounds (or 3.2 billion 8-ounce units), down 8% from 2024. While 20 million units represents less than 1% of annual market share, over 10 years, 200 million units represents about 7% of total annual U.S. production.

While doable, it requires that supply chains are efficient, logistics are figured out, retail buyer contracts are in place and production is optimized to run smoothly. It also means that the farm has a national distribution strategy, because it is unlikely to sell 20 million units per year locally or even regionally.

Second, how does this industry compare to cellphones? Unfortunately, not favorably. Competitive rivalry is intense in a commodity market where vertical farms are competing with greenhouses, field farmers and imports.

The threat of substitution is medium-high since customers can buy leafy greens in other categories, create salads from other ingredients or eat other healthy items. The bargaining power of retailers is immense, and shelf space is at a premium.

Finally, the threat of new entrants is significant. In short, this is not a hugely attractive industry from a high investment/high return perspective.

Advice for entrepreneurs and investors

A $100 million factory is plausible for differentiated, high-margin goods like iPhones because the per-unit contribution is large and the required installed volume to recover CapEx is small-moderate. For low-priced commodities, the same CapEx is only sensible if you have reliable access to tens of millions in annual volume to amortize cost, which is often impractical unless you are a global-scale player or the production technology gives you a decisive cost advantage.

If breakeven annual volume is larger than realistic market size or your achievable share, then this is a red flag.

If fixed asset turnover (sales/property, plant and equipment) is far below industry norms, you’re overinvesting in assets relative to returns. Use industry comparables.

If payback (simple CapEx divided by annual free cash flow contribution) is longer than the project life or your acceptable horizon (often three to seven years), be cautious.

Consider modular or staged CapEx; i.e., build a smaller first phase to validate market and scale later if conditions warrant.

Remember that this analysis does not include selling, general and administrative expenses. Corporate profitability has to be satisfied.

Conclusion

This is a classic chicken-egg problem. If you can harness existing demand and high volumes are assured, and you have the necessary knowledge, talent and technology, then it can make sense to build a new $100 million vertical farm production facility.

On the other hand, if you are a start-up with no track record or contracts, then start small and grow at appropriately timed intervals. Jumping in too large without these key requirements is a recipe for disaster.

What is the appropriate size of the facility? It should be affordable for a small- to mid-sized business but large enough to produce enough revenue to sustain a viable venture.

More on this topic in a subsequent column. Until then, keep growing.