George Siemon was getting milked dry. It was 2004 and the CEO of Organic Valley, the second-largest organic milk company in the country, was facing the worst supply crisis of his career. After years of double-digit sales growth, the whole world seemed to be going organic, and demand had run away from supply. Organic Valley was shorting some orders by up to 40 percent. Customers were getting restless.

Part of Siemon's problem was one of his biggest customers: Wal-Mart (NYSE:WMT). Organic Valley had built its business working with independent organic groceries. Wal-Mart's business didn't cause the milk shortage, but to the small customers it sure looked like the dairy was skimping on their orders to serve Wal-Mart. And Siemon knew that growing demand from Wal-Mart could become overwhelming.

"All of a sudden it hit us: What are we doing?" Siemon says. "We thought, 'We're shorting everybody, treating everybody poorly, and damaging our reputation. We need to decide what's most important." So he gathered his top managers to make some tough decisions. It was time to cull the herd.

Few would pick Siemon as a likely candidate to face this kind of problem. He looks more likely to run a commune than a business projecting half a billion dollars in sales this year. His hair falls to his shoulders and his office attire is blue jeans, a fleece jacket, and wire-rim glasses. He studied forestry in college but abandoned plans to become a park ranger because he didn't want to "count picnic tables for the government forever."

He became an organic farmer during the back-to-the-land movement of the 1970s and settled in southwestern Wisconsin. In 1988, he started a cooperative with half a dozen other farmers just as the organic food industry was taking off. Despite misgivings about being trapped behind a desk, Siemon was tapped to handle the business end of the co-op and didn't receive a salary until the second year--$5 per hour.

The cooperative, based in red barnlike headquarters overlooking the bucolic Kickapoo Valley in LaFarge, Wisconsin, is fundamentally different from conventional businesses. It is owned by the farmers. From the outset, it has sought to maximize direct payments to producers and set a modest profit goal of 2 percent. Over the past two decades, the company has expanded into a national enterprise with 940 farmers and 350 employees and projected 2007 sales of $482 million. It produces more than 200 products, including milk (organic dairy cows are given no synthetic hormones or antibiotics and eat organically grown feed), butter, meats, and eggs that are sold in 13,000 stores.

Organic Valley has remained independent as other organic pioneers have been snapped up by the Jolly Green Giants of the food industry. It touts itself as the "un-corporation" and Siemon's business card identifies him as "CEIEIO." He has a corner office, but its floors and beams are made from local pine and recycled wood. Says Siemon: "We have our own way of doing things."

In 2001, that way was put to the test. Siemon's sales team came to him with the notion of selling to Wal-Mart, which was moving aggressively into organic foods. Organic Valley managers spent weeks ruminating--even talking to activists and local farmers--before agreeing to sell milk to the retail giant. Some employees saw Wal-Mart as the antithesis of everything their company stood for--an impersonal, price-slashing menace, a killer of small businesses and rural downtowns. Siemon saw an opportunity to take the organic movement to the next level. "In the long run, we decided two things: It's the consumer's choice, and Wal-Mart gets organic milk to places where it's not available," he says.

Wal-Mart quickly grew into Organic Valley's third-biggest customer. At its peak, it represented 3.6 percent of the company's fluid milk sales, 1.3 million gallons per year. Organic Valley managers discovered they liked doing business with Wal-Mart. The famously efficient giant taught the co-op to master techniques such as inventory management and electronic payments. "Wal-Mart educated us quite a bit," says Siemon. "When they say on-time delivery, they'll knock you if you're there early!"

But in 2004, everything changed. Early that year, a case of mad cow disease in Washington state sent customers stampeding toward organic milk. A poor crop of feed grain caused a drop in dairy production. "We learned the hard way how important demand planning is," says Eric Newman, Organic Valley's vice president of sales. "I needed about 20 percent more milk for six months."

Customers began padding their orders to finagle more milk. Eventually, there wasn't enough milk to go around. "Some people were screaming bloody murder," recalls Newman.

Meanwhile, Wal-Mart was presenting another problem. Organic Valley's biggest rival, Horizon--the nation's leading organic milk brand, owned by Dean Foods (NYSE:DF), the nation's largest dairy company--had begun making a play for Wal-Mart business. Now what? Should Organic Valley continue underserving all customers? Or choose favorites? If the latter, who? The natural grocers who helped build the business, or big accounts like Wal-Mart with potential for explosive growth?

The Decision

The crisis came to a head on a day that has gone down in company lore as Dry Thursday. In December 2004, managers gathered in a boardroom. They projected spreadsheets onto a screen and began reviewing accounts, scrutinizing sales volume, credit history, pricing, and competition. Then the cutting began.

Their first key decision: to favor the natural food stores--which represented about 45 percent of the company's sales--over mass-market accounts. Then Wal-Mart came onto the chopping block. Siemon's team feared growing with Wal-Mart would make the co-op vulnerable. Eventually, Wal-Mart could consume so much milk that the co-op could become beholden to one client and vulnerable to pressure to lower prices--violating its fundamental mission of providing fair prices to farmers.

Wal-Mart hadn't demanded lower prices--yet. But Siemon and his team had heard that Horizon was selling milk at low-ball prices, at least 15 cents per half gallon less than Organic Valley. Siemon's team harbored few illusions about Wal-Mart's loyalty. "No sense fighting a fight you can't win," says Siemon. "We just walked away." He called Wal-Mart and said Organic Valley was going to withdraw. "The buyer," Siemon says, "was dumbfounded." Wal-Mart declined to comment for this story.

By January 1, Organic Valley had stopped shipping to Wal-Mart. In all, the company cut about 15 of its 200 accounts, including several supermarket chains. In the end, Dry Thursday didn't curtail Organic Valley's growth. Dairy sales grew by 15 percent in 2005 and 37 percent the following year. A few clients retained bad feelings about being cut, but the majority came back once the milk supply caught up about six months later.

Still, more than two years later, Newman thinks Organic Valley could have held off a bit longer before surrendering market share. "Maybe we should have said, 'Can we fend these people off for six more months until we know the milk supply catches up?" says Newman. "I would say we were slightly naive, and we've learned from it."

They've also tried not to burn any bridges with Wal-Mart--a job made more difficult by inaccurate press reports that the retail giant had given Organic Valley an ultimatum to slash prices. In fact, Organic Valley products have quietly returned to Wal-Mart shelves in some regions. "Wal-Mart was never negative to us," says Siemon. "We've become the hero…the little guy who stood up to Wal-Mart. I never felt that way. We just made a business decision about our best odds of longevity."

Horizon remains the overall leader in organic dairy, outselling Organic Valley by $339 million to Organic Valley's $232 million last year. But Organic Valley leads in the natural food stores with $124 million in sales and 28 percent growth, compared with Horizon's $91 million in sales and 9.5 percent decline. These natural grocers tend to be market leaders, and what they do today is what the supermarkets will be doing tomorrow. Says Siemon: "That's why we gave up Wal-Mart."

The Experts Weigh In

Ride out the shortage

I would have kept everybody on allocation and shorted everybody. Selling to Wal-Mart as part of a balanced mix of customers is a really valid thing to do. There's a lot of growth there, they're probably a good credit risk, and it's easier to do business with a large entity. For me, there are two separate issues: maximizing sales of my product and trying to support simpatico businesses. I've never considered the idea of cutting people off. I've viewed shortage as a temporary situation, and once it was over I wanted all my customers.

Good to leave Wal-Mart

It is extremely dangerous to become too dependent on one retailer. While there may be few examples of suppliers saying no to Wal-Mart, there are plenty examples of Wal-Mart dropping suppliers. Such occurrences can cause suppliers great difficulty and not infrequently their demise. This is not about big guys versus little guys, but about making a decision that is best for the long-term health of the business. Failing to completely fill orders from other customers ultimately could result in the loss of those customers as well.

The dilemma continues