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The Consolidation Dilemma

The Consolidation Dilemma

We've all seen the statistics – upwards of 40% of cow-calf producers have been lost over the last four decades; and the numbers are even more dramatic in the poultry, swine and dairy industries. While cyclical, beef production numbers have been stable at best. Actually, the most concerning number of all is that per-capita beef consumption continues to decline as the beef industry has lost competitiveness relative to the other proteins.

The checkoff has been phenomenal in stopping the decline in beef demand that appeared at one point to be irreversible. Still, we simply haven't been able to match the gains of our competitors. As a result, we're facing a situation where the industry is not only consolidating but contracting as well.

Consolidation is simply a sign of a mature industry. It happens – ask the computer industry, the telephone industry, the auto industry, the banking industry, the energy industry, the retail industry, or any industry you can find. The more competitive firms grow at the expense of less competitive firms.

Economies of scale not only exist, but they are significant in both marketing and production. Technology has also altered the equation. Better equipment is just one of the things that have enabled producers to run far more cows than they could in the past.

Even in those cases where increased size didn’t increase margins, it leads to consolidation in that they are willing to accept lower rates of return. The classic example is the decline of small farmer/feeders in the Midwest. Compared to the larger dedicated feeding outfits, they weren't able to add feedmill technology, the latest in mixing and feeding equipment, invest in infrastructure, or reap the marketing benefits associated with larger scale production. However, their basis advantage in input costs still enabled many of them to remain competitive with larger-scale producers.

The game changer was that the larger producers turned their inventory over 2.5 times/year and were willing to accept $20/head margins. For many small farmer feeders with only one inventory turn/year, the $20/head profits were simply not enough to justify the work and effort.

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Of course, there is also the increase in production on a per-cow basis. The average cow produces far more pounds of beef today than it used to, as well as better reproduction, more growth, etc. This productivity has enabled the U.S. cattle industry to produce more pounds of beef per cow. So unless beef demand increases significantly, we'll need fewer cows to produce the same amount of product.

We haven’t seen the concentration in the cow-calf sector of the business that we've experienced in other segments of livestock production. That's largely because the cow-calf sector is a highly competitive, low-margin business that requires a tremendous amount of capital. Plus, the wide geographic differences and lack of selection pressure available to producers has made it more difficult to obtain the dramatic genetic improvements that other segments have enjoyed.

We've made great strides in halting the decline in beef demand. Producers have made strides in improving both genetics and management resulting in a higher-quality product that is produced more efficiently. But despite dramatic changes in our pricing system that have led to more price differentiation and a more efficient means of sending market signals throughout the system, we have remained largely a commodity system.

By its definition, a commodity system results in fewer and fewer producers, as the low-cost producers grow at the expense of higher-cost producers. And the bar that divides the high-cost from the low-cost producer is continually rising. Any commodity system will eventually lead to fewer and larger producers.

So how do we stop consolidation? The remedy is simple and well known, but not very popular. We must grow demand; the ultimate thing, of course, would be to grow per-capita consumption. That means increasing price differentiation, improving the quality of our product, or increasing the efficiency in which we produce it. That means more branding, taking advantage of all technologies and increasing competitiveness with the other proteins, which means taking advantages of economies of scale as well.

In addition, we must move away from a commodity pricing system. We must embrace trade (96% of the world’s population and all demand growth is occurring outside of our borders). And producers who can't take advantage of economies of scale must increase the value and/or demand for their product at a faster rate than the economic advantages created through size.

We simply can't go back to the days of old as many advocate. If we operated in a vacuum and didn’t have to compete with other livestock industries, or if we didn’t have to compete with producers around the world, we could attempt the European model. But, as we’ve seen, that is only viable if the consumer is willing to subsidize our lifestyles at the expense of their pocketbooks. That is not a good long-term bet.

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The reality is we don’t have the ability to force everyone to abandon the technology and production advantages they have produced. Certainly, there are producers who are successful at identifying consumers who are willing to pay more for a product produced without these advantages – organic, natural, and the local food market. But history tells us that these niche markets, while they are great opportunities, will only supplement and not replace the macro-economic environment. I’m a brand enthusiast and believe that upwards of 80% of our product could eventually move through developed supply chains and greatly increase our margin opportunities.

The great irony or tragedy surrounding industry consolidation and concentration is the populist rhetoric that indicates that these trends have occurred as a result of an unfair playing field and can be reversed. They argue that it can be reversed by either returning to the commodity system of the old or that government can intervene and remove the domestic or international competitive pressures.

As proposed, however, the solutions would actually accelerate consolidation. Not only would they return us to a commodity system where size is the ultimate advantage, but they would decrease our competitiveness and our ability to increase consumer value. Whether it be new antibiotics, superior genetics, steam flakers, grids or brands, or even growth promotants, once the toothpaste is out of the tube it won’t go back in. The only caveat is if the consumer decides it is unacceptable.

The bottom line is that we'll never address the issues this industry faces if we continue to attack those who understand the rules of the marketplace, without recognizing the factors that they capitalized upon. I understand the appeal when someone tells you that it's not your fault and that the system is rigged against you. Ultimately, however, we have to address the real causes that are driving change if we expect to truly affect the outcome.

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