Why Future Beef Went Under

About 11 unforeseen squalls, a few navigational blunders, $250 million and you're sunk. At least that's how it went for Future Beef Operations (FBO), which opened its state-of-the-art harvest facility in Arkansas City, KS, in August 2001. By the following March, FBO was ordered into Chapter 11 bankruptcy reorganization. And by its first anniversary in August 2002, the courts ordered it into Chapter

About 11 unforeseen squalls, a few navigational blunders, $250 million and you're sunk.

At least that's how it went for Future Beef Operations (FBO), which opened its state-of-the-art harvest facility in Arkansas City, KS, in August 2001. By the following March, FBO was ordered into Chapter 11 bankruptcy reorganization. And by its first anniversary in August 2002, the courts ordered it into Chapter 7 bankruptcy liquidation.

FBO's intent was to construct a vertically coordinated, closed-loop beef production system that could return producers more dollars. During its production zenith, FBO harvested 1,625 head/day, marketing most of the boxed beef to its exclusive retail partner, Safeway, which also had an investment stake in the company.

Ultimately, FBO planned to not only sort and control the cattle it was putting on feed, but to also have a hand in the genetic selection behind them.

Ronnie Green joined FBO in June 2000 as head of its genetic operations. He was named vice president of FBO's cattle operations in February 2002, just before the Chapter 11 order. By that time, it wasn't so much a matter of plugging holes on a sinking ship, as it was trying to limit the casualties. Green had the dubious honor of being the last one off the boat.

In the end, FBO was the victim of historically bad timing, technical failures, idealism and, arguably, the fact it was out-traded on the front end.

For perspective, FBO sourced all cattle (most of them FBO-owned) that would be fed at its partner feedlots, harvested by FBO and then marketed to Safeway in what was the industry's first exclusive production-retailer relationship attempted in volume. For its money, Safeway was securing a long-term beef supply of known quantity and quality. Meanwhile, FBO and its production partners felt a locked-in customer and long-haul pricing mechanism would guarantee them a profit.

FBO sold boxed beef to Safeway below market prices, thanks in part — at least conceptually — to the cost efficiencies gained through a coordinated system. And Safeway received retail product differentiated for food safety that was second to none.

More specifically, Green explains FBO consisted of five value-added units in addition to its packing and fabrication facility in Arkansas City:

  • case-ready ground beef,
  • case-ready variety meats, primarily for export,
  • cooked and marinated products,
  • pet treats and
  • blue-chrome hides

The five units were to be the profit centers for FBO, while boxed beef from the harvest and fabrication facility was to be the baseline, explains Green. Boxed beef would pay the overhead; value-added products would supply the profit.

Green says the concept of FBO was to “try to build a vertically coordinated supply chain that would allow the capture of value-added dollars from the system that had not been caught in closed-loop systems before. And to try to take out some of the inefficiencies in the system due to a lack of coordination. The idea in this case was to do it through a single retailer.”

Then reality set in.

What Went Wrong

Squall #1 — FBO designed its processing plant and business model around hot-fat trimming. They'd source the right kind of cattle and be paid only for the red meat yield delivered.

“In retrospect, that's one of the things that killed us,” Green says. “Our relationship with Safeway wasn't set up to take advantage of hot-fat trimming.”

So not only was FBO selling product below market price, but hot-fat trimming meant they had fewer pounds to sell at any price.

“Safeway was buying Select carcasses (the contract specification) at slightly under the market because we'd been banking so much on the value-added products,” says Green. “In reality, Safeway paid us the very bottom and then never bought the value-added products like they said they would.”

For instance, rather than buying enough case-ready ground beef to place in three divisions, as the plan dictated, Safeway put it in only one. So, at its peak, the value-added, case-ready ground beef unit FBO was banking on for profit was running at only 22% of capacity.

Squall #2 — Because of FBO's exclusive contract with Safeway, no other customers would jump in to buy product and close the gap. Potential customers figured they'd just be helping Safeway build a system that ultimately would be used against them.

Squall #3 — As for the case-ready variety meats, no one had a chance to buy them, at least not with the promised food safety interventions. Green says the interventions relied on a process called Supa-Chill, but FBO never got the equipment working right, nor would the manufacturer stand behind it.

Squall #4 — In building its business model, FBO felt an industry shortage of blue-chrome hides represented a huge potential for them. The blue-chrome process entails splitting the hair side of the hide from the flesh side — the most labor- and chemical-intensive part of finished leather production. Already planning to de-hair the hides as part of its pathogen prevention program, FBO concluded that extending the process to the blue-chrome stage was a logical step.

But FBO had problems getting the de-hairing process to work right. By the time FBO shut its doors, Green estimates only 5,000-6,000 head had been de-haired. As a result, they had more labor involved in the blue-chrome process than anticipated.

Even worse, just before FBO opened its doors, a competing packer decided to enter the blue-chrome hide market.

“Hides were a total disaster,” says Green. “There was a huge margin built into the hide facility in the business plan. When others got into the blue-chrome hide business right before we opened, the market went down the drain because there was plenty of supply.

“Needless to say, the problems with the de-hairing process, combined with additional competition in the market, meant we were getting under the anticipated market for blue-chrome hides. They were stacking up by the pallet, and we couldn't move them at an affordable (profitable) price,” Green says.

Toward the end, FBO fire-sold a boatload of hides to China. “It was another example of the design for value-added components being right, but the market not being built for them first,” he says.

Squall #5 — By the time FBO closed its doors, Green says the company was making money in its pet treat business, but pet treats are a seasonal market. With the contracts they had for the Christmas season they would just now be running that value-added unit at higher capacity.

Squall #6 — If timing is everything, then FBO had it all — bad timing that is. FBO chose to open its doors in August. Green explains August-October is historically the toughest time of the year for any packer to source supply.

Then came last fall's terrorism horrors of Sept. 11, the Russian ban on U.S. poultry and the foot-and-mouth disease rumor that crashed the futures market.

Squall #7 — FBO cattle buyers, contracting cattle for delivery all through the next summer, were overly bullish, often setting the markets when they were buying. When Green took over cattle operations, he quickly discovered FBO was badly positioned economically on way too many cattle at too high a level.

Squall #8 — Whether driven by pride or idealism, FBO had told people they were opening the doors to full production in August. And they did, despite the fact that none of the value-added units were ready at that time.

“If we could have operated four or five months (harvesting commodity cattle while getting the other units up and running) without investing in captive supply, it could have been a whole different story,” says Green. “One of my biggest personal concerns from the beginning was that the company was never willing to crawl, then walk. It just ran.”

Squall #9 — FBO thought it had addressed risk adequately in its contract with Safeway. The contract employed a “risk collar,” which means Safeway guaranteed that FBO wouldn't lose more than X dollars per head. But when losses began mounting, Safeway stopped paying, Green says. By the time FBO closed its doors, Safeway owed more than $10 million in this stop-loss money.

Squall #10 — What about the contract?

“One of the problems with FBO from the beginning was that the contract with the buyer was poorly constructed and too hard to defend,” says Green.

There were problems with other contracts, too. A disagreement with the owner of the system FBO planned to use for sorting cattle led to a multi-million dollar litigation that's still unsettled. So FBO had to develop its own sorting system, adding cost and delays to the endless money drain of litigation.

But Green points out FBO did honor its contracts with producers.

Squall #11 — FBO's most lethal mistake may have been that no retailer asked them to create the system.

“I think the concept can work, but there has to be a pre-determined outlet for the product in place. It has to be demand-driven. It can't be supply-driven, then see if it will work,” says Green. “There have to be the end users saying ‘we want a closed-loop system that can do these things.’”

Lessons Learned

All told, there was about $50 million in equity investment — no single investor held more than a 20% stake in Future Beef Operations (FBO), says Ronnie Green, the company's former vice president of cattle operations.

Three banks put up secured notes accounting for another $180 million (the largest was $160 million). Add about $18.5 million for Chapter 11 financing and Green says the total bill is about $250 million.

In return, Green shares some valuable lessons for the industry:

Lesson 1 — “We learned producers want to see something like this work and want to participate in it. I thought that would be a hurdle, and it wasn't. The willingness, desire and commitment to make it work on the producer side were there. Producers absolutely aren't the hurdle.”

Lesson 2 — “We learned the industry isn't yet willing to pay for food safety. They talk about it but won't do it. Even with this summer's E. coli attention, retailers were unwilling to pay for a safer product and system.”

Lesson 3 — “I have no doubt a coordinated system, done correctly, allows you to produce a more consistent product. But the implementation of doing that is very difficult. The industry talks systems coordination, but still operates in silos — cow-calf, stocker, feedlot, packer, retailer, etc.”

Lesson 4 — “If your business model calls for a single outlet for your product, the odds are stacked against you. You have to have a phenomenal partner who does everything they say they'll do and more, or it's tough to make it work,” Green says.

In other words, talk is cheap. All the partners involved must be passionate about making the system work.

“We learned that if you're going to set up a vertically coordinated supply chain, you'd better make sure you have good partners, passionate about the concept at all levels. Your contract with them had better be mutually beneficial and equally shared proportionate to the risk. And the contract had better be well-constructed,” he says.

Lesson 5 — “One of the hurdles I didn't foresee was people inside the company getting in the way of the good idea,” Green explains. “The idea was sound, but a lot of human faults got in the way, and the biggest one was greed. Rather than start slow, it was more a feeling of, ‘We'll put it all into this one system and capitalize on it right away.’ Walk before you run.”

Lesson 6 — “We learned there's a great desire among people for more information, but they don't want the hassle of figuring out what to do with it,” he says. “People will make changes, but there's a huge difference between getting data and using information to manage.”

Lesson 7 — “We found there are ways to sort cattle into uniform outcome groups and there is value in that, but there are simpler ways of doing it than some might think,” Green says. “Why have we known the value of sorting cattle for so long but been unable to implement it?”

Lesson 8 — “High cost isn't sustainable. You can't support high overhead unless you're a specialty item,” he says.

Finally, perhaps most telling, Green says, “We talk a lot about value-adding, branding and returning more dollars to the producer. But in reality, retailers and others up the food chain expect us to provide those things — that those things shouldn't be added value but standard value. If true, the ramifications for the industry's future are obvious; the industry will have to operate at higher volume and lower cost.”

Since FBO, Green has become a founding partner of Datagen Beef, a data management consulting firm.