Alternative Entrance Strategies for Value-Added Cattle Production in the Northern Plains (continued)

Abstract

Keywords

Introduction

Results and
Discussion

Conclusion/
Implications

Future Research
Needs

References

Links to
www sites

Project
Background

This article addresses the question — what other opportunities for value-added cattle production and processing are available for farmers and ranchers who produce beef cattle and feedstuffs in the Northern Plains? Several issues need to be considered to answer this question. For example, why was the idea of a producer-owned packing plant not successful? What alternatives are available for Northern Plains farmers and ranchers who are involved in feed and beef cattle production, and who remain interested in new value-added initiatives in the beef industry? Can producers by-pass the step of investing in physical facilities but still capture profit opportunities in wholesaling/retailing branded beef products?

Results and Discussion

What Prompted Interest in Feeding and Packing?
Why Did the Proposal Not Work at This Time?
What Other Opportunities are Available?
How Might Producers Proceed?

What Prompted Interest in Feeding and Packing?

Several events during the 1990s suggested that there was an opportunity to develop beef packing in the Northern Plains. Cattle prices, especially the price for calves, began declining after reaching a peak of almost $110/cwt. in early 1991 (NASS). By 1996, calf prices had declined 50% to $55/cwt. Cattle producers were eager to find a strategy to replace the revenue lost as calf prices dropped.

Because posted retail prices for beef dropped less than 3% during the same time period (Economics and Statistics System), and the packing industry had concentrated into a few firms, ranchers concluded that the packing industry was using its market power to earn exorbitant profits at ranchers' expense. By 1992, the four largest meat packers accounted for 50% of the value of shipments, compared to 32% in 1987 and 29% in 1982 (Department of Commerce). Ranchers decided they needed to be in the beef packing business to capture those expected profits. They also concluded that a producer-owned packing business that was integrated with ranchers' operations would provide consumers with a higher quality, more uniform product. That improvement in quality and perceived value by consumers would, they believed, be necessary to halt the slide in beef consumption as a share of total U. S. meat consumption. Finally, they were interested in capturing a share of the growing export market for high value cuts of meat, having noted the recent success of the pork industry in doing so.

At the same time, the Federal Agriculture Improvement and Reform Act of 1996 created a policy framework of decreasing subsidies to crop producers and increased planting flexibility. This led to speculation that if regional demand for feed increased, Northern Plains farmers would shift some production resources from wheat to feed grains, such as barley, adding to Northern Plains feed grain supplies. In addition, crop farmers in the region were investing in value-added processing of agricultural commodities, which usually results in a feedstuff byproduct. The abundant supply of feed grains and by-product feeds in the region appeared to justify expanding cattle feeding operations.

Finally, there are plenty of cattle in the region. Supporters of the proposed producer-owned packing plants had planned to slaughter about 500,000 cattle, in a region that produces approximately 7 million calves each year. Furthermore, research indicated that cattle feeders in the Northern Plains can achieve costs of gain competitive with other cattle feeding regions, such as Kansas and Nebraska (Anderson). The situation seemed to be right for developing cattle feeding, and producer-owned cooperatively-organized packing plants in the Northern Plains.

Why Did the Proposal Not Work at This Time?

Despite extensive promotion by proposal originators and widespread interest among livestock producers, there was inadequate commitment to capitalize producer owned packing plants in the Northern Plains. There likely are numerous reasons why some cow-calf producers declined to invest. Understanding the reasons for the producers' decisions may help identify whether the proposal can be revised to attract more investors, or what other alternatives remain available.

One reason for the lower than expected level of interest may be timing. The winter of 1996-1997 produced record storms and precipitation in many areas of the region. Some producers found themselves struggling to preserve their breeding herd, and may not have had time to adequately assess the opportunity. Likewise, more producers now may question whether the climate is a disadvantage for the Northern Plains.

In addition, some producers may not have had the financial resources to make the investment after several years of low profit in cattle production (North Dakota Farm and Ranch Business Management). Both producers and their lenders may have been reluctant to make large investments in a venture that was deemed inherently more risky than ranching or other agricultural processing cooperatives.

Contrary to the belief of some cow/calf producers, most analysts point to the packing plant business as a narrow margin and capital intensive business. The potential for creating a profitable specialty market for high quality beef may have been outweighed in potential investors' minds by concerns about high fixed costs of entry into the business and narrow operating margins. Finally, firms distributing and marketing beef at the retail level appear to have had more generous profit margins in recent years than have packing plants (Economics and Statistics System).

Another reason for insufficient interest may be that some cattle producers did not want to add another enterprise to their cow-calf operation, or did not want to replace current activities with cattle feeding. Similarly, some cattle producers may not be interested in vertical integration and the requirements that it imposes (such as an obligation to deliver a specified number of fed cattle at specified times of the year).

Producers may not have been ready to commit to supplying enough fed cattle at this time to fully use a modern packing plant, especially a relatively large plant that offers considerable economies of size. For example, the five state area of Montana, North Dakota, South Dakota, Minnesota, and Wisconsin had only 955,000 cattle on feed in 1994. The time and cost of adding feedlot capacity (especially when producers also are investing in a packing plant) may prevent the packing plant from operating at full capacity for a period of time. Producers may have realized that large-scale feedlots offer cost and marketing advantages over small-scale (finish-your-own) cattle feeding, but that constructing such feedlots requires substantial capital -- approximately $1.4 million for a 5,000 head capacity feedlot, and $4.8 million for a 20,000 head feedlot (Duncan). They also may be concerned that despite the opportunity to incorporate the most advanced technology into a new feedlot, such new facilities often are at a cost disadvantage relative to existing feedlots in other regions. Likewise, producers who are already retaining ownership of cattle being fed at commercial feedlots in other states may not be interested in changing their business strategies.

There was some uncertainty regarding location of the required feedlots and slaughter plants. Many supporters of the proposed slaughter plants envisioned both feedlots and plants located close to the source of feeder cattle. That is contrary to experience in the industry, where feedlots are located in areas of surplus feed production and slaughter plants are located close to adequate supplies of fed cattle. Producers also may know that, historically, packing plants have been constructed only after feeding has been well-established in an area.

Finally, there may be some concern about the impact a packing plant could have on the community. New employment opportunities often are considered desirable (especially in areas of declining employment), but the substantial population expansion associated with a large facility may pose challenges for the community. Likewise, there may be some concern about the impact a packing plant and expanded cattle feeding could have on the environment.

Although the likelihood of success for the concept of a new and integrated industry with producer ownership of cattle, feedlots, and slaughter plants in the Northern Plains may be uncertain, producers are correct in seeking new ways to add value in their business. The next section examines alternatives that could be used to reach that goal.

What Other Opportunities are Available?

The effort to develop a producer-owned cooperative packing plant could be described as a proposal for cow-calf operators to vertically integrate their livestock enterprises. A review of alternative strategies may be one way to identify other opportunities. The discussion begins with backgrounding calves, and then considers feeding-to-finish, packing, and marketing the final product. Each of these major steps of the production system offers producers various opportunities depending on the individual's resources and goals.

The critical decision throughout this discussion is whether producers in the Northern Plains are willing to own, feed, and slaughter cattle, and market a brand identified beef product to retailers. If they do, how much are they willing to invest, what will they invest in, and where will they locate the business?

Sell or Background the Calf?

Each cow-calf operator has to decide what to do with the calves after they have been weaned. One option is to sell the calves at weaning, which many producers currently do. However, these producers have little opportunity to capture the value of superior genetics if the producer does not retain ownership. The inability of individual sellers and buyers to influence the market is motivating many producers to seek alternatives.

An alternative for the producer with high quality cattle is to sell the calves through a preferred supplier relationship or a strategic alliance with a feedlot operator. Such an arrangement may offer cow-calf producers a better price if they agree to deliver a specified quality and quantity at a specified time; that is, vertically coordinate with cattle feeders in the production system. However, a strategic alliance dramatically alters the cow-calf operator's risk exposure, and often requires more time and different marketing skills, but provides an opportunity for producers to reap the benefits of superior quality cattle. An unanswered question is whether the beef industry will evolve to a point similar to the pork or poultry industries where genetics are developed and controlled by proprietary firms.

Another option to selling weaned calves is for the producer to retain ownership while the calf is backgrounded. Backgrounding adds value to the animal, and for producers who background calves on their farm or ranch, it offers an opportunity to use the producers' feed and labor. Likewise, producers with adequate facilities could pursue this strategy with little additional capital investment. Backgrounding one's own calves would not be a year-round activity; instead, the backgrounded calves would be sold several months after they are weaned.

An alternative strategy (and one that is being pursued by several groups at this time) is for producers to cooperate by backgrounding calves in a co-owned facility; perhaps a cooperatively-owned feedlot. This strategy would enhance the local economy by relying on local feed (whether raised by the feedlot owners or purchased from neighboring farms), employing local labor, and returning the profit to local cow-calf producers. Pooling the livestock offers economies of scale and an opportunity to specialize, but requires some investment in facilities. It also may be the better strategy if the cattle producer does not have adequate feed for backgrounding. However, cow-calf operators may need to alter traditional production practices to provide calves throughout the year if the backgrounding lot needs to be operated continuously to be profitable. This strategy can be implemented by having producers either 1) retain individual ownership of their cattle or 2) share ownership of the cattle after the cooperative purchases them upon their delivery to the feedlot.

Another strategy already being pursued by some producers is to ship calves to another region for backgrounding in a commercial feedlot. The Northern Plains cow-calf producers would be exposed to the risk and entitled to the profit associated with backgrounding calves, but the feed and labor necessary to operate the feedlot would be supplied by individuals from outside the region. Having shipped the calves out of the region, it is unlikely that they would be returned to the Northern Plains, and thus limit the opportunity for feeding-to-finish and slaughtering in the region. There would be fewer environmental concerns for the region if the calves are backgrounded outside the Northern Plains.

Producers, or groups of producers, interested in backgrounding calves in their own lot could construct or acquire a feedlot outside the region. In this case, profit from owning the calves and the feedlot would be earned by producers in the Northern Plains, even though the feed and labor would be provided from outside the region. This strategy would require capital investment in a feedlot facility.

The Northern Plains has extensive feed supplies (forages and grain) available to background calves. For this reason, the idea of transporting calves from the Northern Plains for backgrounding may be less attractive than developing a strategy to background them in the region. However, careful management is necessary to assure that the feed ration will produce a competitive rate of gain.

Sell or Finish the Feeder?

Producers who have retained ownership while the calves are backgrounded have a number of options. Should the feeder cattle be sold, or should the livestock producer continue to own them while they are finished for slaughter?

An obvious option is to sell the backgrounded feeder, but face the same inability to influence price as encountered by cow-calf producers. The alternative of developing a preferred supplier relationship with feeder buyers, likewise, offers the same opportunities and challenges encountered by producers who establish a strategic alliance for the sale of their weaned calves. Another strategy within this option that some producers are currently pursuing is to pool backgrounded calves (feeders) to capture added revenue by marketing larger groups of cattle. New technology, such as Musculo Skeletal Imaging, assists in sorting feeder cattle from different producers into uniform lots.

Producers interested in retaining ownership of feeders could finish them on the farm or ranch. Although this approach is unlikely to require much investment capital, it is not likely to offer production or marketing economies of scale. Animal performance may be lower and cost per pound of gain may be higher in a small farmer feedlot and it may be difficult to attract buyers for small groups of fed cattle coming to market at infrequent intervals.

Feeding-to-finish one's own cattle would involve just one group of cattle per calving season. For most producers who focus on spring calving, finishing would not be a year-round activity. However, producers willing to have more than one calving season, or buy feeders, could operate a feedlot year round. Cattle feeding requires different management skills than a cow-calf operation or backgrounding activity. Consequently, a farm or ranch business would need a wide range of management expertise to operate cow-calf, backgrounding, and finishing enterprises as part of a single firm.

A second strategy for feeding in the Northern Plains is for cattle producers to acquire ownership in large-scale feedlots. Such operations offer production and marketing economies of scale, and permit managers to specialize in operating the facility. These lots could be owned individually or in cooperation with other cattle producers or investors, but would need to be built new, because there are limited feeding facilities currently in the Northern Plains. Cattle producers who invest in such feedlots would have to raise the necessary capital (estimated construction cost is between $240 and $250 per head for a new 20,000 head capacity feedlot), as well as face the risk of having invested in an asset with few alternative uses. Lenders are likely to require about 50 percent owner equity in such a business. Waste from a large-scale feedlot could pose a substantial problem; but large facilities are required by law to manage the waste — perhaps even more effectively than smaller lots that are subject to less stringent regulations.

Without a major packing plant in the Northern Plains, there may be some concern about the distance fed cattle would have to be shipped to reach a packing plant. As a general rule, it is difficult to profitably produce and deliver fed cattle to a slaughter plant located more than 150 to 200 miles distance from the feedlot.

Availability of feed also is an important consideration. In other regions, feedlots generally are owned and operated by grain farmers or commercial feedlot operators; they seldom are owned by feeder cattle producers. The reason for this is that the feed market dominates the feeder cattle market; a change in the price of feed has an opposite impact on the price of feeders. The outcome is that feeding-to-finish is more a means for marketing feed, than it is a way to market cattle. This fact raises the question of whether cattle producers can develop a cattle feeding industry in the Northern Plains without commitment and investment from feed producers.

A related question is whether the Northern Plains has the right kind of feed (primarily barley) to finish a large number of cattle. The expanding Canadian livestock industry which relies on barley suggests that feeding less corn is feasible. But for crop farmers of the Northern Plains, the comparative advantage in the past has been wheat and forage production, and thus the feed grains necessary to support large scale cattle feeding have not been widely produced in the region. In addition, most barley planted in North Dakota is intended to be used for malting purposes and only becomes feed after it cannot be sold for its original intent. What remains unclear is whether the change in farm policy will alter the comparative advantage of the Northern Plains and adjacent regions in feed grain production.

An alternative to feeding in the Northern Plains is to transport feeder cattle to a region where feed sources, feedlots and packing plants are already established. The Northern Plains cattle owner would still have an opportunity to earn profit from feeding, but the economic benefits to laborers and feed suppliers would remain outside the region. Distance to the packing plant would not be a problem, and the environmental impact of cattle feeding would be outside the Northern Plains. Currently, commercial feedlot operators in central United States charge $.24-.26/day yard charge, plus feed cost (even though sometimes it is priced as a mark-up in feed cost). The cattle owner still faces the volatility of the feed and fed cattle markets. Once feeder cattle are shipped out of the Northern Plains, they are not likely to be brought back. Thus, this strategy would not advance a local packing industry.

A further variation is to have the cattle owners purchase an existing feedlot in another region. This approach would require a capital investment (about $125 to $160 per head of feedlot capacity), but it would be a lower cost than building a new feedlot. Profit from owning and operating the feedlot would be earned by the cattle producers of the Northern Plains. Other economic and environmental impacts (both positive and negative) of cattle feeding would remain in the other region. Again, this strategy would not advance a local packing industry.

Sell or Slaughter the Fed Cattle?

For livestock producers who retain ownership through the finishing phase, the next question is deciding how to market the fed cattle. Again, a standard strategy is to sell them to buyers from packing plants, usually on a cash or "grade and yield" basis. Such a marketing strategy leaves the producer subject to price uncertainty, and with limited opportunity to capture the benefit of unique carcass characteristics. Developing a preferred supplier relationship with a packing company appears to be growing more common, but its use is still limited and the sellers' primary challenge may be delivering consistent quality fed cattle.

Alternatives to building a packing plant in the Northern Plains include 1) acquiring an existing packing plant, 2) buying a sufficiently large equity position in a meat packing company to be able to place cooperative members on the firm's board of directors, or 3) hiring a packing company to custom slaughter the producers' fed cattle. Each of these strategies, however, would occur outside the region, since there are no major packing plants in the Northern Plains.

Investing in an existing packing plant would likely require less initial capital than building new packing and feeding facilities at the same time. Accordingly, a group effort could be used to assemble the necessary equity capital. On the other hand, custom feeding and custom slaughter require the least investment capital, and offer cattle producers the greatest flexibility while retaining control over the final product.

Selling the Beef Product

Alternatives for marketing the meat include selling 1) a commodity at wholesale (such as boxed meat) or retail, or 2) selling a branded product at wholesale or retail. In attempting to wholesale the meat as a commodity, producers are likely to encounter a high level of competition from existing packing firms. This is confirmed by the data that the revenue received by packers (the farm to wholesale spread) is 5% less since 1990 than it was during the 1980s, and the spread is more volatile (Economics and Statistics System). This contradicts the assumption that the profit potential is in packing. Instead, the opportunity may lie in distribution and retailing, where the spread between wholesale and retail nearly doubled since 1980; and increased approximately five-fold since 1970.

Wholesaling and retailing a branded beef product offers the highest profit margins in the beef industry after "the farm gate." A critical question is whether cattle producers are willing to create a supply of uniformly high quality beef and build marketing channels to enable them to sell their branded products in retail supermarket outlets. Likewise, the additional revenue generated by selling a branded product does not come without marketing, packaging, and quality control costs.

How Might Producers Proceed?

Producers have alternatives, but how do they decide which strategy to pursue. A first step is to recognize the importance of meeting the needs of consumers. Unless the final product attracts customers, no amount of effort in producing, processing or marketing will generate the revenue necessary to provide a return for those involved in the industry.

A second step is to identify the group's goals. Do they want to market their cattle, create a stronger market for feed grains, enhance rural employment (then keep the activities in the region), or earn a larger profit? Are they interested in expanding the Northern Plains cattle industry as a way to add value to the feeds produced in the region (then select strategies that rely on local feedstuffs)? Do they see cattle feeding as a way to sell excess labor? How much risk exposure are they willing to accept (the more risk they are willing to accept, the longer they can retain ownership)? Are they willing to invest the capital necessary to build needed facilities and develop marketing channels? Open communication among group members is critical to assure that differences among members are understood and that their goals are compatible.

A third step may be to study how other agriculture sectors are evolving. For example, changes in poultry and pork are being led by integrators who rely on a combination of strategic alliances and vertical integration. A critical component is having control over genetics, production, processing, and marketing. In the beef industry, some packing firms are apparently buying feeders and custom feeding them (a form of vertical integration), rather than acquiring fed cattle from the open market or through a strategic alliance.

Northern Plains livestock producers could vertically coordinate by developing a preferred supplier relationship as a means of providing livestock, or acquiring custom feeding and packing services. An example of how this is already occurring is a feedlot located in a Midwestern state which relies on several backgrounding lots to provide feeders. These lots, in turn, rely on more than 100 identified producers from several states to provide the calves. All of these firms rely on each other to provide a predictable quantity and quality of cattle, and consistent production and feeding practices.

Another example of cooperation involves a retail grocer and a group of feedlot operators. The coalition slaughters through one packing plant, and sells all the product that meets the group's standard as a particular brand in the grocer's retail stores. All members of the group — cattle producers, feedlot operators, packing plant operator, and grocer — regularly communicate to assure that the desired product is being produced and delivered. Consequently, consumers now pay a price premium for this brand of beef; that is, the group has developed brand-equity.

It also is important to recognize what part of the production process producers may not be able to control. It is not likely that producers will be able to control beef genetics in the near future, as pork and poultry already are doing, but they should not overlook the potential role of improved genetics, especially privately-developed genetics. What is increasingly clear is that much greater uniformity of range and feedlot performance and customer appeal will be required to stem the erosion in beef's share of the U. S. consumer market and to gain a foothold in foreign growth markets. Indeed, the first group to achieve that uniformity of performance and quality will have an enormous advantage from which to leverage profitable market development.

A fourth step in the decision process is to identify resources available in the Northern Plains — calves, feed for backgrounding, and facilities that can handle backgrounding in economic sized operations. By combining these backgrounding efforts with custom feeding and slaughtering in other regions, cattle producers can gain important advantages. They create for themselves an opportunity to retain ownership of their cattle and the final product, while gaining experience with feeding, packing, and marketing, but without investing in limited-use facilities (such as feedlots or a packing plant) until the need for, and the profitability of, such investments have been determined. The producers also could vertically coordinate; that is sell through a preferred supplier relationship. Both of these scenarios offer producers an opportunity to retain ownership or add value to their product, but still have the flexibility to respond to profit and risk considerations. From these scenarios producers can vertically integrate at a later time by acquiring existing facilities in major cattle feeding/slaughter plant locations or building new facilities in the Northern Plains.

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