The beef industry is dividing into two distinctly different marketing systems based on two distinctly different production systems. Beef cow producers must decide which system they will target.
First, there's the traditional beef system producing and marketing commodity beef. Then, there's a value-based beef system producing and marketing quality beef designed to meet tight consumer specifications.
In the next several columns, I'll identify some key production, economic and financial underpinnings of change in the beef industry. This month, we'll look at the economic stress caused by the last cattle cycle's price downturn. I'll also suggest specific management action to reduce the effect of the next downturn in prices.
The Last Downturn
The historic nature of the cattle cycle — and its resulting beef price cycle — implies that cattle numbers will again build to the point that beef prices again turn downward during this decade. In fact, that expansion appears to already have begun.
Kris Ringwall, North Dakota Extension beef specialist, reports that among North Dakota beef cowherds there is now an average replacement rate of 16.3% and an average culling rate of 12.5%. This data from North Dakota's 2000 Production Benchmarks suggests that North Dakota producers are responding to today's strong calf prices by expanding their herds.
While recent droughts in the western U.S. may be delaying this decade's beef herd expansion, I believe it has begun in non-drought areas. Consequently, a downturn in prices should occur this decade.
Producers weighing a decision on whether to produce commodity or value-based beef must understand that I project that commodity beef herds and value-based herds will weather the next price downturn quite differently. Let's begin by examining the impact the last downturn in beef prices had on commodity beef producers.
Figure 1 shows the average profit/cow earned by North Dakota's ranchers and beef farmers in the 1990s. Average profits/cow were high in the early part of the decade and averaged $152-$192/cow.
The downturn began in 1994 when beef cow profits fell 74%. Average profits went negative in 1995 and fell even more in 1996, finally turning positive in 1997. Profits continued upward through 2000 when they hit $124/cow.
Profits/cow in 2001 were projected to continue upward, but the uncertainty following the Sept. 11 terrorism acts has cast some doubt about the upside. As of Sept. 30, however, I believe beef cow profits with 2001 calves will still be quite good. And, I expect them to remain strong into, and maybe through, the 1994 calf crop.
As producers weigh their decision to either produce commodity beef or to produce value-based beef through the next price downturn, they must be aware of two economic facts.
First, the 1990s' downturn was the first time in history that North Dakota's beef cow average profits went negative.
Second, it appears that profit margins are shrinking each progressive cattle cycle. No year in the 1980s averaged below zero, while two years in the 1990s averaged below zero.
In fact, the 1990s' five-year low averaged $3 profit/cow/year while the five-year low in the 1980s averaged a positive $33/cow/year. I believe these numbers are indicative of the total U.S. beef cow sector in general.
If profit margins continue this long-term decreasing trend, the next price downturn could be particularly severe for commodity beef producers. Without some dramatic changes, I expect a substantial number of whole-herd liquidations during the next price downturn.
Reducing The Stress
My Integrated Resource Management studies indicate that the best way to reduce the economic stress generated by beef price cycle downturns is to increase economic efficiency in the cowherd. You do this by increasing total production, lowering total production costs, or both.
Increased economic efficiency, in turn, leads to lower unit costs of producing a cwt. of calf. My low-unit-cost producers made a profit each and every year during the previous price downturn.
The key measure of economic efficiency is your unit costs of producing (UCOP) a cwt. of calf. UCOP gets its management power by including both economic costs and production. Using cost/cow isn't enough because this measure doesn't include any production measures.
No other management factor comes close to UCOP in impacting profits in commodity beef production. As profit margins in the ranching business continue to get smaller, the key to economic profitability (even survivability) is to become a low-unit-cost producer.
Value-based producers, on the other hand, believe they can add value to their beef production through value-based marketing. In fact, my study of premiums paid by various alliances indicates there is added profit potential in value-based marketing.
I'm personally disappointed, however, in the magnitude of the premiums coming back to beef cow producers. I'm also concerned about the increased management required to operate a value-based beef cowherd.
In addition, I'm disturbed that there is little value-based marketing discussion emphasizing the reduction of production costs at the ranch level. There's substantial potential for most producers to pull production costs out of value-based beef production at the ranch level. In fact, there is as much potential for cost reduction at the ranch level as there is for adding value at the ranch level.
Ranchers that do both — reduce unit costs and add value — may well have the best of all worlds.
Harlan Hughes is a Professor Emeritus of North Dakota State University. Retired last spring, he is currently based in Laramie, WY. He can be reached at 701/238-9607 or firstname.lastname@example.org.