Profitability in the beef industry is influenced by many factors, but none more so than the number of consumer dollars coming into it for our products.
The beautiful thing about economics is that it is still part art and not all science. Look hard enough and you can always find an economist to support your view. In fact, a lot of economic reports are created to justify a market position or view, rather than to accurately forecast or explain the market. Still, there’s always a lot to be learned from these economists.
When I worked at CattleFax, there were certain people who were must-reads and I learned a lot from them. However, you always had to keep in mind the paradigm through which the individual was looking at the world. Some are almost always bearish, others almost universally bullish.
It’s been a very difficult recently to be a dyed-in-the-wool bear regarding the industry. Eventually, they’ll be right again, but it’s been a difficult run of late. Conversely, the bulls look brilliant today. That doesn’t mean that the bears are wavering, however; in fact, they’re getting more vocal.
The crutch of the bears’ argument is something like this – the higher prices we’ve enjoyed the last 18 months are great but unsustainable. They contend that for the long-term health of the industry, prices must and should decline.
What doesn’t add up for me is the claim that consumers can’t afford, or are unwilling to pay for, our product at current demand levels. Nonetheless, beef demand actually grew this year, while pork and poultry have faced a harder time.
The bears point to the declining number of cows, fewer producers and lower per-capita consumption, and lament a contracting industry. They claim that the key to building the industry back is to lower prices.
First of all, per-capita consumption tells a lot of stories, but it’s not an indicator of demand. Domestic per-capita consumption is simply production minus exports, divided by the number of people. While per-capita consumption is negatively influenced by population growth and growth of exports, that’s not necessarily a bad thing from an industry or producer viewpoint.
Supply is the other big factor driving the consumption number. As my ex-boss used to say about beef consumption, “They’ll eat whatever we produce (they don’t throw it in the ocean); the only question is at what price will they consume it.”
Industry size is driven by three primary factors – profitability, efficiency, and external drivers like weather or government interference in the marketplace. Of course, cow numbers aren’t a great indicator of demand, as fewer producers are today producing with millions of fewer cows as much beef as they did decades ago. Increases in efficiency have led to more production per cow, and the ability for one operation to run more cows has contributed to decreasing numbers of cows and producers.
Of course, events like prolonged drought, BSE, ethanol and, perhaps country-of-origin labeling, have impacted the economics of the business enough that the industry downsized to adjust to the new economic realities. Some of these impacts are reversible, however. For instance, we’ve essentially erased much of the export losses we experienced as a result of BSE.
However, we haven’t seen a major shift in demand in reaction to higher prices. That means that according to supply, which is driven by profitability, we will move up and down the demand line in relation to our production levels. If production increases at a rate exceeding the growth in population or exports, then prices will move downward; if production doesn’t keep pace with those factors, prices will move up.
The key is profitability. If we’re making significant returns, the herd will expand; if we’re losing money, it will contract. Some of the bears point to declining per-capita consumption as an indication that consumers are rejecting our product. In actuality, it simply reflects declining supply, past profitability, expected profitability and weather constraints.
While it’s incorrect to use per-capita consumption as a demand indicator, these folks still have hit the crux of the argument – if we are to grow the industry, we must increase profitability. In the short term, the feeding and packing sectors have subsidized the cow-calf sector, as they’ve attempted to purchase future supply by increasing cow-calf profitability. Ultimately, however, industry profitability must be measured across all segments and viewed from a total systems approach. Profitability is influenced by many factors, but none more so than the number of dollars coming into our industry.
Higher fuel and land values, and higher grain and forage costs driven by global demand for grains as both fuel, feed and food have led to a dramatic increase in overall production costs; that’s something no economist disputes. We can increase profits by increasing value, or lowering costs.
Part of the contraction in our industry has been driven by these two factors, but that’s where the math becomes real fuzzy. As a seedstock producer, this gets a little tricky for me because we’ve always emphasized moderate milk and mature size, and highly feed-efficient cattle. Our environment puts certain restraints on production that producers can’t ignore, so we’re big-time advocates of matching cows to the environment.
With that said, we have to be intellectually honest and admit that cow size is about matching production to resources and risk management, more so than there being some magical size that is more profitable or biologically efficient. I understand that economic efficiency and biologic efficiency are not always the same trait, either, but the math is neither that complicated nor as simple as some try to make it.
While I’m known to be in the “small cow” camp, it concerns me when there seems to be almost universal acceptance in some circles that small cows are better. From a biologic efficiency standpoint, the data is clear that there is very little difference in biological efficiency between today’s 1,000-lb. cows and 1,500-lb. cows. In fact, today’s market signals would likely favor the larger cows from an economic efficiency standpoint, but those factors can and do change. Certainly, that can change dramatically whether you take a silo approach and only analyze profitability at the cow-calf level, or analyze profitability from a total systems approach, which ultimately is the final arbitrator.
We always talk about the efficiency advantage of poultry, pork and even foreign countries from a cost-of-production standpoint, but we tend to forget the takeaway lessons. A large part of the efficiency advantage of pork and poultry results from integration and their ability to maximize profitability from that total systems view.
They don’t have the beef industry’s segmentation that leads to a vicious cycle where maximizing short-term gains leads to declining demand and being less competitive in the long term. We must look at efficiency from a total systems approach, just like we must look at value and quality from a total systems approach or we will make incorrect decisions.
Secondly, our competitive advantage is, and will likely always be, that we are the low-cost producer of high-quality, corn-fed beef. We must maintain and broaden our perceived quality advantage; we can’t compete with other countries on a grass-fed basis. Those who advocate differently are arguing that the future of small retail is competing with Walmart on the basis of price, or that American manufacturing will grow by being lower cost than China.
Ground beef is, and always will be, a big part of our market. Thank goodness for McDonald’s, Taco Bell and Hamburger Helper, but nobody in their right mind wants to start grinding flat iron steaks or middle meats! In fact, the industry’s best-case scenario is to need to import lean grindings to meet demand; that means we’re selling our product for more value.
I love hamburger, but nobody can make a living making solely hamburger meat. The “too expensive” argument simply is not backed by the data; again, demand has not been weakening at these higher prices.
Certainly, we have to be more customer-centric, and the industry needs to be commended for making the changes it has to stop the decline in beef demand. The demand trend from the mid-’70s to the early ’90s wasn’t sustainable.
Plus, it isn’t possible for us to buy back the market share that our competitors won from us. Price beef competitively with pork and poultry and you won’t see a shrinking beef industry but a non-existent one replaced by foreign competitors.
Chicken lowered costs, improved quality, uniformity, consistency and convenience, while we were putting out a subpar product that did not deliver on the value equation. Beef will always cost significantly more than chicken; the key is that we can justify those higher price levels.
The bears use the same trend line that occurred in the last 25 years and project it out and say that beef consumption will be 30 lbs. in another 25 years. Why that is untrue would take pages to explain, but suffice it to say that chicken and poultry won’t have the kind of efficiency gains they’ve enjoyed in the past; nor is beef today strictly a commodity product that doesn’t respond to consumer needs. We’ve invested millions in promoting and improving our product, and we are now grasping the opportunity to greatly improve efficiency.
Another important point is that, at today’s per-capita consumption level of 56 lbs., consumers aren’t as willing to substitute pork and poultry for beef as they were when it was in the lower 70-lb. range. Without question, the battle for the center of the plate will be determined in part by production efficiencies; that’s an area the beef industry has decidedly more opportunity to improve than our competitors. However, quality also plays a crucial role in that.
Sadly, the doom and gloom crowd will have plenty of ammunition over the next couple of years, as supplies are expected to continue to tighten as expansion begins and as population and exports rise. Total beef supplies will certainly decline, but profitability will increase, and thus eventually production.
Probably the most absurd math of all is when the bears point to the trend for more consumer demand for ground beef. Certainly, cooking methods have changed in the past few decades. There aren’t as many roasts being consumed, and the industry has been addressing the decline of the value of the non-middle meat cuts. In fact, we’ve actually seen good success in this area, with the value of those cuts rising in comparison to the middle meats. The bottom line is that the overall value of the carcass has been moving forward at a very healthy pace. Ground beef is the king of foods, but consumers love and are still eating their steak as well.
The reality is that – along with the efficiency of beef production – land values, ethanol, transportation costs, labor etc., have all increased dramatically. Cattlemen are, and will continue to be, very astute business people. The commodity business model has forced the industry to adopt a low-cost producer mindset, and it will continue to be the key to survival. That’s just a competition that will never cease.
However, it all comes down to the value equation, and we will not and cannot win that competition based solely on price. Everyone supports market differentiation and niche marketing, but it’s misguided at best – and arrogant at worst – to suggest that the current mainstream model has developed because the industry does not understand the consumer and that the grass-fed model or other niche markets are the answer.
We’ll continue to lower costs of production through genetics, improved management, and new technologies, but the ultimate focus has to be demand because it determines the dollars flowing into our industry. And the dollars flowing into our industry will be the primary arbitrator of industry size.
Many other industries have attained their efficiencies by applying new technologies and reducing labor costs. Rarely did they gain those efficiencies by downgrading the quality of their product. The market is doing a better job than ever of signaling what it desires, and the American cattlemen are doing a tremendous job of responding to those signals.
If anything, we need to redouble those efforts. Returning to the production model of the past may be the answer for some, but it isn’t the answer for the industry as a whole. It is really simple math, if we take the time to listen to a changing marketplace.