"It’s a complex business because there are so many moving parts, but it’s not really that complicated,” James Henderson says of the beef packing business. “You figure your cost on a per-head basis and your revenue by the pound. As long as that’s the case, the incentive is to make carcasses heavier.”

Henderson of the Bradley 3 Ranch in Memphis, TX, has a long history in the beef-packing business, including a stint as vice president of B3R Country Meats. He now consults in the packing business.

In simplistic terms, if you’ve invested in the capacity to harvest 6,000 head of cattle/day, the primary way to drive costs lower is by utilizing as much of that capacity as possible. But, as cattle numbers dwindle, that’s tougher to do.

In fact, it was declining cattle numbers and increased competition from poultry – the impact on cost and profit margins – that fueled the mass concentration and consolidation in the 1980s that had so many producers wringing their hands; some still worry their knuckle fuzz over it.

“When both are operated close to capacity, smaller plants are at an absolute cost disadvantage compared with larger plants,” according to the Livestock and Meat Marketing Study (LMMS) prepared for the Grain Inspection, Packers and Stockyard Administration in 2007. “When larger plants operate with smaller volumes, they have higher costs than smaller plants operating close to capacity and, thus, have an incentive to increase throughput. For all plants, large and small, average total cost increases sharply as volumes are reduced…”

Go back to the early 1900s and history says there were the Big Five packers – Armour, Cudahy, Morris, Swift and Wilson. Charges of packer collusion led to the Packer Consent Decree of 1920. Among other stipulations, the law forced them to divest ownership of public stockyards, stockyard railroads and market newspapers.

As the nation’s cattle population and beef demand grew, so did the number of independent beef packing companies. As late as 1980, what is termed the Four-Firm Concentration Ratio (Table 1) was 36%.

Today, we have the Big Four – Cargill Meat Solutions, Tyson Foods, Inc., JBS Beef Co., and National Beef Packing LLC. They accounted for 85% of the nation’s steer and heifer slaughter in 2010, according to the 2011 Packers and Stockyards Program (P&SP) Annual Report.

There were about 140 cattle packing plants (not to be confused with packing companies) in 2010, according to the P&SP report. The Big Four owned 29 of them, according to Steve Kay at Cattle Buyers Weekly. The 258 firms subject to the Packers and Stockyards Act in 2011 were 28% fewer than in 2000.

Incidentally, packer ownership of cattle is far less pervasive than some perceive. According to the P&SP report, packer feeding represented a little more than 5% of cattle in 2010; and it doesn’t fluctuate much. P&SP defines packer-fed cattle as those obtained for slaughter from a subsidiary of the packer, the packer’s parent firm, or a subsidiary of the packer’s parent firm, owned in part, or in whole, for more than 14 days before the cattle are harvested.

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Forward contracting represented just over 12% of packer procurement in 2010. About 60% of fed cattle traded on a carcass basis in 2010 with the remainder purchased on a live basis. According to the P&SP report, around 40% of fed cattle traded in 2010 were procured by packers through negotiated trade; slightly more than 40% were formula-priced. The remainder was procured through forward-contracts or packer-feeding.

Though some folks carry on the packer witch hunt, the fact is that there is no grand conspiracy among packers to control the market. Instead, the sheer scope of this particular margin business demands strict adherence to economics. They’ve embraced tools like alternative marketing arrangements (AMAs) simply because that’s what the market says is in their best financial interests.

Sorting cuts both ways

“In the packing business, it’s never as much about the market as it is about plant utilization,” Henderson emphasizes. “Plant utilization drives packer profitability.”

Arguably both have been helped and hindered by the manifold increase in packer sorting that began with the latest round of beef branding in the 1980s.

“I can remember when there were three cooler sorts – Prime, Choice and everything else,” Henderson says. Today, he says the largest plants utilize more than 30 sorts, many of those occurring before cattle get to the cooler. Think here of such things as natural beef, different export requirements for beef that can go to Europe or Japan, the eligibility requirements for various breed brands, and all of the rest.

For each pre-cooler sort, Hender-son explains the fabrication area must be cleaned, which costs thousands of dollars each time. Then packers must keep track of around 200 products from each of those sorts. Where packers might have produced and marketed 600 products 25 years ago, they might have more than 6,000 products today.

According to Henderson, this exponential increase in sorting, along with heavier carcass weights, has enabled packers to dilute the impact of dwindling cattle numbers to some degree. At some point, though, he suspects some packing capacity must exit the business.

Paradoxically, taking some of the sorting out of packer hands could grow the economic pie, both for packers and producers.

“As an industry, we decided to let the packers sort the cattle rather than sort them ourselves, and that’s not something they’re necessarily good at,” Henderson says.

Instead, imagine producers further employing technologies like ultrasound and genomics to sort cattle before they ever head to the packing plant. Currently, Henderson reckons all the packer sorting mentioned previously equates to a cost of around $15/head. That cost could be reduced significantly with more pre-harvest sorting.

Working closer to the source

In the meantime, the shifting consumer demand that led to product branding and required the additional sorting has fostered closer cooperation between packers and other industry segments.

That congressionally mandated LMMS report cited earlier explored the market effects of AMAs. According to the study, the term includes a variety of arrangements that establish an ongoing relationship for trading multiple lots of cattle to the packer, rather than negotiating the sale of single lots of cattle. In these arrangements, the seller agrees to deliver cattle to the packer at a future date, with the price generally being determined by some type of formula pricing mechanism.

Among the LMMS conclusions:

  • “The beef producers and packers interviewed believed that some types of AMAs helped them manage their operations more efficiently, reduced risk, and improved beef quality. Feedlots identified cost savings of $1-$17/head from improved capacity utilization, more standardized feeding programs, and reduced financial commitments required to keep the feedlot at capacity. Packers identified cost savings of 40¢/head in reduced procurement cost. Both agreed that if packers could not own cattle, higher returns would be needed to attract other investors, and that beef quality would suffer in an all-commodity market place.
  • “The producers surveyed that used AMAs identified the ability to buy/sell higher-quality cattle, improve supply management, and obtain better prices as the leading reasons for using AMAs.
  • “The packers surveyed that used AMAs said that their top three reasons for using AMAs were to improve week-to-week supply management, secure higher-quality cattle, and allow for product branding in retail stores.
  • “Regression analysis of the relationship between cash market (auction barns, dealers and brokers, and direct trade) transaction prices for fed cattle and use of marketing arrangements suggests that if capacity utilization within a plant increases through the use of AMAs, firms pay slightly less per pound for cattle purchased in the cash market.”

The bottom line, according to the independent study: “The cost savings and quality improvements associated with the use of AMAs outweigh the effect of potential oligopsony market power that AMAs may provide packers.”

Henderson points out: “These plants have operated at probably 80-85% of capacity for the past several years. My big concern over the next 18-24 months is who survives. If you lose some of these regional plants out of the heart of cattle country, what will that do to the rest of the industry?”