Visions for the Millennium:
Structural Changes Facing Livestock and Grain Industries
Tuesday, May 9, 2000
Kansas City, Missouri
Executive Vice President – Cargill, Incorporated
Question: Should public policies facilitate or retard the structural changes that are occurring in agriculture and agribusiness industries, and what should those public policies be?
The question is big and multi-faceted. I think the discussion has to involve multiple angles – among these: agricultural production and marketing policy, economic policy, investment policy, trade policy and antitrust policy.
My short answer is that government should be thoughtful and diligent -- and tough when it needs to be. But government should neither encourage nor discourage changes that are a function of a mature industry trying to adapt to a competitive, fickle marketplace.
Policies for Growth
It goes without saying that the U.S. grains-oilseeds-livestock sector will do better if it is growing rather than stagnant or shrinking.
We are learning, sometimes the hard way, that the sector can only grow by aligning with the forces of change at work in the industry -- factors like the drive for efficiency, shifting consumer demands, and the need to expand exports. More simply, the U.S. grains-oilseeds-livestock sector needs to be a low cost producer of what consumers want.
Growth will require change from all segments of the industry, and it will require better communication and collaboration across the industry. A strategy for growth means that each segment must have an opportunity to profit. As an illustration of this, let me tell you about a recent experience we had with a major customer. A restaurant operator met with us to outline his plans for a new group of white tablecloth steakhouses featuring prime beef. But he knew that only 2 percent of cattle grade as "prime," so supplies could be unreliable. We showed this investor that by partnering with a specific group of ranchers and feeders we could bring in cattle that could grade as high as 8 or 9 percent "prime." There is no way that Excel could achieve those high levels alone. We have to have alliances with producers who know that growth happens when we respond to customer demands for taste and quality.
Public policy has an important role in a growth strategy. Policy should be designed and used to remove barriers to growth and to ensure that markets are competitive and free of artificial barriers. If you are a pork producer, there is almost nothing more important for your future than for the United States government to negotiate for greater market access in Asia. If you are a beef producer, one of the most important things would be to win the beef hormone case. If you are a grain or oilseed producer, it may be transparent rules for the marketing and export of genetically enhanced materials. And none of these things can be done without an engaged public policy process.
As difficult as it may be to accept, as economies develop, people leave an agrarian existence and move to other segments of the economy. We see this all over the world. As the poorest countries start to develop, incomes rise, and people can buy their food rather than be required to produce it. In a developed country, where people have food on the table, but want to continue to live in rural areas because they love agriculture or for a better quality of life, this movement from farm to cities can be slowed. But that can happen only if agriculture is allowed to grow, producing more specialized products, and serving global markets. The shift from the farm will not be slowed by resisting changes required to respond to market forces.
The Causes of Change
In order to consider policies relating to the changing structure of agriculture, one must first have a solid understanding of the factors that are driving that change. A constantly changing marketplace presents complex challenges, and we know that anyone in the agri-food complex who doesn’t adapt will be left behind.
I appreciate and understand that constituents are raising concerns about consolidation -- about fewer buyers for their grains, and livestock, and fewer sellers of seeds and chemicals. And in no way do I want to minimize these concerns or suggest that they are not real. I grew up in small-town North Dakota. I know the concern and fear are real.
Most hearings on agricultural consolidation address the effects on producers and rural communities, but they rarely give much reference to the causes of structural change. They don’t get into why the last tractor dealer in town closed its doors, why Continental left the grain business, or why Beef America went away.
The structural change underway in agriculture is not a product of some sinister motivation or vast conspiracy. Rather it is based on the drive to survive and a continued belief in American agriculture and ingenuity. Changes are driven by a host of factors over which Congress and regulators have little control -- things like competition for capital, innovation, changing customer requirements and consumer preferences, shifts in agricultural production, and foreign market access.
For greater detail, let’s look at several factors behind many of the changes that have occurred. Because it is what I am most familiar with, I will use the meat industry as the example.
According to USDA’s Economic Research Service, beef consumption dropped from 84.7 pounds per person in 1971-75 to 66.3 pounds by 1991-95. The ERS also tells us that per capita chicken consumption nearly doubled, from 36 to 70 pounds in the same period. A 22 percent drop in consumption of anything logically means there is capacity that won’t be around long. In roughly the same period, also according to USDA, cattle carcass weights increased from about 580 pounds to 729 pounds, an increase of about 6 pounds per year. We also clearly know that a doubling of chicken consumption has had a huge impact on the industry. These changes present serious challenges to packers and producers – and these changes are beyond the power of the government to control.
Innovation and Technology
Innovation – or the lack thereof – has played a significant role in structural change.
For instance, retailers no longer buy many hanging carcasses or large primal cuts. Starting 20 or 25 years ago, the larger packers made investments in fabrication operations attached to their packing plants so they could produce much more customer-friendly boxed beef. And today that trend is continuing in the form of consumer ready, pre-packaged fresh meat. Retailers want strategic supply relationships that can guarantee them consistency, quality and dependability every day. Retailers want to be known for the quality of their meat case. This is causing even more change in the industry – change that regulators and Congress members need to more clearly understand.
Another area where innovative packers have made substantial investment is in harvesting offal and other items from an animal that, in the past, may have gone straight to the rendering plant. Through this kind of investment, some have been able to obtain new value, adding to their per head margin. Packers that have not done this have missed some important opportunities and have fallen behind.
To stray from the meat industry for a moment, technological innovation has meant huge gains for crop production as well. According to USDA’s Agricultural Statistics Service,
in 1955 it took as much as 12 hours of labor and 4 acres of land to produce 100 bushels of wheat. By 1987, those same 100 bushels could be produced with 2.75 hours of labor on 1.125 acres.
Looking at these figures, one can see a clear picture of why John Deere tractor sales dropped by half from the early 1970’s to 1998.
The retail sector has seen fairly dramatic structural change in the past few years with the advent of superstores and the merger of local and regional chains into national market forces. According to analysis by David Nelson at CS First Boston, in 1993 the top five supermarket chains had a 20 percent market share. Today, that share is 40 percent. The buying power and the supply specifications of these larger firms have made the market extremely competitive and tough to serve. It is a marketplace where some marginal players cannot survive.
Consumer demand for higher food safety assurances presents another dimension to change in the industry landscape. New requirements that necessitate the most advanced risk technology have left a number of major players unable to compete, and they have left the business. Food safety risks have prompted companies to reevaluate their participation in various industry segments.
Structural change also occurs as industry participants decide to specialize. For instance, Excel got into the pork business when Oscar Mayer decided it wanted to streamline its very successful further processed products operations and not slaughter hogs anymore. According to ERS, others did the same, so that today, operators who have no slaughter operations do almost two-thirds of the cured pork business.
Structural change in the processing sector is not unlike the change we have seen in the production sector. According to the ERS report, by 1992, 150 feedlots sold 43 percent of all cattle purchased by packers – and I would wager that that figure has increased in the past eight years. Pork production statistics are even more dramatic, with 2.4 percent of the producers marketing 53 percent of the hogs in 1997.
Some of the change in the feeding sector structure has been to capitalize on genetics, which leads to improvements in carcass grade and yield performance, and changes in finished product offerings. Through these advances, beef and pork are becoming less of a commodity and more of a value-added product. Lines of fat-free or reduced fat products have become possible.
This point should not be taken as a blanket endorsement of a completely vertically integrated livestock and meat complex. Rather, we must recognize that our marketplace is quickly changing and producers, large and small, must change with it. Industry participants who do not understand where the market is going and do not change to move with it will soon be left even further behind.
Well-Intended Steps and Unintended Consequences
No industry can survive without responding to changing consumer behaviors or technological innovations. If the industry, including producers, doesn’t recognize and meet these challenges, we go the way of the Edsel, Packard and Studebaker.
Some of the policy proposals I have seen in Congress, the state legislatures and even from some producer organizations demonstrate a misguided belief that, by locking everything in place, we can somehow stop the hands of time and preserve an industry that is profitable for everyone all of the time. But we know in our hearts, that government solutions cannot force the marketplace to buy something that consumers don’t want. Let’s walk through some of these proposals and the implications they embody.
Merger and Acquisition Moratoria
Last year the Senate voted 71 to 27 against an amendment that called for an 18-month moratorium on agribusiness mergers and acquisitions. After some debate, Congress recognized that this proposal had tremendous negative implications for the agricultural sector – and for the broader business community. Arbitrarily choosing a point in time at which an industry’s structure should be frozen in place makes no sense by any measure.
This kind of control – locking in an industry to the status quo -- would bring further instability to stock prices. It would lead Wall Street to conclude, ever more firmly, that agriculture is not a good place to invest. From a purely parochial view, it would lock Excel – the number two beef packer – into a position that is just over one-half the size of the number one packer, IBP.
Federal and State Prohibition on Packers Owning and Controlling Livestock
There are numerous proposals in Congress and in state legislatures to prohibit packers from owning or controlling livestock. This sounds like a simple enough proposition, but I assure you that it is not simple at all. Some of the legislation is written so broadly as to actually prohibit contracting and to outlaw alliances that producers and packers have created that reward value. Under some of the legislation, the joint venture Excel and the Iowa Cattlemen are working on would be illegal. Premium Standard Farms, Harris Ranch and U.S. Premium Beef would be unlawful and would be required to close down.
Outright elimination of contracts, as some propose, will have a dramatic impact on a producer’s ability to manage risk, and importantly, to access capital. It devalues existing industry investments. It totally undermines value-based marketing. It will destroy the brand names the industry had been struggling to build. It will make the meat dining experience less consistent, undermining our campaign to increase beef and pork consumption.
These are points that proponents of a ban on packer ownership and control really need to consider and evaluate. Full study of the issue will make the right choice on this issue an easy one.
Taxpayer-Funded Processing Plants
Various groups have advocated the use of taxpayer funds for grants to pork producers to build new processing plants. But this kind of selective government involvement has very serious implications for the industry and can bring about a host of unintended consequences.
In spite of the fact that hog supplies filled plant capacity in December of 1998, today’s supply of shackle space is still greater than the overall consumer demand for pork. The decision on whether to increase capacity should not be a function of having a huge supply of hogs; rather, it turns on increasing consumer demand for pork products.
Still today there are unprofitable pork plants. And we won’t be surprised if more close this year. A government infusion of new capital and new capacity will only serve to force more struggling plants out of business. And not only does this harm existing plants, it also harms the producers who surround the plant by eliminating their closest markets and eliminating the value-based marketing arrangements on which they have borrowed money and built their farms.
Is this really what we want to do?
Some groups argue that the problem with consolidation is that the antitrust laws aren’t strong enough. But careful review of the law, and the track record of the Justice Department’s enforcement record in agribusiness, says otherwise.
Probably the most talked about merger in the recent past was Cargill’s acquisition of Continental Grain. I am pretty familiar with the volume of information our firm supplied the DOJ during the review process. I am very familiar with the requirement that in the process of completing the acquisition, Cargill and Continental were required to sell ten elevators (seven owned by Continental and three owned by Cargill) to other parties serving both the domestic and export marketplace. I would call your attention to a comprehensive summary of the DOJ’s activity on this case that is now on the Antitrust Division’s Web site. It shows that the DOJ "slices and dices" mergers and acquisitions from every angle imaginable. Their analysis demonstrates depth and skill. And it shows tremendous cooperation with the USDA.
I can assure you from Cargill’s experience that the DOJ takes its job very seriously. The public only gets to hear about the cases where the DOJ gets involved, taking action to place conditions on mergers and acquisitions. What the public doesn’t hear about are the cases where informal discussions with the DOJ about prospective mergers or acquisitions have caused firms to abandon any plans for going forward. This was our experience when several years ago Excel was interested in buying a competitor – Beef America. Top officials of the DOJ Antitrust Division clearly communicated to us their concerns with this potential acquisition, so we decided to abandon the idea. Incidentally, Beef America is out of business today.
What I’m saying is that the existing system works. Legal scholars and even the Justice Department say that there is no evidence to the contrary. Politically expedient changes in the antitrust laws, to make mergers and acquisitions more difficult or drawn out, will make industry less competitive in the marketplace. By making the food industry less competitive, we certainly are not helping farmers.
The area of non-tariff trade barriers is particularly troublesome. The EU beef hormone case should help U.S. livestock producers recognize that these kinds of barriers, in violation of international trade agreements, are wrong.
Additional country of origin labeling proposals are thinly disguised sticks in the eyes of Canada. The clear intent of these proposals is to block imports of beef from that country. If proponents are successful and create greater hurdles for product entering the U.S., there will be swift retaliation. The very successful Northwest Pilot Project, through which northern tier cattlemen are exporting a growing volume of feeder cattle into Canadian feedlots, would probably be history. Again, it is the U.S. beef industry that would be harmed.
We’ve seen a spate of dumping cases filed against countries exporting meat or livestock to the U.S. – only to lose them because they are found baseless. One could argue that the beef dumping case brought by Mexico may not have happened were it not for the case filed earlier by R-CALF against Mexican feeder imports. In the end, the U.S. beef industry was harmed.
Policies that Help Rural America
In my view, the question for our panel should be reframed. Rather than talk about policies that encourage or retard structural change, we should focus on policies that foster growth or at a minimum do no harm.
A comprehensive rural development strategy is a good place to start -- one that helps create attractive jobs in rural areas, jobs where people want to live and raise their families. If the grains-oilseeds-livestock sector is growing, fewer people must adjust. If the sector is stagnant or declining, more people have to adjust. The adjustment challenge is always there, but it is more manageable under a growth strategy.
In our view, the best growth opportunities for producers are in differentiating their products from the person next door. We want partnerships and alliances with cattle producers who will produce beef that the marketplace values. We want relationships with hog producers that can help us guarantee to an Asian retailer the quality of pork that the Asian consumer wants. We want relationships with corn growers who want to grow the kind of grain that a corn chip or cereal manufacturer needs and is willing to pay for.
The fortunes of agribusiness firms and farmers are inextricably linked. Our success will be defined in part by how good a job we do in forging strategic alliances. The belief by some that partnerships, alliances and contracts turn farmers into serfs for hire is nonsense. This is condescending at best, suggesting that producers aren’t smart enough to decide what’s in the best interest of their farms and families.
Changes in farm policy have freed up farmers to make planting decisions that make sense. There are more common sense steps that Congress can and should take to support the industry.
The most pro-growth step lawmakers can take for agriculture today is passing Permanent Normal Trade Relations for China. That nation represents more than a billion potential consumers for U.S. goods and services.
The next round of WTO negotiations should be used to aggressively pursue further reduction and elimination of non-tariff trade barriers and quotas. Tariffs should be reduced and the power of state trading monopolies should be targeted.
Congress and regulators should take steps to ensure that environmental laws and regulations, such as wetlands preservation, private property concerns and the Endangered Species Act, are applied in a manner that protects the environment with flexibility and common sense.
Congress should review the tax code to make sure that self-employed farmers and ranchers are treated as well as those of us who work for larger firms. Capital gains, health care deductibility and estate taxes are three areas key to farmers and ranchers.
These pro-growth approaches are the things that I believe the agricultural sector would most value. Farmers and ranchers are pretty independent. They are right to be skeptical of any notion that things will be better if only the government were more involved.
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