Hunt, Steven D.

English

Research Papers in Economics

Agricultural Outlook Forum 2001  Presented: Thursday, February 22, 2001
U.S. PREMIUM BEEF
SELLING MEAT AND MEALS INSTEAD OF CATTLE
Steven D. Hunt
Chief Executive Officer
U.S. Premium Beef, Ltd.
Thank you for this opportunity to come before you once again to provide an
update on the success of our Company and plans for the future.  As many of
you are aware, U.S. Premium Beef (USPB) was formed back in July of 1996
as a closed marketing cooperative made up of cattle producers who
organized with the common mission to “sell meat and meals instead of
cattle”.
Winston Churchill once observed, “No revolution was ever fought and won
behind the battle cry, we must reach consensus.”  As producers we must
break out of the commodity mold and move toward the marketing of value-
added products.  This movement of developing creative marketing practices
is at times neither popular nor easy.  For USPB, our shareholders not only
risked their hard earned equity, but withstood political fall-out from the very
people who have been the most vocal against our current marketing
practices.
I urge USDA and our lawmakers to listen to a broad sampling of producer
input regarding such issues as limiting marketing arrangements between
packers and producers and producer contract protection.  We risk
inadvertently squelching the very opportunities innovative producers have
been fostering to move into a value-added category.
It is important to realize up front that not every producer-owned venture has
reached fruition or succeeded.  In fact, we as producers have historically
experienced limited success in owning businesses outside of the ones we
manage daily.  The reasons range from over-optimistic feasibility analysis,
lack of practical vision, lack of expertise, improper Board/Management
roles, becoming too political, improper or limited due diligence, too many
chiefs and lack of lender support.  It takes a tremendous amount of disciplinein order to avoid these pitfalls.  As we were developing USPB, we even
resorted to such economic disincentives as fining an individual $100 each
time planning discussions deteriorated to a political focus.  There are a
thousand ways to put a producer owned cooperative venture together wrong
and only a handful the right way.
The founders of USPB were motivated to pursue our venture by one thing;
FEAR.  Fear is a great motivator.   The fear of being a highly invested
participant in an industry that had lost market share for 20 consecutive years.
The awareness that under the current marketing system, the economic
signals were to buy the cheapest, poorest animal that walked the face of the
earth and feed him until a feedlot bundled him with entire showlist and sold
at one price.  If the consumer paid General Motors the same price for
Chevys as Cadillacs, they would stop manufacturing Cadillacs.  The beef
industry has too many Chevys because of our broken marketing system.  We
also feared that under an extremely segmented marketing system that
independently, we lacked the ability to realize a competitive price.
Our fear motivated us to identify several keys to a successful beef industry.
First, we must implement a value-based pricing system where there is
economic incentive to produce an animal that the consumer wants.  Second,
the producer must have the knowledge, carcass data, to effect change.  And
thirdly, the producer must have ownership beyond the pen gate.  We must
move the price discovery point where the consumer purchases our product.
Only then will the producer realize full value for their product.
From this, we developed a mission.  Our mission in USPB is to profitably
sell meat and meals instead of cattle.
The USPB concept was evolving into an integrated strategy.  Historically,
producers have viewed vertical integration with much skepticism due to the
model developed in other species such as poultry and pork.  In these
industries, vertical integration was typically top-down.  However, by
contrasting the beef industry to other species you see a dramatic difference
in the ability to concentrate production. In swine and poultry, concentration
is feasible because the cheapest feed source, small grains and concentrated
protein sources, is mobile.  However in beef, cattle are most efficiently
grown through he utilization of the grass roughage that is geographically
dispersed throughout the United States.  Therefore there is a limited ability
to efficiently concentrate beef production.  This results in a tremendousdifference in capital investment in production assets.  Universities estimate
that the average investment in production assets per cow/calf unit is between
$2000 and $4000.  This is substantially higher than the cost of processing,
which could run as high as $200 per carcass unit.  Contrast this once more to
pork and poultry where due to the ability to concentrate, the per-unit cost of
production is comparable to per unit cost of processing.  It is more likely in
these species that vertical integration would occur top down.  Now, how
likely is it that a processor will vertically integrate downward into livestock
production ownership in the beef industry?  It is highly unlikely a processing
would make this level of investment.  However, if you are a producer with
over $2000 per animal unit invested, how likely is it that given the
opportunity, you would invest an additional $200 to sell meat and meals
instead of cattle?  This was the point when we decided, USPB could and
should work.
When we began exploring the development of USPB back in the fall of
1995, our hopes were to have a plan to take to producers within one year.
We were wrong.  We incorporated on July 1, 1996 and began developing a
membership base, exploring processing options and lining up debt financing.
We eventually reached a tentative deal with Farmland Industries in the form
of a letter of intent on July 1, 1997.  This led to the introduction of a stock
offering on September 1, 1997.  On November 1, 1997 we closed the first
stock offering raising $38 million in producer equity.  We subsequently
purchased a partnership interest in Farmland National Beef on December 1,
1997 and delivered our first animal on the very same day.
The acquisition can be broke down on a per-head basis as follows: The cost
of acquisition was $104 per head.  We raised $55 per head/share of producer
equity and borrowed $50 per head of capacity.  One share held the right and
obligation to deliver one head of finished cattle per year to the processing
facility and a pro-rata share of company earnings.
While exploring processing ownership options, we considered all
alternatives including building, a buy-out and joint venture.  Our due
diligence of the packing industry revealed many things.  Many of which
were in conflict with the producer perception.  We discovered there was a
difference in profitability, there was intense competition between players,
there were failures even among large sound financial participants and profits
were seasonal among many other things.  Above all, we discovered that
entering this business without an exiting participant as a partner was suicide.Our decision to enter a partnership with Farmland was driven by the results
of our investigation of the company’s size, management, profitability and
presence in the value-added product sector.  As the nation’s fourth largest
beef processor, there existed the size necessary to realize economies of scale
yet small enough whereby we could achieve a significant enough ownership
to establish governance.  Farmland National Beef has successfully built a
company that was competitive in operational efficiencies and began
establishing branded programs utilizing the Farmland brand.  Over time, it
became our first choice of processing partners.
The primary benefits to producers who participate in USPB are a
competitive value-based grid, free carcass data, further processing earnings
and guaranteed market access.  After the following brief summary of the
USPB program to date, I will relate our performance relative to the costs of
participation:
1404 members in 33 states
360 stockholders in 20 states
780 feedyards have shipped cattle in 14 states
1.8 million cattle delivered
$24 million in cash grid premiums paid
$36 million in processing earnings
$1.5 billion in total sales
The foundation behind our value-based pricing system is the USPB grid.  In
industry terms, the USPB grid is considered a “white tablecloth” grid.  As
the name implies, we are attracting cattle that would produce a meat product
in the higher quality categories of choice, upper choice and prime.  For
example, if a USPB producer delivered a prime carcass, they could realize a
quality grade premium of  $150 per head.  Since our program began, the
AVERAGE premium per head has increased over 90% to $14.34.  The top
50% realize an average per head premium of over $31.  The top 25% now
realize on average over $41 per head premium.
Processing earnings continue to distinguish USPB from many other alliance
programs in the industry today.  To date, USPB has generated over $36
million in earnings.  In fiscal 2000 alone, USPB members realized  $27.59 in
earnings on every head delivered, representing a three-fold increase from our
first full year of operations.The best indicator of success of our program is share value.  As a
shareholder in USPB, you have the ability to transfer or sale your shares on a
private treaty basis to other cattle producers.  We routinely assist our
shareholders in selling and purchasing shares.  Since our initial offering in
the fall of 1997, our shares have increased in value 67%, from $55 to $92
per share.
While the early investors in USPB took a calculated risk in capitalizing and
supporting USPB, the returns have far exceeded expectations.  Their $55 per
head investment has realized on average a 200% return taking into account
the grid premiums, company earnings and stock appreciation.  To put it in
cattle terms, in fiscal 2000, the top 50% of our cattle delivered earned their
members over $76 per hundredweight compared to an average $69 market.
That is over $7 per hundredweight advantage by participating in USPB.
These opportunities exist for beef producers and other agricultural producers
if the desire exists.  Darwin said it best, “It is not the strongest of the species
that survives, nor the most intelligent; it is the one that is most adaptable to
change.”  Great words to ponder as producers, processors and legislators
search for the path to the most efficient production of an abundant, better
and safer food supply.
Thank you again for the opportunity to visit with you today.

U.S. PREMIUM BEEF: SELLING MEAT AND MEALS INSTEAD OF CATTLE

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