US - One of the more famous advertisements of the 1970s featured crusty old actor John Houseman explaining that "At Smith Barney, we make money the old fashioned way. We earrrrrrrrrrn it." That line, of course, has led to many "We steeaaaalll it!" parodies of other brokerage firms in the post-Great Recession years, but the original serves as an appropriate touchstone, I believe, for this National Hog Farmer Blueprint issue on maintaining markets for US pork, writes Steve Meyer in this week's "Market Preview".
Like money, very few markets or market opportunities are handed to you. In virtually every case you must earn those markets or, more appropriately, the trust and preferences of the people who buy products in those markets. There was a time when that was relatively easy because products were less numerous and relatively simple, and consumers had relatively simple needs and desires. However, those times are long gone, as pork (or any product, for that matter) must compete with many alternative products in terms of both consumer utility and budget allocation. This is not your grandfather’s pork market!
A great deal of attention has been paid over the years to the concept of "market access." In one usage, the term refers to efforts to lower various countries’ barriers to US pork imports. It also has referred to the degree to which independent (i.e., non-integrated) producers can easily sell hogs at the going price for a given time period. The first context clearly deals with institutional restrictions. The second was a topic of hot debate during the rapid consolidation of pork production during the 1990s.
Beyond the concepts of institutional or market structure barriers, however, lies the important concept of earning one’s place in the market. Just what has to happen for pork to maintain — or even grow — its market? Is it an issue of reducing institutional barriers? Is the challenge to change the ownership and operational characteristics of the various pieces of the pork industry? Perhaps both are true to some extent, but my hypothesis is that the real challenge is earning anew every day the loyalty and trust of consumers both at home and abroad. Without doing so, nothing else matters.
A few years back, "competitiveness" was the hot topic in agribusiness circles. Identifying what country or region was the most "competitive" in various segments became a cottage industry. Many efforts focused solely on costs of production. Others put various scoring mechanisms together to gauge who did what the best. Most focused on one product and the relative strength of several suppliers. Hardly anyone talked about competitiveness between two product types (pork and chicken, for instance).
My definition of competitiveness is: "A company or industry’s ability to offer a product whose consumer-defined value is greater than or equal to that of another product that the consumer will buy, while earning a rate of return on invested capital at least as high as could be earned on another equally risky investment."
The definition makes two main points. First, competitiveness is about value relative to other items in the marketplace. Second, competitiveness must involve profitability that is at least sufficient to keep capital invested. The components are presented graphically in Figure 1, which breaks the definition into even more basic building blocks.
Product value is the combination of quality and price. We all know that the cheapest product is usually not the best, and the best product frequently costs far more than an acceptable alternative. The best value often lies somewhere between the extremes of both. And buyers are not stupid. They will determine value and reward it! If the US pork industry is to maintain markets both here and abroad, it must consistently deliver products that meet or exceed its customers’ ideas of good value.
Some customers will demand the highest in quality and be willing to pay handsomely for it. Components of that "quality" might include the genetics of the source pigs, what those pigs were fed and how they were raised. It doesn’t matter whether producers believe those things enhance "quality." Quality here is in the eye of the buyers.
Other customers will, perhaps due to limited means, put price as their No. 1 priority and be willing to accept quality which the first group of buyers would consider inferior. But remember that user-defined value is the issue, and one group does not get to make decisions for another. Or at least it should not be allowed to do so.
Return on investment is the combination of selling price and cost of production, where that cost includes a normal rate of return on invested capital. That normal rate could be earned elsewhere and thus represents an "opportunity" cost. Low costs may pay great dividends in the short run, but if they cannot be realized without compromising product quality, they will eventually hurt competitiveness.
The model, I believe, provides a useful guide with which to address the issue of market maintenance as well.
At first glance, the section title is self-evident. But let’s remember that both consumers and products can evolve in directions that leave entire markets in doubt, or at least diminished. The pork industry witnessed such changes in the 1980s when consumers, whether right or wrong, became quite concerned over fat and cholesterol levels in food, and began to express desires for leaner meat proteins that they perceived to be healthier. The shift led to a significant decline in pork demand and very difficult times for hog producers. The product simply could not change fast enough to meet the ever-higher expectations of consumers.
But there is some evidence that the opposite occurred in the 1990s and 2000s, as producers continued to make hogs leaner. That "improvement" was driven by our painful 1980s demand experience and the realization that lean hogs were less costly to raise. Cost-centric producers continued to push hogs leaner, to the point where fat content and muscle quality declined and consumers began to shy away from "The Other White Meat." Declining concerns over fat and cholesterol — the very issues that drove consumers away from pork in the 1980s — worked against this leaner, supposedly healthier product. Renewed consumer interest in flavor, juiciness and texture, or "the eating experience," exacerbated the challenge. We couldn’t win for losing!
The industry has steadily adapted to consumer desires and needs to increase the level of consumer-defined quality, thus enhancing the basic value proposition offered to consumers. Pork is available on far more restaurant menus than it once was, better addressing many consumers’ increasing desire for somebody else to cook their food. In addition, new processing methods have improved existing products and created new ones, meeting needs for convenience and flavor.
And has all of this resulted in a growing domestic market? Yes, in terms of total volume, but no on a per capita basis. But the changes did at least maintain pork demand near its late-1980s levels, even as beef demand fell through 1998 and chicken demand continued to grow through the 2000s.
The overriding story of American agriculture has been the steady growth of its productivity and the resulting steady decline in the cost of producing food. Those lower costs have allowed Americans to spend less and less of their incomes on food than any nationality on earth. And the pork industry is no exception.
The cost of producing pork in the United States declined steadily from the early 1980s through 2006. Advances in genetics, nutrition, management systems and facility designs all allowed pigs to grow faster on less feed. In addition, economies of scale allowed specialized management and labor to be leveraged to their fullest, and let producers spread fixed assets over more units of output. The resulting downtrend is clear in Figure 2, which depicts average costs of Iowa farrow-to-finish operations from Iowa State University.
But Figure 2 tells the story of the average. Early adopters drove costs downward more quickly than did producers who were either unable, or simply late, to adopt change. The resulting higher returns gave those innovators a competitive advantage on the production side and allowed them to do what competitive firms do: Grow and capture market share.
Feed vs. Fuel
The pork industry’s long success story of lower costs came to a screeching halt in 2007, when the adoption of the Energy Security and Independence Act of 2007 raised the rate at which motor-fuel blenders would be required to use ethanol, thus increasing the demand for corn. The troublesome part of the policy was that the rate of increase for ethanol usage was far greater than corn producers could match with production growth. Resulting tight supplies pushed corn and soybean prices to record levels. Those prices, in turn, broke the long downtrend of hog production costs, eventually pushing them to record highs in 2008 and 2011-13.
In the middle of this entire competitive effort to maintain market position is price. Determined by the basic forces of supply and demand, it augments quality in establishing value in the eyes of consumers, and works with costs to determine the financial successes or failures of producers, and the ability of the industry to maintain a sufficient stock of capital.
This great lever has changed its direction of force sharply in recent years. Where costs once allowed prices to decline and still provide sufficient returns to capital, their increase since 2006 has reduced those returns, forcing some capital from the industry. That downsizing — at least on a per-consumer basis — pushed prices higher and made the value proposition for consumers more challenging. While other species faced the same cost and price obstacles, cost increases were not uniform. Chicken gained some advantage in the process while the beef industry, which has also been buffeted by significant droughts in recent years, lost some competitive position.
Now the pork industry faces perhaps its greatest challenge ever: porcine epidemic diarrhea virus (PEDV).
The industry has long feared a foreign animal disease that would kill export demand or hurt US consumer confidence. To our great discredit, no one gave much thought to a disease that would reduce output and push prices sharply higher. The higher prices will be good for producers’ returns to capital, but will cause significant damage to the consumer value proposition since the quality terms that balance price have not changed.
Maintaining our market position will be difficult at best, and the odds are that the pork industry will have to win back consumers who decide that our product has asked too much in terms of price to maintain its value position in the marketplace. We will have to either reduce costs or deliver more consumer-defined quality to defend our market position.
The irony is that just a few months ago, I expected the beef industry to be facing the "high prices/constant consumer quality" quandary while the pork industry, by comparison, could deliver an enhanced consumer-value proposition. The worm has turned quickly due to PEDV.
To return to the position where we want and need to be, we must enhance customer-defined quality and lower costs.
A solution to PEDV will go far in accomplishing the latter, especially given the better balance that now exists between corn supply and demand. I believe that, in the absence of PEDV, breakeven carcass-weight production costs of over $90/cwt. are a thing of the past, except in extreme short-crop years such as 2012. Reasonably priced corn and soybean meal should result in frequent breakeven costs between $70 and $80/cwt. In the long run, that means frequent hog prices in the same range. Our world’s-best packing sector will again be able to deliver cost-competitive pork products to consumers worldwide.
Beyond PEDV, though, the cost challenge will center on which technologies we will A) be allowed to continue to use, and B) be able to adopt in the future. Pressure on housing systems, and production practices such as castration, euthanasia and antibiotic usage pose significant roadblocks to reducing — or even maintaining — costs of production. The inventiveness and resourcefulness that producers have relied upon to face other challenges will be tested once again.
Enhancing customer-defined quality is a more difficult task, but one that must be done if the industry is to grow. The industry must continue to respond to consumer needs for consistency and convenience. Processing methods that reduce the use of nitrates and sodium will likely be required by more and more consumers. Muscle quality must be improved. "If people would just cook it properly" will continue to be an unsatisfying commentary in a world in which many, many people don’t really want to cook at all!
Individual producers will be required to meet higher and higher standards. The hogs delivered to packers must not impose any extra or out-of-the-ordinary demands on packers’ systems. It is impressive that excessively fat market hogs are now somewhat of a rarity — so much so that some packers no longer measure carcasses and pay explicit premiums for leaner animals.
But any carcass defects, such as abscesses, bruises or swollen joints, impose extra costs on packers and processors. And those costs eventually add to price, which detracts from consumer value and lessens the pork’s competitiveness, damaging our efforts to maintain and grow our market position.
Will Maintaining Be Enough?
Many would view that question in the context of opportunities for producers. Will we have to grow the US pork business to maintain sufficient scale to keep costs acceptable? Will there be sufficient opportunity in this business for the next generation?
I pose it, however, from a consumer standpoint. Will maintaining our market position be sufficient to allow us to fulfill our responsibilities to feed a hungry world? Will we be able to provide more protein to worldwide consumers whose rising incomes will allow them to move beyond subsistence diets to something more satisfying if we cannot lower costs and add to product quality?
Satchel Paige was fond of telling us "Don’t look back. Someone may be gaining on you." Whether someone is or isn’t gaining on the US pork industry, let’s look forward to improve our competitiveness, and thus maintain and grow our stature in the world marketplace. This result will be necessary for us to help both ourselves and the millions of people who depend on us.As published in National Hog Farmer's Weekly Preview.