Background
The U.S. beef industry has spent the past 20 years realizing a constant and substantial loss of market share to other animal protein sources, particularly poultry. Much blame is laid on a lack of direction, lack of communication and lack of responsiveness to consumer markets. Price action within the production chain is predatory, resulting in consolidation at all levels. Until recently new product development was not a priority and those products that emerged were niche and not significant enough to affect market share trends.
Three companies control 80 percent of packing capacity. To-date these companies have been commodity/volume driven and are merchandising meat and non-edible byproducts throughout the world. Branded labels have been a very rare product in this environment. Volatility of price and margins at all levels has led to consolidation and distrust along the production chain.
Many producers have arrived at a level of frustration that makes them amenable to change. Today, there are several dozen niche players operating as alliances, coops or individual businesses with contracts in beef. These groups are fighting the traditions of cattle marketing and changing marketing and production techniques to receive larger margins in their own businesses. They are willing to own the product longer and take responsibility for quality (e.g. brand name) to increase their net profits.
The U.S. beef industry has maintained a decades-long tradition of selling finished cattle to the packer who then owns and merchandises all products wholesale to a next level middleman. This selling process has been done primarily on a live weight basis with an average price agreed to for an entire group of cattle or even many groups.
Over the past two decades there has been a movement to more cattle being sold on a formulated price or forward contracted with the packer. The result is a phenomenon known as captive supply, which is the term applied to those cattle that are not traded on the negotiated spot market. Out of this has come the idea for the use of closed coops or alliances to give structure to a new system. Such a system would emphasize information, full trace-back of product identity, consumer responsiveness, brand name labeling and system efficiency.
How Cattle Are Sold
Through the first 60 years of the century, live cattle were delivered to terminal markets such as Chicago. Large commission firms at these locations handled the selling of the cattle to a packing company. This trade was on a price per hundredweight negotiated on day of sale.
In 1960, a start-up company called Iowa Beef Processors (IBP) revolutionized the process by moving beef packing to the areas where the cattle were finished and breaking the carcasses into smaller cuts that fit into boxes. This cut freight costs, reduced the overhead of stockyard space and improved some quality factors. They also put buyers in cars with two-way radios, eliminating the commission man from the selling process. The industry quickly went this way and the central stockyards eventually disappeared.
In 1999, the majority of live cattle were sold on the cash market directly to a packing company. The majority of these transactions were based on two factors: 1) the live weight of the animal minus a calculated shrink, usually 4 percent. 2) the negotiated price per hundredweight. This is known as selling live. The second most common method of selling is to use a negotiated price for the hot carcass weight of the animal. This selling method places with the feeder the risk of the percent of the animal that actually ends up in a useable carcass (yield) at the packing plant. This method is known as selling “in the meat.”
Another method that has evolved to a significant percentage of total cattle marketed is called formula pricing or grid pricing. This method uses a grid matrix of several value factors that represent premiums and discounts depending on how the animal dresses out in the packing plant.
Beginnings
U.S. Premium Beef (USPB) has its roots deeply planted in the cow-calf segment of the beef industry. USPB founders believed working together and sharing information in a coordinated system could help them compete against others in the meat industry. Teaming with Steve Hunt, a fourth-generation cattleman from Arkansas City, KS , were Terry Nelson, a commercial cow-calf producer, backgrounder and cattle feeder from Long Island, NY; Doug Laue, a custom backgrounder and cattle feeder from Council Grove, KS; and Terry Ryan, a commercial cattle feeder from Scott City, KS.
The group members first met in November 1995 to discuss the concept of forming a business. They studied business structures and successful agricultural cooperatives. They decided if producers were to be committed to consumer-oriented beef, they also had to be committed to ownership in the structure. Thus they proposed a marketing cooperative in which members would be required to capitalize the cooperative up front, rather than through earnings.
USPB was established on July 1, 1996. The producer-owned business elected a six member board of directors, representing all the beef industry segments. The board was later increased to seven members. In September 1996, the board members held meetings with livestock associations and media organizations explaining their concept of the information-based organization, which would provide feedback to the producers so they could make changes consumers wanted. Five meetings were held in Kansas with rooms packed full of producers. The road show was also taken to Colorado, Iowa, California, Oklahoma, South Dakota, Nebraska and Missouri.
USPB faced several challenges as it started, including a lack of incentive to produce higher quality beef cattle and the problem of a “mature” market. With beef demand seemingly at its peak, fewer and fewer ranchers have been entering the business. However, despite the initial difficulties, within months producers, representing more than 80,000 head of cattle, made a commitment to finance a business plan. The plan offered producers an opportunity by adding value through increased premiums for quality carcass characteristics. Total start-up costs were in excess of $1million. The newly formed company embarked on a membership drive. Members could join with a lifetime membership fee of $500 plus a registration fee of 50 cents per head of cattle that would be delivered to USPB. (The registration fee later was raised to $2 per head.)
Beef Plant Purchase
At the same time, USPB began to look at ways to enter the beef-processing segment. Control of a harvesting facility was necessary to complete its objective. The group analyzed a number of options, including building a new facility and custom-slaughtering cattle. In the end, it voted to partner with an existing successful company, Farmland National Beef, a subsidiary of Farmland Industries.
On July 31, 1997, USPB signed a letter of intent to purchase up to 50 percent of Farmland National Beef. To make its purchase, USPB launched a stock offering at $55 per share and $38 million was raised. That offering closed in late November. On December 1, 1997, USPB became a part owner of Farmland National. The coop initially bought about 25 percent of the stock. USPB matched the amount of stock raised with a loan from the Bank for Cooperatives (CoBank).
In December 1997, USPB launched another stock offering, which closed a month later. With the new stock USPB bought more shares of Farmland National Beef, but will not disclose total percentage ownership.
Farmland National Beef company operates two plants in Dodge City and Liberal, KS. It is the fourth-largest beef packer in the U.S. and markets boxed beef, prime and Certified Angus Beef domestically and internationally. Additionally, FNB markets further-processed and value-added products, primarily portion-controlled steaks, to restaurant, mail order catalogs, foodservice and retail customers through the Kansas City Steak Company, which it acquired in 1997. Farmland National Beef markets its products under four branded labels: Certified Angus Beef, Farmland Black Angus Beef, Farmland Certified Premium Beef and Kansas City Steak Company.
The key to USPB was the purchase of a processing facility, with associated branded products. Without a brand recognizable to consumers, overall the beef business doesn’t have much going for it. In a good year, IBP, the biggest meatpacker ekes out a 1.7 percent pretax margin. National’s results last year were $43 million pretax net on sales of $2.2 billion. But its sales of branded beef, at $100 million and growing 30 percent a year, exceed those of the three largest packers combined.
Farmland National watches the beef all the way to the grocery store shelves. Distribution is helped by the fact that Farmland already has a national branded presence in pork. The Farmland beef brands are displayed in their own refrigerated display cases to distinguish them from commodity meat. The branded beef products are now in more than 800 major stores, including several major chains from coast to coast.
Types and Conditions of Membership
There are two types of membership in USPB: lifetime and associate membership. Additionally, producers can lease shares from stockholders within the membership. The lifetime membership fee for a stockholder is $500. A one-year associate membership fee costs $100. Individuals do not become voting members until they have purchased at least 100 shares of common stock in the cooperative. Although membership common stock and delivery rights are transferable under certain conditions, membership in the cooperative is not transferable. The coop is not obligated to the member other than the obligation to issue a membership certificate.
In addition to signing a membership application, the farmer/rancher signs a Uniform Delivery and Marketing Agreement and commits to deliver one head of cattle annually for each share of stock purchased. There is no refund of the membership fee, but the stock is transferable. Two forms of delivery agreements are available: one agreement for “even slots,” that is an even monthly delivery of the delivery commitment; and one agreement for “odd slots,” that is delivery of the delivery commitment during one or more specific monthly periods each year. For odd slots, the specific monthly delivery period(s) are to be selected by the designation and if overfilled, by an alternative selection procedure. If a person is not able to meet their delivery schedule due to weather or other factors, USPB works with the producer to deliver cattle when they will be ready for market.
Associate members are not allowed to acquire any shares of the common stock of the cooperative or to become voting members until they acquire at least 100 shares of membership common stock. The lifetime associate membership fee is $500. The one-year membership is $100. The Associate membership fee is non-refundable.
The cooperative has the right to terminate membership if the member fails to deliver cattle, dies or takes actions that will impede the Cooperative from accomplishing its purposes.
Getting Started
On December 1, 1997, USPB started processing cattle. Its more than 690 members from 24 states have delivered approximately 8,100 finished cattle each week through the end of 1998 to packing plants in Dodge City and Liberal, KS. Through August 1999, more than 800,000 cattle have been marketed through the USPB system.
Features of U.S. Premium Beef
U.S. Premium Beef lists the following features of membership in the organization.
- Members may lease or own shares.
- The opportunity to partner with feedyards or other members in retaining ownership of cattle.
- No geographic restrictions on where members can do business. Members decide where the cattle will be fed. USPB cattle have been fed in more than 300 yards in 11 states.
- Non-breed specific (except that cattle can not have a high percentage of Brahma, dairy, heiferettes or bulls).
- Value-based grid pricing system that is very competitive.
- Delivery dates are determined by the owner at his/her perception of their optimum endpoint.
- Sharing of profits through stock dividends.
- Transportation credit of up to $0.55/cwt.
- Forward contracting is available.
- Producers receive individual carcass information free of charge.
- Advice and consultation from USPB field staff with assistance in management, genetics, economics and animal health.
- Access to market animals through value added programs such as Certified Angus Beef, Farmland Black Angus Beef, and Farmland Premium Beef.
Producers who lease shares can sell cattle on the grid, receive individual carcass data at no charge, obtain up to a $0.55 per hundred weight transportation credit and earn any patronage dividend paid out to USPB members based on the earnings of FNB.
How Producers Are Paid by USPB
The program is non-breed specific. However, cattle types with heavy Mexican influence do not support the product philosophy, regardless of grading characteristics, and are not encouraged to be marketed through the program. USBP does not accept heiferettes, Holsteins, cutting bulls or cattle with a high percentage of Brahman influence.
The base live price for the grid is the weighted average in Kansas reported by the USDA for the week previous to the week the cattle are delivered plus $0.25 per hundred weight. The base live price is converted to a hot price using the previous week’s plant average hot yield for non-grid cattle purchased in Kansas by Farmland National Beef.
Actual performance of the cattle marketed under USPB’s grid are compared to a base 52 percent for Choice or better and the rolling average performance of Kansas non-grid cattle at Farmland National Beef during the preceding four weeks for Yield Grade premium/discount calculations. Prime, Certified Angus, Hardbone, Ungraded (Standard, Dark Cutter) and carcass weight premiums/discounts are calculated with no comparison to plant averages. The Choice premium/discount is calculated based on a four week rolling average of USDA Heavyweights Choice/Select cutout spread. Yield Grade 1 and 2 receive a premium for being above plant average, but are not discounted if below the plant average. Yield Grade 4 and 5 receive a premium for being below plant average and discounted for greater than plant average.
- Settlement: All cattle sold on the USBP grid are issued a cash advance on the day of delivery, equal to 85 percent of the weighted average live price for the week prior to delivery. A final check is issued when final grade and plant averages are determined, typically Monday or Tuesday of the week after delivery.
- Freight: Farmland National Beef is responsible for lining up transportation and for all costs associated with transporting live cattle from the feedyard to the plants. However, freight charges in excess of $0.55/cwt are deducted from cattle proceeds.
- Carcass Data: Individual and group carcass data are provided at no charge.
- Forwarding Contracting: U.S. Premium Beef offers to members selling cattle under the grid the option to forward contract up to six months in advance. Each week a basis is offered for future delivery periods. All forwarding contracting intentions are communicated to the central procurement office with order execution taking place during market hours.
Unit Retain Fee
A unit retain fee of $12/share is deducted from the cattle proceeds. A unit retain fee is used in a closed marketing cooperative (such as USPB) to build a reserve fund. USPB had the choice of either deducting a unit retain, or increasing the purchase price of its stock to create a capital reserve fund. This unit retain is repaid one year from the date the cattle are processed. The repayment of this fee is contingent on the future success of Farmland National Beef. The $12 is repaid on the one-year anniversary of the processing date calculated at $12 plus one percent over the January 1 prime interest rate.
The First Year
Financial
During the first year of operations the organization delivered about 8,100 head per week. However, the organization incurred additional expense, mostly due to start-up. Also the organization had a 14-month year, because it moved its year end to coincide with Farmland National Beef’s fiscal year. The bottom line is that Farmland National Beef showed a net income of $31 million. USPB’s share was $7.35 million. Expenses and operations for USPB were about $3.4 million. Thus, USPB showed a net income of $3,971,233 and a taxable income basis nearing $3.1 million. That computes to about $12 per head delivered. Estimated taxable income is approximately $9.61 per head. The estimated patronage return per head is $1.00-$1.70.
Producer Satisfaction
One of the concerns that many producers had initially was that if they sold cattle to USPB, other packers would not purchase cattle from their feedlots. According to company officials, it has not been a problem. However, it was difficult initially for producers to sell in a quality-based meat program vs. selling live on the cash market. They had to make changes in management practices.
Also, the company says, some USPB members did not believe the carcass data sent to them was from their cattle. However, the next time the producers marketed their cattle, they were invited to the packinghouse to see what was under the hide of their cattle. Many producers were surprised that the meat was not the quality they thought they were producing and have started to make the necessary changes.
Staff in Place
In its first 12-18 months of operation, the staff has grown to meet the needs of the organization. Currently, there are two offices for the organization, one located in Kansas City, MO, and the other in Dodge City, KS.
Success Explained
It would appear the USPB success in moving relatively quickly from concept to reality was tied to a short list of issues:
- First, through a process of rumination, the principle leadership of the USPB movement was ready for change. Many of the key players and early signatories have had industry involvement on a state or national level that exposed them to the decade long discussions about reasons for loss of market share. They appear to be people with substantial seasoning in the business but also many years ahead of them.
- Second, there is a mix of feeders and cow/calf or stocker operators. Other similar concepts have failed to develop due to a lack of such comprehensive backing.
- Third, emphasis was placed on information with application toward quality improvement. The group seems to have a powerful dual goal of improving individual profitability by doing the things that are good for the industry as a whole.
- Fourth, the group was willing to think no small thoughts. It went for an ownership position understanding the control that would come with it. Since the stock gives a member both the right and the obligation to deliver cattle to FNB, the commitment is solid with all parties.
- Fifth, they chose a company with premier management in Farmland National Beef. The company had already committed huge amounts of money to process and product improvement since 1992, so it was well positioned to grow. Furthermore, FNB had good brand name presence in the domestic market with a strong international reach in place as well. The leadership of USPB was astute in recognizing the value of the brands and the well-developed merchandizing structure of FNB.
The fact that USPB was able to reach a deal with Farmland was probably a matter of timing and philosophy. Farmland itself could see a benefit from freeing capital it had tied up in FNB. USPB was forming under a cooperative structure that offered a good fit for the companies at the outset. Farmland has long recognized its connection to beef production, particularly at the cow/calf level. Through the ‘90s it had been reaching out to vertically coordinate segments of the industry served by the coop. USPB would certainly fit the Farmland philosophy for improving returns for its members.
As the fourth largest packer, FNB has certainly had to feel competitive pressures from the big three packers (Monfort, IBP and Excel.) The company has been a strong “spot market” purchaser over the years and not a big contract procurer of supply. By being tied to such a narrow region there have certainly been times when the big three packers could make life difficult for FNB. In the interest of survival and profitability it became apparent the company would need to reach ahead and control some supply.
Another timing factor is the growth of grid marketing. With a push for information, the producer has become more likely to sell on grid to get the data he or she needs. The commercial feedlots are looking for service value to offer clients so special systems or markets would fit well. They are also struggling to help clients achieve profits. More cow operators are looking to retain ownership through slaughter.
Fall 1999
For more information about the cooperative contact:
U.S. Premium Beef
10100 NW Executive Hills Blvd., Suite 105
Kansas City, MO 64153
Phone: (816) 891-2000
www.uspremiumbeef.com