The Strategic Environment
Increasing demands, shifting sands create an entirely different landscape for pork production.
By Dennis DiPietre
The Food and Agricultural Organization (FAO) of the United Nations recently issued a report announcing that the world is confronting the staggering challenge of increasing food production 50 percent by the year 2030 and doubling total food production by the year 2050. If this Herculean challenge is not enough, it will take place in an environment where many of the old standards, rules of thumb and other landmarks of familiarity used by producers to understand their businesses are fading away rapidly.
Everywhere we look, the landscape seems strangely different. The trusted guideposts that provided comfort we were on the right path just a few years ago are missing or in different places, and the near-term outlook seems murky. The probability is high that as globalization of agriculture becomes more mature, national and global policy makers will intervene to preserve scarce resources, protect regional and national food security and manage the global environment. The timing and extent of the interventions and how they will be manifest is less sure. Expect increases in prohibitions, increased taxes on energy, water and other input uses, enhanced permitting requirements, increased fees and time delays, disqualification of certain production technologies and removal of tools like antibiotics from the tool kit. These actions threaten to materially affect the stability of the mean value of many of the production metrics we have classically associated with benchmarking.
Definitions losing there meaning
For instance, there is no longer any such thing as a high hog price. The same price can produce windfall profits one quarter or staggering losses the next, depending on the price of corn and/or bean meal. The same can be said of key feed ingredient costs. Is $3/bu. corn high priced (like it seemed in 2006) or is $5 corn high (like it seemed in 2008) or is $7 corn high (like it seems in 2011)? What is the meaning of a low-cost producer when key input costs are making historic moves to new equilibrium levels and cycling wildly along the way?
For over ten years, largely the decade of the 1990's, a $0.38 live cost of production was considered a golden benchmark of cost containment and efficiency. Today, what is acceptable, competitive, high, low or normal is blurred daily by the relentless price volatility of feed ingredient markets, where failure to achieve continual record harvests from now forward almost ensures price rationing and huge potential losses for users.
While the capacity to double global food production makes us think immediately of needed inputs and the efficiency required to wring that much production out of a fixed space, the foundational meaning of the word efficiency is under revision as policy makers try to re-shape the term to incorporate the global impact of an individual's resource use. Strong and continued growth in the emerging nations (China, India, Brazil, Indonesia and Russia, for instance) is beginning to accelerate a longstanding shift of rural populations to nearby urban areas and raising per capita income. It is not at all unlikely that meat demand in emerging nations will double (China notwithstanding) or more as per capita incomes skyrocket compared to old world rural farming standards of living.
This article will address coming changes, the challenge of benchmarking in a period of relentless price and cost volatility, and a prescription for increasing the value of benchmarking as the industry navigates one of its most risky and potentially rewarding periods ever.
Benchmarking provides a means for firms to put the "dip stick" in and take a reading across a variety of production, financial and engineering efficiency measures to ascertain if a farm is measuring up to current competitive standards or if it is in need of a tune-up. In addition, the regular practice of benchmarking provides a key awareness mechanism that performs a couple of very important functions.
First, benchmarking provides a means to scan the strategic or external environment for changes embodied in the shifting values of leading firms' performance metrics. This ensures a farm does not become insular and cut-off from progress being made throughout the wider progressive slice of the industry. Second, benchmarking forces the time necessary to systematically assess and measure the current performance of the farm, ensuring own-farm awareness and beliefs are accurate. Herd owners are subject to a kind of delusion about their own performance that will continually overestimate performance unless the hard, cold facts are periodically measured and addressed.
Will classic benchmarking remain relevant?
Classic benchmarking involves comparing the processes, practices, efficiency measures and other performance metrics of your firm to those of a target group - often peers, competitors or industry leaders. It's a practice carried out with the purpose of staying competitive or regaining competitiveness, lowering cost or improving production processes. The typical practice of periodically comparing a wide range of efficiency and cost metrics has been very helpful to many firms when properly understood and carried out. Benchmarking strategy (versus numerical values), while a little less common for the average producer, is also a valuable and insightful undertaking and many producers practice it both as a formal process and informally over coffee with fellow producers. Internal benchmarking as a means to track self-improvement (without referencing an outside standard) also can be beneficial, especially when differences like idiosyncratic farm structures, products, relationships and marketing arrangements make comparison with outsiders too problematic.
In practice, typical benchmarking runs the full gamut between the informal and curious to the nit-pickingly professional. Most producers at least informally benchmark the perceived key competitiveness benchmarks by reading industry magazines, talking with their consultants or in casual conversations with other producers. Keeping an eye on the industry shifts in feed conversion ratio (FCR), average daily gain (ADG), pigs weaned per sow per year (PWS), labor cost/head is an important way many producers strive to make sure they are not slipping compared to peers or larger scale firms. Others engage professional help through their veterinary consultants, record systems or bureaus, bankers or accountants and sometimes through audited benchmarking firms. Benchmarking firms strive to make sure all data utilized is accurate, comparable and that the formulas used to calculate the various metrics are standardized. Audited benchmarking firms frequently provide a skilled consultant to both analyze the comparative reports and information and to present it to the management team and answer questions.
However, massive change in local and global production environments and the volatility this change is bringing means that without some serious evolution, classic benchmarking will gradually become at best, less relevant to competitiveness and at worst, a guiding light to failure and demise.
You are being benchmarked!
At the level of the firm, prices or costs of inputs serve a very important allocation function. As prices of key inputs rise (such as corn), the broader market is sending a message: "Use this input for higher value purposes or seek substitutes!" Without the need of a "Corn Czar," prices ration the product toward high-value uses. Benchmarking is a means to track the efficiency with which you use valuable resources, as their price influences some key benchmarks, especially those related to feed costs.
What you may not know is that your industry is being subjected to a form of societal and global benchmarking that will become increasingly important to you as the resulting policy prescriptions are realized in new laws and regulations, input-use taxes, targeted subsidies, purchase mandates and technology use restrictions. For instance, did you know that while you are measuring the amount of feed it takes to produce a pound of carcass, dozens of researchers at universities, nongovernmental organizations (NGOs) and qu asi-government institutes are estimating the amount of energy (in calories) it takes whole-chain, to produce a pound of pork carcass, as well as beef and other food products?
They are finding that food production is notoriously energy inefficient. The full-chain production process to create a pound of pork carcass is very energy intensive. Right now, published studies show that the usable calories gained from the consumption of a given quantity of meat is far eclipsed by the calories of energy needed to produce it (including all of its inputs), process it, transport it, refrigerate it, cook it and eat it. Not all foods are equally energy inefficient and food products as well as diets are being given scores based on energy benchmarking. As you might guess, vegetables and fish are less energy-consuming per net calorie gained from consumption than is pork, beef or chicken.
Since you stick to firm-level costs in your benchmarking, you have not been concerned with societal costs. But as we push usage rates up on limited global resources, prices plus add-on taxes will allocate scarce energy, water and grain resources to those production processes and products deemed by policy-makers as most valuable to society.
For instance, with the political goal of reducing U.S. dependence on foreign sources of energy, U.S. policy through ethanol subsidies, mandated purchasing and tariffs to block foreign (and cheaper) competitive products for competing is driving massive price volatility into the U.S. corn market. The resulting $7 corn price means that unless you are producing something that society believes is very valuable with that corn, it is time to look for substitutes and to strictly adopt waste-prevention strategies.
Classic benchmarking can help reduce waste, but switching to alternative diet ingredients, formulations and by-products also shifts the biologic and engineering metrics that are not directly input-price-sensitive, such as ADG and FCR. A profit superior FCR may look inferior numerically to a competitor using, for instance, a corn/soy diet. However, if the substitute ingredients are less expensive per unit measure, more can be used to achieve the same level of growth. This underlines a key principle: benchmarking processes with resulting numerical outcomes are critical to correct decision-making, versus only comparing numbers on gross measures of performance. Using a consultant or an audited bench-marker can be a big plus. Similar societal studies are being carried out with respect to global water use. A full 70 percent-plus of all water demanded by humans for any use is allocated to irrigation. Measuring the full chain consumption of water necessary to deliver a pound of pork carcass compared to a pound of potatoes is eye-opening. Fear of water taxes and water shortages and the need to ensure long-term food security has fueled purchasing and leasing of water-rich, arable land masses in Africa and Brazil by emerging nations (like China). Korea recently placed a 99-year lease on a land mass for growing corn in Madagascar that is larger than the nation of Belgium.
BENCHMARKING MUST EVOLVE
Margins have been difficult to benchmark in the past, as many firms have adopted firm-specific accounting practices. While acceptable to auditors, these practices are highly individualized and difficult to unpack for standardized comparisons. Some organize and group cost and revenue information to roll up into the larger integrated firm's account structures, chart and formats. In some cases, certain charges are not made directly for some services - they are lumped into G&A and a percent of total cost is allocated. It is common for standard costs to be substituted for traditional cost roll-ups. Revenues and expenses are often managed for tax strategies too, which can make comparisons among firms difficult. Audited benchmarking firms have usually found ways to harmonize these inconsistencies, but sometimes only footnote explanations are made to note significant departures, hindering standardized comparison.
In an age of damaging price and cost volatility, margins gain increased focus rather than the component parts (like feed cost and market hog prices) when analyzed independently. We live in a time when margin protection through coordinated futures markets transactions (the "crush") combined with risk-shifting packer agreements make comparisons among firms very difficult. If we were to discover the true cost of production today for the top 100 pork producers, it would look like the array of ticket prices one would find if all the airfares paid on any given flight within the U.S. were revealed. Gone are the days when knowing today's corn and bean meal prices gave you strong insight into current costs of production. Those prices and costs may have been established weeks ago. Locking in a "high" corn price weeks ago is not necessarily a poor decision if hog prices were also hedged at the time to provide an expected margin that is higher than the current market is offering.
Being able to compare profit achievement (gross margin, net income, ROE, ROI or ROA) over time is the bottom-line benchmarking achievement, and then benchmarking physical processes that accompany profit achievement completes the picture. Since all physical quantity and input efficiency benchmarks roll up into profits, it is important that both are measured.
Editor's Note: Dennis DiPietre, PhD, is an economist consulting with the national and international pork chains. He is the owner of KnowledgeVentures, LLC .