Bayer Motor Co. Inc.

Revolutionizing Beef Industry
Is Koch Beef Company’s Goal

By Colleen Schreiber

WICHITA, Kan. – Koch Beef Company is one of the fastest growing companies in the beef industry, if not the fastest. Despite record losses experienced this past year in the feeding sector, top Koch officials continue to believe there are profits to be made there.

They say, however, that substantial changes must be made before that profitability can be realized.

Those changes will require nothing less than revolutionizing the beef industry, says Koch Beef Company president Dave Robertson. And Koch Beef, a subsidiary of the nation’s second largest privately held corporation, believes they have the wherewithal to accomplish such a task. Their motivation, simply put, is profitability.

"The only reason Koch Industries wants to be in the cattle business is because we believe on a large scale we can change the way beef production in the cattle industry works and make a very handsome return doing it," Robertson says. "That’s the only reason we’re in the cattle business. It truly is bottom-line driven. We’re not in the business to lose money."

Producing a consistent, high quality beef product that guarantees consumers a good eating experience every time is what Koch’s vision is about. Robertson likens the average consumer’s beef eating experience to a game of Russian roulette.

"A consumer never knows what they’re going to get when they buy a steak. If it’s a bad eating experience, in our belief, more often than not, the reason is because it’s tough. We would argue that the biggest obstacle or problem in the beef industry is the lack of consistency, and within that, lack of overall tenderness."

Consumers don’t have that problem when they buy, say, a box of Cheerios, he points out.

"Assuming that the first box on the shelf isn’t open, you likely pick that first box right off the shelf and put it in your cart. You don’t sort through every box to find one just right for you because you already know that the Cheerios inside are identical, box after box after box.

"Contrast that with a beef buying experience," he continues. "Say you’re going to buy four ribeyes. Do you take the first four that you see? Almost never. Why not? Because you know that they’re all different."

Add to that the fact that the average consumer, Robertson says, doesn’t really know why they pick the ones they pick.

"They usually pick them because they’re more red in color or because they have less external fat or some other subjective value that probably doesn’t correlate to eating experience."

The current grading system, he points out, serves little purpose other than to confuse consumers. They simply don’t understand the difference between Choice and Select. Furthermore, Robertson says, marbling, which is the indicator used in quality grading, is not a good measure for eating quality.

Robertson says the industry instead needs a tenderness measure which in turn connects to the kind of eating experience the consumer can expect.

To achieve their vision, Koch believes the revolutionary process must begin with coordination of the "value chain" so best management practices can be applied at each step in that chain.

"Very few cattle on a percentage basis make it from conception to consumption with best practices applied everywhere," Robertson explains. "You may have very good seedstock with great genetics and that producer may hand them off to someone in the stocker business who totally mismanages them. You ruined them right there.

"We believe that we have the wherewithal," Robertson continues, "to coordinate, not control, all those pieces to ensure that best practices are applied at every single step. There aren’t many other entities in the business that have the resources to coordinate that value chain. You have some pretty significant feeders of cattle, but they probably don’t have the financial wherewithal to step into retail or to step back into the cow-calf sector."

Koch shares with their potential customers their protocol of what they consider to be best management practices and then promise customers that if they follow these practices, Koch Beef will be their best alternative for selling their product.

Is Koch willing to pay for quality?

"Absolutely," Robertson says. "If your cattle are a little better than your neighbors,’ than I’m going to pay you a price commensurate with how much better yours are than my next best alternative."

Smaller producers, he insists, can still be successful even with further integration if, and only if, they produce a superior quality product relative to their competition.

The current marketing tool, the averaging concept, Robertson says, hurts the industry because the proper economic signals do not flow to the producer. In fact, the signal, he says, is a perverse one because it rewards the producer for inferior quality by giving them an average price. In the end it is a disincentive for those who produce superior quality because they also receive the average price.

"At least half the producers in the country today are getting way overpaid for what they produce," Robertson insists, "and another sector is getting underpaid because we average them all together and call it a commodity. The people who are producing inferior cattle are probably selling them for $10 to $20 a hundred too high, and those who produce the better quality cattle are selling them too cheap."

Koch Beef Company kills the majority of their cattle on a formula. Robertson can’t expound on their formula system, but he says that, in his opinion, most of the current formulas and grid systems are not good because they fail to address the ultimate concern, that of eating experience. Most are based on dressing percentage and marbling, criteria which Robertson says rewards or penalizes producers for things that don’t matter much to the ultimate consumer.

In terms of dressing percentage, which is the difference between liveweight and carcass weight, the incentive to the feeder is to make the animal fat. That fat is then trimmed off and turned into a low-value product. As for the quality grading system, some 87 percent of all cattle produced in the U.S. fall in either the Select or the lower one-third of the Choice range, and premiums are paid for Choice cattle over Select. Yet, Robertson notes, there is basically no difference between the two in terms of eating quality.

Formulas, Robertson says, should be designed in such a way that they pay based on red meat yield, tenderness and marbling. As of yet, however, the industry has not found a way to measure red meat yield nor have they found an on-line tenderness test that fits the industry.

Koch realized from the very beginning that the returns available in the commodity beef business simply were not attractive enough for them to invest a great deal of time and money. Their research, however, concluded that there are potentially substantial profits to be made if they could in fact establish a true value-based system and then develop a branded product that would in turn reward the company with improved profits.

Thus, in a series of carefully planned and orchestrated moves, Koch Beef Company has set in motion their plan to coordinate the "value chain" and develop a value based system. Koch Industries, no stranger to the cattle industry, has had part of the puzzle in place for a long time. The company has had a presence in the beef industry since the 1950s when founder Fred Koch first got into the cow-calf business. Today Koch Beef Company is the eighth largest cow-calf producer in the country with approximately 15,000 head of mother cows.

It’s their expansion into other sectors of the beef industry in the last decade, however, that has brought the company its greatest recognition, be it good or bad. Beginning in the late 1980s the company diversified its interests by first expanding into the feeding sector with the acquisition of several key feedlots.

Today they’re the 11th largest cattle feeder in the country. Koch Beef Company currently owns four feedlots, two in Texas and two in Kansas, with a combined one-time feeding capacity of approximately 165,000 head. They also feed a substantial number of cattle in more than a handful of outside lots in Texas, Oklahoma, Kansas, Colorado and Nebraska.

Last year Koch Beef Company branched out even further when they signed a joint venture with Kansas-based Flint Hills Foods which launched them into the fully cooked home entree market.

Another move this past April raised more eyebrows and caused more speculation. It occurred when Koch Agriculture, a subsidiary of Koch Industries, bought out Purina Mills, America’s largest producer and marketer of animal nutrition products with $1.2 billion in annual sales.

Their most recent move came in May when they launched their own line of identity-preserved fresh beef products, branded Clear Creek Ranch-Private Stock. The product will be available in primal and sub-primal cuts.

Time will tell, Robertson says, whether consumers will pay for beef quality.

The company president concedes that this year has been particularly tough, but it’s been tough for anyone in the feeding sector of the industry.

"The bottom line is that we paid too much for the feeder animal relative to what the fat animal is valued at given the amount of fat animals we have," Robertson says. "Supply equals demand," he continues, "it’s at what price, and we’re oversupplied if we want to make money. If, as an industry, we’re going to produce 500 million pounds of beef a week, we better plan on getting about $60 for fat cattle. You can’t pay $80 for feeders and make money at $60 fat cattle.

We did a lot of that," he admits, "but our anticipation was that the production wasn’t going to be nearly this high. We were wrong."

There are plenty in the industry who blame Koch for at least part of the woes of the cattle market, but Robertson says laying the blame at their feet is totally unfounded, though not unexpected.

"I can’t understand how Koch drove the feeder market when there will be 27 million head fed in the U.S. this year and we’ll feed less than half a million head. How did we drive the market?" he asks.

"We haven’t fed significantly more cattle this year than we fed last year. If that’s the case, then why didn’t people blame us the year before because we haven’t done anything significantly different except maybe lost more money. It’s that same victim mentality; everyone is looking for someone to blame.

"To say that we drove the feeder market is ludicrous," he continues, "...paying premiums for cattle just so we could get a position in the market, absolutely not! How can you pin that on us when there are many other firms that bought more feeder cattle than we did?"

What Koch did try to do, Robertson says, was buy the high quality cattle.

"What people need to realize is if we pay a price for the high quality stuff, and someone else pays the same price for the lesser quality, well that’s not very smart."

Rumors have it that Koch Beef has plans to feed a million head a year, but Robertson says there’s really nothing magical about that figure. It’s just a round number.

"If we’re successful, we might do five million head."

Being the biggest, he says, isn’t what it’s about.

"We don’t play market share games. We’re in the business to make money," Robertson asserts, and then adds, "I would tell you, though, that if you’re going to be in something, being the number one or number two player is important if you’re really going to make changes. We’re talking about revolutionizing the way cattle production works, and doing that on a small scale isn’t attractive enough. It’s not worth the opportunity costs of all our people’s time.

"So if we’re going to do it, we want to do it in a large way. But just to be the biggest, there’s nothing driving us which says that we want to be the biggest. Is there something driving us that says we want to be the most profitable? You bet."

The company has expansion plans in place at their own feedyards which are at various stages of progress, and they have and will continue to feed in outside lots to benchmark performance in their own yards. It is also common knowledge that the company has been in the market to purchase additional feedyards, but Robertson says those plans are temporarily on hold because of current market signals.

"Because of what’s going on profitability-wise or lack thereof in the cattle feeding business, it’s our belief that cattle feedyards are going to decline in value in the short-term, so why buy now?"

The company president can’t say when the outfit expects to reach their million-head benchmark.

"If you asked me that last year at this time, I probably would have told you that we would be there at the end of 1999," Robertson says. "But right now I don’t have any great desire to go out and load up into that position because of the economics of the market and how we see it going forward. We don’t see it improving any time soon."

The acquisition of Purina came about, Robertson says, for several reasons, one being that it was viewed as a complement to the overall Koch agriculture company, but the bottom line, he stressed, came down to profitability.

"We think it’s a profitable business and we felt like we could combine some of the core capabilities at Koch Industries with some of the core capabilities that Purina had and make it even better than it was. There’s a lot of synergies to what Purina did and does today and what Koch did and does."

There is always speculation about whether Koch also plans to buy a packer, and the only comment Robertson will make is that they don’t have plans to do so today.

"If the packing piece became an obstacle to us achieving our vision, we might look at it," Robertson says, "but today it’s not an obstacle."

Robertson can’t absolutely say that Koch Industries will always be in the beef business because, he says, "any business we have is for sale. If someone values it more than we do, then they can have it. I’m not going to stand up on a pedestal and say Koch will be in the cattle business forever and ever, amen, because I’m not going to say we’ll be in the refining business or the crude business or anything else forever and ever.

"We are in many businesses and we are charged with allocating resources. We try to put our financial resources in an area where they have the best chance of producing a return. So if our vision of the cattle industry changed or if we found out that we just can’t get at this quality issue, or if we find that the consumer just won’t pay us for that quality, then we would probably get out of the business.

"But are we dedicated? Darn right we are. We’re not doing it for fun."

Clear Creek Ranch-Private Stock will be available nationwide, and though it’s only been on the street since May, Robertson says the reception has been good.

"We’re still in the process of selling people. We’re in the education mode, but we’re very close to inking some deals with some pretty significant players," he insists.

Their target audience, Robertson says, is anyone who likes the taste of beef but who demands consistency.

"Our product doesn’t fit 80 percent of the retailers in the country," he notes, "because they’re purely price-focused. The people who will buy our product will be upscale retailers and restaurants who are concerned about quality and who are willing to pay for that quality."

All of the beef that goes into their branded program is identity-preserved and source-verified. Performance of the animals is tracked in groups all the way back to the origin.

"We keep them origin-specific so that we can learn how cattle from one ranch perform compared to cattle from another," Robertson explains.

Animals that go into their branded beef program are not breed-specific because Koch has the philosophy that not enough is known about the role that breeds play in overall eating experience.

"The only thing we know for sure is that Bos Indicus cattle have a higher tendency to produce tough meat than Bos Taurus cattle, but after that we don’t know a lot. I can’t tell you that Angus are better than Charolais, or better than Herefords, etc. We don’t have any studies to prove that. So our contention is that it is the animal husbandry practices, which we can control, that significantly affect eating experience."

Koch employs certain post-mortem techniques proven to enhance eating experience, the two primary ones being low voltage electrical stimulation and aging of the boxed product.

"Aging is just part of the protocol," Robertson says. "None of our fresh beef product will be served anywhere prior to a minimum of 14 days of aging."

The middle cuts are primarily used in Koch’s fresh beef program while value is added to the chuck and the round through further processing for their precooked entree market.

Robertson says there are a lot of challenges facing Koch Beef Company.

"Education of our customers and ultimately the consumer on these quality issues, and then eliminating some of the myths or paradigms that the industry has about what quality is are two of the biggest," Robertson says. "And there is always the challenge of living through the fundamental problems of the overall industry like the current cattle cycle," deep pockets or not.

"We know about the volatility and we accept it," Robertson says. "We wouldn’t make our decision on whether our strategy is successful or unsuccessful based on the fact that cattle feeding margins are terrible. Now, if we thought that cattle would lose $100 a head indefinitely, we would get out. Fortunately, we have the wherewithal to weather the volatility of certain storms."

Some in the industry might question their fast paced, grow-big-quick attitude, but Robertson says he and his team are humble and don’t pretend in any way to have all the answers.

"We’re not egotistical," Robertson assures. "We realize that we could fall flat on our face. Everyone wants to talk about how to save the industry. We’re not out to save the industry," Robertson remarks. "In saying that, however, I will say that if we are successful that’s what will save the industry, because we’re going to raise the bar. We will create a system where those who do things right get paid more, and those who don’t get paid less.

"I’m not talking a dollar a hundredweight difference," he continues. "I’m talking $20 a hundredweight. I’m talking big money differences. That’s what will save the industry. Sitting around trying to get the whole industry to agree on the right thing to do is a futile exercise. That’s like getting all America to agree on religion or politics — it doesn’t work."

Robertson can’t say for sure when they will know whether their system will work, and by work he means whether the consumer will pay for quality. So far, the feedback has been positive, he says, and early indications are that it is working. He hopes by the end of the year to have solid data which proves or disproves their theories.

"We could fail. We could be wrong," Robertson reiterates. "We could put all these things in place and find that we actually can’t get paid enough for the effort that we put in. If that’s true, then my contention is that we’re going to have a beef industry in the future that is roughly half to 25 percent the size it is today."

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