Barkema/Drabenstott.qxd 6/21/01 1:37 PM Page 33 The New U.S. Meat Industry By Alan Barkema, Mark Drabenstott, and Nancy Novack new meat industry is rapidly emerging in the United States, as food retailers, meat processors, and farms and ranches coalesce Ainto fewer and larger businesses. The industry’s rapid consolida- tion in recent years has triggered alarms that the industry’s new giants in retailing and processing could drive up food prices for consumers and drive down livestock prices for producers. How should public policy respond to the industry’s consolidation? And how can all participants in the industry—producers, processors, retailers, and consumers—benefit from its new structure? This article studies the striking changes in the meat industry in three steps. First it describes how the industry is changing. Then it examines the forces driving the industry’s consolidation. Finally, it con- siders how consumers and industry participants are affected. While cur- rent evidence is scant that market power has hurt either consumers or producers, the industry’s rapid consolidation nevertheless warrants vigi- lance. At the same time, public policy might also play a role in ensuring that all participants in the market benefit from its new structure. All three authors are members of the bank’s Center for the Study of Rural America. Alan Barkema is vice president and economist, Mark Drabenstott is vice president and director, and Nancy Novack is a research associate. Kate Sheaff, a research associate in the Center, helped prepare the article. The article is on the bank’s web site at www.kc.frb.org. 33 Barkema/Drabenstott.qxd 6/21/01 1:37 PM Page 34 34 FEDERAL RESERVE BANK OF KANSAS CITY I. HOW IS THE MEAT INDUSTRY CHANGING? A wave of consolidation is sweeping the U.S. meat industry. The trend is a relatively new phenomenon in food retailing but well advanced in meat processing and livestock production. The result is an industry of fewer and larger businesses. At the same time, a new supply chain structure is emerging in the industry, bypassing traditional mar- ket arrangements to forge tighter linkages among farms and ranches, meat processors, food retailers, and the consumers they serve. Consolidation in food retailing The wave of consolidation that began in the retail grocery industry in the 1990s was spurred by two key events. First, a handful of large grocery stores merged or acquired other stores, spawning several major grocery chains. As these chains grew, they soon spread into other regions of the country. Second, large general merchandise stores and warehouse clubs appeared on the retailing scene. Wal-Mart, for exam- ple, joined the ranks as one of the nation’s top grocery retailers in the mid-1990s, and by yearend 2000 its Supercenter division had become the nation’s top grocery retailer. As a result of these megamergers and the emergence of other large new retailers, the large retail grocers have quickly gained customers at the expense of the smaller ones. From the mid-1990s to 2000, the mar- ket share held by the nation’s top four food retailers—the four-firm concentration ratio (CR4)—soared from 17 percent to 34 percent. Con- solidation in metro areas has become even greater. The average CR4 among grocers in the nation’s 100 largest cities reached nearly 72 per- cent in 1998 (Kaufman). Consolidation in meat processing Unlike the food retailing industry, where consolidation is fairly new, the meat processing industry began its trend to fewer but larger proces- sors more than a half century ago. Some consolidation occurred among poultry processing plants in the 1950s, but rapid gains in poultry con- sumption has supported an almost steady number of poultry plants Barkema/Drabenstott.qxd 6/21/01 1:37 PM Page 35 ECONOMIC REVIEW • SECOND QUARTER 2001 35 Chart 1 MARKET SHARE OF TOP FOUR PROCESSING FIRMS Percent 100 1999 80 60 1999 1997 40 1982 20 0 Broilers Hogs Steers & heifers Source: USDA since the 1960s (MacDonald, Madison, and Ollinger). In contrast, a much more rapid consolidation has recently swept beef and pork pro- cessing. Since 1980, the number of slaughter plants has plunged from more than 600 to about 170 for cattle and from more than 500 to about 180 for hogs. The number of meat processing firms has also dwindled rapidly, boosting the market share held by the industry’s largest players, especially among beef processors (Chart 1). The rapid consolidation has vaulted the beef processing industry into “highly concentrated” status, the highest rank in the classification scheme the U.S. Department of Justice uses in its antitrust oversight. The pork processing industry ranks “moderately concentrated.” The Justice Department uses the Herfindahl-Hirschmann Index (HHI) to measure market consolidation, a gauge that is more comprehensive than the CR4. The HHI is calculated by summing the squared market shares of all firms in a market. Industries with an HHI below 1000 are classified as unconcentrated, while an HHI between 1000 and 1800 is moderately concentrated, and an HHI above 1800 is highly concen- trated. In 1998, the HHI was 1936 for beef processing and 1036 for pork processing. Barkema/Drabenstott.qxd 6/21/01 1:37 PM Page 36 36 FEDERAL RESERVE BANK OF KANSAS CITY Chart 2 LIVESTOCK PRODUCTION IN SUPPLY CHAINS Percent 100 1980 2000 80 60 40 1998 20 0 Broilers Hogs Cattle Sources: USDA and University of Missouri Consolidation in production Like most of production agriculture, the long-standing trend in livestock production has been toward fewer and larger farms and ranches. But more recently, a new trend has emerged in the industry. A growing share of livestock producers are joining “supply chains”— tightly orchestrated production, processing, and marketing arrange- ments stretching from genetics to grocery. Supply chains by-pass traditional commodity markets and rely on contractual arrangements among the chain participants to manage the transformation of livestock on the farm to meat in the cooler (Barkema). The poultry industry pioneered the supply chain structure nearly a half century ago, and today nearly all the nation’s broilers are produced in supply chain arrangements (Chart 2). In recent years, hog production has rapidly followed the poultry industry’s lead. Since the early 1980s, the number of hog farms in the nation has plunged from nearly 500,000 to only 85,000. And following its striking consolidation, hog production has also shifted rapidly into supply chains (Barkema and Cook). A recent survey by researchers at the University of Missouri Barkema/Drabenstott.qxd 6/21/01 1:37 PM Page 37 ECONOMIC REVIEW • SECOND QUARTER 2001 37 found that the share of hogs sold to processors under some type of con- tractual arrangement climbed above 80 percent in January 2001, up from about 65 percent in 1999 (Doanes Agricultural Report). Consolidation has been slower to take hold in cattle production, perhaps due to a structure that includes two disparate segments, feeder cattle production and cattle feeding. Farms and ranches that produce feeder cattle vary widely in size, ranging from many small “lifestyle” farms to huge commercial ranches, and relatively little consolidation has occurred in this segment of the industry. In contrast, the consolidation trend is strong in cattle feeding. In 1980, feedlots with capacities of greater than 32,000 head of cattle accounted for less than a third of the cattle marketed in the nation’s leading cattle feeding states. By 2000, that share had climbed to almost half. And while supply chains are much less prevalent in cattle feeding than in poultry and hog production, the trend is gaining ground. The share of cattle marketed under supply chains doubled from about 10 percent in 1980 to more than 20 percent in 1998. II. WHY IS THE MEAT INDUSTRY CHANGING? Two powerful economic forces are at the root of the meat industry’s transformation to a more compact structure: food demand and technol- ogy. Consumer food demand is shifting toward food products that are easy to prepare while also promising safe eating, improved nutrition, and greater consistency. The food industry’s efforts to fulfill consumers’ changing food needs have shifted competitive balances among food companies, triggering broad efforts to maintain or gain a competitive edge by trimming costs. The result is a sweeping trend toward consoli- dation in food retailing, meat processing, and livestock production. Food retailing Two trends stand out in retail food sales in recent decades. First, the U.S. food market is notoriously slow growing, with food spending rising more slowly than consumer incomes. As a result, the share of disposable income spent on food has declined steadily from nearly 14 percent in 1970 to less than 11 percent more recently. Barkema/Drabenstott.qxd 6/21/01 1:37 PM Page 38 38 FEDERAL RESERVE BANK OF KANSAS CITY Chart 3 CONSUMER SPENDING ON FOOD Billion dollars 900 800 Total 700 600 500 Away from home 400 300 200 At home 100 0 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 Sources: Economic Research Service, USDA Second, consumers are eagerly buying more conveniently prepared food products of consistent quality, despite the sluggish growth of over- all food spending. The share of food expenditures that pays for process- ing, packaging, and transportation is climbing, while the share that pays for raw farm commodities is falling, down from nearly a third in 1970 to just a fifth in 1999.1 And nearly 40 percent of the consumer’s food dollar is spent in restaurants and other eating establishments—the ultimate in food preparation convenience and consistent dining quality (Chart 3).2 Demographic factors account for much of consumers’ new penchant for dining convenience.