AFF Sentinel Vol.5#43

The Department of Justice made it plain in its suit that it believes a major key to packer profitability is total industry output. The spread between the cost of fed cattle and the selling price of beef is where the profit is made and this margin is "highly sensitive to changes in the aggregate output levels" of all packers, Justice contended in its lawsuit.

"All else being equal, when the meat packing industry reduces production levels, feedlots and cattle producers are paid less for fed cattle because fewer fed cattle are demanded and the customers pay more for USDA-graded boxed beef because less is available for purchase."

The suit recounts how packers figure and project each other's shift numbers and days of production, subtract from USDA aggregate production and plan production.

In other words, all packers have to do is buy fewer cattle and sell less meat for more money - and ignore their rising fixed costs per head. If it were that simple, the industry's overcapacity wouldn't be a problem. Everyone needs to produce less anyway, under Justice's theory.

No mention of consumer demand is mentioned in Justice's model. How the industry is to keep processing record beef volume, serve growing export demand and a growing population by processing less beef is not explained. Packers themselves have said they need a larger supply of cattle to make money. The reality is that a supply in line with domestic and international consumer demand gives the best chance for profit for everyone in the chain. But no sector benefits from a long-term devotion to shrinking its volume.

For a short period of time, it is true that cutting back slaughter can lift the price of boxed beef and improve packer margins. But Justice seems to miss the big picture. Packers -- like any other business - cannot pay for fixed assets, meet labor contract minimums, fill customer contracts, service debt and grow their business by shrinking volume and revenue. If that principle were true, American automakers would be highly profitable selling fewer cars.

In fact, the suit contends that if the industry goes from three major packers and a smaller fourth to three majors, that the three packers would "compete less vigorously to produce and sell" boxed beef. The department evidently fears suddenly blooming conspiracy, charging that the change "would substantially increase the incentive and ability of these major packers to engage in coordinated conduct in output and pricing decisions." They contend the result would be higher prices for consumers and lower cattle prices.

So let's review. Justice sees a model in which packers have only to slaughter fewer cattle and sell less beef to make more money. Because "less is more," they won't need to compete for cattle and they will be falling over themselves "coordinating" their "conduct" to make sure they don't buy too many cattle and sell too much beef. Cattle prices will drop.

By the economics we know, this model works only for a monopoly: only one firm in the market, no other firms can enter the market and the market must buy the company's product. That isn't this case. If packers have been losing money with the fixed costs and capacity they have now, how would increasing their fixed costs per head make them more money?

We checked the GIPSA data for 2006, the last available year. The largest four packers averaged $2,000,000 in losses for every billion dollars in sales (0.2 percent). For example, a six-billion-dollar packer - similar to Swift's size -- would have lost $12,000,000 for the year. The 5th - 20th largest packers averaged about 2.25% profit.

Given packers' narrow margins, poor profit records and debt loads for most, with one packer having 30-35 percent of capacity, another 25-30 percent and the third 20-25 percent, which ones would have it so good they could just lay back?

Both National and JBS Swift have said they will fight the suit in court.

Where does this idea come from that no effort, no attempt to compete is likely - or necessary -- to profit? We see no rational economic basis. Is it ideology? We're sorry but it appears delusional bureaucratic lawyers who actually believe businessmen are lazy and only want to play golf until their company goes out of business are in charge of this case -- not economists who observe the real world.

Next Issue: Competition Theories & Packer Profits

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