Six Months Later Pilgrim’s Pride Still Has Pricing Problems – What Went Wrong?

Pilgrim’s Pride rose from humble beginnings as a feed store to become the world’s leading chicken supplier.  Yet, 2008 proved to be a year of stumbles, eventually leading to bankruptcy filings and the ousting of CEO J. Clinton Rivers.  Business press cites a rise in the cost of chicken feed and oil and the lack of a concurrent increase in price, however many other companies went through similar fluctuations in input costs without the same disastrous results.  So, what went wrong with pricing at Pilgrim’s Pride?  To answer this question, we will examine Pilgrim’s Pride pricing at the industry level, market level, and transaction level.

Industry Price Signals Were Healthy, Execution Was Not

Back in the first of August, CEO Clint Rivers told Americans to “brace themselves for sticker shock in the meat case over the next 12 months.”  His comments came on the heals of those made by Dick Bond, CEO of Tyson a rival chicken producer, who stated that he anticipates price increases on the horizon.  Combined, these two companies managed a nearly half of the US chicken production.  Pilgrim’s Pride processed 26% of the nation’s chicken, just slightly more than Tyson’s estimated 21% market share.  With both of the leading executives in chicken production signaling price increases, we should have seen higher prices.

These concurrent statements of price increases by chief executives should not be misconstrued as illegal price signaling.  Both executives made their comments in public to enable consumers to prepare for price changes and enable investors to anticipate future returns.  The statements were made to clarify what was needed to restore the chicken industry to profitability.  Executed in this manner, such statements are generally legal and safe from antitrust action.

What kind of a price increase should we have seen? We can estimate the needed price increase by examining the changes in input costs.  The largest single input cost factor is feed, grains produced by farmers.  Between 2006 and 2008, the cost of chicken feed roughly doubled from $2.40 to $4.00 a bushel.  Reports from Pilgrim’s Pride indicate that they incurred a 41% increase in the cost of chicken feed.  Internal Pilgrim’s Pride statements and industry estimates indicate that chicken feed constitutes between 40% and 60% of the cost of production.  As such, if the 41% increase in the cost of chicken feed was directly reflected in a price increase, we should have expected chicken prices to increase by 16% to 25%.

As with any normal market, increases in prices don’t just happen because a chief executive says they want higher prices, they result from shrinking supply.  How much would supply need to shrink?  To answer this, we need to know the elasticity of demand.

According to William P. Roenigk, chief economist at the National Chicken Council, the elasticity of demand for chicken is -0.75.  Meaning that chicken is already priced in the inelastic part of the curve, where smaller changes in volume are required to deliver larger changes in price.  (In general, companies should not price in the inelastic part of the demand curve, to do so means forgoing profit opportunities. Yet, at the industry level, it is common for competition to drive supply up and prices down thereby placing the industry into the inelastic part of the demand curve, even though individual companies are facing elastic demand curves for their individual brands.)

To get a 16% to 25% price increase in chicken, the producers would need to reduce supply by 12% to 18% if the price elasticity of demand is -.75.

Did Pilgrim’s Pride reduce supply in accordance with River’s stated goal of increasing prices?  No.

According to Pilgrim’s Pride 10-K annual reports, Pilgrim’s Pride operated at 90.7% capacity in 2008, down from 92.8% capacity in 2007.  No material changes in capacity were made during the interim time period.  Thus, production only decreased by 2.1%.  If Pilgrim’s Pride was to lead in pricing, in accordance with Mr. River’s statements, then their production cut would set the example for other suppliers.  If all suppliers cut the exact same amount, no doubt a questionable expectation but one which will lead to the most optimistic estimate of the potential for a price increase, then industry wide supply would have decreased by 2.1% as well.  Unfortunately, a mere 2.1% drop in production industry wide would potentially yield only a 2.8% price increase, a far cry from the needed 16% to 25% price increase that would match the input cost increases.

(For the associated spreadsheet of this analysis, download 09-01-Pilgrims.xls.)

The annual report goes on to make a gross understatement:  “Although many producers within the industry, including Pilgrim’s Pride, cut production in an effort to correct the oversupply situation, the cuts were neither timely nor deep enough to cause noticeable improvement to date.” (p. 49)  Laying-off 2,300 employees and reducing operations by 2.1% is no where near a sufficient action to reduce the oversupply situation.

Was the failure to reduce production a result of the production process or of management?  It was management.

According to the National Chicken Council, it takes six to seven weeks to go from hatchling to a 5 lb. roaster ready for processing at an integrated chicken production facility. Within one fiscal quarter, inventory could have been cleared and the oversupply situation could have been corrected if management had the fortitude to correct the situation.  Chickens aren’t like pigs which take 6 months to complete production, nor are they like power plants which take years to develop and operate.  Chicken production could have been curtailed between the time of the statements at the first of August and Halloween in October.  Better yet, production could have been curtailed in the spring of 2008 when the rise in chicken feed was first observed in the futures and options market.

If the failure to reduce supply is not a constraint of the chicken production and inventory management process itself, then it must be a failure of management.  To get at the decision failure, we contacted both Pilgrim’s Pride and ex-CEO Clint Rivers.  Unfortunately, both declined to comment.

It is possible that Pilgrim’s Pride was unaware of the size of the needed production cut.  While using public numbers on price elasticity of demand and estimating the needed production cuts to deliver the required price increase is nothing new, it is also not a common task.  Perhaps Pilgrim’s Pride failed to ask a pricing professional and was simply uninformed.  If so, the management failure was a failure to create the right team.  Yet, it is hard to believe that no one at Pilgrim’s Pride nor any of their advisors recognized that a 2.1% drop in production is woefully insufficient.

If Pilgrim’s Pride was informed of the need to cut production much further and yet failed to take proportionate action, we are left with the conclusion that we have a decision fortitude failure, one in which the leaders knew what was necessary but refused to make the right decision anyway.

Public statements from both CEO Clint Rivers and Chairman Lonnie “Bo” Pilgrims point towards a decision fortitude failure in opposing opinions about production and pricing.  From his public statements, Mr. Rivers appeared to be prepared to cut production and raise prices.  However, Mr. Pilgrim appeared to be driven by his ego and desire for market share, perhaps fueled by his successful acquisition of Gold Kist just two years prior (as can be inferred from his autobiography).

In a fight between the CEO and the Chairman, who is also the largest shareholder, the CEO is definitely at a disadvantage.  Thus, we speculate that Mr. Rivers lost the debate along with his job, while Mr. Pilgrim won the debate at the cost of profits.

On December 16th, J. Clinton Rivers was forced to resign from the CEO position of Pilgrim’s Pride.  He is to be followed by Don Jackson, an executive recruited from rival Foster Farms.

Market Level Pricing Appears Healthy

Accepting that Pilgrim’s Pride industry level pricing and production management is way off the mark, how is Pilgrim’s Pride doing at the market level?  It appears as though things are good.

Different products, chicken vs. marinated chicken for instance, deliver different amounts of value.  Proper pricing implies that products that deliver more value should be priced higher.  Also, different products appeal to different markets.  Proper pricing relies upon placing the right product into the right market.  On both of these accounts, Pilgrim’s Pride appears to be doing well.

Pilgrim’s Pride does not produce chickens alone, the produce processed chicken, chicken parts, marinated chicken, deli chicken, eggs, and even a unique EggsPlus. (EggsPlus are a natural product produced from hens fed on a diet of natural grains, fish oil, antioxidants, and flaxseed. The result is an egg rich in Vitamin E and Omega-3 fatty-acids.)  Page 13 of their 2008 10-K annual report states that prepared chicken products, such as marinated whole chicken and chicken parts, offer “greater growth and higher average sales prices than fresh chicken products”.  Moreover, Pilgrim’s Pride uses value based pricing.  Also from page 13:  “we establish prices for our prepared chicken products based primarily upon perceive value to the customer, production costs, and prices of competing products”.

Pilgrim’s Pride is also aware that the demand for dark meat chicken is lower in the states than in other countries.  As such, it operates an export business selling dark meat to other markets, such as Mexico.

In terms of pricing to value and finding markets where their product has the highest perceived value, Pilgrim’s Pride appears to be executing proper market level pricing.

Transaction Level Pricing Is Suspected To Be Below Par

Each individual transaction needs to be managed to ensure that proper pricing flows through to the bottom line.  All too often, a good market based pricing plan is undermined by discounts provided at the channel level.  Proper transactional price management requires:

• Tracking and monitoring pricing of each individual transaction
• Understanding of the source of price variances and the methods of shaping discounts towards the company’s favor
• Profit sensitivity analysis of individual transactions, clients, and market segments
• Incentives to encourage salespeople and channel managers to price appropriately
• Decision authority and escalation management to curtail poor judgment and instruct developing salespeople
• Insight into the actual risk of loosing a transaction if price concessions are not made

Pilgrim’s Pride declined to comment on the specific transactional pricing techniques they use, or even if they have transactional level price management.  As before, this leaves us to infer their techniques from their statements.

Their 10-K reports that 11% of their volume derives from a relationship with Wal-Mart and goes on to state that this is an important relationship, one in which changes may have a material impact on earnings.  However, it does not state whether that relationship is profitable nor what the relationship is between profitability and volume.  In fact, it does not indicate any relationship between transactional level profitability and other factors such as channel (restaurant vs. grocer), size (large orders vs. small), delivery frequency, or if the sales person in charge of a particular transaction determines transactional profitability.  Without this data, it is hard to put merit behind the claim that a relationship with Wal-Mart is profitable for shareholders.

Grading Pilgrim’s Pride on Pricing

From this analysis of Pilgrim’s Pride, we will have to give it an F on managing pricing at the industry level.  It simply failed to reduce production sufficiently.  Granted, a 12% to 18% reduction in production is hard for the ego to execute, but the complete destruction of shareholder value and bankruptcy filings are worse.

On market level pricing, Pilgrim’s Pride appears to be doing ok.  Nothing stellar, but also not abysmal.  We will give them a B for recognizing that marinated chicken is worth more than standard breast meat and that EggsPlus are worth more than standard Grade A eggs.

At the transactional level, Pilgrim’s Pride earned an uncertain C.  No clarity into its methods of managing competing clients and channels leaves us uncertain regarding its ability to properly manage its transaction level pricing.

Fair enough grading, but what is the point?  If you’re an executive, this brief outlines the methods to avoid a failure in pricing.  If you’re an investor, it outlines the reasons to be wary of certain opportunities.  Pilgrim’s Pride is in bankruptcy court and hunting for fresh investments or bank loans.  If we were the judge or potential investor reviewing this corporation, we would force them to fix their pricing first.  If a company can’t produce a product people value and price it appropriately, then it isn’t company that can stand on its own two feet.  Bankruptcy protection is designed to enable companies a chance to regain their footing.  Pricing is the groundwork problem Pilgrim’s Pride must fix, a problem they should have fixed back in the spring of 2008 when the price of feed was increasing in the future’s contract market.  Hopefully, the investors and judges overseeing the recovery of Pilgrim’s Pride are demanding the above fixes.

References

• Julie Jargon, Lauren Etter, “Passing Along Rising Costs Lifts Kraft, Wrigley, Meat Glut Chops Tyson’s Earnings”, Wall Street Journal, July 29, 2008, p. B1.
• Karen Robinson-Jacobs (2008, 12 August). “Pilgrim’s Pride cutting 600 more jobs as feed costs soar”. McClatchy – Tribune Business News,  Retrieved November 7, 2008, from ABI/INFORM Dateline database. (Document ID: 1529474101).
• Scott Kilman (2008, August 8). “Food Giants Race to Pass Rising Costs To Shoppers”. Wall Street Journal  (Eastern Edition),  p. A.1.  Retrieved November 7, 2008, from ABI/INFORM Global database. (Document ID: 1527463481).
• Kirsten Valle, Ames Alexander. (2008, 28 October). “Processors of poultry facing big challenges: Higher costs, lower demand amid faltering economy force officials in Carolinas to eye the situation warily”. McClatchy – Tribune Business News.  Retrieved November 7, 2008, from ABI/INFORM Dateline database. (Document ID: 1583757051).
• Lauren Etter, Jeffrey McCracken. (2008, October 17). “Debt Woes, Feed Costs Come Home To Roost At Pilgrim”. Wall Street Journal  (Eastern Edition), p. A.1.  Retrieved November 7, 2008, from ABI/INFORM Global database. (Document ID: 1576167571).
• Lauren Etter, Dough Cameron. (2008, October 28). “Pilgrim’s Pride Lenders Grant Temporary Waiver”.  Wall Street Journal. Retrieved November 6, 2008, from WSJ.com.
• Janet Adamy, Jeffrey McCracken. (2008 December 2). “Pilgrim’s Pride Seeks Chapter 11 Protection”. Wall Street Journal (Eastern Edition).  http://www.proquest.com.ezproxy2.lib.depaul.edu/ (accessed December 28, 2008).
• Lauren Etter (2008, December 17). “New CEO Is Selected As Pilgrim’s Reorganizes”. Wall Street Journal (Eastern Edition).  http://www.proquest.com.ezproxy2.lib.depaul.edu/ (accessed December 28, 2008).
• Pilgrims Pride 10-K Annual Report, 2007 and 2008.