A SMALLER, leaner and more focused Australian Agricultural Co is signalling that vertical integration is a powerful tool in the beef industry, managing director Jason Strong told a producer audience in northern NSW last week.

Addressing about 500 cattle producers at the Yulgilbar field day on the picturesque Clarence River in northern NSW on Friday, Mr Strong said globally, there were few industries as fragmented as the beef industry, and few major beef producing countries as fragmented as Australia.

“Despite significant improvements in the way we manage our businesses and market our products, vertical integration is a concept that has largely escaped our industry,” he said.

He defined vertical integration, in its purest form, as a combination within one or two businesses, in two or more stages of production that are normally operated by separate entities.

“When we talk about it more generally in the beef industry, largely we are looking for connections along the supply chain, from production, through to processing and end-users. Right now, I think we’d accept any loose interpretation of vertical integration, if we could make any of it happen.”

So why is it so important to try to eliminate fragmentation?

Pointing to the last five years as an illustration, Mr Strong said there had been three years of unprecedented margins for beef processors, followed by two years of unprecedented prices for producers.

“But neither are any good for the long-term profitability of the industry,” he said.

“In both cases, there were people in each sector realising that this was not a good result, but at the same time, there were plenty of us taking advantage of it – sticking-it to the other side, for as long as we possibly could.”

There was not a huge shift, year-on-year, or season-on-season, in the total margin in the supply chain, he said, however there was massive shifts in where that margins actually sat.

“We’ve had cases in the last five years where all of the supply chain margin has sat with a single sector – either processor or producer. In simple terms, that means everyone else in the chain must receive either a negative margin or some part of the supply chain must be running at a significant loss, which we have all experienced.”

“This is a challenging way to run a sustainable business – some would say impossible.”

In this context, what is AA Co doing to manage risk?

As the world’s largest cattle producer, the company operates 21 properties two feedlots and a processing plant. It also works closely with a number of partners who background, grow, feed and process cattle on AA Co’s behalf.

“This may sound like the perfect model for vertical integration. It absolutely is, but we’re actually relatively new in the approach. The potential is phenomenal, when every part of the system can work together to produce a result,” Mr Strong said.

“Something had to change, and change dramatically. That change was vertical integration”

Since re-listing on the stock exchange in 2001, AA Co revenue had increased nearly six-fold, to a high last year of $489 million. Profits including revaluations had gone up $180 million year on year, from a low in 2009 in the negatives to a high this year of $133m. Net assets had increased five-fold to over $1 billion in that time.

“They’re pretty big numbers, but they’re actually not that helpful. Because over that time (2001-17), we’ve produced $4.3 billion in revenue, but our net operating cash flow has been negative,” he said.

2013 was the turning point for the company – debt had reached a record high, the herd had peaked at 685,000 head, and profit was the second lowest ever recorded. Something had to change, and change dramatically.

“That change was vertical integration,” Mr Strong said.

“We recapitalised the business; we decided to become a beef company, not a cattle company; and we decided to change the way we ran and managed the business. We also came to some realisations about ourselves – one being that bigger is not always better.”

“High quality land and cattle assets are no value if they are not put to work. There is no point in investing in genetics and production efficiencies if you can’t maximise the benefit of those by having to sell the cattle before they reach their genetic potential.”

“Probably most importantly, we absolutely have to integrate the company business units that have been operating large in isolation from each other. And just as importantly, you really shouldn’t under-estimate the ability of good people to adapt to change, when given the opportunity.”

Since 2013, when the vertical integration process started in the business, AA Co had reduced its cattle herd by 20pc, today running about 540,000 head; it had increased the percentage of revenue derived from branded beef sales by 70pc, now accounting for 85pc; overall revenue increased by 40pc to $445m this past year; and most importantly, net operating cash flow increased from a negative figure in 2013 to just over $21m this past year.

“Since 2013, we’ve shown a number of key things in our business – for example, we can actually produce more revenue from less cattle,” Mr Strong said.

“Our revenue peaked in 2016, and even though revenue declined by 10pc in the 2017 year, we actually improved our profit year-on-year threefold. Bigger isn’t always better. We’re now producing more revenue from fewer cattle and more profit, with less revenue.”

How has AA Co achieved this, as a business?

It had focussed on four key pillars, Mr Strong said:

• Integrating its supply chain
• Investing in innovation and technology
• Focus on branding and marketing, and
• Producing a high quality end product

“We’ve moved away from the individual business unit decisions to a supply chain-based approach, where station targets are based on kilograms of production. We have one point of revenue recognition, being our price per kilogram of branded beef sales,” he said.

“We’ve assigned every station operation with a focused, specialist role in our supply chain, whether that is for the Wagyu program, the composite breeding program, or the Brahman program directed at northern live export markets. These roles cover everything from specialised bull breeding units to cow calf production, backgrounding or lotfeeding.

“We’ve largely stopped selling cattle to other markets, and have significantly reduced the purchase of external cattle, reduced our sales to live export and channelled these cattle into our branded beef program.

“We’re now forecasting product sales and demand with our key customers well into the future, and this has enabled us to make every calf breeding decision with our end-markets in sight.”

Most importantly, focusing on the company’s own cattle supply meant it could realise an increased margin on each beast.

“Owning our animals as far down the supply chain as possible enables us to create and capture the most value possible. It also gives us a point of difference to many other exporters, and gives us a lot more control over the end-product quality, when we can apply our own systems right through the supply chain,” he said.

Quality beef in every category – hamburger to Wagyu

“As food producers, the quality and consistency of our product is of utmost importance in securing the future of our industry,” Mr Strong told the Yulgilbar field day audience. “This means we need to get better as an industry at producing consistently tender, flavoursome and juicy beef, if we are going to maintain and grow our margins. It’s that simple.”

“We’re reliant on feedback through the supply chain to facilitate the improvement through our production systems. All we are aiming to do at AA Co is produce the highest quality beef in every category that we work with – whether that’s our luxury branded beef that goes into the Wylarah brand, or manufacturing beef that comes out of Livingtone plant near Darwin.”

“We’ve put a lot of work into defining our products based on eating quality – and not just carcase specifications, that mostly consumers just don’t understand. We’re building brands that are uniquely Australian, that represent the history and heritage of our company.”

“As we develop the down-stream relationships and better understand the complete supply chain, one thing that strengthens our resolve for vertical integration is the erosion that we see of margin from producer through to the consumer.”

“When we see our (Wagyu program) product in Harrod’s display in London selling for the equivalent of the equivalent of $495/kg – knowing we sold that product for less than $100/kg – you’d think there must be a couple of people between us and them driving Ferraris. But we actually know they are not. It’s not about cutting people out of the system, it’s about getting them properly connected to capture all of the margin that possibly exists,” Mr Strong said.

This could be achieved by building better relationships, reducing the cost of logistics, reducing the value-loss in storage, reducing under and over-ordering which creates discounting opportunities, and improving understanding of consumer requirements so that supply chains get the right products in from of the right people in the right condition at the right time.

So what does the future hold for the industry?

“We’re really lining-up for significant change. If Australia is going to produce high quality beef products, we have to be better aligned and better integrated right across the supply chain.

“If you, as a beef producer, don’t think we’re up for change, ask a taxi license holder what they think of Uber; a suburban hotel what they think of AirBnB, or the owners of Fairfax what they think of Facebook.”

To add further weight to the theme of change, AA Co last year hosted a visit by Bill Gates to see how the company applies technology to livestock production, with the aim of applying these principles in developing regions like Africa, to significantly increase beef and protein production.

“But also in his comments about his visit, Bill Gates referenced his investments in companies working on meat substitutes as well,” Mr Strong said.

“Global demand for red meat protein continues to increase. We have to get better at delivering consistent high quality products to consumers, because if we don’t, someone else will find or invent a way to do so,” he warned.

Mr Strong said it was impossible to tell where the share in the value chain might trend in future.

“All we can say with certainty is that it is going to continue to move, and substantially. In Australia what drives that is purely supply and demand. We are about the most extreme case of supply and demand volatility that you could ever find. If there is one more cow, the price goes down, if there’s one less cow, the price goes up. That’s the problem,” he said.

“There’s no connection. We have ten chunks of the supply chain, and only about two of those have any real connection through to the end value of the product. There’s very little connection between a backgrounder or a lotfeeder to the value of a product that goes to a consumer in Singapore.

“It’s just trading a product that just happens to be a cow. We find some better way to connect those things – and as a business, AA Co has an opportunity to do some of that, because we have some critical mass.”

“We’re trying to sell an animal. The question shouldn’t be, ‘What’s the market price on the day that I can maximise my value from?’ it should be, ‘How do I get a price which provides me with consistent margin and profit from every animal?’

“Until we make that sort of maturity leap as an industry, then we are going to continue to struggle, and the margin will continue to charge up and down the supply chain,” he said.