THE ARKANSAS EGG COMPANY

Michael Cox had a problem. As president of Arkansas Egg Company (AEC) based in rural Summers, Arkansas, he produced organic cage-free eggs for a living, but consumers were not buying them. It was early September of 2016 and the retail specialty egg market, which included cage-free, was weak, mostly due to an oversupply of conventional caged white eggs. Until now, the market for specialty eggs, reflecting consumer preferences for supporting small farmers, improved animal welfare, and organic food, had been growing steadily, but these eggs cost much more to produce and were more expensive in the store. As Cox described the relationship,

A shift to sustainable farming practices (with a focus on animal welfare) is dependent on the consumers’ willingness to pay more for that item and understand why it costs more. Organic farming has been a breath of life into small farms across the country. It creates an environment where the focus is on doing the right thing, not the cheapest thing. As a result the products cost more to produce and net more income that sustain this method of production.1

Conventional caged eggs were a commodity and producer prices were sensitive to shifts in supply and demand. But specialty eggs were often grown under contracts that protected producers, and the current oversupply meant that consumer prices of conventional eggs had plummeted, while specialty egg prices remained high. This differential had gotten so large that consumers of specialty eggs were switching back to conventional eggs. Cox could not remember a time when prices for on-shelf conventional caged-eggs had fallen so low that they affected consumer demand for specialty eggs. Cox bemoaned his situation:

This is the first time that a bad caged market has affected the specialty market. You go to the grocery store and you see 75-cent white caged eggs, you’re going to buy those eggs, not our $5 eggs. White eggs have gotten so cheap that it’s pulling our consumer base away.2

Until now, his margins on production had been largely protected by a key contract with CCF Brands, a wholesaler of packaged foods, including organic eggs. But that

—————————– Copyright © 2018 by the Case Research Journal and by David G. Hyatt. This case study was prepared as the basis for classroom discussion rather than to illustrate either effective or ineffective handling of an administrative situation. The author wishes to thank Michael and Erin Cox of Arkansas Egg for their assistance in preparing this case. The author also wishes to thank Gina Vega and the anonymous CRJ reviewers for their helpful suggestions on how to make this a more effective case. This effort was supported by a grant from the Worthen Case Fund at the University of Arkansas Sam M. Walton College of Business. D

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2 Case Research Journal  Volume 38  Issue 1  Winter 2018

contract would expire on October 1, and Cox would be competing in the open market for egg prices that were now a fraction of his production costs. Cox wondered how he could protect his investment and minimize his losses.

THE ARKANSAS EGG COMPANY

Michael Cox was a third-generation egg producer. Over time, the family had built a vertically integrated company for conventional caged, white egg production, meaning that the operations included a feed mill, pullet houses for raising baby chicks, houses for hens to lay eggs, a production facility to clean, grade and pack eggs, and a refrigerated warehouse to store eggs for customer pickup. The operation peaked production with around 2.5 million hens, but his father closed the business in the 1990’s during a sharp downturn in the egg market,

My grandpa was with Cargill—that’s who he retired with—but my dad was an independent cage producer in the ‘80s and ‘90s. The market really crashed, bad, in 1999 and that was kind of the end of that. It was just one of those cyclical bad crashes that the little guys have a hard time withstanding. So he was one of the larger independent producers in the country, but trying to sell independently in that market without sales locked up, you can’t survive.

Cox purchased the assets from the business and created Arkansas Egg Company in 2001.

By 2007, aiming to differentiate his product, Cox began to shift from conventional caged-egg production to specialty eggs. Product marketing attributes in the specialty egg market affected the food or welfare of the hen laying the egg. This included organic feed, cage-free production, cage-free with outdoor access (free-range or pasture- raised), or other dimensions that commercial customers might demand.3 Cox first contracted with Arkansas-based CCF Brands to produce organic, cage-free eggs for its Great Day Farms label, sold in Walmart stores.4 The timing was good for Cox, who was concerned about poultry welfare issues and, just like his father before him, was hard-pressed to compete in the conventional market,

We converted into organic production for several reasons. One, we had old, run down facilities which helped me see firsthand the environmental and welfare issues that accompanied conventional production. Second, the market for organic was stable compared to the conventional side. We could obtain the margins we needed to do a lot of things differently, the right way.5

Cox continued to expand operations in the specialty egg market. In 2010, AEC partnered with Texas-based Vital Farms, becoming first company in the nation to commercially produce pasture-raised eggs. Using contract growers, in 2012 AEC became Happy Egg Co.’s first U.S. producer and packer for its free-range certified brand.6 Cox reflected on the value AEC provided to egg consumers and family farmers,

My dad was a mass producer of cheap egg and he felt like his good work was providing the lowest cost product to the consumer. Now we have a lot of stakeholders, a lot of family farms. And we’re creating a better life for a lot of different people on both ends. It does cost a little bit more, but the consumers that buy our eggs feel good that their purchase is directly impacting family farmers. Some companies want to be on the right side of change, and that is where are at. D

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Arkansas Egg Company: Cracks in the Specialty Egg Market 3

By 2016, Cox was servicing these three contracts, as well as selling on the open market, with production from his own farms and from 25 contract growers in Arkansas and Missouri. His contract production in Missouri comprised 320,000 hens producing free-range eggs. His production on his own farms in Arkansas included 38,000 hens producing pasture-raised eggs and 130,000 hens that were producing organic cage-free eggs for the now expiring CCF Brands contract.

CCF Brands contracted for the output of a certain number of hens (up to 150,000) at a set price. Although Cox could profit by achieving higher-than-average egg production with efficient feed conversion, he also risked losses if production was below average. While his contracts contained feed escalator clauses that largely protected Cox from changes in feed costs, to achieve expected profit margins of 6-8 percent, Cox had to keep costs low and production high. Cox elaborated on his approach and the costs:

We use the Hyline Brown breed—commercial layers that will lay 26 to 28 dozen eggs in their lifetime. They’re good layers, are hardy, calm, and have good feed conversion. We get them from the hatchery at 95 cents, 35 to 80 thousand chicks at a time. By 24 weeks, when they really start laying, we’ve got $6.35 invested in cage-free and $10.64 in organic cage-free. Over their life, cage-free hens will cost us about $1.10 a dozen and organic cage-free hens will cost us about $1.70 a dozen. That $1.70 includes the original investment, feed, compliance, transportation and other direct costs, as well as 16 cents long- term debt and overhead.

On average, peak hen egg production occurred around week 31 and decreased thereafter. (Table 1 provides an approximation of the production pattern.) Generally Cox considered hens “productive” for 55 weeks beginning with week 24 and ending with week 78, when the hens were “spent.” Hens were spent when they were not producing many eggs, but they were still consuming the same amount of food and thus it was no longer financially feasible to keep the hens alive and in production.

Table 1. Production patterns

Adapted from: Food and Agriculture Organization of the United Nations (FAO). 2010. Egg Marketing: A Guide for the Production and Sale of Eggs. http://teca.fao.org/read/6895.

When the hens were spent, the layer house was “depopulated,” costing about 14–16 cents per hen, and the house was readied for the next flock.7 Although AEC had previously explored various end-of-life alternatives, including specialty food markets and other products like salad toppings, pizza toppings, sausage, and even dog food, in D

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4 Case Research Journal  Volume 38  Issue 1  Winter 2018

2016 there were no options for recovering any value from hens after 78 weeks. Cox described the situation, exacerbated by the fact that laying hens were a third of the size of hens raised for meat,

What we run into is that these are old birds—this is an 80-week-old bird relative to a 35- to 50-day-old meat chicken you’re getting from the store. The texture’s different, the flavor profile’s different, and it’s not really something American consumers like. And from a cost standpoint, the yield of meat from a layer hen is minuscule compared to a meat bird, and considering the processing cost in a meat plant, you just can’t justify it. At the end of the day you have a product that costs more per pound to create that visually looks worse and that tastes worse, to the American consumer.

At the two layer farms in Arkansas (called Summers and Thomas) servicing the organic cage-free eggs contract for CCF Brands, Cox was operating 12 layer houses with about 130,000 hens (see Table 2). The contract specified that CCF Brands would accept the output of up to 150,000 hens at a set price. Cox aimed to produce at least 26.6 dozen eggs per hen over its productive life. If he produced 26.6 dozen, he could operate with a normal profit margin and recover costs. If he produced more, he could achieve greater profit on the remaining eggs produced (having recovered his costs). If he produced less than 26.6 dozen, he could potentially lose money. Without the contract, Cox would have to sell eggs on the open market where brown eggs were trading at around 30 cents per dozen.8 (See Exhibit 1 for additional cost and production information.) Table 2. Arkansas Egg Company organic cage-free hen populations.

Hens (approximate) Farm, barn number, and age of hens in barn

30,000 Summers #1 (15,000) & #5 (15,000): 48 weeks

15,000 Summers #2: 40 weeks

Summers #3: Empty due to regular flock transition

15,000 Summers #4: 34 weeks

10,000 Thomas #21: 47 weeks

20,000 Thomas #22 (10,000) & #23 (10,000): 58 weeks

20,000 Thomas #24 (10,000) & #25 (10,000): 45 weeks

20,000 Thomas #26 (10,000) & #27 (10,000): 40 weeks

Note: Hen ages estimated as of the date of the contract expiration.

EGG INDUSTRY MARKET DYNAMICS

In the United States, the $6.6 billon, mature shell-egg industry was dominated by large- scale, vertically-integrated producers of caged eggs. Sixty-four egg producers accounted for approximately 85% of the total production of 83 billion eggs from a domestic stock of about 302 million hens. About 88% of these hens supplied conventional eggs, and 12% produced specialty eggs, and most of the production supplied retailer and foodservice firms’ demand.9 Even given the current weak market for specialty eggs, Cox felt that it was poised to grow dramatically over the long term: More than 100 large-volume purchasers, including Walmart, McDonald’s, Compass Foods, and Unilever, had recently committed to 100 percent cage-free eggs by 2025. This was projected to affect over 50% of egg production in the United States. D

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Arkansas Egg Company: Cracks in the Specialty Egg Market 5

The egg market overall was cyclical and depended on multiple factors, including feed costs and the lead time required to bring hens into production. In addition, seasonal demand variation made life tough for producers. Cox described how demand changed over the year.

The egg market is one of the most volatile commodity markets there is. Not only are there fluctuations with feed costs but there are significant demand changes over the year. Usually about the time school starts in August, demand hits. You’ve got cafeterias that are cooking eggs every morning and things like that. And then through the holidays, demand exceeds supply through Thanksgiving and Christmas, all the way to Easter. Then around May 1st, demand falls until school starts again.

However, the September 2016 market oversupply problem was related more to the ripple effects of an avian flu outbreak that began in the U.S. during December 2014 and continued through the middle of 2015. This outbreak had devastating effects on egg production; at least 35 million hens were lost by June 2015 from a base of nearly 310 million in January 2015.10 That loss, and the subsequent restocking, had sent prices spiraling upward in 2015, then crashing down again in 2016.11 (See Exhibit 2.) Cox described the dire impact of the situation on smaller producers and his optimism for a market rebound in the fall:

This market fell off a cliff in early spring of 2016. The egg market usually goes through huge cycles, like seven-year cycles, but this is the worst that we’ve seen. By early spring of this year growers had their farms restocked, and basically the market flooded. A lot of small growers are going out of business. People hang on until they can’t anymore. Part of what has me holding on is that historically the market turns around. So if you’re looking at this in the summer you think, man, things stink now, but hey, the worse things are now, maybe the more likely they are to come back in the fall.

Complicating things for Cox, competition also was heating up because the largest producers in the industry moved into the specialty market in response to the cage-free commitments by the retailers and foodservice firms. These producers operated large, integrated complexes (often with more than a million hens) and took advantage of that scale to lower their costs. Because the cage-free standards (with the exception of organic) did not require access to the outdoors, high-volume producers could easily convert their facilities to achieve this standard. At the same time, as larger conventional producers made this shift, they would either have to cut production or expand facilities. Cage-free hens required at least double the space of conventional hens. How this shift happened would influence the supply of both conventional and specialty eggs. Already, the U.S. cage-free hen inventory had doubled from 6 percent of the total flock in April 2015 to 12 percent in August 2016.

MOVING FORWARD

Michael Cox considered what to do about the expiring contract with CCF Brands and the 130,000 hens supplying that contract. Future marginal cost from these birds would exceed marginal revenue. Although he had known far in advance that the contract would not be renewed, Cox had not been overly concerned because prices were good. But now, given the industry’s current oversupply, it would be tough securing another contract with favorable terms. D

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6 Case Research Journal  Volume 38  Issue 1  Winter 2018

Should he hang on through the current laying cycle, hoping for a market rebound in the fourth quarter? Market conditions usually improved in the fall and early winter as schools were in session and as holiday cooking required eggs. If market conditions improved, so would the possibility of contracts. Further, some of the largest food retail and foodservice companies were making commitments for procuring specialty eggs (cage-free). While these commitments were for the years 2020-2025, many large farms producing conventional eggs would need to cut production to meet the cage-free demand (barns that housed 10,000 hens in cages housed less than 5,000 cage-free). As supply of conventional eggs decreased, demand should be restored for Cox’s organic eggs as the decreasing price differential drew consumers of organic eggs back.

Holding on would mean selling on the spot market through Egg Clearing House Incorporated, where brown eggs were trading at around 30 cents per dozen. White eggs were even cheaper.

He wondered if he should depopulate the flock; contractors would kill the hens humanely and dispose of them at the county landfill. That would probably also mean laying off the employees currently working in those houses. What if he got a contract opportunity, but had no chickens to fulfill it? He had to count on 6 months lead time to get back into production. Further, if he did depopulate, he gave up all possibility of recovering his initial investment. While depopulating hen houses was a fact of life for Cox, as a producer concerned with hen welfare, it was never easy to do.

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Arkansas Egg Company: Cracks in the Specialty Egg Market 7

Exhibit 1. Arkansas Egg Company Cost and Production Information

Arkansas Egg aimed to collect 26.6 dozen eggs from each hen over its productive laying cycle of 55 weeks. If that happened, based on the contract price, then AEC recovered the costs of bringing the bird to its productive cycle (about 40 cents/dozen) as well as fixed overhead (about 16 cents/dozen). The approximate contribution margin during this time was 7%. After the breakeven point, the only costs incurred were the variable production costs.

Information on hen life cycle

Approximate life of hen 78 weeks

Pre-productive period of hen life cycle First 23 weeks of life

Productive period or laying cycle Last 55 weeks of life

Average age of laying hens at Summers’ barns 43 weeks

Average age of laying hens at Thomas’ barns 48 weeks

Minimum production target (PT) over which to allocate costs 26.6 dozen

Approximate costs based on 26.6 dozen production target

Total pre-production cost through week 23 $0.40 per dozen or $10.64 per bird

Fixed overhead cost (facilities, debt service, depopulation, etc.) $0.16 per dozen or $4.26 per bird

Variable production costs (feed, transportation, labor, etc.) $1.14 per dozen or $30.32 per bird

Total cost for producing organic cage-free eggs $1.70 per dozen or $45.22 per bird

Expected profit at 26.6 dozen (7%) $0.12 per dozen or $3.17 per bird

Note: Arkansas Egg Company, as a family business with less than $25 million in revenue, used cash basis accounting for book and tax purposes. For purposes of this case, assume that revenue was produced after eggs are laid. Fixed and variable production costs were incurred evenly across the hen production cycle.

Exhibit 2. Trends in the Conventional Egg Market

2016 2015 2014

Sep Jun Mar Dec Sep Jun Mar Dec Sep

Farm Price White Egg (doz.) $ 0.40 $ 0.32 $ 0.67 $ 1.06 $ 1.70 $ 1.72 $ 1.24 $ 1.47 $ 0.85

Retail Price White Egg (doz.)1 $ 1.55 $ 1.49 $ 2.08 $ 2.75 $ 2.97 $ 2.57 $ 2.13 $ 2.21 $ 1.97

Table Egg Laying Hens (millions)2 307.6 301.0 302.4 286.6 275.6 269.9 304.1 307.8 302.1

Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3

Table Egg Production (billions)2 22.4 21.6 21.1 20.2 19.5 20.3 21.5 22.2 21.6

Table Egg Demand (billions)3 20.2 21.4 21.4 20.8 19.7 20.0 20.9 21.9 21.4

Per Capita Demand (dozen eggs)3 69 66 66 64 61 62 65 68 67 1 Source: Ibarburu, M., 2016 “U.S. egg cost of production and prices,” Egg Industry Center. 2 Source: USDA Economic Research Service. Livestock & Meat Domestic Data. Chickens and Eggs. Latest report available at: http://usda.mannlib.cornell.edu/MannUsda/viewDocumentInfo.do?documentID=1028 3 Source: USDA Economic Research Service. World Agricultural Supply and Demand Estimates Report. Latest report available at: https://www.ers.usda.gov/data-products/livestock-meat-domestic-data/

Note: The USDA Cage-Free Shell Egg Report described that September prices to the first receiver (farm price) of organic cage-free eggs varied between $1.35 and $2.40. These were most likely contracted prices. Latest report available at https://www.ams.usda.gov/mnreports/pymcagefree.pdf

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8 Case Research Journal  Volume 38  Issue 1  Winter 2018

NOTES

1 Vital Farms (July 21, 2011) “An Interview with Michael Cox, family farmer, Arkansas.” Company website posting retrieved from https://vitalfarms.com/an- interview-with-michael-cox-family-farmer-arkansas/

2 Unless otherwise noted, quotes from Michael Cox come from interviews conducted during September and October 2016.

3 See this poster by the USDA that includes some information on egg marketing attributes: https://www.flickr.com/photos/usdagov/6904946814/sizes/o/

4 See this link for information on CCF Brands operations: http://www.ccfbrands.com/great-day-farms.

5 Vital Farms op. cit.

6 See this link for information in Vital Farms: https://vitalfarms.com/ including an interview with Michael Cox here: https://vitalfarms.com/an-interview-with-michael- cox-family-farmer-arkansas/. Also, see this link for more about the Happy Egg Company: http://thehappyeggco.com/

7 When Cox depopulated his houses, contractors normally came on site and euthanized the hens and removed them to the county landfill.

8 In general, there is no difference between white and brown eggs. White chickens lay white eggs and red/brown chickens lay brown eggs. While the marketing attributes of organic, cage-free, etc. could be used in the production of either hen type, they were most often used with brown chickens. White chickens were smaller, ate less and were better suited to caged production environments. Cox means caged production when he says “white eggs.”

9 American Egg Board (2016) “About the U.S. Egg Industry.” See also O’Keefe, Terrence (2015) “Top 21 U.S. egg company profiles,” WATT Global Media; United Egg Producers (2016) “Egg Industry Fact Sheet.”

10 USDA (n.d.) HPAI 2014/15 Confirmed Detections; Ibarburu, M. (2016) “U.S. flock trends and projections,” Egg Industry Center.

11 Ibarburu, M. op. cit.

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  • Structure Bookmarks
    • Arkansas Egg Company: Cracks in the Specialty Egg Market
    • THE ARKANSAS EGG COMPANY
    • EGG INDUSTRY MARKET DYNAMICS
    • MOVING FORWARD
    • Exhibit 1. Arkansas Egg Company Cost and Production Information
    • Exhibit 2. Trends in the Conventional Egg Market
    • NOTES