Babbitt ranches: adding value to cattle.
This case study explores the feasibility of a new business venture by a fourth-generation family business, Babbitt Ranches. As the business leader of a vast ranching empire in northern Arizona, Mr. William Cordasco, President of Babbitt Ranches, has developed a business plan to produce, process, distribute and sell beef and related beef products. Historically, Babbitt Ranches has simply raised and sold cattle at the going spot prices in the beef commodity markets. Students, in their analysis of the case, will face a number of challenging issues including ethics, marketing channels of distribution, family business values and financial analysis and forecasting. (1)
In the spring of 2005, William Cordasco was putting the final touches on his presentation for the upcoming annual shareholder meeting of Babbitt Ranches. As the President of a fourth generation family-owned business, Mr. Cordasco was sensitive to the liquidity needs of his 188 family shareholders. Babbitt Ranches, formerly known as The Babbitt Brothers Trading Company (BBTC), had recently undergone a major transition. Started in 1886, BBTC became one of the largest and most successful mercantile and ranching empires in the West in the late 1800's and early 1900's. However, in 1988 a number of factors led to a debt-financed stock buyback from some of the third-generation family members/shareholders, who wanted to cash out of the family business. These events forced the company to sell off most of their retail businesses during the 1990's in order to pay off the debt of the company. In the wake of this major transition, Mr. Cordasco wanted to shift the focus of the family business back to its roots in ranching and land stewardship. Babbitt Ranch lands, encompassing 700,000 acres in northern Arizona, had great value as real estate, but it was not a liquid asset. Thus, one of the greatest challenges for Mr. Cordasco as business leader was to identify and pursue business opportunities generated from the land that could provide cash flow to his remaining family shareholders.
Having begun as a ranching operation in the late 1800's, it seemed appropriate to explore adding value to their cattle by processing and selling beef products versus simply selling their cattle at variable spot prices in the beef commodity markets. Currently, Babbitt Ranches owns approximately 8100 head of cattle (including heifers, steers, cows, and bulls). Mr. Cordasco's vision was to first utilize cows primarily to produce beef patties (burger) and beef jerky. Once this first phase became operational and profitable, he planned to expand and utilize steers to produce and sell premium quality fresh cuts of beef. For the past year Mr. Cordasco had been working on the development of a business plan for the first phase that he would be presenting to his shareholders at the annual meeting. The mission statement for this new business opportunity was: "To produce, process, distribute and sell at a profit, premium beef patties, beef jerky and related products under the CO BAR brand."
History of Babbitt Brothers Trading Company
In 1886, five imaginative and energetic brothers moved out West from Cincinnati, Ohio. Through hard work and dreaming they parlayed a small herd of cattle and a small lumber store into a mercantile and ranching empire that is considered to be one of the more successful and respected family business endeavors in the West. With a $20,000 draft in their pockets, they purchased a herd of 864 cattle that were branded with the Babbitt "CO Bar", a sentimental reminder of their old home in Cincinnati, Ohio. The five pioneering Babbitt Bothers settled in Flagstaff, Arizona and proceeded to expand their land ownership, cattle ranches and business ventures throughout the 1900's. One Arizona historian has written: "The Babbitts, in short, fed and clothed and equipped and transported and entertained and buried Arizonans of four generations, and they did it more efficiently and profitably than anyone else."
Mr. Cordasco's grandfather, John George Babbitt, was the son of the youngest of the five founding Babbitt brothers. Raised by his grandfather, young William grew up on the ranching side of the business that his grandfather presided over for nearly 50 years. Growing up in this environment, Mr. Cordasco gained great appreciation for the strong ethical values of the family business as stewards of the land. Since graduating from Northern Arizona University in 1990 with a degree in Business Administration, Mr. Cordasco became President of Babbitt Ranches in 1992 and President of Babbitt Brothers Trading Company in 2001. As President he believes that private landowners have an ethical obligation to preserve the land in an ecological and environmentally responsible manner. (See Table I for a list of environmental awards.) This philosophy, handed down through four generations, has led to the adoption of a "multiple bottom-line" goal shared by the Babbitt Ranches Board of Directors. The multiple bottom lines meant that any new business proposal must make sense organizationally (in line with family business values), economically (profit generation), environmentally (stewardship and protection of the environment), and for the betterment of the community (any business activity should contribute to the community).
Recent Financial History of Babbitt Ranches
Data provided in Tables 2 & 3 depict Babbitt Ranches' financial performance over the six year period from 1999-2004. During this time period, the company primarily relied on cattle sales as their major source of income. Total revenues for the company remain fairly stable at a little over $2 million per year. However, cattle sales drop off noticeably in the years 2002 through 2004 and the company incurred a net loss in 2002 of $268,306.
The company has very little debt and is extremely liquid as indicated by the quick and current ratios. However, total asset turnover is less than 1 and the return on assets and return on equity are quite low. These low returns reflect the nature of the ranching business as their assets consist primarily of land and cattle inventory.
Profitability for the company declined dramatically from 1999 to 2002 with profits turning negative in 2002. However, profitability for the company as a whole recovered in 2003 & 2004. When focusing on the ranching operations, one observes that ranch income was negative in 2001 and in 2002 they lost almost $700,000! While income from ranching operations picked back up to around $80,000 in 2003 & 2004, ranching was not the major contributor to overall net income for the company in those years.
Several factors may have contributed to the drop in ranch income that began to occur in 2001. One major factor was the severe drought that occurred in the Southwest beginning in 1999 and continuing through 2004. The effects of the severe drought conditions are evidenced in Table 2 where it can be seen that the average weight per cow drops off substantially in 2002 and the number of cows sold declines compared to prior years. Also, in 2002 ranch expenses exceeded cattle income by almost $700,000. This was due to the added cost of feed, since there was nothing growing for the cattle to eat. Another potential economic factor contributing to the drop in cow sales was all the negative publicity relating to "Mad Cow Disease."
The Beef to Market Project
The opportunity to process and distribute beef related retail products presented a solid business opportunity. Rather than sell a full grown cow weighing 1000 pounds for roughly 45 cents per pound on the spot markets, a single cow could be slaughtered and processed into approximately 400 pounds of assorted beef products that would retail for $4-$9 per pound. This would enable Babbitt Ranches to convert a natural resource directly into a commodity that would provide a healthy, all-natural product for local residents. Potentially, it could also provide a consistent percentage return to shareholders above and beyond the profit obtained by selling cows at highly variable spot market prices (See Table 2 for recent years' spot prices.)
The business cycle for taking their beef to market involved four steps:
1. Manufacturing: Raise calves to full-grown on Babbitt Ranch land (about 1 1/2 years).
2. Initial Processing: Transportation of cattle to and from a slaughterhouse in Chino, Arizona.
3. Final Processing and packaging: To be performed by Flagstaff Custom Meats in Flagstaff, Arizona.
4. Distribution: Jerky products to be sold to and warehoused by a wholesale distributor. Retail distribution of patties, sausage and steaks directly to grocery/convenience stores including existing Babbitt locations in Arizona.
Each step of the business cycle presented certain challenges and issues that had to be resolved The manufacturing phase (ranching) was already in place, however cattle production is greatly influenced by human perceptions, economic trends, and natural factors. Beginning in 1999 the livestock industry suffered declines in the Four Corners Region (Arizona, Colorado, Utah, & New Mexico) due to severe drought, surface water and aquifer over-allocations, high grain and supplemental feed prices, low cattle prices due to the post-NAFTA flooding of the U.S. markets with Mexican cattle, and plummeting consumption of U.S. beef by consumers following the December 2003 "mad cow" scare (Nabhan and Taylor (2004)).
Since there were no slaughterhouse facilities in Flagstaff, Babbitt Ranches would have to ship their cattle to Chino Valley, 1 1/2 hours away, to have the cows slaughtered and then ship them back to Flagstaff to be processed into beef products. The major costs involved in processing were the costs of transportation (Babbitt Ranches already owned the vehicles, but gas prices continued to rise). Another cost at this stage was regulatory as the cattle had to be certified by state inspectors.
A local butcher, Mario of Flagstaff Custom Meats, had been working closely with Mr. Cordasco throughout the project's conception and was already onboard to handle the processing and packaging of the beef products. However, the design and printing of the packaging for the various beef products represented a significant up-front cost. Additionally, since many of the packaging units had to be purchased in minimum 100,000 lots, they needed to be fairly confident of the packaging. practices in the industry. For example, do stores sell beef jerky in 2 or 3 ounce" bags?
Finally, Babbitt Ranches had to decide on what channels of distribution they wished to use for their beef products. Babbitts could earn a greater profit margin if they could sell their products directly to retailers, rather than to distributors at the wholesale level. A few opportunities existed to sell their products directly to retailers in northern Arizona. Although the bulk of the retail arms of the Babbitt Bothers Trading Company had been sold off following the stock buyback in 1988, a few of the Trading Posts on the Navajo Reservation were still owned, where their products could be sold. The local Basha's grocery store chain (another family owned business started in Arizona) also was willing to purchase and sell Babbitt products. Mr. Cordasco also had entered into an agreement with the manager of the local New Frontiers store (a health food store) to sell their organic, all-natural beef products. Another option would be for Babbitts to set up their own retail store and perhaps capitalize on the Babbitt name recognition in northern Arizona. While he intended to fully capitalize on these opportunities to take their products directly to retailers, he realized that these distribution channels limited their sales to northern Arizona.
At the wholesale level, there were many distributors who could handle the Babbitt beef products line. Although the profit margins to Babbitts would be lower if they sold to wholesalers, they likely would sell a greater volume as the distributors already had accounts with all the major retailers. However, in conversations with potential distributors, Mr. Cordasco was disturbed by an underlying "what's in it for me?" mentality. In other words, while not directly asking for 'kickbacks', the distributors' sales representatives related how other clients had arranged for family vacations and other perks for the sales reps. It appeared that the distributors indirectly were asking for incentives in order for them to agree to distribute the Babbitt's product line. Mr. Cordasco was somewhat disturbed by these discussions and was not sure how to respond or react. Given this situation, Mr. Cordasco preferred to brainstorm ways to bypass the wholesalers entirely and take their products directly to retailers. He believed that Babbitt Ranches could engage in "niche market" product positioning due to the fact that their cattle were grass-fed, all-natural, and hormone and antibiotic-free.
As Mr. Cordasco prepared for his annual shareholder meeting, he formulated some questions to ask the Babbitt Ranches' board of directors:
(1) Should they sell beef products versus simply selling cows at spot market prices?
(2) Would the project provide a stable cash flow stream to their shareholders?
(3) What marketing channels should they use to distribute their beef products?
(4) Should they structure an incentive plan for distributors?
(5) Does this project meet our multiple bottom-line goals?
In order to properly address these questions, Mr. Cordasco has asked his assistant, Kim, to prepare some financial projections based on the historical data and pro-forma assumptions contained in Tables 2 through 5.
Gary Nabhan and Naima Taylor (2004), "Linking Drought and Long-Term Water Scarcity to Food Security in the Four Corners States: A Food Policy Paper", Northern Arizona University.
Waddock, Bedwell & Graves (2002), "Responsibility, The New Business Imperative", Academy of Management Executive, Vol. 16 #2, 132-148.
(1.) The author wishes to thank Mr. William Cordasco, President of Babbitt Ranches for his time and enthusiasm for this project. He was an invaluable source of information and provided much of the materials and data needed to prepare this case.
Lisa F. Majure, Associate Professor of Finance College of Business Administration, Northern Arizona University, P.O. Box 15066, Flagstaff, AZ 86011, Phone: (928) 523-7400, Fax: (928) 523-7331, E-mail: Lisa.Majure@nau.edu
Table 1 Babbitt Ranches Awards and Accomplishments 1995 Arizona Environmental Stewardship Award--Arizona Cattle Growers Association 1996 National Environmental Stewardship Award--National Cattleman Association 1999 Cattleman of the Year--Arizona Hereford Association 2001 The Nature Conservancy--Conservation Easement (40,000 acres) 2002 Ecological Monitoring & Assessment Foundation--A Research and Information Dissemination Program developed in conjunction with Northern Arizona University 2004 Donated Land for a County Park in Tuba City, AZ (on the Navajo Reservation) 2004 International Stewardship Award--International Association of Fish and Wildlife Agencies 2005 Remuda of the Year (Best horses)--American Quarterhorse Association Table 2 Babbitt Ranches Historical Cow Data 1999 2000 2001 Spot Price/lb. $0.35 $0.35 $0.45 # of cows sold 711 609 590 Avg. Weight/cow (in lbs.) 1040 1040 1045 Sales Price per Cow $364.00 $364.00 $470.25 Cow Inventory 3967 3967 4040 2002 2003 2004 Spot Price/lb. $0.43 $0.45 $0.63 # of cows sold 1083 313 404 Avg. Weight/cow (in lbs.) 900 1000 1000 Sales Price per Cow $387.00 $450.00 $630.00 Cow Inventory 3621 3843 3975 Table 3 Babbitt Ranches Selected Financial Data 1999-2004 1999 2000 2001 Cattle Sales $2,408,260.00 $1,905,644.00 $2,054,424.00 Other Revenues $(33,378.00) $51,512.00 $435,326.00 Total Revenue $2,374,882.00 $1,957,156.00 $2,489,750.00 Total Expenses $1,718,515.00 $1,620,859.00 $2,148,497.00 Net Income $656,367.00 $336,297.00 $341,253.00 Total Equity $6,744,765.00 Total Assets $7,107,845.00 Total Asset Turnover .9x Net Profit Margin 27.64% 17.18% 13.71% Return on Assets 4.80% Return on Equity 5.06% Current Ratio 4.64 Quick Ratio 1.57 Ranch Expenses $1,552,070.00 $2,074,667.00 (expenses not related to ranch backed out) Ranch Income = $689,745.00 $353,574.00 $(20,243.00) Cattle Sales - Ranch Exp Ranch Income/ $80.63 41.48 -2.39 animal owned Ranch Income/ $161.46 105.2 -6.26 animal sold Ranch Expense/ $200.90 $182.10 $244.86 animal owned Ranch Expense/ $402.27 $461.79 $641.72 animal sold (Manufacturing cost per cattle) # cattle owned 8554 8523 8473 # cattle sold 4,272 3,361 3,233 2002 2003 2004 Cattle Sales $1,656,750.00 $1,847,007.00 $1,648,970.00 Other Revenues $527,085.00 $394,333.00 $464,828.00 Total Revenue $2,183,835.00 $2,241,340.00 $2,113,798.00 Total Expenses $2,452,141.00 $1,840,000.00 $1,601,434.00 Net Income $(268,306) $401,340.00 $512,364.00 Total Equity $6,476,459.00 $6,952,106.00 $7,391,606.00 Total Assets $6,889,451.00 $7,033,830.00 $7,554,064.00 Total Asset Turnover .8x .79x. .66x Net Profit Margin -12.29% 17.91% 24.24% Return on Assets -3.89% 5.71% 6.78% Return on Equity -4.14% 5.77% 6.93% Current Ratio 5.91 23.20 16.86 Quick Ratio 1.60 9.81 8.25 Ranch Expenses $2,349,390.00 $1,765,884.00 $1,571,619.00 (expenses not related to ranch backed out) Ranch Income = $(692,640.00) $81,123.00 $77,351.00 Cattle Sales - Ranch Exp Ranch Income/ -85.62 $11.51 $9.45 animal owned Ranch Income/ -188.99 $25.75 $35.08 animal sold Ranch Expense/ $290.41 $250.66 $192.06 animal owned Ranch Expense/ $641.03 $560.42 $712.75 animal sold (Manufacturing cost per cattle) # cattle owned 8090 7045 8183 # cattle sold 3,665 3,151 2,205 Table 4 Babbitt Ranches Beef Products-Cost Data: Single Cow Basis Beef Beef Beef Patties Jerky Sticks # of Packages 44 316 171 Weight Per Package 3 lbs 2 oz 2 oz Total Selling Weight in lbs. 132 39.5 21.375 Costs: % allocation 25% 35% 15% # of lbs @ spot price Initial Processing (Beefway) Transportation Final Processing (FCM) Storage/Refrigeration SG&A Costs (prorated) Packaging $16.64 $49.60 $26.79 Total Costs Cost per Package Ranch Profit Mark-up 7% 20% 12% Distributor Cost $- $- $- Distributor Mark-up 15% 25% 25% Retailer Cost $- $- $- Retailer Mark-up 30% 40% 40% Retail Price per package $- $- $- Gross Sales (# Packages x Cost): Sales to Distributor $- $- $- Sales to Retailer $- $- $- Net Profit/cow (Ranch) Net Profit/cow (bypass distributor) Link Shredded Tenderloin Sausage Chew Steaks # of Packages 29 167 8 Weight Per Package 14 oz .32 oz 14 oz Total Selling Weight in lbs. 25.375 3.34 7 Costs: % allocation 6% 8% 4% # of lbs @ spot price Initial Processing (Beefway) Transportation Final Processing (FCM) Storage/Refrigeration SG&A Costs (prorated) Packaging $4.28 $21.44 $1.15 Total Costs Cost per Package Ranch Profit Mark-up 7% 12% 7% Distributor Cost $- $- $- Distributor Mark-up 15% 25% 15% Retailer Cost $- $- $- Retailer Mark-up 40% 40% 30% Retail Price per package $- $- $- Gross Sales (# Packages x Cost): Sales to Distributor $- $- $- Sales to Retailer $- $- $- Net Profit/cow (Ranch) Net Profit/cow (bypass distributor) Liver Bone Bulk Bulk Totals # of Packages 1 1 736 Weight Per Package 7 lbs 167 lbs Total Selling Weight in lbs. 7 167 402.59 Costs: % allocation 1% 6% 100% # of lbs @ spot price $ Initial Processing (Beefway) $45.00 Transportation $100.00 Final Processing (FCM) $280.00 Storage/Refrigeration $16.00 SG&A Costs (prorated) $50.00 Packaging $0.06 $1.34 $121.30 Total Costs Cost per Package Ranch Profit Mark-up 7% 7% Distributor Cost $- $- Distributor Mark-up 15% 15% Retailer Cost $- $_ Retailer Mark-up 30% 30% Retail Price per package $- $- Gross Sales (# Packages x Cost): Sales to Distributor $- $- $- Sales to Retailer $- $- $- Net Profit/cow (Ranch) $- Net Profit/cow (bypass distributor) $- Table 5 Babbitt Ranches Sales Projections And Pro-forma Data Sales Projections: 2006 2007 2008 # of cows processed/year 200 400 500 Fired Expenses: Selling General & $20,000 $30,000 $30,000 Administrative Expenses: Equity (Cash) Contribution to Project $30,000 Start-up Expenses $25,000 All sales on account with Net 30 day terms (ACP = 30 days) Accounts Payable - Net 30 day terms (APP = 30 days) (Accounts with Beefway and Flagstaf Custom Meats) Inventory Turnover = CGS/Ending Inventory = 26 times/yr. (Note: Ending Inventory = Beg. Inventory+Purchases-CGS) Variable Expenses (per cow processed): See Exhibit 3 Initial Processing (Beefway) Final Processing (Flagstaff Custom Meats) Transportation Storage/Refrigeration Packaging