Case 2.

4 Understanding the Clients Business and Assessing Risk

Asher Farms, Inc.

Required: [1] A useful approach for understanding a clients business environment and associated business risks is to perform a PESTLE analysis. PESTLE is an acronym for Political, Economic, Social, Technological, Legal and Environmental factors that are used to assess the clients business environment. A PESTLE analysis focuses on factors that may affect an entitys business model, but are beyond the control or influence of the client. While beyond managements direct influence, such factors may significantly impact an entitys business risk. Read the background information about the poultry industry and conduct additional research on the internet to obtain latest news and information on the industry. Brainstorm political, economic, social, technological, legal and environmental factors that could affect Asher Farms business risk. Unless your instructor indicates otherwise, identify at least one business risk factor for each component of the PESTLE acronym. The increasing demand for animal products resulting from demographic factors, technical and scientific developments, diminishing resources, and increasing consumer demands for more food safety, lower environmental impact, and better animal welfare conditions will determine the development of the poultry industry during the next decade. Here are the components of PESTLE contributed to the business risks of Asher Farms, Inc.: P Political

Regulation for Broiler Production

After decades of rapid expansion, growth in both broiler production and productivity began to slow in the mid-1990s. Slowing growth creates challenges for industry decision makers, as they consider how to encourage further investments in capacity and new technology, and attempt to manage existing and aging production networks. The broiler industry has a unique organization. Firms called integrators own processing plants, hatcheries, and feed mills, and contract with independent growout operations to raise their broilers to market weight. The contractual relationship between farmers and integrators, however, is coming under growing scrutiny from Congress and regulatory agencies, and the industry relies heavily on a particular kind of production contract that has attracted considerable attention.

The broiler industry plays an important role in several public policy issues: Large animal feeding operations, including those raising broilers, are under increasingly strict environmental regulation by all levels of government.

The broiler industry has dealt with poultry diseases and associated bio-security issues for many years, while growing public awareness of such threats plays an increasingly important role in industry and public policy planning.

Corporate Bureaucracies Hindered Improvements in Innovation

Capital management will be subjected to stringent corporate evaluations and assessments, such that the time to complete a project and its successful outcome could be jeopardized by inefficient corporate bureaucracies. Therefore, implementing clear, concise procedures for managing this process efficiently is critical to long-term success of the new technology program and the poultry companys long-term survival. E Economic

Sensitivity of Production Prices

Broiler production is gradually shifting to larger operations, a trend common to most agricultural commodities. As a result, operators of larger enterprises may be more sensitive to the income risks arising from energy price fluctuations and contract settlements. Contract features may need to be redesigned to adjust for differing risk exposures faced by growers. Overall production growth slowed sharply after 2000. While per capita consumption continued to grow at 1.9 percent per year, the contribution of population growth fell in comparison to earlier years and export growth fell sharply. But changes in exchange rates can affect the competitiveness of U.S. exports, and growth in foreign incomes can be an important force. In the near future, a declining dollar, combined with income growth in Asia, may boost export growth again. It is expected that prices for raw materials will remain low due to new market developments and introductions, improved technology offerings, especially herbicide resistant crops, and genetically engineered crops with improved economic traits. All of these changes translate into lower costs per unit of available nutrient, and as such, will provide most companies with inexpensive raw materials costs with which to produce their products. The challenge and the opportunity that most companies will need to address in the future is how they might continually add value and differentiate their finished products from the existing competitor pool. The answer will likely lie in further processing solutions that provide value added products to consumer markets. Customers of the poultry industry will continue to demand inexpensive, high quality finished products

Rigorous Competition
The poultry industry from its inception has been largely a cost driven industry. As such, feed prices and the ingredients that comprise a finished poultry feed have typically represented 65-70% of the cost of live production and therefore a focal point for most managers trying to save money. Recently, and with the evolution toward further processing and value added production, producers can now effectively lower their total feed costs as a percentage of total costs of production by investing capital into further processing equipment and the production of value added products.
Page | 2

However, it is clear that opportunities exist for companies that can continue to move toward further processed, value added products that meet consumer demand for convenience, wholesomeness, safety, and palatability at a reasonable price. Investing in capital to achieve these higher margin product offerings is the wave of the future and will be the new arena of competition in the industry. Competition is fierce and is today still largely driven by the cost of manufacturing and the quality of the output or product sold to the customers. As demand for poultry products slows around the world, the next wave of consolidation in the industry will occur. Larger companies will continue to get larger and poultry plants will be designed larger still to capture all possible scale economies. Getting larger for these companies means that transportation issues on effectively manage supply will become ever more critical to address and resolve for long term company sustainability. Similarly, some of the other issues that competitors will have to address to survive in the existing environment will include all aspects of manufacturing and cost efficiency. The objective will be to produce more product, cheaper, faster, better, higher quality, differentiated, and market driven to address the changing consumer needs. It is believed that feed prices, like grain and soybean prices will remain soft, given no unforeseen dramatic reductions in yield due to droughts or other factors that might impact a healthy harvest, globally. Moreover, the continued oversupply of these grains, compounded by US price supports, and new improved technologies, including herbicide resistant grains and other improved varieties that achieve higher yields, will continue to keep prices at or below the 9 year average for the foreseeable future.

Price Advantages Are Limited

The industrys rapid productivity growth has been driven, in large part, by improved poultry genetics, but also by steady improvements in structures, equipment, and production practices. These improvements, taken together, have led to greater feed efficiency, lower mortality, and more intensive use of capital and labor servicesessentially, raising the output of broiler meat that can be achieved for given inputs of feed, fuel, capital, and labor inputs. Slowing investment in new housing could reduce the industrys productivity growth and, in turn, limit any price advantages over other meats. S Social

Convenience and Quality Contributed to Growth of Consumption

The demographics of the consumer as already mentioned has changed and will continue to change over the foreseeable future but with a continuing trend toward embracing convenience and quality. The poultry products consumer of tomorrow will be a cross between the retiring baby boomer of today and the sophisticated Gen-Xer that will continue to balance career, family and household management with food protein solutions that are cost effective, convenient and wholesome. That includes the selection of protein food sources that are part and parcel of a total nutrition program
Page | 3

that delivers quality, safety and convenience at a reasonable price. This translates to pressures on the poultry industry to significantly reduce or eliminate any risk of food borne pathogens, reducing or eliminating the use of antibiotics and/or other controlled additive usage in the feed, and providing products that are tasty, tender, and convenient to prepare at a reasonable price.

Healthier Diet Consciousness

Fanatical pressures on the meat industry in general and the poultry industry, specifically will continue to create doubt in the consumers minds about the wholesomeness of meat products in general and poultry products specifically; both from a health standpoint and from an animal welfare perspective. However, a more powerful, opposite influence, based on ongoing, empirical, scientific evidence, is the endorsement of credible nutritionists and dietitians that the consumption of poultry products is paramount to achieving a well balanced, high protein, lean, healthful diet to prevent obesity, heart disease and diabetes. These forces are also in play in the global arena and will likely spur additional growth in third world countries as these nations improve their overall nutritional programs and the quality of food choices available to their citizens.

Inequality Working Conditions Existing Among Labor Force

According to the investigation of Department of Labor, 60% of poultry companies cheat workers out of failing to comply with the overtime and record keeping requirements of the Fair Labor Standards Act. The violations found by the DOL included failure to pay for all hours and unlawful deductions from pay. The work environment is inhumane in every aspect. The employment of large numbers of low-skill, low-wage workers at all stages of production is because poultry processing is not fully automated. Consequently, the working conditions are appalling and a threat to the health of workers. T Technology

Genetic Engineering
Feedstuffs should no longer be considered as commodities. Qualitative and nutritional criteria should be used for their purchase and segregation in feed mills. Technologies allowing the immediate analysis of feedstuffs, such as NIRS, will be required. Genetic engineering will become an important tool to improve feedstuff nutritional quality and, perhaps bird performance. Growth modeling and data-analysis using computer systems will allow more robust decision-making, which will be the key for the sustainability and success of the poultry industry. Moreover, new technologies on the live production side must be implemented to both ensure source of supply and improve the overall efficacy of production so that profitability from the further processed end products will be maximized. Technological approaches that accelerate improvement in the supply situation include genetics programs that create ever more efficient, fast growing, high yielding birds. In addition, hedging futures commodities to lock in future costs will continue to be critical in managing the overall cost structure, future risk and uncertainty of the supply side of. This area of
Page | 4

raw material management will require a more accurate and precise global perspective of the dynamically volatile international markets to ascertain the impact of these global changes on domestic grain prices. To that end, decision-enhancing models that assess the impact of these changes will become more valuable to companies who wish to manage this process with precision and accuracy.

Ongoing Improvement
At any given snapshot in time, there is a host of new technologies, both promising and not so promising under development by both industry and university scientists. The categories of innovations under development span the continuum between those technologies that attempt to address current needs to those designed to solve the foreseeable problems of tomorrow. A particular need may either be defined by the market per se, or by a specific component of the value chain. Cost improvements per se, throughout the value chain, will not in general add significant, breakthrough value enhancements to the bottom line. Rather, these improvements and additions to earnings will usually be of an incremental nature. A poultry companys constant awareness of the new technologies on the horizon is critical to its ongoing improvement and competitiveness in the market. Structurally, poultry companies should organize in such a way as to encourage the ongoing exploitation of economies of scale from the integrated system. This means that creating reward and bonus systems around both departmental and corporate earnings goals should be a top priority in every poultry company. In this way, technology cost inputs at any particular point in the production system that result in a major, positive impact on earnings creation downstream of the production input, would be given the appropriate priority and consideration since all factions (departments) of the company and their personnel stand to benefit both professionally and personally. In effect everyone in the company has a vested interest in implementing technology projects that create growth, profitability and earnings regardless of their point of implementation. This approach will minimize the reduce cost mentality often prevalent in cost center departments in lieu of occasionally increasing costs if the payoff and earnings generation downstream is significant. L Legal

Unique Manners in Managing Contracts

Other industries use production contracts, but the broiler industry is distinguished by the dominance of such contracts and the methods by which growers are paid. Almost all broiler growers contracts base the compensation on how each growers performance compares with that of others. Beyond that feature, however, contracts are far from uniform. Variations in contract design likely follow from differences in grower location, size, and type of broiler housing, but the wide variation in terms and payments makes it difficult for growers to evaluate contracts. Long durations tend to be offered to newer and larger operations. Among recent entrants, those with long-term contracts averaged half again as much production as those with shorter contracts.

Contracts and Competing Integrators

Page | 5

Because production is so localized, most producers have few integrators to choose from. Those findings may overstate the number of integrators farmers can choose among if some integrators are not actively seeking new growers. Integrators must recruit growers away from other activities, such as producing other commodities on the farm or working off the farm. Those outside options for growers set limits on the degree to which integrators can impose low fees on growers. There is little empirical evidence, however, of the effects of integrator concentration on grower returns. Once a contract has expired, growers may have to retrofit their houses with new capital equipment in order to gain a contract extension. These expenditures can be substantial.

Fees Paid in Production Contracts

Broiler farms are quite specialized and depend heavily on fees from broiler production contracts, which account for 85 percent of their gross cash farm income on average. Broiler contracts specify compensation arrangements, which usually depend on the growers performance in raising chicks to market weight, with performance measured in comparison to other growers. Growers who deliver more meat, for the amount of feed and chicks provided, get rewarded under the relative performance design of contract compensation. In turn, that depends on feed efficiency and mortality. Other factors may influence contract payments.

Health and Safety Concerns

The traceability of poultry products will be essential. This requires the careful selection of input suppliers, with the focus on product quality rather than on price. Monitoring flock health status will also be the key for the safe expansion of the poultry industry. As to the rearing environment, heat production by broilers should be taken into account, and its utilization considered as an alternative energy source. Consumer preference for wholesome products and a perception that antibiotics create potential health problems in the human sector will put pressures on antibiotic use in poultry production facilities. But, since science supports the safe, effective use of these products, producer decisions to remove or reduce the antibiotics in the feed, driven by a desire to further differentiate their branded products will probably precede any regulatory actions by the government. Europe, which is more politically charged, will regulate the removal of most antibiotics, as has been the recent trend. However, opportunities will continue to evolve for alternative approaches to managing the health of production animals while still maintaining adequate densities to meet supply to keep plants at peak operation. However, the government will continue to keep pressure on the industry for producing wholesome product free of food borne pathogens. As such regulation of processing plants is likely to continue or increase, particularly to minimize contamination of salmonella, campylobacter and listeria in further processed products. Also, to qualify their products in the international markets, producers will continue to improve handling methods and explore alternative ways in which they might produce

Page | 6

these products to qualify for the export trade. The awareness of animal health has been widely promoted in last decades. E Environment

Litter Disposal Contamination

Larger operations may realize scale economies in production, but they also concentrate poultry litter in localized areas. Litter disposal remains a major issue confronting the industry.

Waste Contaminated Water

Overwhelming amounts of pollution is affecting the land, water, and surrounding communities of the chicken raising areas. This untreated waste flows into nearby streams, wetlands, or watersheds which created a breeding ground for infectious disease in the environment. The pollution thus renders harmful effects to the environment which are caused by the poultry industry. Environmental justice does prevail, however in small doses. For example, Hudson Foods, Inc. agreed to pay $4 million I federal fines and $2 million to curb chicken water runoff in Marylands waterways, the largest water pollution settlement in state history. The agreement may shift much of the financial cost of pollution control from chicken farmers to the large scale processors.

Page | 7