IdentiGEN – Insurance for your Supply Chain

By Jesse

In our discussion of IdentiGEN and their go to market strategy we identified three main players with which they could align themselves: regulators, trade associations, individual companies. IdentiGEN appeared to want to resist playing on the side of the regulator and preferred to align with companies. They brought their value to the beef industry by gaining large retailer buy-in and pushed tracking through their supply chains. I’d like to explore the potential in aligning with the trade associations. I hypothesize that this avenue would have the largest impact in the least amount of time and is feasible because there is a financial incentive to do so from an industry standpoint given their history. IdentiGEN should position itself as a form of risk mitigation or insurance against large scale negative incidents.

In addition to building customer trust and brand support IdentiGEN can be thought of as insurance against industry shocks due to supply chain issues (most notably Bovine spongiform encephalopathy [BSE]). As opposed to typical insurance where you pay a premium and collect in the event that an incident occurs, this would be similar to a safety department in an operating plant. The premium is paid to avoid a large net loss incident. This value proposition is historically hard to sell until a large incident happens (consequently it then becomes hard to justify once implemented because the value isn’t tangible due to the events being actively avoided). However, we can use past events in the beef industry to help justify from a financial perspective the value of IdentiGEN being implemented.

Let’s look at the most recent large-scale BSE outbreak in the United States. The direct losses were estimated in the range of approximately $3.2 – $4.7B as measured by lost revenue (1). Another report by the CREATE Homeland Security Center (2) suggested the losses in revenue were actually much greater, by an additional $9B, when you take into account indirect costs such as those associated with interstate trade (2). Figure 3 in the report by “CREATE” demonstrates the impact of the BSE outbreak on US exports in a compelling way:

This clearly was a huge hit to the beef industry. The main advocate for the beef industry is the National Cattleman’s Beef Association (NCBA) which collects approximately $1/cow to promote the beef industry (this amounts to roughly $80M/yr) (8).

Now let’s look at the cost to implement this across the industry and the impact looking over the past 30 years. Unfortunately we don’t have much visibility into IndentiGEN’s pricing or cost structure as we were not given financial statements in the case. However, the following is an attempt to get a sense for the potential cost to the industry. On page 9 of the case it states that testing costs “on the order of a few cents per pound” which I’m interpreting as $0.03/lb. I make the following assumptions to get some idea for the cost of a test.

· Average beef cow weight = 1350lbs (3)

· Dressed carcass Yield = 62.2% (4)

· Meat from dress carcass yield = 80% (4)

· Total Yield percentage (0.8 * 0.622) = 49.8%

· Average cow meet yield (1350 * 0.498) = 672.3 lbs.

· Implied cost per cow ($0.03 * 672.3) = $20.17

Now apply this to the total number of cows slaughtered each year. Using two separate methods I get the following:

Method 1: Using Exhibit 3a from the case: US production 11,855,000 metric tons = 26.1 billion lbs. / 1350lb/cow à ~20M cows

Method 2: Reference USDA (See citation 5) à 31.89M cows

I will use 30M cows/year going forward because Method 1 uses 1350lbs for all cows which would underestimate total population when considering the veal supply chain. The yearly cost for the industry would then be $20.17 * 30M = $605.1M/yr to monitor the full supply chain. This is an extreme case as the concept of an experience curve as well as economies of scale would suggest that costs would be drastically reduced during this implementation. Let’s assume there is full market penetration with an 85% experience curve (6) and the calculated costs represent a 2% markets share. 2% market shared doubled 5.65x would be required to get full penetration (i.e. 0.02*2^5.65) and this would represent 85%^5.65 cost reduction à 40% of original cost à~$240M/yr.

Case Cost to Trade
Pessimistic Case $605M/yr
Optimistic case $240M/yr

Assuming the industry paid for this tracking since 1984 the chart below shows how much would have been spent up to current day:

· Note: Yearly adjustments made using http://www.dollartimes.com/calculators/inflation.htm

There have been multiple BSE incidents since 1980 (7), the largest being the aforementioned 2003 case. If tracking could have prevented the 2003 BSE outbreak then the industry would have avoided a direct loss of $4.7B by paying out $5.3B. This may not be enough to make industry implement. Potentially the states will be incentivized to subsidize this goal in order to avoid the additional $9B of indirect costs à $5.3B cost to avoid $13.7B total loss.

This is just the “financial insurance” case in the value proposition. The IdentiGEN pitch can be made even stronger when considering that costs can be reduced even further with full industry buy-in (i.e. All of North America). The costs could also be significantly lower if not all cows need to be tested. Additionally, it is not unreasonable to assume there would be top line growth as a result from the industry standing out as more transparent than other meats. As a 2nd level effect, the US beef industry would then have the opportunity to begin branding US Beef as top quality worldwide which may drive margins in addition to top line growth internationally.

In conclusion I believe there is a case to be made that suggests the industry associations have a strong financial incentive to bring traceability to their supply chain. Additionally, the CREATE report along with the brief analysis provided suggests that states may be incentivized to offer subsidies to encourage this behavior in order to avoid the interstate and indirect loses which can result from large negative industry shocks.

Note: Further work in this area could look at how $13.7B in loss revenue translates into total supply chain profit loss. Also, quantifying the costs associated with minor outbreaks would help granularly price recent isolated events. Another issue is that $240M/yr would equal a 3.0X increase in current funds raised by the NCBA assuming they absorb all costs – hence more emphasis for states to get involved.

(1) http://www.kwtx.com/home/headlines/1528127.html

(2) http://research.create.usc.edu/cgi/viewcontent.cgi?article=1078&context=nonpublished_reports

(3) http://www.americancattlemen.com/articles/beef-cows-how-big-too-big

(4) http://www.askthemeatman.com/yield_on_beef_carcass.htm

(5) http://www.ers.usda.gov/topics/animal-products/cattle-beef/statistics-information.aspx

(6) http://en.wikipedia.org/wiki/Experience_curve_effects

(7) http://www.centerforfoodsafety.org/issues/1040/mad-cow-disease/timeline-mad-cow-disease-outbreaks#

(8) http://www.beefusa.org/nationalcattlemensassociation.aspx

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About macomberjohnd

HBS Finance faculty interested in sustainability in the built environment including devices, structures, townships, and cities.

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