From Feedlot to Food Court (2024)

This complex system has come under increased scrutiny recently with revelations of accounting questions at the country's second-biggest food distributor. The troubles at Columbia-based U.S. Foodservice Inc. caused its parent, Dutch supermarket conglomerate Royal Ahold NV, to overstate its earnings over the past two years by at least half a billion dollars, triggering numerous public and private inquiries.

But while officials are probing the books of U.S. Foodservice, the typical consumer might be asking an even more basic question: What exactly does U.S. Foodservice do, and what is its role in the U.S. food industry?

Most people who know of U.S. Foodservice think of it simply as a truck on the road bearing a logo for a company that means very little to them. That's because U.S. Foodservice's activities are largely behind the scenes. But the company does touch the average consumer. One way to see that -- and to understand the labyrinth of the American food industry -- is to follow a hot dog from the cow to the consumer.

A Path From the Plains

The long path to Hasan's Frank & Stein outlet at Tysons Corner begins on a cattle ranch on the Great Plains. There, a calf will graze with its mother until it's about seven months old and weighs about 500 pounds, according to John Nalivka, president of livestock consulting firm Sterling Marketing in Vale, Ore. After it's weaned, the animal is either kept by the farmer or sold to a "stocker" until it's 16 to 18 months old, or about 800 pounds, Nalivka said. At that point, it's ready for sale to a feedlot.

The 800-pound animal is sold -- along with thousands of others -- to a feedlot in a live auction, in a video auction or under contract, for about 75 cents a pound, or around $600. At the feedlot, the animal is grain-fed for five months until it weighs an average of 1,250 pounds, at which point it is sold to a packing plant for about 77 cents a pound, or roughly $960.

At the packing plant, the animal is slaughtered and butchered into cuts of meat and trimmings. It's an increasingly mechanized and quick process, as 130,000 head of cattle alone are slaughtered every day in the United States.

One 1,250-pound steer yields about 450 pounds of finished cuts of meat, such as a tenderloin or rib roast, and another 150 pounds of "trim," as trimmings or smaller cuts with a higher fat content and a lower market value are called in industry-speak, according to Nalivka. Trim is most often used for ground products, such as hamburgers and hot dogs.

That trim meat is then sold to any number of processing plants, including the Cincinnati plant that makes the all-beef Hillshire Farm hot dog sold by Hasan in Tysons Corner. But the buying of trim is no simple matter.

Like so many agricultural commodities, the value of trim meat fluctuates, depending on the weather and seasonal demand, so a hot-dog processor has to find a way to hedge his risk. A buyer may know he needs a million pounds of trim to make hot dogs for the next six months, and he'll try to lock in as much of that meat as he can at a set price. The rest he'll have to buy on the spot market.

Currently, at the start of the hot-dog season, the price of 50 percent-lean trim is about 50 cents a pound, but last fall it was just 30 cents a pound. The smart processor, Nalivka said, is one who was able to order a six-month supply of trim last December, when it was cheaper. The smart packer is one that kept some supply out of such contracts for sale on the spot market.

It's a bit of a dance between supplier and processor, and it's repeated all the way back to the farm. The ranchers, the stockers, the packers and the feedlot operators are all trying to set their prices for months at a time.

"What that does is that it ends up locking up supply all the way back to the live animal," Nalivka said.

Delivering the Goods

At the hot-dog plant, the trim is put in huge choppers along with spices and curing ingredients, ground into a thick paste, piped into cellulose casings, cut, cooked and packed.

In the case of Hillshire Farm, which is owned by food giant Sara Lee Corp., the vacuum-packed hot dogs headed for Hasan are put on Sara Lee trucks and shipped to the Severn, Md., warehouse of U.S. Foodservice.

If you eat a hot dog at a Frank & Stein -- there are 45 nationwide -- you are likely to get a hot dog or a drinking straw or a blast of mustard that's been through the U.S. Foodservice network. About 85 percent of the company's hot dogs are delivered to franchisees by U.S. Foodservice -- as are ketchup, mustard, relish, onions, napkins, straws and so forth. In this process, U.S. Foodservice acts like a "commercial grocery store that delivers," said Greg Caldwell, president of the family-owned Frank & Stein company, based in Roanoke.

One of two major food distributors nationwide -- the other is Sysco Corp. -- U.S. Foodservice buys products from manufacturers and resells them at a profit to a host of restaurants, schools, hospitals and other commercial venues.

The company doesn't make much money on the hot dogs it sells to Frank & Stein -- its markup on them is only about 12 percent. That's because Caldwell's hot-dog account is so big he negotiates his prices directly with Sara Lee, the Hillshire parent, for his national account. Caldwell then negotiates with U.S. Foodservice how much profit the distributor will get for delivery of those hot dogs.

Caldwell says his outlets in the Washington area order about $2 million of goods a year from U.S. Foodservice, with the lowest margin on the hot dogs and going up from there. But even with those higher margins, U.S. Foodservice has huge fixed costs in delivering all those products. That makes its other income stream -- from the manufacturers -- even more important.

Foodmakers commonly pay retailers, restaurants and distributors to carry their products. These bonuses, known as "vendor allowances," help manufacturers ensure that their products are widely circulated by making them more profitable for everyone to sell. When a distributor gets such a rebate or allowance, it might agree to feature the manufacturer's products in trade shows, or may commit to selling a certain amount, or to set up critical face-to-face meetings between the foodmaker and the end user.

But these payments can also create problems. Last month, Royal Ahold, which bought U.S. Foodservice in 2000, cited "irregularities" in the way U.S. Foodservice had accounted for its vendor allowances. Because of the bookkeeping problems, Royal Ahold had inflated its earnings by at least $500 million in 2001 and 2002.

The accounting problems at U.S. Foodservice offer a glimpse into how pervasive these rebates have become in the food-distribution business -- and no wonder. Historically, grocery stores ate up the largest share of the American food dollar, but that is changing. Currently, about 49 cents of every dollar spent on food is spent on meals away from home, said Rick Abraham, vice president of industry affairs for the Grocery Manufacturers of America. By 2010, food service is expected to overtake retail, driven in large part by the proliferation of restaurant chains, fast-food joints and "fast casual" venues such as Panera, according to a joint study by the International Foodservice Distributors Association trade group and the consulting firm McKinsey & Co.

"It will be the first time in our history that Americans are spending the majority of their food dollar on meals prepared outside the home," said John Gray, president and chief executive of the IFDA.

To help get at that business, foodmakers last year sold $180 billion of products to distributors who supply food institutions and restaurants, according to the Chicago-based food-service consulting firm Technomic. To gain leverage with distributors, manufacturers are constantly sweetening the vendor allowances they pay, hoping those bonuses will help ensure that the distributors will unleash a huge sales force to sell the manufacturers' products.

The result, experts say, is that some distributors may even make more profit from the vendor allowances than they do from selling the food.

Neither Sara Lee, which owns Hillshire Farm, nor U.S. Foodservice would say what kind of rebates U.S. Foodservice gets on Hillshire hot dogs. U.S. Foodservice said in a statement: "We cannot comment specifically to these issues. We are fully cooperating with the investigation to resolve any issues, so we can move the company forward."

Caldwell says he's certain that U.S. Foodservice gets a rebate on Hillshire hot dogs "because that's just how the business works."

That's how it's worked since the 1970s, said Richard Kochersperger, director of the Food Marketing Group, a consulting firm. Vendor allowances became the norm soon after the Nixon administration lifted the wage and price controls it imposed during an era of high inflation.

When the controls were in place, manufacturers were barred from raising their prices even though the cost of producing their product was going up, Kochersperger said. Once the price controls were lifted, manufacturers started raising their prices and then negotiating them back down through allowances.

"They concluded they never wanted to be in that situation again," Kochersperger said, referring to price controls.

Even with that rebate, though, U.S. Foodservice isn't making a lot of money off the hot dogs it sells to Frank & Stein because of the chain's pricing contract with Sara Lee.

Caldwell said U.S. Foodservice would probably prefer that his company "carry a cheaper product that they could try to squeeze bigger markups in on us, or a product where they get better rebates," but he said he's wedded to his higher-quality, more expensive dogs.

End of the Line

At Tysons Corner, Hasan might serve you himself. In many ways, he is the prototypical franchisee. He's an articulate immigrant running his second franchise. He turned to hot dogs after a previous experience operating a Dunkin' Donuts outlet. But beyond the ins and outs of his own little piece of real estate at one of the country's busiest malls, Hasan doesn't seem to know much about the complexity of the system that brings his products to his doorstep.

"Frank & Stein's corporate headquarters decide who to deal with, and they are the ones that make the arrangements for all the products to be available," said Hasan, 44. "It doesn't make sense for me to make 20 or 30 calls to get the stuff I need. They can negotiate better prices, and people knock on their doors more than they knock on my door."

Here's what Hasan does know: He buys hot dogs three times a week from Frank & Stein's sales rep at U.S. Foodservice in Severn. He pays $2.39 a pound for his all-beef Hillshire hot dogs, which come in packs of eight to a pound (the company also sells bigger hot dogs, sausages and bratwurst). The hot dogs Frank & Stein uses are more expensive than many on the market because they're beef and have never been frozen.

As an added incentive to use and sell those hot dogs, Hillshire Farm pays Hasan 10 cents per pound of hot dogs sold -- money that he is required to put toward promotional materials such as brochures or free samples for passersby in the mall. He gets that bonus in a lump sum once a quarter.

That leaves Hasan with a cost of about 30 cents for the hot dog, and another 10 cents or so for the bun, according to Caldwell. On top of those costs are Hasan's other fixed expenses, including paper products, labor, insurance, marketing, franchise fees to the parent company and thousands of dollars a month in rent to the mall for his 600-square-foot stall. The final price for a plain hot dog at Hasan's stand is $1.90. With all the toppings, it's $2.39.

"It's profitable, but the margins aren't what they used to be 10 years ago," Caldwell said. "The costs of doing business go up, the cost of utilities, of insurance, of being an employer. You can only charge so much for a food product."

A Long Trail

By the time the Hillshire Farm hot dog is turning on the grill at Abdul Hasan's outlet, it's been through a lot: from the calf to a truck to a feedlot to another truck to a packer to another truck to a hot-dog processor to another truck to a food distributor to Frank & Stein at Tysons Corner Center.

At each step along the way, the margins are low and the profit is made on volume and hard-driving dealmaking. At no one point is making money easy, and that's why the end product costs only $1.90.

It's a testament, say people in the food industry, to how sophisticated and efficient the American food production and distribution system has become, turning out millions of pounds of overwhelmingly safe, affordable food.

"Ten people had to handle that hot dog, and it's remarkable what it costs," said Randy Habeck, general manager of Key Impact Sales Systems, a food brokerage in Columbia. "And it's amazing how many businesses make their livelihood off it."