Dean Watson became agitated in the face of this resistance. “He got up on the stage and started screaming and yelling,” Sumner said. He remembered Watson shouting: “Who the hell do you think owns this damn thing? You guys are going to do what the hell we tell you to do. If you don’t like it, get your ass out!”II
If this was a sales pitch, it was less than inspiring. Senior executives began quitting the company soon after the meeting. They took retirement packages or moved on to new jobs. Watson seemed to realize his mistake immediately.
“Afterward, he said to me, ‘I really screwed up, didn’t I?’ ” Sumner said.
* * *
Things started to go south for Purina Mills because of a change in government policy. It wasn’t an OPEC-style embargo that unleashed an era of volatility in food production. It was Congress. For the preceding half century, the world of agriculture had been remarkably stable. Prices for crops like corn and soybeans moved around, but they moved within a narrow band. The food industry was a lot like the oil industry during the 1960s. It was predictable.
This changed in 1996, shortly after Republicans took control of Congress. Newt Gringrich, the Speaker of the House, led the Republican Revolution, and farm programs were one of the conservatives’ first targets. Farm programs were the cornerstone of the New Deal. Back in 1933, farming was a pillar of America’s middle class, but the business was whipsawed by violent booms and busts. The Great Depression had been the biggest bust of all. In response, President Franklin Roosevelt created an intricate system of price supports and crop quotas using pages stolen from the books of Soviet-style central planning but burnished with a patina of capitalistic freedom. Farmers had production limits, but the limits were voluntary. The guidelines were encouraged by subsidies. Many farmers got checks in the mail to ensure they let part of their land lay fallow—they got money for nothing. In 1996, Congress passed a bill called “Freedom to Farm” that largely abolished the New Deal farm programs. Subsidies did not disappear, however. They were simply replaced with a complex system of insurance payments and “disaster” relief. (It turns out that virtually every year is a disaster of one kind or another for farmers. The so-called disaster payments turned into a dependable flood of cash to large-scale farmers.) What did get abolished were the production controls. Farmers were encouraged to grow as much food as they could, market prices be damned.
This caused a wave of volatility to flood through every nook and corner of the farm economy in 1997 and 1998. Purina Mills was sitting right in the center of it. Purina bought grain from farmers and sold feed to livestock producers. Both of those businesses rose and fell in wild and unpredictable swings, each one hurting Purina Mills in a different way.
The brain trust of Koch employees around Dean Watson had to figure out how to respond, and they were utterly unprepared to do so. A lot of his team members were the “freelancers”—the MBAs from business schools on the East Coast or in Chicago. “We had no depth when it came to local knowledge, which was our ability to understand the nuance of the businesses we were in,” Watson said. “Most of what we relied on was from the free agent markets. . . . You had no idea how these guys and gals would react when the shit started hitting the fan.”
The heaviest damage started to emerge from an unlikely place: Purina’s business selling pig feed.
Before the deal to buy Purina closed, Watson had been warned about Purina’s pig business. It turned out that Purina owned some pigs, which was odd. Purina sold feed; it didn’t raise animals. Watson was told that Purina had signed some contracts to buy baby pigs and then turn around and sell those baby pigs to farmers. The idea seemed to be that Purina would lock in the business to sell those farmers feed as the pigs matured. Watson asked one of his lieutenants, a former Cargill employee, about the pig contracts. He told Watson that the exposure was limited. Purina didn’t own the pigs for very long; it was basically acting as a middleman.
As it turned out, Purina’s exposure to the hog business was not limited at all. The volatile markets exposed that fact. In 1998, the US hog market experienced a shock comparable to the stock market crash of 1929—a market convulsion that obliterated all the rules everyone thought applied to the business. The root of the problem could be traced to the very industrialization that created Purina Mills’ feed business in the first place. Now that hogs were raised on factory farms, the supply of animals was enormous and inflexible. Farmers were raising herds of tens or even hundreds of thousands of pigs. When prices started to fall, these industrial farms couldn’t adapt quickly. They had mortgage payments to meet on the big pig houses, and they needed to keep production high. Factory farms were a machine that wasn’t easily turned off. The flow of pigs continued into the slaughterhouses, and prices fell even further. Then everything spun out of control. Hog prices plummeted, sucking the entire business into the ground almost instantly. The price of hogs fell from about 53 cents per pound to 10 cents per pound in a matter of months. When adjusted for inflation, this was the lowest price for pigs in US history. It cost far more to raise a pig than the animal was worth.
Purina Mills should have been insulated against this crisis. It only sold feed, not the hogs themselves. But with its decision in 1997 to start buying baby hogs, Purina had exposed itself to the risk of falling pork prices. Dean Watson began to discover just how large that exposure was. As one farm economist put it at the time, the rational number of hogs to own in 1998 was zero. Purina discovered this fact quickly. It bought baby hogs, and turned around to sell them to the farmers. But there were no buyers. The farmers refused to take them.
“The people who we were supposed to be selling the pigs to were basically saying: ‘Sue me.’ The people we had bought the pigs from were saying: ‘You’re not getting out of my contract or I am suing you,’ ” Watson said. “All of this ownership risk that I was assured didn’t exist started to just come out of the woodwork.”
There was no central repository in which all these hog contracts were kept. That meant there was no easy way to figure out how much money Purina stood to lose. The company was discovering its contractual obligations with each new angry phone call that came into its pig division. One giant pig contract was sent into the company via fax from a large pig company in Pennsylvania. No one on Watson’s team had been aware of the contract before it arrived.
“I remember asking the question ‘How in the hell can this show up in a fax without us knowing about it?’ ” Watson said. “You kind of get these deer-in-the-headlight looks.”
* * *
In December of 1998, Watson was named CEO of Purina Mills. His job was to stanch the bleeding. At the time, he was still working at Koch’s headquarters in Wichita, but Koch chartered him a private jet to St. Louis that departed each Monday morning at five thirty. He spent his weeks at Purina headquarters and flew home on the weekends to see his family.
The hog market crisis raced forward faster than Purina Mills’ leaders could respond. And Purina could not respond quickly to the market convulsions because it was shackled with debt. In mid-1998 it owed about $557 million. The company had to post periodic payments of several million dollars just to pay interest.