In 1997, Purina Mills was one of the largest producers of animal feed in the country, generating hundreds of millions in revenues with stable, positive cashflows. By 1999, the company had gone bankrupt.
Founded by Ralston Purina in 1894, Purina Mills began as a producer of pet food. By the 1980’s they were one of the largest producers of “Dog Chow” in the country. As the business grew, they recognized an opportunity to expand into feed products for livestock.
The agricultural economy in America was booming and millions of cows, pigs, and chickens were being systematically bred each year. These animals needed food and Purina had the right set of competencies to expand into the segment.
After successfully launching their pig feed product, they recognized an important opportunity. Every year they had to convince farmers to buy their feed over other producers. They only metrics to compete on were higher quality feed and lower prices.
The quality of the feeds weren't all that different, so ultimately prices would drop to the level of the cost of production. They were in a commodity business.
So how could Purina Mills change the dynamics of competition? Farmers were already buying weanlings (baby pigs) from hog producers each year. Purina realized they could set contracts with hog producers to buy weanlings in bulk, and sell those at cost to the farmers downstream. And, in exchange for the cheaper price on pigs, farmers would agree to only feed their pigs Purina Mills products.
It was a win win— Purina would use its scale to negotiate bulk discounts on pigs for farmers while guaranteeing the sale of its own feed.
This is classic vertical integration.
As I think about how we can apply this to our own business at Loop Health, it’s clear that certain layers of healthcare will commoditize over time. By way of vertical integration, we can hasten the commoditization of these layers of the health stack, neutralizing competitors. Or, we might expand into bands of the value chain which we believe will accrue disproportionate value over time.
But integration is never without risk. And not just the risk of opportunity cost— I mean existential risk. Going into new products in your value chain should be done with an eye towards competency.
What happened to Purina Mills? Two years after they doubled-down on their hog purchasing strategy, they went bankrupt. Hog supply tripled, and spot prices dropped. Purina was contractually obligated to purchase at a higher price- nearly 5x the spot rate. They failed to manage risk and ultimately went bankrupt on their strategy to verticalize.