Case Analysis: “Who’s Afraid of a Little Mud?”

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The case of Joe W. Luter III and Smithfields Foods Inc. (SFD) is the classic tale of an entrepreneur who pulled himself up by his bootstraps and succeeded in low-margin agribusiness. But the era of relentless expansion and close attention to the bottom line has already transitioned to one where good corporate citizenship must be incorporated into the business model.

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Luter grew SFD with a combination of individualistic control and ruthlessness reminiscent of the robber barons and factory owners of the Industrial Age in the late 19th century. One notes that almost the first thing he did on taking over after the death of his father was to buy out all non-family stockholders and arrogate all decision-making to himself. This was effective for its time because America was in the midst of a huge expansion binge. The eldest of the famous “Baby Boomer” generation were in their teens. They and their siblings contributed to the buoyant markets for housing, cars, schooling, entertainment, clothes, toys…the list was endless. The Kennedy and Johnson administrations reigned over peace and unprecedented prosperity at home while still keeping a low profile in what would soon become an ill-fought Vietnam War. In addition, multinationals found welcoming markets abroad for branded goods of practically any kind as long as they bore labels saying, “Made in the USA”.

The time was therefore right to cater to seemingly endless demand growth, to compete for a fair share with other supplier-processors, and, where possible, reach for a commanding market position. Since agriculture and animal husbandry were (and remain) industries too fragmented to effectively monopolize nationwide, Luter had to content himself with lording it over his statewide market.

Thus Luter gained satisfying revenue growth and margins by taking advantage of the microeconomic concepts of economies of scale, horizontal diversification and backward integration.

Early on, Luter recognized the value of expanding while “sticking to your knitting”. When in 1969, the acquiring conglomerate asked him back to turn LPC around, he immediately divested the operation of everything unrelated to the core business: slaughtering and processing livestock.

A scant dozen years after returning, Luter had restored the family company to such profits by 1981 that he pitched for, and won, Gwaltney’s, second-ranked in the region. As a result, what was by then Smithfield became the largest pork processor on the entire East coast.

With the benefit of hindsight, it is easy to say that Luter made all the right moves to catapult SPC to prominence and a commanding market position. Still, one concedes that Luter waited another two decades, persisting in his vision, cultivating growth through internally-generated cash flow before finally seizing the opportunity when a glut forced hog prices down to historic lows. In the historically low-margin business that is meatpacking, SPC cash reserves never matched the over $1 billion that buying out producers ultimately aggregated to. Nonetheless, it seems that prudent management afforded the company enough liquidity to make financing a viable option for the lending banks.

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For his grower-suppliers, there was little hope of making money when independents endured a feed-to-marketable weight ratio of 3:1 and a continuing glut that might well leave selling prices at an all-time low for the time being. For SPC, however, the notion of backward integration made a great deal of sense because pork on the hoof paid more than simply slaughtering and packing for distribution. As a result of persisting with this eminently sensible area of expansion, the SPC economies of scale – particularly where spreading corporate fixed costs around a greater volume of production was concerned – Luter garnered a 2.6:1 feeds-to-live weight ratio, well below the industry norm.

Besides gaining control of that portion of production cost formerly owed to suppliers, backward integration earned Luter the classic virtue of control over cyclicality of volume and price in the supply chain. That portion of risk to financial planning was therefore eliminated.

Yet another risk minimized had to do with consistency of quality. Obviously, diseased, maimed or malnourished hogs reduced the quantity that could be processed and packed from every carcass.

Competitors carp that at least a decade must pass before Smithfield ownership of its own hog farms can be accepted as not just logical but commercially feasible. Truthfully, SPC has laid itself open to new risks to go hand in hand with the benefits of hog farm ownership. Highly contagious variants of swine flu or hoof-and-mouth disease, for example, could ravage herds and seriously cut into operating capital.

Another diversification move was the purchase of Moyer. While smaller than Luter’s original target that is presently subject to litigation, IBP, the Moyer operation does enable SPC to synergize its valuable relationships with retailers. Having two meat types in its freezers can also set the company to thinking about forwarding integration into value-added meal packs.

Leadership Hubris

In addition to expansion and integration for cost efficiency, Luter began to evince a ruthlessness with employees that was consistent with the scorn he showed external stakeholders later on. Asked to return to try and turn around Luter Packing Co. after acquirer Liberty Equities Corp. ran it to the ground, Luter apparently saw an extra layer of management in the organizational chart that his do-it-all leadership style could not tolerate. Forthwith, he axed an entire level of the hierarchy without bothering to ask whether any of the occupants were carryovers from the earliest days of SFD. Nor could he be bothered to ask whether the foregone talent might have made productive contributions in the line departments. Transferring good talent simply to keep them was anathema for the young Luter, even though enlightened managements of the time already knew about humanistic management, motivation and organizational development for future success. Such an abrasive and autocratic style is, unfortunately, tolerated in the wealthy and successful as in the case of Microsoft’s Bill Gates who is not above cutting off the legs of his programmers in front of their peers.

One may also be forgiven for thinking Luter the cynical and manipulative leader for claiming, by case end, that he was pretty much detached from day-to-day operations and gave his two presidents free rein. This may seem like a desirable delegation of responsibilities. But it is also consistent with the cynicism of an autocrat who does not tolerate failure nor fools lightly and will descend on erring subordinates with a heavy hand.

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Into the Era of Sustainable Competition

This seeming detachment, lack of commitment and avoidance of responsibility for operational matters can also be classed as a defense against a rising clamor from regulators and environmentalists for SPC to clean up its act. There is no use pretending that the irresponsible release of farm and packinghouse effluvium into North Carolina’s Neuse River has gone unnoticed. North Carolina has already refused to permit Smithfield any more expansion. State governments in South Carolina, Iowa and North Dakota are also hostile to the thought of more corporate hog farms set up. One can no longer take a cavalier view of such matters. Autocratic leadership just does not sit well with newly recognized groups of stakeholders who wonder what Smithfield is doing to their community and environs.

When Luter first became involved hands-on in Smithfield about 1965, businesses could do pretty much as they pleased. The only outsiders they cared about were consumers, the retail trade, and the taxman and not necessarily in that order either. The kind of corporate philanthropy exercised by the Fords and Rockefellers seemed exceptional, worthy only of the wealthy elite of the nation. Public relations and its concept of stakeholders seemed necessary only for politicians and manufacturers of branded goods confronted with a quality mishap and fearful of losing the public trust. Press releases were viewed as mere “puff pieces” designed to get some free publicity mileage.

But a fresh wind was blowing. The 1980s and 1990s saw the emergence of the concepts of corporate social responsibility (CSR), good corporate citizenship, good governance and ethics.

The prevailing concepts of CSR originated in the aforementioned corporate giving for PR purposes, in socialist governance policies that flourished in the UK and the Continent, and contemporary concerns about degradation of the ecosystem. Yet a third wellspring was the failure of corporate ethics that was demonstrated by the Enron scandal and the speculation in home mortgages that precipitated the current global recession. Governments as stakeholders have therefore clamored for both increased regulation and voluntary “good corporate citizenship”.

As the concept of “good citizenship” flourished, truly responsible managers recognized that they needed to address multiple audiences. Whether merely an influential audience, voting bloc, or local residents whose health may be affected by pollutants released into the air and water, “stakeholders” include every audience that is impacted by corporate activities. For instance, the shareholders of the coal-burning Kingsnorth power plant potentially threaten everyone in the UK by adding to heat, carbon dioxide (CO2), grit and sulfur dioxide emissions. This makes all residents stakeholders. Since emissions inevitably diffuse, are carried this way and that by wind currents, and add to the total concentration of CO2 in the atmosphere, the health and safety of every human on earth is potentially at stake.

Stakeholder theory, which underlies all CSR programs, creates severe demands on controlling shareholders like Luter who is long attuned to maximizing profits. It takes unusually enlightened management and shareholders to accept that businesses cannot exist for themselves alone. Rather, commercial enterprises ought to see their raison d’être as harmonizing the interests of the full range of their stakeholders.

In contemporary times, the surrounding community as stakeholder has been institutionalized and expanded. Where companies used to be essentially self-serving about giving to their employees by helping the surrounding community, it is now virtually mandatory for profitable enterprises to reach out nationwide or even overseas to Africa and other developing nations to relieve the misery of hunger, the thirst for clean water and sanitation, domicile, power, health care, and basic (even primary) education.

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No firm can afford to isolate itself and ask to be left alone to concentrate on making a profit. Alarm over the accumulation of greenhouse gases in the atmosphere, the harm to marine life that release of untreated hog wastes can create, and the potential consequences of global warming in the long term has made sustainable investing the new byword in CSR. No less a disinterested world body than the United Nations and the “International Council for Local Environmental Initiatives” (ICLEI, also known as “Local Governments for Sustainability”) have enunciated the “Triple Bottom Line” (TBL, otherwise known as the “three pillars”) principle of “People, Planet, Profit” for public sector accounting. “People” means being benevolent to one’s own workers as well as the community at large. And “planet” naturally means minimizing adverse impacts on the environment. True, private businesses are not necessarily bound by these policy statements. But then, there are no drawbacks to being recognized as doing good. The media and buyers of company products will certainly see to that.

There are many options for Smithfield to be seen as behaving more responsibly concerning community ecosystems. For example, all effluents from the hog farms can be sequestered in huge tanks and used to produce methane gas which will make the operation self-sufficient for power. Then Smithfield can honestly claim to have markedly reduced its “carbon footprint” and going “green”. The run-off from the methane digester tanks can then be used to fertilize nearby field crops; because it is now largely a nutrient-rich solution, fears of run-off to irrigation canals and main waterways are allayed.

At the end of the day, being a more responsible company will reap goodwill and give Smithfield more leeway for expanding operations to more states. Publicizing these could also help neutralize the subjective but passionate opinions of animal welfare campaigners, small growers, and packers. Since there is no economic way to confine hogs except in comparatively tiny stalls, Smithfield must co-opt them in other ways. Hostility to big business is also a fact of life. The only really feasible response is to be more benevolent, to listen to stakeholder concerns and to give back to the community.

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