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Interview with the founder of K&Nís poultry group: Why Pakistanís poultry exports arenít taking off?

Earlier this month, BR Research wrote a column on Pakistanís meat exports, wondering why the country isnít tapping the huge potential of poultry exports. To help answer that question, we met Khalil Sattar Ė the founder and CEO of K&Nís, the family-owned fully vertically integrated poultry enterprise. Formed in 1964 by Sattar who was then a college student, K&Nís success has been featured in a Harvard Business School case study. Last year, at the IFFA International Quality Competition in Germany, K&Nís won five gold medals and a silver and bronze medal in the category of sausages and cold cuts.

In this interview, Sattar, who is also the Chairman of Pakistan Poultry Association, talks more about the issues faced by Pakistanís poultry industry, and what the government needs to do to help achieve the industryís potential, both locally and for the purpose of boosting exports.

BR Research: How does the cost structure of the industry look like?

Khalil Sattar: Feed is about 70-75 percent of the cost, the rest is the cost of day-old chicks, labour, utilities like electricity, fuel for heating, rental of poultry sheds or depreciation, vaccines/medications, etc.

In volume terms, nearly all the feed ingredients are agro-based, on which we have no control. The government has control on wheat support prices. With the price of wheat going up, the price of other commodities such as maize and rice also go up. These ingredients are locally available. Then among the imported feedstuffs are soybean meal, which is more than 75 percent of the product, and micro ingredients which include vitamins, amino acids, and prophylactics. Imported ingredients cost about 50-55 percent of the poultry feed.

BRR: Since soybean meal is one of the biggest chunks of the costs, why canít we make it here in Pakistan?

KS: During the lifetime of late Chairman Agriculture Development Bank Mr. Jameel Nashtar, efforts were made to grow soybeans within the country but the solvent extractors were not interested in extracting oil from soya as the yield was only 17 percent. As such, soybean was not marketable at that time. Besides, there was need to do extensive research as to the cropping area keeping in mind that the cropping period did not override another crop.

Recently, seeing and understanding the progressive attitude of the current Chairman Zarai Taraqiati Bank Limited (ZTBL) Mr. Yawar Ali, I took up the matter of growing soybeans within the country. Since NARC was already doing some research, we brought about a tripartite agreement between the ZTBL, NARC, and Pakistan Poultry Association (PPA).

The Association has given its consent to buy soybeans at a factory delivered cost of the imported beans. Such cost would include, in addition to the cost of beans, freight, import duty, and sales tax. We are hoping to make a breakthrough as some of our feed mills already have solvent extraction units ready to support the soybean growers; the poultry sector is the end user of the meal, which is more than 75 percent of the product, and would also use some quantity of oil in the feed.

BRR: What kinds of taxes are imposed on your feed and feed inputs?

KS: Fifty-five percent of our total input that is imported is subject to substantial tax. There is a total 10 percent import duty, then a 10 percent sales tax, plus a one percent additional duty, which was imposed for only one year but continues even after two years. Despite all these taxes, the poultry is being sold very cheap and the farmers are incurring losses because of oversupply situation. There is no respite in sight insofar as the taxes are concerned.

BRR: Are the taxes transferred to the consumers?

KS: The principle of sales tax is that every time a product changes hands, the sales tax is transferred forward based on the selling price but, unfortunately, the poultry sector cannot pass on the tax because the pricing of poultry products is not based on cost of production; it is based on demand and supply.

If the government today decides to levy any other additional tax on key inputs, be it sales tax or import duty, the cost of production increases immediately but it cannot be reflected in the selling price as we are unable to increase the prices at will. However, eventually every tax other than income tax has to be paid by the final consumer of the product, which fluctuates with demand and supply, but there will be a delayed transfer.

The mechanism involved is that if todayís cost of production is Rs130/kg, then anything above Rs130 is profitable; thus, the level of production can be continued. Tomorrow, if the government levies an additional tax which increases the cost of production to letís say Rs145, then the farmer obviously needs a price above Rs145 to continue production, thus the threshold of loss increases from Rs130 to Rs145. In case the selling price is lower, he starts to reduce or discontinue production, which creates a short supply in the market, forcing the prices to go up. In such a situation, the prices may increase far above the actual increase in cost because of a lack of equilibrium between demand and supply.

BRR: Isnít the poultry sector zero-rated?

KS: Yes, it was only zero-rated prior to 2013-14. Zero-rating came about during the course of my meeting with the then President Pervaiz Musharraf when, I asked him, why is it that when a mother wants to give her child a cheese sandwich she doesnít have to pay any sales tax, but when she decides to give her child a chicken sandwich, she has to pay sales tax. Why is the government penalising the mother for giving more protein to her child? He said ďSearch me, I donít know but I will find out.Ē Soon I got a call from the then Finance Minister Dr. Salman Shah, who after discussing the matter with me, zero-rated the poultry sector.

For eight years, this zero-rating continued. However, three years ago, the FBR issued Show Cause Notices inquiring as to why we were claiming and getting input tax when it could only be claimed against imported goods and supply but not against locally produced goods and supplies. We were taken aback by this very strange philosophy of FBR, which was contrary to the norms of taxation policy throughout the world. No country in the world provides tax relief to imported goods & supplies and levies tax on the same locally produced goods & supplies. Even in Pakistan, I believe, there is no other example, which gives an import incentive rather than local production incentive.

After the Show Cause Notices, FBR rejected not only all the RPOs in hands but also the claims Ė which were to give rise to the RPOs Ė notwithstanding the fact that the producers calculated the refunds in their cost of production and had passed on the benefit of the zero-rating to the consumers. As a result, billions of rupees in tax refunds have been blocked.

BRR: Poultry prices for a long time were much lower than current prices. This volatility is frequently seen in the sector. Why?

KS: Whenever the product is selling below cost of production, it is construed to be in oversupply. When prices of chicken persist below the cost of production for a prolonged period, the entire chain of poultry Ė the broiler farm and the breeder farm that produce day-old chicks, grandparentsí farms, and even the feed industry Ė all suffer loss. In the continued loss situation, the first reaction comes from the broiler farmers, who have a much lower loss-bearing capacity. In order to stop or cut down their losses, they either discontinue or reduce production. This action results in surplus day-old chicks, which are highly perishable having a holding life of maximum 24 hours. Their prices crash very rapidly forcing all those farmers having lower loss-bearing capacity to dispose off their flocks prematurely to save at least the cost of feed which is 70 percent of the total cost. Resultantly, the supply of chicks, i.e. the seed, results in short supply, which increases not only the price of day-old chicks but also the broilers. This phenomenon has continued over the years. I have seen this very frequently during over 50 years of poultry production.

BRR: What are the other reasons of price increase or a sudden change in price?

KS: Both broiler and egg demand are influenced by the prices of supplementary food items like beef, mutton, pulses, etc. and also react to fluctuating climate changes and Islamic calendars. For instance, during the month of Muharram, Safar, and Zil Hajj, chicken meat demand goes down and during the month of Shaban, Shawwal, and Rabi-al-Awwal, being wedding season, demand goes up. Demand also changes with the percentage increase in per capita income.

Egg demand decreases during summers and with the school closures because there is no tiffin, which mostly includes egg or chicken products taken to the schools. Prices also go down during mango season because income is channelised towards mangoes.

BRR: How can the volatility in the sector be eliminated or reduced?

KS: The only way reduce or eliminate volatility is to bring about equilibrium in demand and supply. The only way to bring equilibrium in demand and supply is by encouraging poultry and egg processing and adding value to the products, which would change the perish ability of the products from being highly perishable to a non-perishable product i.e. a frozen chicken product and powdered egg products or pasteurized liquid eggs. During the time of short supply, frozen products can fill in the gap and the powdered egg from the store can play its role.

BRR: Why is the history of poultry processing checkered with a number of failures?

KS: Until the early 2000s, processed packed frozen chicken was subject to sales tax. During this period, a number of processing units, namely Pakistan Poultry Produce established by the Minwalla Group, Jiffy Chicken established by a family member of the Wazir Ali Group, KK Chicks established by Climax Fans Group, Modern Poultry Processor and BiBi Jan Processing all had closed down. The main reason attributed to the closure was that they could not compete with the unorganised poultry processor sitting on the footpath.

BRR: What is the current status of the value-added poultry sector?

KS: Pakistan is the tenth-largest producer of broiler chicken in the world after Thailand; the dominant players are US, Brazil, China, France, etc. The top nine producers process between 95 to 100 percent of all live chicken produced; Pakistan processes only about five percent of the total live chicken produced.

BRR: What has stopped Pakistan from following suit?

KS: It is the overall government policy, or I would say, a lack of policy to encourage poultry processing. The first poultry processing unit was established in the 1980s by some of the prominent players. As already discussed in your earlier question, the value-addition sector could not compete with the unorganised sector sitting on the footpath, which virtually has a cost of no more than Rs2/kg against the cost of processing, excluding the cost of the chicken, which was somewhere between Rs45-55/kg. This cost is only to the extent of slaughtering and meat processing. In this cost, there are a number of taxes and levies, which includes sales tax on sanitizers, detergents, gases for freezing, equipment /machinery, Social Security, WPPF, Workers Welfare Fund, EOBI, education cess, compulsory employment to handicaps, etc. The only way to survive is to add value and create products. Here too, all inputs are subject to import duties and sales tax. The total cost of taxes in value addition works out to more than Rs49.63. This does not include taxes pertaining to employees. Thus, the addition of taxes limits the consumers.

BRR: Whatís the state of taxes globally or elsewhere in the region?

KS: In other parts of the world Ė even in the EU Ė poultry and meat production (in fact, all food items that cannot be consumed standing in the store) are zero-rated. Even the inputs such as poultry feed and its ingredients are zero-rated.

Unless and until we provide relief from taxes, the processing and value-addition sector will not grow at any significant pace. To push the growth in value addition, the government must consider zero-rating the sector, which will go to the benefit of the consumers and the economy.

BRR: In order to convince the government, what are the advantages of value addition?

KS: Well, there are number of advantages. First, there will be stability in prices as gradually there will be equilibrium in demand and supply. The quality of products will improve very substantially as is seen in branded products because in selling a generic product, there is no competition, but in selling a branded product, quality becomes a predominant factor. Price is also rationalised. Processing also gives rise to exportable products.

BRR: What is the export potential?

KS: The Halal food market was worth $3.5 trillion in 2012 growing at an average rate of 10 percent annually, and the market of our interest which includes UAE, Saudi Arabia, Oman, Kuwait, Yemen, etc. being not only Muslim countries but in close proximity, is $5.8 billion. As such, there is a great potential for earning foreign exchange as well. As little as exporting an additional 10 percent live chicken production converted to value-added products would earn $440 million per annum but of course, the taxes have to be zero-rated for the purpose.

BRR: What are some of the limitations to the growth of processed chicken?

KS: People still believe that this is not Halal, though we have shown our movies to explain many times. Second, selling a frozen product means that you need to have an infrastructure, cold storage, power supply, etc. Besides that, I have to compete with the person sitting on the footpath, who buys few knives, a drum, puts up a Ďkunda,í pays some money to the police or KMC and he is in business.

The cost of processing chicken is well about Rs40-50 per kilogram, because everything the processed-chicken player does is taxed; they also have to hire competent manpower Ė including veterinarians with heavy salaries Ė just to slaughter, freeze, and send it to the retailer. For the person on the footpath, the cost of processing is Rs2 per bird.

So unless and until the government encourages value addition, there will be no stability in prices because there will no stability in supply. Processing has many advantages. The consumer gets a healthier product, because when a person brands a product, then he ensures that he gives a quality product. When you are buying live, you donít see the health of the bird and the kind of medicines it has been subjected to.

The development of the processed-chicken market at home is critical to be able to export, because without it the industry will not have the necessary scale.

BRR: What has been the governmentís response so far?

KS: So far the government has only been increasing the taxes year after year. On account of the lobby of solvent extraction industry, the government increased the import duty from five percent to 10 percent plus one percent additional customs duty, and also increased sales tax from five percent to 10 percent on duty paid value. Soybean meal, which is one of the most important components of poultry feed, is exceptionally higher taxed. Other feedstuffs of the solvent industry such as sunflower meal and canola meal when imported are subject to five percent import duty and five percent sales tax.

The government policies are going against the local poultry sector. The government has been signing FTAs without proper knowledge. It is suicidal. Do they think we will ever have the positive trade balance with any country given the environment at home?

A host of raw materials are needed to make value-added chicken products such as nuggets, burger patty, sausages, etc. These raw materials include spices, coatings, condominiums, etc., and all of these are subject to 15 to 30 percent import duty and a 17 percent sales tax. On the other hand, under the FTA, value-added processed-chicken products are coming in free of import duty from Malaysia and on 10 percent import duty from China.

These taxes have substantially increased our cost of production and rendered us uncompetitive against imports as well.

BRR: Can you share any examples of how FTAs are giving local players an unfair competition?

KS: Certainly. I can give examples but it would be inappropriate to give names. The international quality auditors of one of the leading American fast food chains carried out our audit and approved us with flying colours. We even developed new products for them to meet the local taste. The company started buying some of their requirements from us but immediately after the FTA with Malaysia started importing from Malaysia and China. Thereafter, international quality auditors of yet another international fast food chain, which came in Pakistan later, also approved us with flying colors but subsequently started importing from Malaysia and China.

BRR: What fiscal policy changes do you want?

KS: We would like poultry farming to be treated at par with agriculture. Agriculture, poultry, and also livestock produce food. The meat sector produces a higher quality of food, particularly protein in quantity and quality. We have a serious protein deficiency. It is a matter of great concern that in Pakistan, deficiency of animal protein foods for its rapidly growing population poses serious health hazards, which include mental retardation, mortality of infants, lowered resistance to infections, and reduced capacity to work. Commonly, more than five percent of newborn children die before the age of five, because of malnutrition and under-nutrition in Pakistan.

To quote some of the examples of differential in tax, vegetable seeds are subject to three percent plus one percent import duty whereas seed for poultry, which is grandparents chicks as also parent stocks chicks, broiler chicks and hatching eggs, are subject to 11 percent customs duty and 10 percent regulatory duty. Similarly, controlled environment poultry farming machinery is subject to three percent customs duty, one percent additional duty and 17 percent sales tax, whereas greenhouse machinery is exempted from all taxes. Why this disparity between one food production with the other food production sector when both fall within the scope of agriculture?

BRR: At the start of this calendar year, the UAE government allowed poultry imports from Pakistan; why hasnít it started to reflect in our export number?

KS: The first step towards materialising exports is that the Animal Quarantine Department in the Ministry of National Food Security has to register the farms that are considered capable of exporting. This process required inspection of farms and hatcheries. The Ministry is short of manpower, thus it takes time to inspect the farms. Besides, there is certain documentation which, from the quarantine point of view, is redundant. However, three monthsí time for registration of farms is not too slow a process.

If exports of poultry and livestock products are being considered as a major export item, the Ministry will have to gear up with the manpower, especially some who have a commercial background, maybe on deputation from the Ministry of Commerce, as there is a need to speak the language of commerce, if not permanently employed in the Ministry of NFS&R.

BRR: What are your growth forecasts for industry exports?

KS: I canít forecast the numbers. I can say that it will expand. But by how much it will expand, we cannot predict. A lot depends on whether the government wants it to expand. If the government doesnít want it to expand then it will expand very slowly. If it wants the formal sector to expand, then it can expand very rapidly.

The government must understand that we are ready to compete notwithstanding very adverse conditions of infrastructure Ė particularly electricity outage at the farms Ė and the high cost of agriculture by-products because of the lower yields of agriculture as compared to other exporting countries. That being said, the government will have to come forward to compete with other countries fiercely engaged in the export arena. If other countries are giving a freight subsidy, our government too will have to provide freight subsidies.

Since there are very heavy taxes on all the inputs of poultry, be it feed ingredients, vaccines, medicines or vitamins and amino acids, the government will have to give duty drawback and give the refunds immediately on retirement of Letters of Credit through the negotiating banks and certainly not through FBR; once the money is to be paid by FBR, it can take years to get the refunds, leading to drying up of the working capital of the exporters. Thus, it would be futile to pay through FBR.

BRR: How good are overall quality and Halal standards in Pakistan?

KS: Our Halal regulations require that the birds should not be stunned by giving electric shock or gas to make them unconscious before slaughtering. The standard also makes it mandatory that the birds should be hand-slaughtered and that the feed for the chicken should not contain any porcine. There is, however, criminal negligence on part of the government to ensure that the products being imported are Halal as per our regulations. A Halal certificate must include a declaration by the Halal-certifying authority that the animals were not stunned and were hand-slaughtered and were not given any porcine product in the feed of chicken. Such a pro-forma should be part of our import policy order.

In addition, I would like to state that no country allows import of chicken without accrediting the producer by inspecting its production facilities, which will include inspection of the farms, feed mills, and processing plants to ensure that they can meet the Halal standards and also hygiene and sanitary standards of exporting disease-free products. Pakistan is the only exception, which requires only a Halal stamp on the invoice or a simple certificate stating that the product is Halal.

Yet another surprising and a glaring inept attitude of the authorities concerned is seen in the stores where you find products with labels in French, Italian, Arabic, etc., In short, in the languages of the country from where the product is being imported. No country allows import of food products with labels in the language of the exporting country. If Arabic of one country is different than the other country, they want Arabic to be written in their own countryís language. For instance, Saudi government does not accept any product written in the script of UAE, while we accept everything, which means we are unconcerned with what are the ingredients in products we are eating, importing, and using. For Godís sake, we should not be so oblivious to the cardinal principle of Halal.

BRR: On a parting note, many people are concerned about their health due to the kind of hormones and chemicals fed to chickens in Pakistan and abroad?

KS: There are no hormones fed to chickens. Their size, growth, and colour are a function of genetic selection and nutrition. My chickens eat a better balanced diet with more nutrients than my children or grandchildren. Their protein and vitamins are balanced, their amino-acids are balanced, and everything is taken care of to the last particle, including the rate of ventilation and temperature which is measured and managed in a computer-controlled environment.

All this, because I cannot cheat a chicken; if I cheat a chicken, she will lays fewer eggs or otherwise wonít grow at the right pace, or die on me.

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