Econ 337, Spring 2012 ECON 337: Agricultural Marketing Chad Hart Assistant Professor...

Econ 337, Spring 2012

ECON 337:Agricultural Marketing

Chad HartAssistant [email protected]


What Causes CyclesResponse to economic signalsTime lag

Psychology BiologyInvestment

LivestockTree cropsLand development


Seasonal Price PatternsPatterns that repeat themselves with

some degree of predictability within a year’s time frame.

Driven by supply and demand factors that are impacted by time of yearWeatherHolidaysInput prices


Seasonal Pricing Patterns

Source: USDA, NASS,Monthly Price Data 1980-2011

0.90

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Cattle Hogs


How to Calculate Seasonal Index

Pick time period (number of years)Pick season period (month, quarter)Calculate average price for seasonCalculate average price over timeDivide season average by over time

average price x 100


U.S. Cattle Prices, Cattle 500 Lbs. or Higher

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Annual

2002 67.40 70.00 70.60 67.30 65.10 64.00 63.70 64.40 64.50 64.60 67.30 70.40 67.40

2003 72.90 73.90 72.60 74.50 75.50 74.90 75.80 79.30 84.90 91.50 93.40 90.40 72.90

2004 81.10 78.50 83.70 84.90 88.50 89.80 88.00 87.60 85.90 86.50 85.30 86.70 81.10

2005 89.10 88.80 91.00 93.70 92.10 88.00 85.00 84.40 88.00 90.40 90.80 93.30 89.10

2006 95.00 92.40 87.90 84.80 82.20 84.00 85.80 87.20 90.00 88.30 84.40 83.10 95.00

2007 83.70 86.10 91.60 93.70 92.80 88.80 89.00 91.40 93.10 90.90 89.90 89.20 83.70

2008 87.50 89.00 87.90 86.80 91.30 91.90 95.00 95.80 94.20 87.40 84.30 79.70 87.50

2009 80.10 78.90 79.10 83.80 83.20 80.10 80.90 80.40 80.50 79.20 79.60 78.50 80.10

2010 82.30 85.70 90.40 95.60 94.70 90.40 91.70 93.50 94.10 93.10 94.00 98.10 82.30

2011 107.00 108.00 115.00 119.00 112.00 107.00 111.00 111.00 112.00 117.00 120.00 120.00 107.00

Avg. 84.61 85.13 86.98 88.41 87.74 85.89 86.59 87.50 88.72 88.89 88.90 88.94 87.36

Ratio 96.9% 97.4% 99.6% 101.2% 100.4% 98.3% 99.1% 100.2% 101.6% 101.8% 101.8% 101.8%


Using Seasonal Index to Forecast

Observe price in time t1 P1

Forecast price in time t2 P2

Start with P1/ I1 = P2 / I2 Then P1 x I2 / I1 = P2

Assume that cattle are selling at $125/cwt in February. What is the forecast of July?


Cost of ProductionRaised livestock

Farrow to finish, Cowherd to finishAccumulate cost from birth through finishRelatively stable cost over timeImpacted by input prices and production

Feed is typically 60-70% of costLow productivity increases the cost of those that

make it to finish because the fixed costs are divided by a smaller number.


Cost of ProductionPurchased feeder livestock

Derived demand for feeder animalHighly variable priceDepends upon

Expected selling price for finished animalFeed costs


Cost of Production BudgetsStarts with production functionIncorporates input pricesProject cost per unit sold

Variable $/unitTotal $/unit

http://www.extension.iastate.edu/agdm/livestock/html/b1-21.html


Swine Production - Finishing Weaned 12 lb Pigs, Total Confinement - One PigAg Decision Maker -- Iowa State University Extension

Income Price Unit Quantity Unit Total Market Hogs $0.00 per lb x 260 lbs = $0.00

Variable Costs Price Unit Quantity UnitWeaned Feeder pig $32.00 per head x 1 head = $32.00Interest 9% 4.9 months = $1.18

Feed CostsCorn $3.80 per bu x 9.8 bu = $37.24Soybean meal $0.15 per lb x 119.0 lbs = 17.85Dried distiller grain $0.06 per lb x 32.0 lbs = 1.92Vitamin & minerals $0.45 per lb x 14.4 lbs = 6.48Pre-nursery diet 3.00Feed Additives 3.00Feed processing & delivery 6.75Other 0.00

Total Feed Costs $76.24

For more information see Information File B1-21 Livestock Enterprise Budgets.

Enter input values in yellow grid-lined cells.Place the cursor over cells with red triangles to read comments.


Veterinary and medical $5.00Fuel, repairs, utilities 4.20Marketing, miscellaneous 4.00Other 0.00Manure application cost $0.01 per gal 220 gal = 2.20Interest on variable costs 9% 3 months = 1.03Death loss 0.05 head = 1.60Labor $14.00 per hour 0.7 hours = 9.80

Total Variable Costs $137.25

Income over Variable Costs ($137.25)

Fixed Costs Facilities & equipment $11.28

Total All Costs $148.53

Income over All Costs ($148.53)

Break-even selling price for variable costs $52.79 per cwtBreak-even selling price for all costs $57.13 per cwt


Using Budgets in Planning

Project a breakeven “point estimate”Sensitivity analysis for key variablesBack calculate from revenue to what you

can afford to pay for feeder animalEconomic versus financial costs


Feeder & Financing 729.24 60.77+ Feed Costs 186.71 76.33+ Operating Costs 30.46 78.87+ Labor Costs 36.55 81.91+ Fixed Costs 24.63 83.96+ Desired Return 25.00 86.05

Objective Based Pricing Strategy

550# steer calf fed to 1200 slaughter weight

Cost/hd $/cwt


How Much to Pay for Feeder AnimalWork back from total revenue

Expected revenue 1020.00 185.45- Interest Costs 41.74 177.87- Feed Costs 186.71 143.92- Operating Costs 30.46 138.38- Labor Costs 36.55 131.74- Fixed Costs 24.63 127.26- Desired Return 25.00 122.71

550# steer calf fed to 1200 slaughter weight

Cost/hd $/cwt


Feeder Cattle Break Even Purchase Price for a Steer Calf

Corn Fed Cattle Selling PricePrice $125.00 $127.00 $129.00 $131.00 $133.00

In weight 550 $4.00 174.12 178.09 182.05 186.02 189.98Out weight 1150 $4.20 171.89 175.86 179.82 183.79 187.75Target ADG 2.85 $4.40 169.66 173.63 177.59 181.56 185.52Death loss 1.50% $4.60 167.43 171.39 175.36 179.32 183.29Corn (bu) 63.0 $4.80 165.20 169.16 173.13 177.09 181.06Hay (ton) 0.5 $5.00 162.97 166.93 170.90 174.86 178.83Hay Price ($/t) $100.00 $5.20 160.74 164.70 168.67 172.63 176.59Supplement ($/hd) $23.00 $5.40 158.50 162.47 166.43 170.40 174.36Interest 9.50% $5.60 156.27 160.24 164.20 168.17 172.13Yardage $0.25 $5.80 154.04 158.01 161.97 165.94 169.90Vet-Med $14.00 $6.00 151.81 155.77 159.74 163.70 167.67Trucking $9.00 $6.20 149.58 153.54 157.51 161.47 165.44Other $5.00 $6.40 147.35 151.31 155.28 159.24 163.21Target Return $0.00 $6.60 145.12 149.08 153.05 157.01 160.97

http://www.iowabeefcenter.org/Software/Cattle_feeding_budgets.xls


Contractual Relationship Focus today is not on internal transfer Only relationship is the marketing contract Typically 3-10 years in length or evergreen Defines delivery schedules, carcass

specifications, pricing, and in some cases production practices

Small portion of contracts have risk sharing provisions


USDA MPR Definitions

Negotiated: Purchased in the cash market for delivery within 7 days.

Swine or pork market formula: A formula tied to the cash market for hogs or pork cutout., i.e., weekly average price, 3-day rolling average, percentage of the cutout.

Other market formula: A formula tied to something other than the hog market or pork cutout, i.e., feed prices.

Other purchase agreement: Currently this includes window contracts.


Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009*

Year 99 00 01 02 03 04 05 06 07 08 09

Hog or meat market formula 44.2 47.2 54 44.5 41.4 41.4 39.9 41.8 38.3 37.1 41.2

Other market formula 3.4 8.5 5.7 11.8 5.7 7.2 10.3 8.8 8.5 11.0 7.9

Other purchase arrangement 14.4 16.9 22.8 8.6 19.2 20.6 15.4 16.6 15.2 13.4 11.6

Packer-sold 2.1 2.2 2.1 2.4 2.6 6.7 6.1 5.6

Packer-owned 16.4 18.1 17.1 21.4 20 22.7 23.1 25.7

Negotiated - spot 35.8 25.7 17.3 16.7 13.5 11.6 10.6 10.2 8.6 9.2 8.1

Source; Grimes and Plain, University of Missouri http://agebb.missouri.edu/mkt/vertstud09.htm


Contract SpecsContract Specs

Product specificationsPQA, Right to approve inputs

Method of pricingWhich markets and formula

Delivery schedulingShort and long term

Exemptions


Types of ContractsTypes of ContractsFormula

Most common contractPrice tied to another market, typically spotNo risk shareExamples:

3-Day rolling average of ISM weighted average +$1.50

Last week’s average excluding the high and low92% of the previous day pork cutout value

Packer does not share risk


Types of ContractsTypes of ContractsFixed window

Formula tied to cash price Predetermined upper and lower boundsShare pain and gain outside windowExample: $50 and split 50/50 above and below

Floating windowFormula tied to cash priceBoundaries move with feed pricesDo not share outside of window

Packer shares risk


Weekly Hogs Prices, Cost of Production and Window

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Cash COP Floating Window Fixed Window


Types of ContractsTypes of Contracts Cost-Plus

Price direct function of feed pricesFixed amount for non-feed costs + known marginPacker assumes all price risk

Ledger Floor price is fixed or based on feed pricesProducer is “loaned” the difference between floor and

lower cash pricesLoan is repaid at higher cash pricesPacker provides line of credit but not risk share


Weekly Hogs Prices, Cost of Production and Contract

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Cash Cost + COP Ledger


Contract Examples

Iowa Attorney General http://www.state.ia.us/government/ag/working_for_farmers/contracts/index.html


Consumer satisfactionMoisture enhanced pork Preference for attributesGrowing interest in safety and

productionSpot market not sufficient

Premiums and discountsMarket access and risk

Motivations for Vertical Linkages


Traditional IO theoryAvoid market power, reduce price

volatility, technology complements, minimize transaction costs

Agency theory Integrate rather than contract to avoid

opportunism and shirking by contract partners



Asset specificity Firms with more significant relationship-specific

investments (RSI) benefit from predictable throughput and prices

As assets become more specialized, the costs of using the spot market increases

Costs are particularly high when food safety and product quality problems occur encouraging greater process control



Attitude Toward Marketing Contracts by Pork Producers with and without Marketing Contracts1 = strongly disagree, 6 = strongly agree

WithWithout

Coordinate slaughter to better meet Industry needs 3.7 2.9

Have caused lower cash market prices 4.2 4.2

Producers with contracts have received higher prices 3.9 3.5

Packers show preference in who was offered a contract 3.5 3.5

Contracts should be made illegal by Congress 2.7 3.1

Contracts should be more closely monitored by USDA 4.0 4.0

Prefer to market all my hogs on the cash market 3.0 4.1


Summary of Cattle Volume of RTI – GIPSA Study

Stephen Koontz, John Lawrence, Gary Brester, Mary Muth, and John Del Roccili (formerly Beef Team Leader; deceased)


Marketing and Pricing Methods

When selling to packers 85% of small producers and 24% of large producers surveyed used only the cash market

Pricing methods by size of operation LargeSmall

Individually negotiated pricing 74%32%

Public auction 35%84%

Formula pricing 57%6%

Four times as many large producers sold cattle on a carcass weight basis with a grid compared with small producers.


Beef producers and packers interviewedbelieved that some types of AMAs

Helped them manage their operations more efficiently, reduced risk, and improved beef quality.Feedlots identified cost savings of $1 to $17/head

improved capacity utilization, standardized feeding programsreduced financial commitments to stay full.

Packers identified cost savings of $0.40 per head in reduced procurement cost.

Both agreed that if packers could not own cattle, higher returns would be needed to attract other investors and that beef quality would suffer in an all-commodity market place.


Packer Purchases Using only the cash or spot market

10% of large beef packers surveyed78% of small beef packers surveyed

While nearly all packers bought some cattle on a live weight basis, 88% of large packers purchased cattle on carcass grids, while almost no small packers used this method.

Neither the producers nor packers surveyed expected the use of AMAs to change dramatically in the next 3 years


Reasons for AMAs

Producers surveyedThe ability to buy/sell higher quality cattle,Improve supply management,Obtain better prices

Packers surveyedImprove week-to-week supply management,Secure higher quality cattle,Allow for product branding in retail stores


Reasons for Cash OnlyProducers surveyed

Independence and flexibility, Quick response to changing market conditions,Ability to buy at lower prices and sell at higher

prices

Packers surveyedIndependence and flexibility, Quick response to changing market conditions, Securing higher quality cattle


What did the analysis of procurement transactions data show?

Cash, marketing agreement, and packer-owned prices similar.

Auction higher and forward contract lower than cash prices

When AMA use increases cash prices decrease:10% increase in AMA use (as % of plant capacity) is associated

with a $0.40/cwt of carcass weight.10% increase in AMA use is associated with a 0.11% decrease

in cash price.

Impacts are economically small but statistically significant.


What did the packer P&L data show? Substantial economies of size (declining average

total costs of slaughter and processing per head)Large plants have lower ATCs than small when both are

operating close to capacity.For all plants ATCs decline over the whole range of

volumes.The representative plant operating at 95% of max

observed capacity is 6% more efficient than when operating in the middle of the observed range of volumes and 14% more efficient than when operating at the low end of observed volumes.


What did the packer P&L data show?

Plant costs are lower for those that procure through AMAs.

Costs are directly lower -- all else constant. Costs are lower because of increased volumes. Costs are lower because of less variable volumes. Cost savings are approx $6.50 per animal. Weighted-average profits for the four largest

companies were -$2.40 per head for packers over the 10/02-3/05 time period.


The information and characteristics that consumers are demanding may require tighter vertical linkages. Can the spot market provide the non-

measurable process control for consumers? If so, at what cost? Who will pay the added costs? Will greater control speed consolidation?

Role for Economists


The great success of formula pricing contracts is likely to lead to its demise.

Producers want an agreement, but fear thin markets.

How much volume is needed for satisfactory price discovery?

Where should it take place?Who should be involved?

Role for Economists


Concerns about contract linkages negatively affecting prices

Research is inconclusive on price impacts.Thin market implications.Arguments have been greater in the

industry where there is less contracting.Politically charged debate.

Role for Economists


SummaryMarketing contracts are common in hog

marketMost common is tied to dwindling cash market

for price discovery

Less common but widely used in fed cattle marketing

USDA GIPSA has proposed rules that will restrict and possibly prohibit use of contracts


Class web site:http://www.econ.iastate.edu/~chart/Classes/econ337/Spring2012/

Have a great weekend!

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Econ 337, Spring 2012 ECON 337: Agricultural Marketing Chad Hart Assistant Professor...

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