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Market Vertical Coordination Communication and distributionCommunication and distribution Historically relied upon price signalsHistorically relied upon price signals
» Markets and spot negotiation
Moving toward non-market Moving toward non-market transactionstransactions» Contracts and long term negotiation
Trends
SpecializationSpecialization» Producing or processing only one or
a few products (Farming, Packing)
DiversificationDiversification» Multiple plants
» Multiple products
» Complementary products
Trends Decentralization Decentralization
» Move away from central markets
Drivers of trendDrivers of trend» Transportation
» Processing technology
» Communication systems
» Economies of scale
Integration
Vertical and horizontalVertical and horizontal OwnershipOwnership
» Mergers
» Growth to include function
ContractContract» Formal agreement
Integration?
Improved communication and Improved communication and control of the food supply to control of the food supply to increase customer satisfaction?increase customer satisfaction?
An attempt by processors to An attempt by processors to drive down farm level prices for drive down farm level prices for short and long term gain?short and long term gain?
Reasons for Integration
Profit potentialProfit potential Risk reductionRisk reduction Improved bargaining powerImproved bargaining power Operational efficiencyOperational efficiency Improved communicationImproved communication
Food Industry Alliances
Preferred/exclusive suppliersPreferred/exclusive suppliers Marketing contractsMarketing contracts HyVee and Farmland porkHyVee and Farmland pork
Production Ag Integration Premium Standard FarmsPremium Standard Farms Smithfield FoodsSmithfield Foods
» Largest pork packer and producer CargillCargill
» Nutrena, Production, Excel» Corn genetics, grain handling, processing
US Premium BeefUS Premium Beef Iowa Quality Beef Supply CoopIowa Quality Beef Supply Coop Farrow-Finish grain farmFarrow-Finish grain farm
Johnson Amendment, 2001 Prohibits packers from owning, Prohibits packers from owning,
feeding, or controlling livestock feeding, or controlling livestock for more than 14 prior to slaughterfor more than 14 prior to slaughter
Amended to allow contractingAmended to allow contracting»Farmer must materially participate
Excludes coops and poultryExcludes coops and poultry Packers would divest in Packers would divest in
» Hogs 18 months» Cattle 180 days
Contract Integration
Market specification contractsMarket specification contracts» Forward contracts» Common and general
Resource providing contractsResource providing contracts» Prescribed inputs and management
Management and income sharingManagement and income sharing» Greater integrator control
Integration into farming
Horizontal integrationHorizontal integration» Fewer and larger farms» Networking and alliances
Vertical integrationVertical integration» Cooperatives» Input production» Grain and meat processing
Value of Selected Commodities Produced
under Production Contracts, 1997 Commodity Value of
Production
PercentBroilers 99Cattle 14Eggs 37Hogs 33
Vegetables 8Total value of production under production contracts, all commodities
12
Source: USDA, Economic Research Service, 1997 Agricultural Resource Management Study, special analysis
Value of Selected Commodities Produced
under Marketing Contracts, 1997 Commodity Percent
Sugar beets 82
Fruits 59Canola 46Potatoes 43Peanuts 41Cotton 33Vegetables 24
Barley 19Cattle 9Peas 9Soybeans 9Corn 8
Source: USDA, Economic Research Service, 1997 Agricultural Resource Management Study, special analysis
Types of contracts
Market-specification termsMarket-specification terms» Product characteristics» Basis of price and payment
ExamplesExamples» Forward deliverable contracts
Little management control by buyerLittle management control by buyer
Types of contracts Resource-providing termsResource-providing terms
» Inputs are specified by buyer» Little price protection
ExamplesExamples» Specialty grain» Processing vegetables
High degree of management by High degree of management by buyerbuyer
Types of contracts Management and income Management and income
guaranteeingguaranteeing» Specifies characteristics and input use» Provides price and maybe production risk
ExamplesExamples» Hogs, poultry
High degree of management by buyerHigh degree of management by buyer
Contract grain production Forward contracts for deliveryForward contracts for delivery Specialty grainSpecialty grain
» Seed corn, popcorn, white corn» Formula contract tied to another market
Silage productionSilage production Production for grainProduction for grain
Cattle Production Contracts
Commercial feedlotsCommercial feedlots» Feedlot provides the management
not the buyer or cattle owner
Custom grazingCustom grazing» Cowherds
» Stockers
Cattle Marketing ContractsCaptive supplies of cattle Captive supplies of cattle
» Under the buyer’s control 14 or more days before delivery
Marketing contracts Marketing contracts » Forward contract for delivery» Formula contract
Types of captive supplies, 1999Types of captive supplies, 1999» Packer owned 4% (now 6-8%)» Under contract 28%
Captive Supply Research Results
1993 KSU Study:Captive supply shipments associated with a $0.15/cwt to $0.31/cwt decline in cash fed cattle prices
1996 KSU - OSU Study:1% contract delivery associated with $0.02/cwt to $0.03/cwt. cattle price
1% packer fed delivery associated with $0.13/cwt. to $0.19/cwt. cattle price
1% mktg agrmnt delivery associated with$0.04/cwt to $0.26/cwt. cattle price
Hog Production Contracts Farmer is paid to provide building Farmer is paid to provide building
and laborand labor Hog owner provides inputs and Hog owner provides inputs and
managementmanagement Limited production risk, no price riskLimited production risk, no price risk Currently 33-35% of hogs produced Currently 33-35% of hogs produced
under a under a productionproduction contract contract
Hog marketing contracts Relatively new - growth since 1993Relatively new - growth since 1993
» Open market was 87-89% in 1993» Open market was about 15% in 2003
Product specification importantProduct specification important» Genetics, inputs, food safety
Delivery schedulingDelivery scheduling Types of contractsTypes of contracts
» Formula price» Share price risk
Risk Sharing Contracts
Window contractWindow contract» Set upper and lower bound» Share the “pain and gain” outside
Cost based price floorCost based price floor» Minimum price tied to feed price» Pay back “loan”» Give up part of higher prices
Weekly Hogs Prices, Cost of Production and Contract
$-
$10
$20
$30
$40
$50
$60
$701
/6/9
0
1/6
/91
1/6
/92
1/6
/93
1/6
/94
1/6
/95
1/6
/96
1/6
/97
1/6
/98
1/6
/99
Cash Cost + COP
Weekly Hogs Prices, Cost of Production and Contract
$-
$10
$20
$30
$40
$50
$60
$70
1/6
/90
1/6
/91
1/6
/92
1/6
/93
1/6
/94
1/6
/95
1/6
/96
1/6
/97
1/6
/98
1/6
/99
Cash COP Margin Band Window
Ledger Balance: $/Live Cwt
$(200)
$-
$200
$400
$600
$8001/6
/90
1/6
/91
1/6
/92
1/6
/93
1/6
/94
1/6
/95
1/6
/96
1/6
/97
1/6
/98
1/6
/99
Contract Examples
Iowa Attorney GeneralIowa Attorney General» http://www.state.ia.us/government/ag/ag_contracts/
Current research on webCurrent research on web» Hogs: http://www.econ.iastate.edu/faculty/lawrence/HOGS.htm» Production and Marketing Characteristics of U.S. Pork Producers,
2000,» Understanding Hog Marketing Contracts - September 18, 1999
» Cattle: http://www.econ.iastate.edu/classes/econ135/lawrence/
» Packer Concentration, Captive Supplies and Fed Cattle Prices
Packer Motivation for Increased Pork and Beef Marketing Contracts, 1999.a
Pork BeefReduce plant operating costs by improving plant scheduling 3.5 2.9Secure higher quality animals 4 4Secure more consistent quality of animals 4.3 4Assure food safety 3.8 3Long run price risk management 3 2.8Week-to-week supply/price management 3.5 2.2Reduce costs of searching for animals to procure 3.5 2.3Able to purchase animals for lower price 2.3 1.8aScale of 1 to 5, 1=not important to 5=very importantSource: Reported by Lawrence, Schroeder, and Hayenga (2001)
Producer’s Motivation for Entering Marketing Contract with Packer
Access to capital and better Access to capital and better financingfinancing
Reduced price riskReduced price risk Assure a buyerAssure a buyer Reduced marketing costsReduced marketing costs Improved prices or premiumsImproved prices or premiums
Reasons for production integration
Greater controlGreater control» Product quality / specifications
» Scheduling
» Industrialization
Risk managementRisk management Access to resourcesAccess to resources
Motivations and Implications
Profit potential???Profit potential???» Multiply management
» Production efficiency and product quality
Thin market concernsThin market concerns Encourages expansion by Encourages expansion by
reducing riskreducing risk
So What???? How do you establish value in a How do you establish value in a
system in which there is little or system in which there is little or no open market activity?no open market activity?
Do you need to?Do you need to? How do you determine returns to How do you determine returns to
the various segments?the various segments?
Open market impacts
Packer may have ability to call Packer may have ability to call suppliessupplies
Formula tied to cash marketFormula tied to cash market Potentially depress pricesPotentially depress prices Potentially increase volatilityPotentially increase volatility Value-based pricingValue-based pricing