The PigSite.com, UK
04-28-07
Market Preview: Thinking Through Packer Concentration
US - Weekly U.S. Market Preview
by Steve R. Meyer, Ph.D., Paragon Economics, Inc.
One of the joys of fatherhood has been the opportunity to coach my children's
sports teams. I don't know if they have learned much, but I sure have!
Along with the enjoyment comes a good dose of frustration from time to time.
None more than getting a young basketball team to apply "what we taught you in
practice" to making good decisions on the fly when opportunities present
themselves in a real game.
It goes something like this - we teach player #1 to dribble to point A, then pass
the ball to player #2, who is coming off a screen set by player #3. To their credit,
the players try to do exactly what we taught them in spite of three defenders
standing in front of player #2 while our player #5 suffers from terminal loneliness
right under the basket! This is when I or another coach calls a timeout to tell
them: "Kids, we appreciate your following instructions so well, but you also have
to observe and think!"
Such is also the case with economic matters. Regardless of how well one
understands theory or knows the quantitative methods of estimating coefficients
and measuring impacts, there is no substitute for simply observing and thinking.
The renewed debate over industry structure and market competition brings this to
my attention, as there appears to be a dearth of both on several fronts. Some of
it is due to ignorance, but much of it appears to be due to ideology.
Concentration, defined as a condition in which only a few companies hold a high
aggregate share of a given business, has been a hot issue in agriculture for
many years. That's a bit ironic, since agriculture is not unusually concentrated
relative to other industries in our economy. Still it's understandable, since
agriculture was once the poster child for the economic ideal called perfect
competition that involves many buyers and sellers and homogenous products.
Packer Concentration
The four-firm concentration ratio (i.e. the sum of the market shares held by the
largest four firms, called CR4) for pork packing has risen in recent years, jumping
from its 1996 to 2002 range of 54-57, to roughly 64 in 2003, when Smithfield
bought Farmland Foods. CR4 has remained near 63 since that time, but the
Premium Standard Farms (PSF) merger would push it to just over 65.
Note, however, that the last big shift in CR4 (from the mid-50s to the low-60s)
was in 2003. What has been the profit situation in the pork industry since then?
Iowa State University's (ISU) returns estimates for pork production systems
turned positive in February 2004 and remained positive through January 2007.
Under ISU's new production assumptions, returns are still positive. This is the
longest period of profits in the ISU estimates' history and it occurred just after a
large jump in packer concentration.
So, just how correlated is packing CR4 and producer profits? This is just one
instance -- but the answer is "not very." The lesson here, for people willing to
think about it, is that while concentration can lead to problems caused by a
limited number of market participants being able to more accurately anticipate
and counteract the actions of competitors, it is not the end-all for measuring
competition level. The behavior of firms is far more important than their
ownership structure.
Smithfield-PSF Merger
As an example, let's consider the case of the Smithfield-PSF merger and
As an example, let's consider the case of the Smithfield-PSF merger and its
impact on hog markets. Smithfield Foods is buying a company that was never a
player in the Midwest hog markets because it bought no hogs to speak of. I say,
"to speak of" because I can't say with 100% certainty that they never bought any
hogs. If they did, it is safe to say that the number was insignificant.
How will making a company that was never in the midwestern hog market affect
the midwestern hog market by its absence?
In addition, PSF's Clinton, NC, plant would join Smithfield. But even that would
have no effect on competition for hogs, since a North Carolina market does not
determine North Carolina hog prices. Virtually all of their prices are formulated off
of the Corn Belt markets.
Theory tells us that North Carolina hog prices should equal the next closest hogdeficit area (most likely Indiana), minus the transportation costs. Eastern
seaboard packers must pay only enough for hogs to keep producers from putting
them on a truck to the next closest deficit market. Market hog value data from the
National Pork Board indicates that to be the case, actually.
I don't see that merging PSF-Clinton into Smithfield Foods will change that
regional price relationship at all.
Could the merger affect the level of competition for meat products? It is possible,
especially in eastern markets where Smithfield and PSF have competed. But
even there the merged company is not immune to competition from Hormel,
Tyson, Cargill, Hatfield, Swift, Indiana Packers and all the other national pork
marketers, not to mention beef, chicken and turkey.
Impact on Contract Finishing
The one area that I see this merger could have an effect on competition is in the
purchase of contract hog growing services in North Carolina and surrounding
states. There are growers in those areas that now have one less bidder for the
use of their buildings, which, obviously, are not mobile. That could be a problem,
especially since some of those growers had made an explicit decision to not work
with Smithfield in the past. This aspect of the merger, to me, deserves careful
scrutiny. Should the merger be approved, as I expect it will, this area deserves
constant monitoring in future years.
Let's be careful not to automatically adopt old adages in judging the merits of
change. Our basketball offense was a good one, but it was not nearly as useful
as having players pay attention to the facts and making adjustments in a fluid,
ongoing game. That sounds like a good approach to, and appropriate description
of, today's hog and pork business, doesn't it?