Livestock Marketing Practices
and Competition Questions
John D. Lawrence
Extension Livestock Economist
Iowa State University
1
Overview
• Recent history and trends
• Literature review
• Remaining questions
2
National Fed Cattle Marketing Breakdown
60%
50%
40%
30%
20%
10%
0%
II III IV I II III IV I II III IV I II III IV I II III IV I II III IV
2005
Negotiated
2006
Negotiated Grid
2007
Formula
2008
2009
Forward Contract
3
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
2002
Hog Marketing by Method
2003
2004
2005
Negotiated
Hog & Pork Formula
Packer sold
2006
2007
2008
2009
2010
Other market formula
Other Agreement
Packer Owned
4
Overview of the 2007 USDA
GIPSA / RTI Livestock and
Meat Marketing Study
Data from Oct 02 – Mar 05
5
General Study Conclusions
• AMA use was 38% for cattle, 89% for hogs,
and 44% for lambs.
• Packer-owned <5% for cattle & lamb but 2030% for hogs.
• Little or no increase in AMA use is expected
for cattle and hogs -- moderate increase
expected for lambs.
• Cash market is important -- outlet for small
producers and packers and reported cash
prices are used by AMAs.
6
General Study Conclusions
• AMA use is associated with lower cash market
prices -- larger association for hogs than cattle.
• Packers and producers benefit from AMA use -lower costs, risk control, and quality
management.
• Restrictions on AMA use will have a negative
economic impact on producers, packers, and
consumers.
• Restricting AMAs doesn’t eliminate market
power
7
Summary of Cattle Volume of
RTI – GIPSA LMMS Study
Stephen Koontz, John Lawrence,
Gary Brester, Mary Muth, and
John Del Roccili (formerly Beef
Team Leader - deceased)
8
Beef producers and packers interviewed
believed that some types of AMAs
• Helped them manage their operations more
efficiently, reduced risk, and improved beef quality.
– Feedlot savings of $1 to $17/hd from improved capacity
utilization, more standardized feeding programs, and
reduced financial commitments required to keep the
feedlot at capacity.
– Packers 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.
– Where do higher returns come from?????
9
Marketing and Pricing Methods
• When selling to packers 85% of small producers
and 24% for large producers surveyed used only
the cash market
• Pricing methods by size
Large Small
– Individually negotiated pricing 74% 32%
– Public auction
35% 84%
– Formula pricing
57%
6%
10
Packer Purchases
• Using only the cash or spot market
– 10% large beef packers surveyed
– 78% of small beef packers surveyed
• Neither the producers nor packers surveyed
expected the use of AMAs to change dramatically
in the next 3 years
11
Reasons for AMAs
• Producers surveyed
– The ability to buy/sell higher quality cattle,
– Improve supply management,
– Obtain better prices
• Packers surveyed
– Improve week-to-week supply management,
– Secure higher quality cattle,
– Allow for product branding in retail stores
12
Reasons for Cash Only
• Producers surveyed
– Independence and flexibility,
– Quick response to changing market conditions,
– Ability to buy at lower prices and sell at higher
prices
• Packers surveyed
– Independence and flexibility,
– Quick response to changing market conditions,
– Securing higher quality cattle
13
Analysis of procurement
transactions data
• From the 29 largest plants and included 58
million animals and 590,000 transactions.
– 61.7% cash
– 28.8% marketing agreement
– 4.5% forward contracts
– 5.0% packer-owned, other, or missing
• Regional differences in AMA use.
14
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 is associated with a
0.11% decrease in cash price.
• Impacts are economically small but statistically
significant.
15
What did the packer P&L data show?
• Substantial economies of size
– 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 the middle range
• 14% more efficient than operating at the low end range
16
What did the packer P&L data show?
•
•
•
•
•
•
Plant costs are lower for those that use 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.
17
Summary of Hog Volume of RTI
– GIPSA LMMS Study
Tomislav Vukina (Pork Team Coordinator),
Michael Wohlgenant, NC State
Mary Muth, RTI
18
AMAs are an integral part of hog
producers’ selling practices and pork
packers’ procurement practices.
• Significant regional differences
– stronger reliance on cash/spot markets and
marketing contracts is apparent in the
Midwest
– stronger reliance on production contracts and
packer ownership of hogs is apparent in the
East.
19
Based on transactions data, there are
substantial differences in hog prices paid
• On average, the price dispersion is about
40% of the average value of the transaction
prices each day.
– Controlling for region, quality, or plant size
explained little
– The regression model can only explain 26-27%
of the daily variation in the cash price.
20
Effect of both contract and packer-owned
hog supplies on spot market prices
• A clarification: they report
– a 1% increase in contract hog quantities causes the spot
market price to decrease by 0.88%
– a 1% increase in packer-owned hog quantities causes
the spot market price to decrease by 0.28%.
• What is missed is that
– a 1% increase in the supply of spot market hogs is
associated with a 0.27% decrease in cash market price
• Watch the math! Consider 100 million hogs
– 61 contract, 31 packer-owned and 8 spot-market
– 1% contract or PO is 7.6% and 3.9% of spot market
21
Measured a statistically significant presence
of market power in live hog procurement,
but the results are inconclusive.
• Two approaches were used with somewhat
different results. Both found market power.
– One found that the benefits of AMA out weighed
the market power harm.
– The second couldn’t conclude that AMAs were
the source of the market power.
22
Estimated TC and ATC functions indicate
that economies of scale diminish as the
pork packing firm size increases
• Estimated that scale economies are exhausted well
within the sample output range such that the biggest
plants already exhibit negative returns to scale.
• Certain combinations of AMAs may reduce costs
and/or increase economies of scale.
• Relative to using spot market procurements alone, all
other combinations of marketing arrangements
improve the efficient scale of production.
23
Wang and Jaenicke
• Simulating the Impacts of Contract Supplies in a Spot
Market–Contract Market Equilibrium Setting
• Acknowledge limitations of their model
• Results are inconclusive
– For formula-price contracts increased contract supplies
are negatively related to the expected spot market price
when participating producers contract high proportions
(greater than 0.8) of their hogs, but are positively related
when producers contract lower proportions (between 0.6
and 0.8).
– Moreover, increased contract supplies reduce the
variance of spot market price under formula-price
contracts.
24
Wang and Jaenicke
• Formula-price contract offers the highest expected
profit to processors and highest expected utility to
producers
• Because of uncertainty on processing demand, the
cash market remains valuable to processors
• Important linkage between the contract market and
the cash market could, of course, disappear if realworld cash markets become too thin and disappear
altogether.
25
Remaining Questions
• What are the necessary conditions for a viable
spot market?
• Do lessons learned in cattle apply to hogs?
• What trade-offs are necessary or acceptable?
– Quality? Efficiency?
• What is the source of market power and what is
the cost of controlling it?
• What is the risk?
– Niche markets and branded products
– Asset values and loans contingent on contracts
26