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Market Vertical Coordination

Market Vertical Coordination. Communication and distribution Historically relied upon price signals Markets and spot negotiation Moving toward non-market transactions Contracts and long term negotiation. Trends. Specialization

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Market Vertical Coordination

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  1. Market Vertical Coordination • Communication and distribution • Historically relied upon price signals • Markets and spot negotiation • Moving toward non-market transactions • Contracts and long term negotiation

  2. Trends • Specialization • Producing or processing only one or a few products (Farming, Packing) • Diversification • Multiple plants • Multiple products • Complementary products

  3. Trends • Decentralization • Move away from central markets • Drivers of trend • Transportation • Processing technology • Communication systems • Economies of scale

  4. Integration • Vertical and horizontal • Ownership • Mergers • Growth to include function • Contract • Formal agreement

  5. Integration? • Improved communication and control of the food supply to increase customer satisfaction? • An attempt by processors to drive down farm level prices for short and long term gain?

  6. Reasons for Integration • Profit potential • Risk reduction • Improved bargaining power • Operational efficiency • Improved communication

  7. Food Industry Alliances • Preferred/exclusive suppliers • Marketing contracts • HyVee and Farmland pork

  8. Production Ag Integration • Premium Standard Farms • Smithfield Foods • Largest pork packer and producer • Cargill • Nutrena, Production, Excel • Corn genetics, grain handling, processing • US Premium Beef • Iowa Quality Beef Supply Coop • Farrow-Finish grain farm

  9. Johnson Amendment, 2001 • Prohibits packers from owning, feeding, or controlling livestock for more than 14 prior to slaughter • Amended to allow contracting • Farmer must materially participate • Excludes coops and poultry • Packers would divest in • Hogs 18 months • Cattle 180 days

  10. Contract Integration • Market specification contracts • Forward contracts • Common and general • Resource providing contracts • Prescribed inputs and management • Management and income sharing • Greater integrator control

  11. Integration into farming • Horizontal integration • Fewer and larger farms • Networking and alliances • Vertical integration • Cooperatives • Input production • Grain and meat processing

  12. Value of Selected Commodities Produced under Production Contracts, 1997 Source: USDA, Economic Research Service, 1997 Agricultural Resource Management Study, special analysis

  13. Value of Selected Commodities Produced under Marketing Contracts, 1997 Source: USDA, Economic Research Service, 1997 Agricultural Resource Management Study, special analysis

  14. Types of contracts • Market-specification terms • Product characteristics • Basis of price and payment • Examples • Forward deliverable contracts • Little management control by buyer

  15. Types of contracts • Resource-providing terms • Inputs are specified by buyer • Little price protection • Examples • Specialty grain • Processing vegetables • High degree of management by buyer

  16. Types of contracts • Management and income guaranteeing • Specifies characteristics and input use • Provides price and maybe production risk • Examples • Hogs, poultry • High degree of management by buyer

  17. Contract grain production • Forward contracts for delivery • Specialty grain • Seed corn, popcorn, white corn • Formula contract tied to another market • Silage production • Production for grain

  18. Cattle Production Contracts • Commercial feedlots • Feedlot provides the management not the buyer or cattle owner • Custom grazing • Cowherds • Stockers

  19. Cattle Marketing Contracts Captive supplies of cattle • Under the buyer’s control 14 or more days before delivery • Marketing contracts • Forward contract for delivery • Formula contract • Types of captive supplies, 1999 • Packer owned 4% (now 6-8%) • Under contract 28%

  20. 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 deliveryassociated with $0.02/cwt to $0.03/cwt. cattle price 1% packer fed deliveryassociated with $0.13/cwt. to $0.19/cwt. cattle price 1% mktg agrmnt deliveryassociated with $0.04/cwt to $0.26/cwt. cattle price

  21. Hog Production Contracts • Farmer is paid to provide building and labor • Hog owner provides inputs and management • Limited production risk, no price risk • Currently 33-35% of hogs produced under a production contract

  22. Hog marketing contracts • Relatively new - growth since 1993 • Open market was 87-89% in 1993 • Open market was about 15% in 2003 • Product specification important • Genetics, inputs, food safety • Delivery scheduling • Types of contracts • Formula price • Share price risk

  23. Risk Sharing Contracts • Window contract • Set upper and lower bound • Share the “pain and gain” outside • Cost based price floor • Minimum price tied to feed price • Pay back “loan” • Give up part of higher prices

  24. Contract Examples • Iowa Attorney General • http://www.state.ia.us/government/ag/ag_contracts/ • Current 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

  25. Packer Motivation for Increased Pork and Beef Marketing Contracts, 1999.a

  26. Producer’s Motivation for Entering Marketing Contract with Packer • Access to capital and better financing • Reduced price risk • Assure a buyer • Reduced marketing costs • Improved prices or premiums

  27. Reasons for production integration • Greater control • Product quality / specifications • Scheduling • Industrialization • Risk management • Access to resources

  28. Motivations and Implications • Profit potential??? • Multiply management • Production efficiency and product quality • Thin market concerns • Encourages expansion by reducing risk

  29. So What???? • How do you establish value in a system in which there is little or no open market activity? • Do you need to? • How do you determine returns to the various segments?

  30. Open market impacts • Packer may have ability to call supplies • Formula tied to cash market • Potentially depress prices • Potentially increase volatility • Value-based pricing

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