ECON 337: Agricultural Marketing

ECON 337: Agricultural Marketing Lee Schulz Assistant Professor lschulz@iastate.edu 515-294-3356

Overview of the U.S. Livestock Production and Marketing System • Background on overall system • Production, consumption, trade • Basic biological / timing patterns and how they affect markets • Industries within the beef and pork sector • Cow-calf, stocker, backgrounding, feedlot, packing, retail • Farrow-to-finish, farrow-to-wean, wean-to-feeder, feeder-to-finish, farrow-to-feeder, wean-to-finish • Contract arrangements: Producer and integrator • Competition as it applies to the industries within each sector

Economics of Livestock Production • Competitive industry • Long-run economic profits = $0/head • Can expect average return for capital, labor, management, etc. • Average returns reflects the risk in the industry • Tremendous variance in profitability across producers • Identify key factors that drive profitability • Capitalize on them,  probability of business survival • Failing to recognize • Not Competitive → equity drain → forced to downsize or exit

Efficiency of production + Greater return on investment + Expansion or new participants = Increased production = Lower costs to consumers = Greater consumption Main source of long-term profitability for a producer lies in their efficiency relative to other producers

Data Source: USDA-NASS, Compiled by LMIC Livestock Marketing Information Center

Data Source: USDA-NASS, Compiled & Analysis by LMIC Livestock Marketing Information Center

Overview of the U.S. Beef System Cow-Calf Operations Sell weaned calves Stocker / Backgrounding Sell feeder cattle Feedlots / Finishing Sell slaughter cattle Packing Plant / Slaughter Sell boxed beef Retail / Restaurant

Basic Beef Definitions • Cow – mature female to produce calves • Bull – in-tact male • Calf – young cattle, typically used through weaning time • Steer – young male, no longer in-tact • Heifer- young female, prior to first calf

Basic Beef Definitions • Weaned calves – calves after being removed from cow • Feeder cattle – cattle ready to be placed on feed in feedlots • Fed cattle – cattle ready for harvest • Boxed beef – beef processed and ready to be sold at retail level

The Cow-Calf Operation • Own cows, produce weaned calves • Spring vs. fall calving • Usually weaned around 6-7 months of age • Key impacts • Weather • Production costs • Price of calves • Future beef outlook

CHANGE IN BEEF COWS 2008 TO 2018(1000 Head) -1 -36 -2 5 -6 61 -32 -59 Livestock Marketing Information Center Data Source: USDA-NASS -2 1 50 15 157 -9 -4 0 57 5 1 27 0 0 0 -26 -27 -30 5 85 0 -2 -59 2 96 -126 3 -2 -169 78 -8 -37 -19 -18 -68 -565 to -26 47 2 -26 to 0 0 to 6 -565 -40 6 to 158 -1 -54 -8

BEEF COWS THAT CALVED JANUARY 1, 2018(1000 Head) ~30% ~15% ~10% 5 236 ~21% ~24% 10 1497 15 985 365 536 Livestock Marketing Information Center Data Source: USDA-NASS 7 105 510 285 1801 714 102 2 215 970 6 1910 296 9 238 208 338 397 660 809 203 3 633 1507 2166 1033 46 370 910 2131 187 483 924 174 485 714 501 4585 473 5 886 0 to 174 174 to 473 473 to 924 75 924 to 4586

The Cow-Calf Operation • Cow-calf operations are heavily capitalized • Land, cows, equipment, etc. • Timing issues • Revenues tend to come in big chunks, expenses tend to be more spread out • Fixed cost structures can be very high! • Especially for small operations who want to do it all • Profits tend to run in cycles

Why do profits tend to run in cycles?

Data Source: USDA-NASS Livestock Marketing Information Center

The two terms • Price cycles – multi-year trends in prices that result from patterns in inventory changes • Changes in inventory affect marketings, production, and price • Price seasonality – price trends within a year (January to December) • Seasonal patterns tend to repeat themselves

Why do we have cycles? • Biology and time lags of animal production • Production levels change in response to profitability • Producers tend to be small and unable to individually affect the market

Steps to a Cattle Cycle • Prices are strong and producers are making nice profits, they want to expand • Heifers are held for replacements, fewer heifers on market, prices actually rise further in short-run • This amplifies the expansion signal, high prices = more expansion

Steps to a cattle cycle 4. Eventually, those heifers become cows and calf crops increase in size, pushing prices down, producers want to liquidate 5. More heifers come to market, pushing prices down even further 6. Eventually smaller cow herd leads to small calf crop and higher prices again 7. Go back to Step 1.

Time lag in cattle production • Heifer calf is born in spring 2018 • She is weaned in fall 2018 • She is bred in summer of 2019 • She calves 1st time in spring of 2020 • She weans her 1st calf in fall of 2020 • Calf must still be finished and slaughtered before it truly adds to beef production

During expansion, we can expect • Short-term decreases in marketings as we start to expand, prices usually rise • Holding of heifers for breeding purposes leads to fewer weaned calves sold • Over time, larger breeding herd leads to more calves being sold – prices decrease in long-run

During liquidation, we can expect • Short-term increases in marketings, prices usually drop in short term • Hold fewer heifers for breeding – more weaned calves are sold • Over time, smaller breeding herd leads to fewer calves sold – prices rise in long-run

Why was expansion so slow to start in the current cattle cycle?

Prices vs. Profit • Producers respond to profits, not prices • Historical prices are only a good indicator of expansion points if costs don’t change • Prices must increase by enough to offset rises in production costs

Data Source: USDA & LMIC, Compiled by LMIC Livestock Marketing Information Center

Data Source: USDA-AMS & USDA-NASS, Compiled and Analysis by LMIC Livestock Marketing Information Center

Capital Investment Approach • Decisions are not just made year-to-year • Breeding stock is ~ 7-12 year investment • Current profit isn’t enough • Return expectations over time • How would you compare breeding stock to a CD or bond? • How have risk levels changed? • How have profit expectations changed? • How does this affect expansion?

A Capital Investment Approach • Breeding stock represents large up-front investment • That investment should yield positive return each year • Salvage value = value of cull cow • Return over costs each year must yield return to initial investment

Should I Retain/Buy Replacement Females? • Yes if: • Market encourages that • Compare NPV of replacements females available to buy/retain Objective of a cattleman is to maximize the present value of the stream of residual earnings from cows in the herd; prices and interest rates are important (Melton, 1980; Melton and Colette, 1993)

Replacement Female Decision Resources Iowa Beef Center | Ag Decision Maker • Raising versus Buying Heifers For Beef Cow Replacement • Fact sheet and video tutorial available online: • Tutorial - http://www.iowabeefcenter.org/heiferdevelopment.html • Factsheet - www.extension.iastate.edu/agdm/livestock/html/b1-73.html • Net Present Value of Beef Replacement Females • Fact sheet and video tutorial available online: • Tutorial - http://www.iowabeefcenter.org/heiferdevelopment.html • Factsheet - www.extension.iastate.edu/agdm/livestock/html/b1-74.html

Stocker Operations • Purchase weaned calves in spring, add additional weight and sell feeder calves • Typically own calves for 5-8 months • Key impacts • Pasture growth / availability (weather) • Expected margin (feeder value minus calf cost)

Backgrounding Operations • Purchase weaned calves in fall, add additional weight and sell feeder calves • Typically own calves for 5-6 months • Key impacts • Feed costs • Expected margin (feeder value minus calf cost)

Feedlots • Purchase feeder cattle, place on feed, sell slaughter cattle • Cattle usually on feed 5-7 months • Key Impacts • Expected margin (expected slaughter value minus feeder cattle cost) • Feed price

Number of Cattle and Calves Sold: 2012

Data Source: USDA/NASS, Census of Agriculture

2,319,313 2,010,004 = -309,309 (-13%) Head Data Source: USDA/NASS, Census of Agriculture

Cattle Finishing in General • Very volatile industry • Risk vs. returns • Returns usually run in multi-month cycles • Profit typically higher for cattle sold in spring • Cheaper feeders in fall • Strong fed market Feb-Apr • Many feedlots purchase feeder and sell slaughter cattle themselves • Many others finish cattle on a custom basis • Why do feedlot returns sometimes look terrible for long periods?

Custom Feeding • Feedlots provide “finishing service” for those who own calves • Owner of calves incurs feed, vet, med, etc. • Feedlot typically is paid “yardage” • Yardage – charge to cover cost of facilities, management, etc. • Think of this as room and board

Typical Ownership of Custom Fed Cattle in Iowa • Only 11% of surveyed producers custom fed

Packing Plant / Slaughter/ Processors • Purchase slaughter cattle, harvest, and sell boxed beef • Cattle are purchased and harvested within a week or two • Some are contracted in advance • Much more concentrated, small # of large firms

2013

Retailers / Restaurants • Purchase boxed beef and sell retail to consumers • Also concentrated, small number of large firms • Shelf-life • Sell beef, pork, poultry, etc • Collectively contribute to the bottom line • Respond to changing consumer preferences

Wholesale-Retail Share (56.9%), ‘15=62.1%, ‘16=60.0%, ‘17=58.9% Farmers’ Share (29.5%), ‘15=22.7%, ‘16=21.4%, ‘17=23.1% Farm-Wholesale Share (13.6%), ‘15=15.1%, ‘16=18.6%, ‘17=18.0% Data Source: USDA/ERS

Basic Pork Definitions

Farrow-to-Finish Operations • Example of vertical integration • Own sows for farrowing • Wean pigs and finish for slaughter around 6 months of age • Capital investment in facilities and breeding stock • Heavily dependent on slaughter hog market and feed prices

Other hog operations • Farrowing operations – sell small pigs at weaning time or after nursery • Finishing operations – specialize in feeding hogs – much like cattle feedlots

ECON 337: Agricultural Marketing