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GERAEE R. CAMPEELL
1973

 
  
 
 

  

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This is to certify that the
thesis entitled

PROCUREMENT CONTRACTING AND SO“ LEASING
AS VERTICAL COORDINATION ARRANGEMENTS
IN THE HOG-PORK SUBSECTOR

presented by

Gerald R . Campbell

has been accepted towards fulfillment
of the requirements for

Ph .D . degree in Agricultural
Economics

 

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Major professor

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Date February 20, 1973
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ABSTRACT

PROCUREMENT CONTRACTING AND SOW LEASING
AS VERTICAL COORDINATION ARRANGEMENTS
IN THE HOG-PORK SUBSECTOR

BY
Gerald R. Campbell

The objectives of this study were: 1) to examine
sow leasing programs and packer procurement contracts as
they evolve in the hog—pork subsector; 2) to analyze the
incentives and disincentives for these arrangements; 3)
to project the evolutionary patterns of these arrangements
and the implications to adopting firms, their competitors,
suppliers, and customers; and the overall performance of
the subsector; and 4) to identify future research needs
and possible approaches to vertical coordination research
on the hog-pork subsector. In order to accomplish these
objectives an in-depth case study of the contract procure-
ment activities of a major meat packing firm was completed.
This case study was supplemented by a survey of four other
major meat packers who had had contract procurement exper—
ience. In order to examine sow lease programs a survey of
the three leading feed manufacturers leasing sows was

completed.

Gerald R. Campbell

The meat packers interviewed were all offering some
variation of a procurement contract where payment for
future delivery of slaughter hogs was related to prices of
live hog futures contracts for the delivery month. Two
firms were experimenting with or considering procurement
contracts which would offer a price floor approximating
out of pocket production cost combined with a flexible
price ceiling in which packers and producers would split
any increase in prices above a certain negotiated level.
These contracts would also involve grade and yield buying
and in some cases precise delivery specifications within a
particular quarter. The fairness of several pricing
arrangements examined and their potential effect on the
cyclic nature of hog production were found to be related
to the length of contract and the point in the hog cycle
at which the contract was entered.

Incentives for contracting involved: 1) savings
through contract pricing, 2) savings from improved sched-
uling and regularity of hog supplies, 3) savings from
improved quality of contract hogs, 4) savings from improved
procurement strategy, and 5) savings from market leverage.
Contract costs involve mainly bookkeeping and accounting
costs which were estimated by firms interviewed to be

approximately the same as for grade and yield programs.

Gerald R. Campbell

Savings or increased earnings from contract
procurement are generally contingent on the ability to
coordinate contracted hog volume and quality with the
corresponding demand for pork products. Meat packers and
feed manufacturers had found that contracts in which.they
owned the livestock typically resulted in poorer production
results than occurred when farmers owned the animals.
Management problems, excessive requests for service, and
high capital requirements were major problems reported by
feed firms leasing sows. On the benefit side, feed firms
estimated that ninety percent of the sows leased were fed
their feed and fifty percent of the sows leased represented
new feed sales for their firms.

Two firms had switched their emphasis from leasing
to selling because of the problems cited above and the
expectation that feed sales would be about the same as
under the lease program. Opportunities for contract pro-
curement to substantially alter the cyclic nature of hog
production may be limited by the tendency of industry
managers to emphasize current market conditions in their
decision making. Current Operating procedures produce a
preference for flexibility which may contribute to system
instability.

In general an increase in packer procurement
contracting can be expected. Much of this activity will be

centered on marketing contracts with emphasis on establishing

Gerald R. Campbell

equitable pricing formulae which encourage the desired
quantity, quality, and timing of hog deliveries. These
contract efforts may be limited by possible farmer reaction,
relatively high accounting costs, possible efficiencies in
procurement through other methods, and the inability of
firms to stabilize the subsector at other levels.

Sow leasing seems to be declining, at least on a
large scale basis. Firms who have been leasing sows are
now selling them, possibly altering the competitive situa-
tion in breeding swine markets.

Improved vertical coordination through packer
procurement contracting could result in a more efficient
and progressive production and marketing system. This
results partially from the potential increase in stability
for the system which can be achieved without inequitable
payoffs to participants, if efforts are made to insure that
bargaining power is evenly distributed.

Major research needs highlighted by this study
include: 1) a better understanding of the current and
develOping market for breeding swine, 2) a study of farmer
reaction to current and future price information, 3) a
study of major swine market areas and factors encouraging
or limiting contracting in each area, and 4) a study of
efforts by meat packers, wholesalers, and retailers at
improved vertical coordination in the market for fresh and

processed pork products.

PROCUREMENT CONTRACTING AND SOW LEASING
AS VERTICAL COORDINATION ARRANGEMENTS
IN THE HOG-PORK SUBSECTOR
BY

Gerald RfiCampbell

A THESIS

Submitted to
Michigan State University
in partial fulfillment of the requirements
for the degree of

DOCTOR OF PHILOSOPHY
Department of Agricultural Economics

1973

ACKNOWLEDGMENTS

The author wishes to express his appreciation to
all those who assisted him in the preparation of this
dissertation. The author is especially indebted to the
personnel from the several meat packing and feed manufac-
turing firms who cooperated in the study.

Special thanks are extended to Dr. Marvin Hayenga
who served as thesis supervisor and Dr. James Shaffer who
served as major professor. Thanks are also due to Dr.
Warren Vincent, Dr. John Allen, and Dr. Bruce Allen who
served on the guidance committee and helped direct my
studies.

Appreciation is also expressed to Dr. Harold Riley
and the Department of Agricultural Economics who provided
the financial support for this study. Thanks also go to
Ms. Janet Munn and Ms. Sandy Mouser for their good natured
clerical assistance throughout the project.

I am also extremely grateful for the kindness,
understanding,and empathy of my friend Ms. Karen Goebel.

Without her, the thesis would not have been bearable.

ii

TABLE OF CONTENTS

Chapter Page
I. INTRODUCTION . . . . . . . . . . . . . . . . l
The Problem Situation . . . . . . . . . . 1
Problem and Objectives . . . . . . . . . . 2
Procedure . . . . . . . . . . . . . . . . 4

Analysis of Packer Procurement

Contracts . . . . . . . . . . . . . . 5
Analysis of Sow Lease Programs . . . . . 7
Implications for Industry Organization
and Needed Research . . . . . . . . . 8
II. VERTICAL COORDINATION: MOTIVATIONS
AND CONCERNS . . . . . . . . . . . . . . . 9
Introduction . . . . . . . . . . . . . . . 9
Vertical Coordination within the Firm . . 9
Vertical Coordination Between Firms . . . 16
Degree of Vertical Coordination . . . . 16
Vertical Coordination in Market
Structure Research . . . . . . . . . . 18
Vertical Coordination and
Competition . . . . . . . . . . . . . 18
Vertical Coordination and Economic
Performance . . . . . . . . . . . . . . 23
III. THE HOG-PORK SUBSECTOR . . . . . . . . . . . 27
Feed Manufacturing and Distribution . . . 29
Swine Production . . . . . . . . . . . . . 33
Hog Markets . . . . . . . . . . . . . . . 35
Meat Packing . . . . . . . . . . . . . . . 37
Pork Retailing . . . . . . . . . . . . . . 43
Conclusion . . . . . . . . . . . . . . . . 46
IV. PACKER PROCUREMENT CONTRACTING:
A CASE FIRM COMPARATIVE ANALYSIS . . . . . 47
Procedure . . . . . . . . . . . . . . . . 53
Profile of the Case Firm . . . . . . . . . 54

iii

Chapter

Contract Arrangements Attempted
by the Case Firm . . . . . . . .
"Future Contract" . . . . . . .
"Production Contract" . . . . .
"Bargaining Group Contract" . .
"Marketing Contracts" . . . . .
"Feed Firm Contracts" . . . . .

Analysis of Contract Benefits . .

Benefits from Certain Pricing Formulae

Pricing Formulae Examined . .

Benefits from Procurement Leverage

Benefits from Supply Scheduling,
Improved Quality, and
Increased Sales . . . . . . .

Economies through Improved
Procurement System . . . . . .

Summary of Case Firm Analysis .

Comparison and Contract with Other

Meat Packers . . . . . . . . . .

Changes in Contracting Patterns

Attitudes Toward Contracting . .

Contract Benefits Expected . . .

Problems with Past Contracts . .

Contract Pricing Formulae . . .

Other Contract Provisions . . .

Product Promotion and Contracting

Carcass Grade and Yield Buying .

Producer Participation . . . . .
Summary and Implications of

Procurement Contracting . . . .

V. SOW LEASE PROGRAMS: A SURVEY . . .

Introduction . . . . . . . . . . .
Procedure . . . . . . . . . . . .
Results of an Earlier Survey . . .
Survey Results . . . . . . . . . .

Reasons for Entering Sow Leasing

Supporting Facilities for Leasing

Lease Contract Terms . . . . . .
Length of Lease . . . . . . .
Lease Payments . . . . . . .

Ownership and Disposal of Animals

Depopulation . . . . . . . . .

Management, Health Requirements,

and Costs . . . . . . . . .
Warranties by the Lease Firm .
Other Provisions . . . . . . .

iv

Page

57
57
60
61
62
63
65
65
67
86

92

105
107

108
109
110
111
113
115
116
118
119
119

120
129

129
130
130
131
131
132
133
133
134
138
139

139
140
141

Chapter

Promotion and Management of

Sow Leases . .

Results of Sow Lease Programs . . .
Problems Encountered in Sow Leasing
Summary of Benefits and Problems

in Sow Leasing .
Conversion from Leasing to Selling .
Farmer Reaction to Sow Leasing . . .
Implications of Sow Leasing . . . .

VI. SUMMARY, IMPLICATIONS, AND SUGGESTED

RESEARCH . . . . .

Implications and Subsector

Efficiency . . .
Equity . . . . .
Stability . . .
Progressiveness
Suggested Research

Feed Manufacturing
Pork Production on

Meat Packing . .

Farms

Performance

Wholesaling, Retailing and

Consumption .
LIST OF REFERENCES . . .

APPENDIX C O O O O O O O

Page

142
143
144

147
147
149
150

153

159
159
161
163
165
166
166
168
170

171
173

177

LIST OF TABLES

Table Page

3.1 Formula Feed Production and Milling Capacity
Selected Regions of the United
States, 1969 . . . . . . . . . . . . . . . . 31

3.2 Percentage of Fresh and Frozen Pork Sold by
Selected Groups of Firms to Specified
Customer Classes, 1964-1965 . . . . . . . . 41

3.3 Average Pork Consumption Per Week for United
States Urban Households, 1965-1966 . . . . . 44

4.1 Percent of Slaughter Hogs Sold Through Various
Outlets, Sioux City and United States . . . 48

4.2 Federally Inspected Hog Slaughter as a Percent
of Rated Capacity, 1964-1965 . . . . . . . . 50

4.3 Pricing Losses and Gains from Three Pricing
Formulae Over Selected Time Periods,
10 Percent Contract Level. . . . . . . . . . 77

4.4 Comparison of Losses or Gains from Production
Contract for Selected Period at 10 Percent
Contract Level for One Plant of the
Case Firm . . . . . . . . . . . . . . . . . 84

4.5 Average Difference Between Prices of Hogs
by Markets and by Periods, March 1966
to March 1970 . . . . . . . . . . . . . . . 90

4.6 Distribution of Additional Available Hog
Supply, Run 2, Case Firm Hog Model . . . . . 96

4.7 Differences in Optimal Hog Procurement Mix
with Additional Available Hog Supply
Case Firm Model . . . . . . . . . . . . . . 97

4.8 Comparison of Sales, Expenses, and Operating

Margin, with Additional Available Hog
Supply, Case Firm Hog Model . . . . . . . . 99

vi

Table

Total Unit Cost of 600 Head Per Hour Slaughter
Processing Plant at Selected Levels of

Supply Variation . . . . . . .

Relative Procurement Cost for Different
Sources of Live Hogs Case Firm, 1971

Seven Market Average Prices and Contract
Prices for Slaughter Hogs, December

1965 - March 1972 . . . . . . .

St. Louis Market Prices and Production
Contract Prices, Monthly, May 1966 -

January 1972 . . . . . . . . .

Prices and Interest Rate Used in Calculating

Production Contract Price, Monthly,

February 1966 — December 1971 .

vii

Page

102

107

177

178

179

LIST OF FIGURES
Figure Page

2.1 Hypothetical Plant Process Flow Diagram . Q . . 11
3.1 Major Activities in The Hog-Pork Subsector . . 28

4.1 A Comparison of Market and Contract Prices
for Three Selected Formulae . . . . . . . . . 69

4.2 Seven Market Average Price and Contract
Formula I Price . . . . . . . . . . . . . . . 70

4.3 Seven Market Average Price and Contract
Formula II Price . . . . . . . . . . . . . . 72

4.4 Seven Market Average Price and Contract
Formula III Price . . . . . . . . . . . . . . 74

4.5 St. Louis Market Price and Production
Contract Price . . . . . . . . . . . . . . . 85

4.6 Hypothetical Supply and Demand Curves for
a Local Hog Market in the Short Run . . . . . 87

4.7 Seven Market Average Price and Contract
Formula IV Price. . . . . . . . . . . . . . . 117

5.1 Relationship of Sow Lease Payments to Market

Hog Prices for Selected Parts of the
Hog Cycle . . . . . . . . . . . . . . . . . . 137

viii

CHAPTER I
INTRODUCTION

The Problem Situation

Meat prices have been a major issue in recent econo-
mic policy. Rising meat prices have plagued efforts to slow
down inflation. Increasing meat prices have also created
interest in the way in which our food system is organized.
An important part of this food system is the livestock-meat
sector. Within this sector, there have been substantial
technological and organizational changes in recent years.
These changes have produced competitive conditions which
encourage firms to seek new methods to accurately match
their products with changing consumer demands. In the past,
the livestock meat sector has relied on market price signals
to guide investment and operating decisions. While the
market price system has functioned fairly well in this
capacity, it is apparent that there are some flaws in coor-
dinating production and marketing of meat.

These flaws have been particularly apparent in the
production and marketing of pork products. For example, the
continued existence of a cyclical pattern of pork prOduction

and prices coexisting with a fairly stable demand for pork

products indicates some lack of coordination. In addition,
for many years, the "fat hog" was produced while consumers
demanded lean pork. The perfect coordination system would
accurately match changes in consumers demands for pork
products with adjustments in resources allocated to pork
production and marketing. This perfect market may not be
physically attainable. Its cost may make it economically
infeasible. However, the current situation does stimulate
industry interest in alternatives which may lead to improved

coordination and better allocation of resources.

Problem and Objectives

Many firms within the hog-pork subsector-—from feed
manufacturer to retailer-~are experimenting with new forms
of vertical coordination. This search for new vertical
coordination arrangements is both the consequence and
evidence of dissatisfaction with the market price system
currently in use. These arrangements have taken many forms
and have occurred at all levels within the subsector. Some
examples of these arrangements include: feed firms leasing
sows to farmers, meat packer hog production contracts,
production of breeding stock by meat packers, contracts for
pork procurement, ownership and operation of meat packing
plants by farmers and farmer cooperatives, etc. Each of
these new vertical coordination arrangements has potential
benefits and/or costs for the participants in the arrange-

ment, for the subsector, and for society.

In an earlier subsector survey it appeared that
most new vertical coordination arrangements were initiated
by two industry groups--feed manufacturers and meat packers
[ll-p. 14]. Several of the major feed manufacturers were
operating sow leasing programs at either commercial or
experimental scales. While meat packers were involved in
a multiplicity of new arrangements, contracting for live
hog procurement was the area where the potential for in-
creased activity appeared greatest. Thus, these two
coordination arrangements were selected for further study
and evaluation.

The specific objectives of this study are:

1. To examine sow leasing programs and meat packer
procurement contracts as they are evolving in the
hog-pork subsector.

2. To analyze the potential incentives and disincen-
tives for these arrangements as compared to existing
vertical coordination systems.

3. To project the possible evolutionary pattern of
these arrangements and the implications to adopting
firms, their competitors, suppliers and customers,
and the overall structure and performance of the
subsector.

4. To identify future research needs and possible
approaches to vertical coordination research on the
hog-pork subsector.

The accomplishment of these objectives will provide
insight into several kinds of problems facing decision
makers. For management personnel in feed manufacturing and

meat packing firms, the study will provide a view of devel-

opments in their industry, as well as a new perspective on

their firm's vertical coordination efforts. The study will
highlight for farmers the implications which contracting

may have on their short and long run production and marketing
decisions. The study should aid them in evaluating parti-
cular contracts and understanding the concerns and motiva-
tions of the feed manufacturers or meat packers who might
offer those contracts. For meat processors, wholesalers

and retailers, the study will point up potential improve—
ments in vertical coordination at their levels in the
subsector. For government policy makers, the study will
provide additional insight into possible conflicts over
contract conditions or questions of equity. The issues of
vertical integration, market control, and monOpoly power,

as they relate to the production and distribution of pork,
are often hot political topics. It is hOped that this study
will aid in a more enlightened consideration of market rules
or regulations which might prohibit or limit certain types
of vertical coordination. For other researchers, this

study will provide new research questions about vertical
coordination and its effects on the organization of the

hog-pork subsector.

Procedure

The primary determinants of the research procedure
used in this study are: (1) the limited number of firms

having experimented with or used the two vertical coordination

arrangements being considered, and (2) the in-depth analysis
required to generate a comprehensive picture of the incen-
tives and disincentives surrounding these arrangements.

It seemed that the most productive approach would be an
in-depth case study of one firm in a particular industry
combined with parallel interviews with firm managers in
competing firms. It was felt that this procedure would
provide the degree of depth necessary while providing some
estimate of the generality of results. It was anticipated
that this procedure would build on existing literature,
supplement an earlier broad industry survey [11], and
provide a clearer picture of the economics of these
arrangements.

A selective review of the substantial bodies of
literature on vertical coordination and the hog-pork sub-
sector provided the setting for collection of primary data.
The concerns about and motivations for improved vertical
coordination which have been expressed in previous litera-
ture are presented in Chapter II. Then the recent market
structure changes in the hog-pork subsector are briefly
described in Chapter III to provide the backdrop for our

analysis.

Analysis of Packer Procurement Contracts

In order to examine the incentives and disincentives

surrounding the contract procurement of slaughter hogs,

five firms were selected from those surveyed earlier. All
of these firms had some experience with procurement con-
tracting, all were within the top eight firms in hog
slaughtering, and all had indicated some degree of willing-
ness to cooperate with further research on vertical coordi-
nation. One of these firms had broader experience than a
the other four firms in procurement contracting. This firm
was approached and agreed to cooperate in this study.
Management within the case firm was interviewed in
depth in several relatively open-ended interview sessions.
From these sessions, information was generated which indi-
cated that interviews with personnel at the plant level
would be desirable. Open-ended interviews were then con-
ducted with personnel at one of the case firm's plants
where contract procurement had been extensively used. These
interviews at the firm and plant level provided the bases
for an analysis of the possible purchase price adVantages
of selected contracts. The evaluation of savings from
improvements in quantity, quality and timing was carried
out using an extensive linear programming model of plant
Operations in use by the case firm. In addition, the impact
of extensive contract procurement in a market on prevailing
market prices was statistically estimated. These interviews
also provided insights into the real world of pork procure-

ment which tend to modify the results of more simplified

theoretical analyses. The results of these interviews and
the analyses resulting from them are the substance Of
Chapter IV.

After completing the interviews with the case firm,
the four remaining firms were interviewed either in person
or by phone. These interviews provided perspective to the
results Of the case firm interviews. This made possible
the generalization Of some Of the case firm results and
provided the basis for speculation on long and short run

implications Of the results.

Analysis Of Sow Lease Programs

 

Sow lease programs were examined through personal
interviews with the top three sow leasing firms in the feed
manufacturing industry. The data was not available from
the firms involved in sow leasing in the same degree Of
detail as was the procurement contract data. This is in
part due to the unwillingness of firms to disclose informa-
tion regarding particular operations and in part due to
their lack Of knowledge regarding particular aspects Of
their sow lease Operations. The descriptive analysis Of
current sow lease programs Operated by these firms, along
with an analysis Of changes occurring in these programs,

is presented in Chapter V.

Implications for Industry Organization
and Needed Research

The examination Of current and potential evolution
of sow lease programs and packer procurement contracts
suggests several implications for subsector participants.

An attempt was made to describe those implications which
might particularly affect the structure and performance Of
the subsector. The competitive and organizational implica—
tions for individual participants are then considered within

this broader industry organization framework.

CHAPTER II

VERTICAL COORDINATION:
MOTIVATIONS AND CONCERNS

Introduction

The literature relating tO vertical coordination
and vertical integration is extensive. This chapter briefly
integrates the literature related to these aspects Of
economic organization. The central policy questions sur-
rounding vertical coordination relate tO the potential
control Of one participant by another; at the same time,
the coordination Of decisions and actions is central tO the
efficient organization Of the subsector. This concern about
efficiency and control is central to societies' decisions
regarding the rules under which the hog-pork subsector is
organized. In this chapter, we consider factors affecting
the efficiency of different vertical coordination arranger
ments and the concerns which have been voiced about the
potential control Of economic activities arising from these

vertical coordination arrangements.

Vertical Coordination Within the Firm

Vertical and horizontal coordination are the princi-

ple tasks Of firm management. The organization Of the

10

factors and processes of production required to produce
any product is generally quite complex. The basic organ-
ization of firm activities is generally broken down into
"stages". French, Sammet, and Bressler define a "stage"
as consisting "of all productive services durable and.non-
durable that cooperate in performing a single operation or
group of minor closely related Operations" [lO-p. 545].

Figure 2.1 illustrates the concept of a "stage"
and its relationship to other "stages". The production
process begins with the receipt Of some material A at stage
1. The material is then transported to another "stage"
where another transformation occurs. At various points
other materials may be received, then transformed and fed
into the main line of production. Some partially completed
products may be split Off at different stages and given
different treatments through a new series Of stages so that
several types of completed products emerge from the produc-
tion line.

It is important to note that such a production
process involves transportation between stages and temporary
storage between stages. This transportation and storage
strategically affect the flow of materials through the
plant; and thus, they are important parts of the vertical
coordination of the several stages in production.

In most instances the inputs at each stage are re;

lated to the flow Of a single physical volume variable. In

11

Receive Material A

Receive Material B Stage

0.000
o

8

C
0

Stage
11

[:> Partial Product 1

Stage
9 D

Partial Product 2

Stage

.00:

Stage Stage

14

H
U

PartialiProduct 3

Stage
10 0
Final Product 1 Partial Product 4

U

.090

 

Stage

a:
n
\19
00
0

Storage

Final Product 2 Tramportation

O
[:> Temporary Storage
V
D

CJ<lCI

Figure 2.1. Hypothetical Plant Process Flow Diagram.

Source: Prench,B.C. , et.al. chononic Bfficienc in Plant eratione
with S eciel Reference to the Herketi of California Peare,
gar a, n vereity o i era a. r eIey, California,
Volume 24, Number 19, July, 1956, p. 546.

 

 

12

the case of hog slaughtering firms, this volume variable
is the flow of hogs, carcasses, and partially processed
pork through the plant. As the various stages become more
directly connected (as transportation and storage between
stages are reduced), the flow Of materials and partial
products becomes highly integrated. Unless rates Of out-
put can be varied simultaneously, the impact Of such inte-
gration is tO lessen the possible range Of rate variation
at any particular stage. In the extreme, this may reduce
to virtually a single rate or perhaps several discrete
rates [lO-p. 597]. It is possible to overcome this inflex-
ibility by Operating several plants and by Operating the
plant for different lengths Of time at the same rate.

The organization of firm production stages into
specialized functions permits increased productivity. This
increase in productivity may be Offset by the relative
inflexibility imposed by highly specialized stages. The
range Of possible volumes or rates at which these stages
can be efficiently Operated may prove a disadvantage to
firms facing input or output markets where product flows
are highly variable over relatively short periods.

French, Sammet and Bressler consider the problems
surrounding harmonizing plant stages to be essential needed
modifications of marginalist economic theory. In discussing

these modifications, they state:

13

Each Of the many stages which in the aggregate forms a
plant has a cost function. The total cost curves along
with certain overall cost components not associated
with specific stages form the total cost functions for
the entire plant. The integration and aggregation Of
these stages lead to several problems. First is the
problem of finding harmonious combinations of capacities
for the units Of fixed (but discretely divisible equip-
ment used at each plant stage). This involves finding
a common denominator representing the rate Of output
that minimizes average total unit cost Of Operation.
A second problem is the choice Of appropriate types of
equipment or the most harmonious technology at each
stage and in the aggregate [lo-p. 555].
A third problem is that Of determining how many stages will
be included within the firm. All three Of these problems
are long run planning problems. A currently Operating
firm is faced with many other vertical coordination problems
which occur due to day-to-day uncertainty. The firm thus
faces both long run and short run decisions regarding the
Optimum vertical organization Of their firm.
Improvements in vertical coordination may result
in economies to the firm and to society. These economies
are associated with: l) bringing technologically comple—
mentary productive processes together in a single plant;
2) elimination Of expenses Of purchase and sale transactions
incident to moving goods from one stage to the next; 3) elim-
ination Of profit tO customer or supplier firms; and 4)
improved coordination Of rates, amounts, and quality Of
output at successive stages [l7-p. 26]. These potential

economies are not apparent in all forms Of vertical coor-

dination but are most evident in those firms which own

14

successive stages Of production (or approach complete
"integration"). The economies or cost savings possible
through improved vertical coordination are generally thought
to Offer potential increases in firm profits. There are,
however, other possible incentives for firm adOption Of new
vertical coordination arrangements.

While profits are an important factor affecting firm
decisions, they are Often not the only factor considered.
Absolute firm size, sales volume, market share, and long
term firm survival are also possible firm goals. In this
context, Logan [14-p. 835] suggests that economies Of
vertical integration are more realistically considered in
a framework Of multiple firm goals. Two variables seem
most relevant tO analyzing new vertical coordination Oppor-
tunities, return on investment and risk. Logan's proposed
framework would emphasize the joint consideration Of these
two variables as the essential decision making process.

Risk may result from internal as well as external
sources. Some examples may include fluctuations in the
quantities and qualities of inputs available to the firm,
price fluctuations for inputs and outputs, variation in the
quantity and quality Of output demanded [l4-p. 843]. It
is clear that reducing risk as a goal is not more important
than return on investment, but is sufficiently important
to be considered as an additional variable affecting many

decisions.

15

The consideration Of risk avoidance or control as
an incentive for vertical integration or improved vertical
coordination may represent no real resource savings. If
the risks and losses Of resources attributed to variability
in certain input, output, and production characteristics
are passed along or shifted tO others within the total pro-
duction system then there is no gain in efficiency from a
system point Of view. However, if improved vertical coor—
dination of production stages throughout the system results
in a saving Of total input used or an increase in system
output, then a real cost saving has occurred. The deter-
mination Of which Of these has occurred may Often depend
on the degree Of acceptance Of the coordination practice
and its relative effect on system variance. Thus, real
system cost savings may not be realized during the transi-
tion from one mode of vertical coordination but may require
a more general or system-wide acceptance for realization.
This does not mean savings to individual firms at various
stages in the system will not occur during the transition.
It should be emphasized that these individual firm savings
may be losses to Others in the system. The desirability
Of particular arrangements from the perspective Of other
subsector participants does depend on how savings from the

new arrangements are distributed.

16

Vertical Coordination Between Firms

The boundary separating that activity which is
between firms and that activity which is within firms is
sometimes unclear. The degree Of control of one firm over
another may be such that many Of the critical management
decisions are made by the controlling firm. This lack of
clarity does not exist where the customer-supplier rela-
tionship occurs through an organized market with competitive
bidding. As there is more and more bilateral negotiation
over terms and conditions Of transfer, the boundaries of
control become increasingly confused. The extent Of one
firm's control over its suppliers or buyers and over the
subsector as a whole is the crucial policy issue raised by
new vertical coordination arrangements. Issues Of efficiency
also surround the effect of new vertical coordination
arrangements between firms and their effects on the allo-

cation Of societies' resources.

Degree Of Vertical Coordination

 

The degree Of administrative vertical coordination
which exists between firms is often compared to the norm
Of market price competition. Competitive bidding in organ-
ized markets to establish prices and exchange prOperty
rights would evidence a low degree Of administrative

vertical coordination. Ownership and management Of two

17

stages of production1 would indicate a high degree Of
administrative vertical coordination. It is important to
point out that the degree of vertical coordination as
commonly used in reference tO firms is very industry-
specific. For example, to say that a single meat packing
firm is highly vertically integrated and to say that a
steel manufacturer is also highly vertically integrated
does not generally imply that their relationships with
suppliers or customers is similar. Rather this means
that compared to other meat packing or steel firms, these
firms have more administrative control over suppliers or
customers.

Sichel [22] has recently argued that vertical inte-
gration or the degree Of vertical coordination should be
viewed as a "dynamic industry concept". He points out that
to have any relevance, the degree Of vertical coordination
must be measured against some industry norm over time. It
is easy to see how what would have been highly vertically
integrated poultry firm twenty years ago would be considered

normal today.

 

1For purposes Of clarity, vertical integration is
considered in this thesis to be a term which describes the
particular form of vertical coordination in which a single
firm owns and exercises management control over two succes-
sive stages Of production.

18

Vertical Coordination in Market
StruEture Research '

Market structure research has been an important
part of the study of economic organization for many years.
Market structure research concerns itself with inter-firm
relationships, how these relationships affect firm's be-
havior and the economic performance which flows from these
relationships. In this context the degree Of administrative
vertical coordination is part of market structure in its
effects on the organization Of a market and part Of market
conduct when firms change their behavior, especially their
degree of administrative vertical coordination, in reaction

to their rivals.

Vertical Coordination and Competition

 

The purpose Of trying tO classify vertical coordin-
ation or integration as part Of market structure or market
conduct is to enable us to more readily see how this aspect
Of market organization relates tO competition and perfor-
mance. Corwin Edwards [8] attempted to identify possible
linkages between internal vertical structure and the external
relationships that are relevant to competition and monOpoly:

Each difference in scope between enterprises in the

same line Of business means that one enterprise has
undertaken to coordinate successive activities through
administrative decisions, whereas a rival relies upon
purchase and sale in the market to dovetail its more
specialized performance with that Of other more special-

ized concerns. Alternative types Of business organiza-
tion are thus brought into competition with each other.

19

The coordinating function Of the administrator is tested
against that Of the market. Specialized activity is
tested against activity less specialized [8-p. 405].

He illustrated the economies possible in certain
instances from administrative vertical coordination and
discussed its market power effects. Some market power
effects are closely related to the relative size Of the
firm in question; they include price discrimination, greater
risk for other firm's operating in thin markets, preferential
access to supplies and markets, extensions of monopoly power
at one subsector level to another, and the squeezing Of
independent customers.

Price discrimination may be the result Of the excep-
tional buying power Of large vertically integrated firms.
This buying power rests in the firm's potential and actual
ability to produce its component requirements at an econ-
omically efficient scale. This ability gives the firm a
threat not available to other firms in negotiating with
component suppliers. Because actual or potential integra—
tion may give the buyer the advantage of lower input prices,
it may give firms an incentive to grow large enough to gain
this advantage.

Problems Of competition in thin markets arise when
there is a limited supply Of product or inputs available to
non-integrated firms. Edwards cites two problems which

occur in these markets:

20

First, the disappearance Of alternative customers and
sources Of supply exposes concerns that must continue
to rely upon the market to unusual risks. . . . sup~
plies and market outlets are precarious, and the
continued Operation Of a business dependent on them

is insecure. Second, this lack Of alternatives may
have effects upon bargaining power similar to the
effects Of monopoly or monopsony. If both sides Of

the market have become thin to the same degree, neither
sellers nor buyers have attained predominant bargaining
power, and the relation between these groups is likely
to resemble that of bilateral OligOpOly or bilateral
monopoly. If one side Of the market has become thin
more rapidly than the other, the concerns that have

the least adequate alternatives Open to them may be
unable tO protect themselves as to price and quality

[8-p. 407].

Preferential access to supplies and markets occurs
because the integrated firm has control Of supplies through
its own contracted production when other firms do not.

Thus, in short supply situations the vertically integrated

firm has access to supplies; and in times Of long supply,

it reduces its outside purchases of inputs. The vertically

integrated firm thus transfers the impact Of demand fluctua-

tion to its independent rivals. Edwards says,
Thus either boom or depression permits a vertically
integrated concern, by preferring self-supply tO pur—
chase and sale in the market, to transfer risks to
independent enterprises, enhance its own integration,
and reduce the relative importance Of the non-integrated
[8-pe 408] 0

Extensions of monopoly power occur when a firm which
possesses monopoly power at one level extends that power to
earlier or later levels through vertical integration. The

firm can favor itself over its independent suppliers or

customers without fear Of competition.

21

The squeezing Of independents occurs when the
integrated concern charges a low end product price relative
to the price of inputs. The firm chooses to take a lower
margin on the final stage while it takes the same margin on
earlier stages. This reduction in margin at the last stage
is Often impossible for independent competitors since they
Operate no earlier stage at which to make up thier possible
losses.

The conclusions of others, including Mueller, Caves,
and Kaysen and Turner [18, 6, 13] are basically the same,
vertical integration associated with large relative size
may have detrimental effects on market competition and
ultimately on market performance. It is important, I

think, to emphasize the pptential as Opposed to actual

 

nature of this conclusion. Each situation involving verti-
cal integration must be examined closely to determine the
extent to which these possible results have occurred.

The other important point to note is that the
detrimental effects possible from large relative size
combined with vertical integration may be detrimental to
competition long before the power gained by the firms is
substantial enough to give them complete control over
price. This combined with the incentive for further inte-
gration and the tendency toward increasing market power
makes these size-integration relationships important in
industries which have not yet become OlogOpOlistic or

monopolistic in structure.

22

While the degree Of control involved in ownership
integration is generally considered greater than the control
under other coordination possibilities such as contracts,
it is possible for contractural coordination arrangements
to have the same economic advantages tO firms and the same
potential for detrimental effects tO competition. Crucial
dimensions in contract vertical coordination are relative
firm sizes, degree Of competition among suppliers or cus-
tomers, firm goals, management abilities, profitability and
financial stability, applicable legal regulations, and
other factors influencing relative bargaining power. These
relationships will determine the extent of control Of one
party over another and the cost in terms Of contracted
rewards necessary to achieve a certain level Of performance.
The terms of the contract as affected by bargaining rela-
tionships will also indicate the distribution of contract
costs and benefits and the degree Of administrative control
involved. Thus some contracts may only involve very general
agreements while other contracts may involve detailed
specifications as tO quantity, quality, timing, and price
Of delivery. It is clear that some contracts are distinctly
different in coordination potential from the internal com-
munications Of the vertically integrated firm. In other
cases contract specifications may produce closer vertical
coordination than that which exists between vertically

related divisions Of a single firm.

23

Vertical Coordination and
Economic Performance

In the final analysis vertical coordination is an
important component Of the overall economic performance Of
our economy. Returning to a market structures framework
we define economic performance as "the strategic end results
Of market adjustments engaged in by sellers and buyers"
[2-p. 340]. In simpler terms this means how well does a
sector Of the economy accomplish the overall goals society
sets out for it.

For the Hog—Pork subsector the goals set by society
could be looked at under the following categories:

Efficiency: Society expects resources used in produc—
tion Of pork products to be used with as little
waste as possible. Society also expects that pork
production decisions as to quantity and quality Of
products produced will be responsive to consumer
demands.

Equity: Society expects that participants in the Hog-
Pork subsector will share gains or losses from
system adjustments in proportion tO their contri-
bution tO these gains or losses.

Stability: Society expects a reasonable degree Of
stability in the quantity and quality Of pork
products produced. While reasonableness may be
difficult tO define, it implies the absence Of
wide daily or weekly fluctuations in price or
availability and the absence Of rampant price
inflation.

Progressiveness: Society expects participants in the
Hog-Pork subsector to take advantage Of new tech—
nology which increases the efficiency Of pork
production and marketing and to make available to
consumers new and improved pork products.

24

While these categories are not exhaustive in their descrip-

tion Of the possible goals which society has for the Hog—

Pork subsector, they probably do represent the major areas

Of concern.

Vertical coordination arrangements can affect

economic performance in several ways. Improved vertical

coordination has the following potential benefits in terms

of the

1.

performance dimensions listed above:

Improved vertical coordination can result in sav—
ings Of scarce resources through better timing and
synchronization Of production processes within

and between firms.

Improved vertical coordination can result in more
accurate and more rapid communication Of consumer
preferences to participants in the Hog-Pork sub-
sector. Improved vertical coordination implies

the transfer Of information in addition tO market
prices which may increase the accuracy Of producers
decisions.

Improved vertical coordination may produce a more
stable flow Of products to the marketplace by
reducing the time required for changes in consumer
demand to be communicated to producers.

Improved vertical coordination may improve market
stability by reducing the amount Of risk and
uncertainty facing producers because Of increased
information.

Improved vertical coordination may increase the
speed at which producers adopt new technology and
develop new products because Of the more rapid
dispersion of information.

Improved vertical coordination may result in more
or less equitable transfers of products between
subsector participants, depending on the nature Of
the arrangements and the relative strength Of the
participants.

25

These potential benefits Of improved vertical coor-
dination are not costless. The development of new and
improved methods of vertical coordination between and within
firms requires substantial time, physical resources, and
energy. We have also seen that some efforts tO improve
vertical coordination through administrative control can
be detrimental to competition to such an extent that any
performance benefits are lost.

In order to examine the effects Of packer procure-
ment contracting and sow leasing on the performance Of the
Hog-Pork subsector it is necessary to determine what firms
using these coordination arrangements see as the benefits
and costs Of these arrangements. Our earlier discussion
pointed out that these arrangements may result in technolo-
gically more efficient production, reduced transactions
costs, elimination Of profits to suppliers or customers,
more accurate coordination of rates, amounts, and quality
Of output, and reduced input prices or improved product
prices because of changes in competitive relationships. At
the same time these contractural attempts at improved
vertical coordination could result in price discrimination,
increased risk for firms Operating in thin markets, prefer-
ential access to supplies and markets, extensions Of
monopoly power, and squeezing Of independent customers.

It is in the light of these potential advantages

and disadvantages Of increased administrative vertical

26

coordination through packer procurement contracting and
sow leasing that we will proceed in a more detailed analy-
sis of current experiments in these areas.

In order to establish the setting in which these
new vertical coordination arrangements are being attempted
the next chapter gives a brief overview Of the Hog—Pork

subsector.

CHAPTER III

THE HOG-PORK SUBSECTOR

The hog-pork subsector is a system composed of
specific production, processing and distribution stages
linked through various vertical coordination systems. The
vertical coordination arrangement linking most Of the stages
or industries in the hog-pork subsector is an Open market
where prices are arrived at through competitive bidding.

The prices arrived at in this way serve several functions.
First, prices allocate resources used in production and
marketing. Secondly, prices allocate or ration goods and
services among consumers. Thirdly, prices serve to balance
the forces of demand and supply. Lastly, prices produce

and allocate income payments among various recipients. The
traditional market pricing system in the hog-pork sub-sector
coexists with the system Of physical functions and stages
necessary to produce and market pork products. These
systems are outlined in Figure 3.1 which shows the various
vertical stages Of production and the markets linking them.
TO illustrate some of the physical and pricing relationships
which have existed between the various stages, let us con—
sider more thoroughly the vertical sequence from feed

manufacturing through retailing pork products.

27

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29

Feed Manufacturing and Distribution

While traditional industry studies would exclude
feed manufacturing from a consideration of the pork indus-
try, the concept Of a subsector implies the examination of
all vertically related activities in the production Of pork.
Corn is still the main ingredient in many hog feed rations,
but the use of protein supplements, feed additives, and
complete formula feeds has grown as their contribution to
efficient conversion of feed to pork has been demonstrated.
This has resulted in gradual growth of the feed manufac-
turing industry.

In 1967 the value of shipments of prepared feeds
was $4,796,900. This feed was produced by 1,835 firms
throughout the United States. The four largest feed manu-
facturers accounted for 23 percent of the feed shipped
while the fifty largest firms accounted for 58 percent.

For the four largest firms this was an increase in market
share from 22 percent in 1958 and 19 percent in 1947
[27-p. 9’10].

In 1967 feed manufacturers produced over eleven
million tons of complete feed. Over two and one-half
million tons of complete swine feed were produced. There
were over six and one-half million tons of feed supplements
and concentrates produced in 1967. Nearly half of these

(3,008,000 tons) were for swine [26-p. 20D-19].

30

Data from a preliminary report of a feed industry
study by the U.S.D.A. show that production of primary
formula feed for hogs accounted for 14.2 percent of total
feed produced by mills producing 1,000 tons or more. This
formula feed for hogs was accounted for by 8.0 percent
complete feed, 5.9 percent supplement and 0.3 percent
premix [28-p. 14].

Data from this same study indicates that there is
substantial excess milling capacity in the feed industry.
Using a base of a forty-hour week for forty-eight weeks
firms in the one-thousand to ten-thousand ton range were
using less than one-fourth of their capacity. Larger firms
(over 100,000 tons) were using 150 percent of capacity on
the forty-hour base [28-p. 5].

Table 3.1 shows that for the major hog producing
regions there was substantial excess capacity when produc-
tion for 1969 was compared to rated capacity in that same
year.

This relatively high degree Of excess capacity
indicates that many feed firms could produce substantial
additional feed tonnage without adding additional facilities.
This implies that the marginal cost per ton would be low.
Thus firms with excess milling capacity have an incentive
to increase feed sales and production through a variety of
promotional devices. These promotional efforts have some—

times involved the offer Of services such as feed delivery,

31

ration formulation and nutritional consulting, and other

management services in addition to feed.

TABLE 3.1

FORMULA FEED PRODUCTION AND MILLING CAPACITY
SELECTED REGIONS OF THE UNITED STATES

 

 

 

 

 

1969a
Formula Feed Milling
Production Capacity Production
Percent

Region tons tons Of Capacity
Lake States 8,683,432 11,183,760 77.6
Corn Belt 20,167,202 29,060,928 69.4
Northern Plains 8,656,915 12,875,664 67.2
Total 37,507,549 53,129,352 70.6

 

 

 

 

aFor firms producing 1,000 tons or more

Source: The Formula Feed Industryiin 1969, A Preliminary
Re ort, Economic Research Service, U.S.D.A., ERS -
494.

Formula feeds are sold directly and through local
dealers to hog feeders and breeding firms. These firms
are generally faced with several alternative sources of
feed ingredients, mixing, and grinding services. The market
for formula feeds consists of different pricing arrangements
depending on the feed firm, the local dealer, and the farm

firm in question. For many small scale hog producers, the

32

purchase Of feed is a direct transaction with the price Of
feed ingredients, mixing and grinding services being estab-
lished by the local dealer. The price the farmer pays is
usually subject to discounts for cash payment or charges
for additional services, such as financing, mixing and
grinding. Larger scale hog producers may be able to nego-
tiate directly with feed companies and gain further dis-
counts for large-scale purchases and direct delivery of
feeds.

In describing the system of feed pricing in
Illinois, Bursch [4-p. 13] states that where differential
pricing systems were found to exist, they could be viewed
as related to selling cost differences, at least to some
degree. Pricing Of services varied a great deal between
dealers, while feed processing and delivery of processed
feed carried a charge in addition to feed price in nearly
all cases, prices Of formula feed included delivery. Credit
was priced with either a cash discount, a service charge,
or both by over 75 percent of dealers interviewed. Tech-
nical assistance and informational services were rarely
priced separately but were considered an integral part of
the product.

Bursch suggested that differential pricing schemes
'which now exist afford livestock producers opportunities

for economies in feed purchasing [4-p. 17]. These economies

33

are based on technical economies achieved by feed manufac—
turers and dealers as the result Of large purchases.
Whether these purchase economies are great enough to stimu-
late increased size Of agricultural production units is not
clear.

Competition among feed manufacturing firms at the
local level is very service oriented. The homogeneity of
many major feed ingredients leads to a high degree Of
substitutability between feed products. Manufacturers
have reacted to this feature by developing complete formula
feeds with unique combinations of ingredients. They have
also attempted to differentiate their retail outlets based
on services available along with feed products. These
services may include many forms of managerial assistance,
nutritional consulting, veterinary consulting, financing,
delivery, and other services. The high degree of service
competition has set the stage for some of the new vertical
coordination arrangements being Offered. Feed firms who
have previously helped farmers to locate breeding stock or
feeder pigs have a potential market for their own livestock

programs.

Swine Production

Swine production of farms involves the husbandry of
live swine including breeding animals, piglets, and market

barrows and gilts. While the care and feeding Of all these

34

swine classes generally takes place under the management
Of a single farm firm, there are many farm firms special-
izing in the production of either feeder pigs, breeding
animals, or market animals.

On farm production Of swine was carried out by
about 900,000 producers in 1970 as Opposed to 3 million
producers in 1950 [30~p. 4]. The number Of pigs on farms
ranged from 87,563,000 in 1966 to 102,270,000 in 1971.
While these figures represent the boundaries of recent
inventory fluctuations, there has been a slight upward
trend in pig production in the last twenty years. A recent
projectiOn by the U.S.D.A. indicates that there could be
as few as 500,000 hog production units producing pig crops
of 90 to 110 million head annually by 1980 [30-p. 4].

There has been a trend toward separating farrowing
and feeder pig producing units from finishing units. In
1969 seventeen percent Of all hogs and pigs sold were sold
as feeder pigs [30-p. 5]. Additional evidence Of the
importance of feeder pig production is the recent develop-
ment of new marketing arrangements for sale and pricing of
feeder pigs.

Hog production units have continued to be concen-
trated in the Corn Belt, with the 10 major corn belt states
producing about 75 percent of the United States pig crop.
The significant seasonal pattern in hog production has

smoothed somewhat in recent years; the distribution Of

35

farrowing is now: December to February, 22 percent; March
to May, 31 percent; June to August, 24 percent; and 23 per-
cent during September to November [30-p. 5]. Efficiencies
in hog production have come through improved genetic char-
acteristics which have increased litter sizes, resulted in
better feed conversion rates, and improved the yield Of
meat products. Disease remains a major problem in hog
production and appears to be a deterrent to very large
production units. The incidence of disease in a single
production facility may wipe out the firm's entire herd,
This has resulted in some large firms having several separ—
ate confinement Operations on a single farm to increase
firm scale without the risk of being wiped out in a single

season [30-p. 8].

Hog Markets

Trading in breeding swine is relatively unorganized
compared to slaughter hog markets. The unique nature of
the animals and, thus, the inherent product differentiation
along with concern about disease make large volume markets
somewhat infeasible. This has resulted in a market and
pricing system which consists Of auctions held by breed
associations and/or individual breeding stock producers,
directly negotiated sales between individual farmers, and
some (relatively new) attempts to sell or lease breeding

stock in large quantities.

36

The uncertainties that surround the question of
quality Of breeding animals makes the pricing of these
animals extremely imperfect. The lore that surrounds the
different breeds and the breeding animals selection and
evaluation process complicates efforts to objectively
evaluate an animal. Precise prediction of the animals'
worth in production is quite difficult and the subject of
many arguments within the breeder groups; this clouds
accurate pricing Of breeding animals. Further, the prices
at which breeding animals sell are clearly related to the
prices of slaughter hogs; however, the exact nature of this
relationship is clouded by the lack of information on
breeding stock characteristics and prices over a fairly
long period of time.

There are only a few large-scale markets for feeder
pigs. These have been started relatively recently, as have
U.S.D.A. grades for feeder pigs. In general, feeder pigs
are marketed through auctions. In most cases, these auc-
tions are of the ascending bid type, although there is one
system in Missouri which is Of the Dutch or descending type.
There are also some contractual arrangements for feeder pig
sales; theSe tend to be individually negotiated. The market
for feeder pigs is currently evolving rapidly, accompanied
by a wide range Of marketing arrangements and much experi—
mentation. This makes it difficult for the farmer or

researcher to establish what the current marketing methods

37

and market prices are, either from the buyer or seller side
of this market. Prices tend to be determined without sub-
stantial market information available about current supply
and demand conditions, prevailing prices, and premium and
discount patterns.

The movement of finished hogs from farm firms to
slaughterers and processors is accomplished through several
methods. These include direct sales, auction market sales,
terminal market sales, sales to local dealers, and sales
through producer marketing agencies. In 1950, 40 percent
of the hogs purchased by packers moved through terminal
markets. In 1950, 40 percent of the hogs purchased by
packers moved through terminal markets. By 1970, only 17
percent Of the hogs purchased by packers moved through
terminal markets; 69 percent were purchased direct or
through country dealers, and 14 percent through auctions

[30-p. 6].

Meat Packing

Hog slaughter is concentrated in the Corn Belt in
close proximity to hog production. This reflects the lower
costs of shipping carcasses and primal cuts (rather than
live animals) very long distances. Iowa was the leading
state in hog slaughter in 1971 with 25.2 percent Of total
U.S. slaughter. More than half of all hogs slaughtered
were slaughtered in the six leading states: Iowa, Minnesota,

Illinois, Ohio, Indiana and Pennsylvania [30-p. 6].

38

There has been decreasing concentration in hog
slaughtering nationally. The four largest firms accounted
for 41 percent of the slaughter in 1950 and by 1970 the
four largest firms accounted for 21 percent [36—p. 7].
Concentration of hog procurement is more relevantly measured
at the state than national levels because high transport
costs limit the market for live hogs to fairly localized
areas. In six of the twelve most important hog producing
states (Kansas, Minnesota, Missouri, Nebraska, South Dakota
and Wisconsin), the four largest buyers buy more than 90
percent of the hogs. In Indiana and North Carolina the
four largest buyers buy more than 75 percent. In Georgia
and Illinois, the four firm buyer concentration ratio is
more than 65 percent while in Iowa and Ohio this same ratio
is less than 50 percent.

Meat packers buy hogs from several sources using
different pricing procedures. Hogs purchased at the
packer's plant, buying station, or through local dealers
are generally purchased based on quoted prices with differ-
entials for various weight categories. These quotes are
established on a daily basis and are usually coordinated
through a central procurement officer who tries to balance
dressed meat demands from major consumer market areas with
supplies at their plant and market locations. Packers also
buy hogs through terminal markets where their buyers (either

salaried or order buyers) negotiate with commission men in

39

competition with other packers and packer order buyers.
Packers also buy hogs through auctions where prices are
determined by Open competitive bidding.

As we can see from the above, farmers have a vast
array of outlets for their hogs, although not all types of
outlets are available in all areas. It is Often difficult
for farmers to assess the actual market Opportunities Open
to them and the costs of the alternatives. The U.S.D.A.
has made substantial efforts toward keeping farmers informed
Of hog prices through their market news service. Even with
this news service available, it is still a difficult task
to keep informed about prices available from alternative
sources. Another confusing aspect of pricing at the farm
level is the continued predominance of live average weight
pricing. This method Of sorting hogs into relatively uni—
form weight groups, weighing the sorted lot, and establish-
ing their value based on the average weight seldom accurately
determines the real value of the hog. Carcass grading or
grade and yield is a system where hogs are identified by
tattoo prior to slaughter and the carcass is graded and
yield calculated after slaughter. This system can much
more accurately reflect value of the hog in terms of final
cuts, but this system has been slow to catch on among
farmers and packers. The National Commission on Food
Marketing found that in 1964, the four largest packers were

buying less than one-tenth of one percent of hogs on a

40

carcass basis. The packers ranking five through ten in
size bought 7.4 percent of their hogs on a carcass basis
and overall the top 40 packers bought 2.6 percent Of their
hogs on a carcass basis [20—p. 135]. While these percen-
tages have increased slowly, they are still very low (per-
haps 10 percent) in terms of the desirable goal Of accurate
pricing Of live hogs.

There have been limited efforts by the National
Farmers Organization and other farmer bargaining groups to
establish contract selling arrangements for their farmer
members. These efforts have had varying degrees Of success.
The pricing provision in these contracts have generally
related to some market price reported by the U.S.D.A. market
news service, Often with premiums or discounts for hog
quality or meeting specified delivery schedules.

After slaughter, the hog carcass is transformed
into various fresh or processed pork products. The hog
carcasses are broken down into primal cuts which are further
trimmed, ground, smoked, and/or mixed with other meats to
arrive at fresh pork, bacon, ham, sausage, hot dogs and
other pork products. These processes take place under the
management Of several different kinds of firms and through
various marketing channels before appearing at the retail
counter or in the restaurant or institutional kitchen.

It is clear from Table 3.2 that the largest meat

packers sell a major portion of their fresh and frozen pork

41

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42

to large food chains and to manufacturers and processors.
Smaller meat packers seem to depend less on manufacturers
and processors and more on food chains. The smaller packers
with sales Of one million pounds of meat or less per month
rely more heavily on sales to the government and mass feed-
ing institutions. Meat processors also rely on sales

mainly to food chains and manufacturers and processors.

A similar situation exists for sales of cured hams,
picnics, and bacon [20-p. 52]. In this case, the four
largest packers sold 17.6 percent to the 10 largest food
chains, 5.0 percent to mass feeding institutions, 2.8
percent to the U.S. government and 2.8 percent to manufac-
turers and processors. The meat packers with sales under
one million pounds per month sold 34.9 percent of cured
products tO the ten largest food chains, 5.9 percent to the
U.S. government, 4.4 percent to mass feeding institutions
and 2.6 percent to manufacturers and processors. Meat
processing firms with under 5 million pounds of monthly
sales sold 36.8 percent of cured products to the ten
largest food chains, 17.3 percent to mass feeding institu-
tions, 1.8 percent to the U.S. government and 1.5 percent
to manufacturers and processors. In contrast to meat
packers who exported less than one percent Of cured product
sales, meat-processors exported 10.5 percent of their cured

hams, picnics and bacon.

43

The complexity of the channels of distribution for
the meat industry is pointed out in a study done by McKinsey
and Company for the National Association of Food Chains and
the American Meat Institute. They cite the following as
examples Of practices which make meat distribution complex.

1. Branch houses distributing to jobbers who distribute
to other jobbers who in turn sell to retailers.

2. Sausage manufactured at all levels of the distri-
bution system.

3. Packers competing at the retail level with whole-
salers selling the packers own beef and pork.

4. Plants competing with their own branch houses.

They conclude that these practices lead to duplica-
tion of effort and add significantly to the cost Of distri-
bution, and that distribution practices in the meat industry
are still geared largely to the requirements of the grocery

industry of twenty-five years ago [l9-pp. 40-41].

Pork Retailing

On the cOnsumer side, an examination of some data
from the U.S. Department Of Agriculture 1965-66 household
consumption survey (Table 3.3) shows that the majority of
pork consumed was in cured form. Further, it is clear that
hann bacon, and pork chops are by far the most popular
products, accounting for a combined 57.7 percent Of weekly
household pork cOnsumption. Fresh hams and loins accounted

for only 7.6 percent Of weekly consumption, while fresh

44

sausage accounted for 10.5 percent of weekly consumption.

These statistics show fairly clearly that pork is consumed

mainly after either grinding and blending, as cured ham or

bacon, or in the traditional form of pork chops.

TABLE 3.3

AVERAGE PORK CONSUMPTION PER WEEK FOR
UNITED STATES URBAN HOUSEHOLDS

 

 

 

 

 

 

 

 

1965-1966
Pounds
Per Household Percent
Per Week of all Types
Fresh Pork
Chops .55 17.0
Ham .09 2.7
Loin .16 4.9
Sausage .34 10.5
Other .36 11.1
Total 1.50 46.4
Cured
Ham .61 18.8
Bacon .71 21.9
Salt Pork .08 2.4
Canned/Cooked .12 3.7
Other .21 6.5
Total 1.73 53.5
All Pork 3.23
Source: Food Consumption of Households in the United

States, U.S.D.A., Agricultural Research Service,

Household Food Consumption Survey,
Table 8.

Report NO.

12,

p.

1965-1966,

45

At retail, pork prices fluctuate in response to
consumer demand and the relative supply of various cuts of
pork. Pork does not seem to be used as a "special" item by
meat retailers as Often as beef. This is perhaps due to
its limited importance in consumers' menus and, thus, the
more limited drawing power of pork specials.

Retailers purchase pork from a number of sources.
This market for dressed meat at wholesale has been called
the "most significant and sensitive" in the livestock meat
economy [20-p. 55]. Buyers of dressed meat rely on
either direct negotiation or formula pricing to establish
the price Of sale. The formulas are usually based on
quotations as reported in the "National Provisionner Daily
Market and News Service" commonly known as the "yellow
sheet". This daily commercial market report quotes end-of-
day car lot prices f.o.b. Chicago. In the National Commis-
sion on Food Marketing study, packers indicated that 41
percent of their sales of fresh and frozen pork and 29 per-
cent Of their sales of cured hams, picnics and bacon to
their five largest customers were on the basis Of a formula
tied to a quotation [20-p. 58]. Many packers also issue
periodic price lists which may serve as starting points
for specific price negotiations but are seldom representa-
tive of actual sale prices. Other major meat buyers shun
formula pricing and rely on long-term, close contacts with

their suppliers, negotiating each sale separately.

46

Conclusion

It is clear that the hog—pork subsector is a highly
complex system Of product and information flows. The com-
plexity of this system creates the potential for misunder-
standing the price signals which flow through the system.
The misunderstanding of price signals has allowed the
cyclic swings in hog volume and prices to persist. The
slow evolution away from producing the "fat hog" long after
consumers had tried to indicate a preference for lean pork
also is evidence of misunderstanding. In attempts to
improve the understanding or coordination between them—
selves and hog producers, meat packers and feed manufac—
turers are experimenting with procurement contracting and

sow leasing.

CHAPTER IV

PACKER PROCUREMENT CONTRACTING:
A CASE FIRM COMPARATIVE ANALYSIS

Live animal procurement is an extremely important
part of the meat packing business. Since raw material costs
constitute about three-fourths Of the sales dollar, profit
margins are dependent upon efficiency in acquiring live
hogs. Live hog purchases have been estimated to be 85-90
percent of raw material cost [l6-p. 166].

As was pointed out earlier, meat packers have several
channels through which they purchase hogs. The importance
of each source of hogs varies between packers and over time,
but a rough estimate of the relative importance of the
various sources is shown in Table 4.1.

While auctions and direct buying channels have
increased in importance, terminal markets have declined.

This decline in terminal marketing has generally meant an
increase in direct contact Of hog producers and meat packers.
It has also led to some suspicion among market participants
that terminal market prices are no longer accurate indica-
tors Of supply and demand conditions.

Competition among meat prackers for hog supplies

is fairly localized due to the high cost Of transporting

47

48

live animals. Most slaughter livestock is sold out Of first

hands by the producer to a buyer located within 50 to 100

 

 

 

 

miles.
TABLE 4.1
PERCENT OF SLAUGHTER HOGS SOLD THROUGH VARIOUS
OUTLETS SIOUX CITY AND UNITED STATES
Sioux Citya U.S.b

Outlets 1957 1967 1960 1964
Terminal Markets 49.2 31.5 30.3 23.8
Auctions 10.8 11.3 8.7 13.1
packing plants (Direct) 11.3 11.9 61.0 63.1C
Buying Stations 23.8 35.5
Dealers and Others 4.9 9.8

 

 

 

 

 

aSource: NCR Research Publications 199, Long-run

Adjustments in the Livestock and Meat Industry, p. 53.

bSource: National Commission on Food Marketing,
Tech. Study NO. 1, Organization and Competition in the
Livestock and Meat Industry, p. 3.

CIncludes buying stations, dealers and others.

Most meat packers can be said to be purchasing
slaughter hogs in markets where their rivals are readily
identifiable. .These packers face a fluctuating supply of
hogs on daily, weekly, seasonal and cyclic bases. These
fluctuating hog supplies cause packers considerable uncer—

tainty, expecially in short range planning.

49

From Table 4.2 the seasonal fluctuation, as well as

the annual fluctuation in potential capacity utilization,

is obvious. These fluctuations reflect in part the seasonal

farrowing pattern discussed earlier, as well as some lags

due to farmers' variations in feeding efficiency. The

unused slaughter capacity illustrated in Table 4.2 indi-

cates a potential for vastly increased slaughter volume

without addition Of new equipment and facilities.
Major variable production factors in meat packing

are raw materials and labor; and labor is somewhat restricted

by union agreements. Many labor contracts in the meat

packing industry contain the "thirty-six-hour rule", which

generally requires the packer to notify the union of its

labor requirements for the coming week. Once the packer

specifies the number of workers he will need for the coming
week, he is required to pay those workers for at least
thirty-six hours of work whether they are needed or not.
Thus, the packer is faced with calling in too many workers
and under-utilizing them or calling in too few workers and
being forced to pay these workers overtime if supplies
exceed his estimates.

These labor regulations make labor a relatively

fixed component in the production process. Since the packer

is limited in varying the amount Of labor used (or paid for)
in response to variation in raw material supplies, this
nakes the accurate prediction or control Of raw material

supplies critical to plant profitability.

 

50

TABLE 4.2

FEDERALLY INSPECTED HOG SLAUGHTER
AS A PERCENT OF RATED CAPACITY

 

 

 

1964-1965
Percent

Month 1964 1965
January 83.4 71.3
February 70.7 62.5
March 77.0 77.0
April 77.7 68.4
May 9 65.6 55.6
June 60.4 55.6
July 59.1 52.2
August 58.0 56.0
September 67.5 64.5
October 81.6 63.9
November 78.5 64.8
December 79.7 59.0

Year 7IT6 6276

 

Source: National Commission on Food Marketing, Tech.

Study NO.

the Livestock and Meat Industry, p.

1, Organization and Competition in

51

Raw material procurement and the variability in
raw material supplies presents the packer with four main
problems:
1) how tO get the most raw material for his procurement
dollar given different markets, different grades
and weights of hogs, and different product trans—
formation rates from these various grade and weight
categories;

2) how to best utilize available plant and equipment;

3) how to utilize labor most efficiently with variable
supplies; and

4) how to match raw material quantities and qualities,

with prevailing product demands at reasonable

profit margins.

Each of these problems represents a potential for
increased firm profits. The solutions to these problems
all result in firm acquisition of the desired quantities
of live hogs. Several solutions are possible. First, firms
can use their current market sources and adopt pricing poli-
cies which reward producers for specific delivery times and
weight and grade specifications. It may be difficult for
firms to alter substantially short run quantities or
qualities by Offering high or lower prices, given the time
lag required for farmers tO adjust their hog production
schedules. However, short run price policies may result in
shorter or longer feeding by farmers attempting to market
at higher prices. It may also be difficult for firms to
indicate with prices their desire for specific types Of

animals given the traditional average weight pricing system

52

which fails to accurately reflect quality price relation-
ships. Some firms have gone to a carcass grade and yield
pricing system to avoid this problem. Here again, firms
are relying on a greater use of supplemental communication
with the producer to indicate their preference.

Secondly, firms could enter into production of hogs
themselves. In this way, they could presumably modify the
fluctuations in the quantity, quality, and timing of hogs
from their traditional sources through their direct control
of marketing from their herds. This alternative has been
tried by some firms; but limited management experience in
hog production, substantial capital investment, adverse
public opinion and other factors have discouraged firms
from this alternative.

Third, meat packing firms could enter into contracts
with hog producers.or marketing intermediaries which specify
the timing, quantity and quality Of hogs to be supplied.
The degree of control the firm exercises over its supply
depends both on contract terms and performance of the con—
tractor in meeting those terms. The contract alternative,
however, supplies a potential advantage over the pure
pricing alternative. It allows the firm to exercise an
increased degree Of control over its raw material supply,
and it provides the mechanism through which supplemental

market information can be transferred.

53

It will be the purpose Of the remainder of this
chapter to explore the evolution of contracting for hog
supplies. First, procurement contracting will be examined
in relation to a single case firm and then in relation to

several other firms and the subsector as a whole.

Procedure

In order to gather empirical data on the way in
which meat packers had actually used contracting arrangements
for hog procurement, the following procedure was followed:
First, the results of an earlier pork industry survey were
reviewed in consultation with one of the major investiga-
tors. In reviewing these results, it was determined that
five major meat packing firms had at least limited exper—
ience with procurement contracting of some type. Because
Of the depth of information required to evaluate the incen-
tives and disincentives for procurement through contracts,
it was decided that a case analysis approach was required.
It was also decided that it would be desirable to supplement
the data gathered in the case analysis with a comparison
survey Of several large meat packers who also had some
experience with contracting.

The case firm was selected from the five firms
surveyed earlier because of the depth Of experience in
procurement contracting and the indicated willingness of

this firm to cooperate in further research. After data

54

was collected from the case firm, a survey using personal

or telephone interviews of the remaining four packers was

conducted.
Profile of the Case Firm

The case firm was among the top eight meat packing

firms in the United States in 1964. It is a part of a

conglomerate firm in the food industry listed on the New

York Stock Exchange and among Fortune's list of 500 largest

corporations. The case firm Operates livestock slaughter

facilities throughout the United States which kill and

process hogs, cattle, and sheep.

The case firm purchases hogs through a central mana—

ger Of hog procurement. The central manager consults daily

in joint telephone conversations with plant managers and
hog procurement managers at each plant to balance the cor-

porate demand for pork products with supply and demand

conditions at the several plants. While these conferences

occur on a daily basis, the central hog procurement manager

and the plant managers are also responsible for longer range

planning for hog procurement. This generally consists of

evaluating various sources of hogs, including their own
buyers, evaluating the various pricing systems for hogs
JhiCh they employ, and planning and evaluating any longer

:erm procurement commitments which the firm or its plants

may make .

i, “um
.: J

 

55

The central manager of hog procurement is responsi-
ble to a vice-president for pork Operations. This vice-
president is responsible for both sales and procurement
and exercises responsibility for coordinating these
functions.

Interviews with the vice-president in charge of
pork and the manager of hog procurement were conducted to
gain data on contract procurement. It should be pointed

out that while the experience with procurement contracting

 

by the case firm was broad, the particular contract arrange-
ments provided only a small portion of total firm supplies.

Potential benefits from contract procurement as
seen by case firm management were: 1) possible savings
through new pricing arrangements, 2) possibilities for pro-
curement leverage if part Of their raw material supply was
guaranteed through contract, 3) possible savings gained by
replacing some of the more costly current sources Of hogs
with more efficient contracted hogs, 4) possible improve-
ments in scheduling fixed and labor facilities at various
plants, 5) improved hog quality and more equitable payment
procedures, 6) possible merchandising of specific high
quality products when there was an increase in the avail-
ability Of high quality raw material, and 7) better service
to farmer suppliers.

Case firm managers were not as specific in their

estimates about possible costs of operating contract

56

programs. They recognized that there were some additional
administrative and enforcement costs associated with con-
tracting. A major concern was the potential for cost
increases due to price formulas which guaranteed prices to
be paid producers over time. It was believed that the
number of buyers at a particular plant was relatively fixed
by plant volume within a fairly broad range; thus the buyers
needed by serve the hog contracts would be serving other
sources of hogs if the contracts did not exist. Case firm
personnel believed, based on past experience, that producer
groups tended to over-value the contribution of contract
procurement arrangements and guaranteed delivery times.
This, they said, resulted in requests for pricing premiums
unjustified by product or delivery characteristics, pro-
ducing a situation where further contracting became unde-
sirable.

Management also saw some internal firm Obstacles
to contracting for hogs. This resistance took two forms.
Lower management personnel sometimes were unwilling to take
the responsibility for price commitments made by those above
them, and resisted efforts on the part of the corporate
procurement manager to negotiate contracts with producer
groups which would involve their plants. Some buyers at
the plant level resist contracting because of the increase
in administrative duties associated with contracts compared

to more traditional sources of hog supply. Management above

57

the corporate vice-president level seemed to resist con-
tracting because Of its relative inflexibility. The general
need for flexibility is deeply ingrained in many levels Of
the meat industry. The day-to-day fluidity of prices and
supplies has produced a situation where time horizons are
short and flexibility commands a premium. This produces

an atmosphere where the evaluation of a particular pro-
curement strategy by corporate management may weigh heavily‘
the possibility Of a disastrous quarterly loss.

Contract Arrangements Attempted
by the Case Firm

In most Of the contracts attempted by the case firm,
the primary Objective has been to facilitate desired producer
sales relationships while reducing procurement costs. These
arrangements have not been Offered at all Of the firm's

plants, but on a selective and situation—specific basis.

"Futures Contract"

 

‘The case firm's largest volume procurement contract
is geared to the futures market. Unlike the other contracts,
this contract is offered by the case firm at several of its
plants in slightly different form. In this contract, the
farmer agrees several months in advance (possibly at the
time he places feeder pigs on feed) to deliver hogs to the
case firm during a designated month. He promises to give

the case firm a one-week notice prior to delivery. The

58

case firm in turn agrees to pay the farmer the Chicago
Mercantile Exchange live hog futures contract price for
that delivery month, plus some market adjustment based on
the relationship between the local markets cash price and
Chicago cash prices. The farmer is given some "earnest
money" at the time he signs the contract usually about
$5.00 per head. Final payment is made at the time he
delivers the hogs.

An example might be a farmer who wanted to sign a
contract on January 9, 1973, to deliver hogs in April, 1973.
The farmer would receive the January 9, 1973 Chicago Mercan-
tile Exchange live hog futures closing price of $29.35 per
hundred weight for April delivery [34-p. 26] less, say,
$1.00 per hundred basis for the differential between local
and Chicago markets. The farmer thus was guaranteed a price
of $28.35 per hundred. Five dollars of this would be paid
to him today to demonstrate the case firm's commitment to
purchase.

These contracts have been Offered selectively at
several of the firm's plants. Whether or not they are
Offered is generally determined by farmer interest, which
usually is conditioned by the recent trends in hog prices
and price expectations. These contracts would not be
expected to have been very popular during the last six

months when prices have trended upward fairly steadily.

59

Buyers at one Of the case firm's plants found that
this contract arrangement was in demand most by farmers
who needed the security of a previously fixed price to
secure feeder pig financing or financing of other produc-
tion supplies. These same buyers stated that there had
been few problems of default on these contracts (less than
5 percent Of the contracts were not delivered on); in those
cases where there were problems, they were generally due to
unavoidable circumstances. The case firm took a fairly
easy but concerned posture with respect to unmet contract
commitments trying to settle the situations as quietly and
as equitably as possible.

These contracts give the case firm only limited
assistance in reducing uncertainty because of their delivery
specifications (farmers determine the exact date of delivery
during the delivery month). This type of contract merely
places the case firm in a position of intermediary between
the farmer and the futures market. Instead of the farmer
hedging his hogs, he sells them to the case firm for future
delivery; and they usually hedge the hogs they have
purchased.

This contract does leave the case firm with the
Option of hedging the hogs or becoming a speculator if they
assume the risk Of price fluctuations by not hedging. The
case firm had followed this strategy in the past and saw

the returns from such speculation as a possible benefit to

60

hog contract procurement. It is apparent, however, that
this return to speculation is not a real return to hog
contracting and could, in fact, be generated by simply
entering the live hog futures market as a speculator inde-

pendent Of hog contracting operations.

"Production Contract"

 

Another type Of contract which the case firm had
tried was one in which the firm owned the hogs and con-
tracted with the farmer to feed them. This contract spec-
ified that the case firm would deliver to the farmer a
specified number of hogs periodically over a two—year
period and in a specific pattern within that period. The
farmer would be paid according to the total pounds gained
by these hogs. The compensation was to be paid in a fixed
payment per hundred pounds Of gain adjusted for changes in
feed costs which increased the payment if corn and SBOM
prices increased,and decreased the payment if these prices
decreased. There were also provisions for death loss
adjustments and payment in compensation if the case firm
chose not to deliver the specified number Of feeder pigs.
This contract is similar to poultry contracts which pay on
a per pound Of gain basis.

This contract was continued for a very short period
due to management problems at the feed lot level which made

the hogs from this contract extremely expensive. Management

61

in the case firm seemed very reluctant to enter further
contracts of this type due to management difficulties they
had experienced. They felt that while the contract speci-
fied that good husbandry practices would be used in the
care and.feeding.of the animals, these had not been carried
out. This resulted in poor rates of gain, high death

losses, and other production problems.

"Bargaininngroup Contract"

The case firm also had some experience with con—
tracting with a farmer bargaining group. This contract
lasted over a period of about three years. The contract
made the bargaining group responsible for delivery of a
specific number Of hogs over a six—month period at a speci-
fied daily rate. These hogs were purchased on a grade and
yield program using a specified price quotation as a base.
The case firm paid a 15 per cents per hundred service
charge to the bargaining group plus five cents if the hogs
were delivered to a buying station in time for that day's
slaughter. In addition, the case firm paid a 10 cent pre-
mium for delivery of the specified number of hogs on a
daily basis. This premium was held in escrow for a six-
month period and was to be defaulted to the case firm if
the bargaining group failed to deliver the specified number
of hogs any three days in a row during any three-month
period. In this way, an extended diversion of hogs to other

markets was penalized.

62

This contract was by far the most specific on price
premiums and delivery incentives, as well as controls that
the case firm had. It was allowed to lapse because in
re-negotiations the bargaining group was asking for an
increase in the service charge beyond what the case firm
felt justified for the services provided.

It was this type Of contract which the case firm
believed was large enough in volume and gave it sufficient
supply security that its demand for hogs from other sources
was reduced. Firm management believed that this reduced
demand would reflect itself in lower prices paid by the
case firm for other supplies due to its ability to "ride

out" short term fluctuations at other markets.

"Marketing Contractsfi

The case firm had experimented with several types
Of marketing contracts with individual large volume pro-
ducers. These contracts all took a similar form. The
seller guaranteed delivery Of a specified number Of hogs
over a specific period of time, usually one year or more.
These hogs were to be delivered over that year and were
to be purchased on a grade and yield basis with base price
determined in one of several ways. The contract price was
determined from a formula which related it to a published
market quotation. The several formulas all involved lower

prices to the packer when market prices were very high in

63

exchange for higher prices to the farmer when market prices
were very low. The exact boundaries specifying high and
low prices varied. The case firm management saw an advan-
tage from this type Of contract especially when rapidly
rising hog prices squeeze meat packer profit margins. They
felt farmers would be attracted to this type contract
because it would enable them to trade very high prices
during a few periods for the security of a price floor
during periods of low prices.

The case firm's major objection to this type Of
contract was the possibility for sustained losses relative
to Open market prices during a period of low prices. Man-
agement thought this type of contract was desirable to both
farmers and packers as it reduces potential losses to both
parties from either extremely high or extremely low market
levels. This would tend to stabilize profits in both

industries.

"Feed Firm Contracts"

The case firm has also participated in a contracting
scheme through a feed manufacturing subsidiary. This con-
tract involved promotion and servicing of hog purchase
contracts by the feed firm. The contracts provided for
hogs sales to the feed firm for future delivery to the case
firm's plant. Delivery was specified within a twenty-day

period selected by the producer with the requirement that

64

the case firm be given three days advance delivery notice.
The contract gave the producer the Option of a fixed for-
ward price or case firm's delivered price quotation on day
of delivery. Producer had the option Of selling all or
part Of his hogs on either basis to be specified at time
of contract. The feed firm would advance a fixed percentage
of the feeder pig cost to the producer in partial payment
for the market hogs. The feed firm also agreed to furnish
to the producer feed, supplement and supplies up to a set
dollar amount per head after the producer signed a feed
contract with the feed firm. Payment under this contract
was made to the feed firm who in turn paid the local dealer
for items delivered to the producer during the contract.
After delivery of the market hogs, the feed firm
retained an amount equal to that advanced tO the producer
plus interest at an 8 percent annual rate. The remainder
was paid to the producer. This contract was in essence a
financing contract which tied the financing Of feed and
feeder pigs to a forward sale agreement. The forward sale
was on a partially fixed price basis (depending on what
proportion of the hogs sold were sold at a fixed forward
price), such that producers risk was decreased to a limited
extent. The contract did, however, specify that control
over all monies from sale of market hogs remained in the
hands of the feed firm until all feed and interest expenses

incurred were paid. It removed the possibility of

65

producers defaulting on feed contracts. This type of

contract is being used by the case firm on a limited basis.

Analysis Of Contract Benefits

Selected contract benefits accruing to the case firm
from various contracts and contract provisions were evalu-
ated. This evaluation involved several types Of benefits.
These benefits include benefits from certain pricing formu-
lae, price leverage benefits from market security, scheduling
benefits from contracted supplies during seasonally low
supplies, quality improvement benefits from improved quality
Of hogs purchased under contract, and product merchandising
benefits resulting from improved availabilities of high

quality pork cuts.

Benefits From Certain Pricing Formulae

Pricing benefits from contracting for future
delivery Of hogs occur when the prices paid for a certain
grade and weight of hogs are lower than those paid for the
same hog under normal market arrangements. The case firm
has tried or considered several different pricing formulae
for their contract purchases. Three of these pricing for-
mulae were considered in a simple analysis of the savings
or losses accruing to the case firm under different market

conditions.

66

Using data from the United States Department of
Agriculture "Livestock and Meat Statistics" annual Summary
[29], the cost of hogs with and without contracts was
analyzed. Data from the case firm on their market share
was used in combination with data on federally inspected
hog slaughter tO give monthly estimates of case firm
slaughter from December 1965 through March 1972. This time
period contains the most recent full cycle in hog prices
and facilitated the examination of a wide range of market
conditions.

It was assumed that the case firm would be contrac-
ting ten percent Of their market share and that all hogs
contracted were purchased according to the contract pricing
scheme under analysis. It was further assumed that the
average weight Of hogs purchased, both under contract and
in other markets, was equal to the average weight for all
hogs under federally inspected slaughter; and that all non-
contracted hogs were purchased at an average price equal
to the seven market average used in the analysis. The
average or base price appropriate for all hogs was assumed
to be the U.S.D.A. NO. 2-3, 220-240 pound price as reported
in "Livestock and Meat Statistics" [29].

Thus, in order to determine the gain or loss from
a particular contract pricing scheme during a particular
month, the weighted expenditure of all hogs purchased at the
market price was compared to the expenditure when ten per—

cent are purchased through contracts.

67

Pricing Formulae Examined

The first pricing formula examined (Formula I) was
a fairly simple formula with an upper and lower limit with
contract prices equal to prevailing market prices between
these limits. The limits considered in this case were
$19.00 for the lower limit and $25.00 for the upper limit.
The lower limit is arbitrary for purposes of illustration;
the upper limit is also arbitrary, although it was chosen
with some reference to case firm experience. In possible
bargaining over these limits between packers and farmers
case firm personnel felt the lower limit should equal out
of pocket production costs. The upper limit would repre-
sent the point at which meat packer profits began to be

squeezed. In this case, the pricing formula becomes:

<

cp = MP if $19.00 - MP 5 $25.00
CP = $19.00 per hundred if MP < $19.00
CP = $25.00 per hundred if MP > $25.00

where CP = Contract Price and MP = Market Price.

The second pricing formula examined (Formula II)
was one containing a floor price with a fixed percentage
of the difference between the floor price and the market
price going to the contractor whenever market price was
greater than the floor price. Again, the floor price con-
sidered was $19.00 with the percentage figure at 75 percent.

In this case, the pricing formula becomes:

68

CP $19.00 if MP < $19.00
CP = $19.00 + 0.75 (MP - $19.00) if MP 3 $19.00
where CP = Contract Price and MP = Market Price.
The third pricing formula considered (Formula III)
is a sort Of compromise between the first and second. In
this case, there is a floor price $19.00 and a ceiling
price $22.00; but above the ceiling price, there is a

variable split between the contracting parties. The pric-

ing formula in this case is:

CP = $19.00 per hundred if MP < $19.00 per hundred
0p = MP if $19.00 3 Mp $22.00

cp = $22.oo+o.9o (MP - $22.00) if 22.005Mp<24.00
cp = $22.00+0.80 (Mp - 22.00)if 24.003Mp:26.00
0p = $22.oo+0.75 (Mp - 22.00) if 26.00:MP< 28.00
cp = $22.00+0.70 (Mp - 22.00) if 28.003Mp< 30.00.

These pricing formulae are illustrated with refer-
ence to market prices in Figure 4.1. It is clear that none
Of the pricing formula is to be preferred from a packers
point of View in all situations. With market prices below
$25.00 per hundred Formula I gives the least savings over
market prices; while above $27.00, it gives the greatest
savings.

Figure 4.2 illustrates the relationship between
actual seven market average prices and contract prices under

Formula 1. Visual inspection indicates that this sceme

69

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71

might be approximately fairl if the contracting parties
were both in the contract for the entire period from.12/65
through 3/72. Contracts of shorter duration, depending on
their starting date, could be highly biased in terms of
gains to one party or the other.

From a meat packer's perspective, this fixed floor
and ceiling contract would appear to be unwise because of
the length of time necessary to balance out gains and
losses. Stockholders and Boards of Directors may not be
persuaded of the longer term desirability of contract pro—
curement if it involves high losses during several succes-
sive quarters.

Figure 4.3 shows potential losses and gains from a
contract with pricing Formula II. In this case, the fact
that contract prices follow market prices more closely in
the above $25.00 range and less closely in the $19.00 to
$25.00 range more evenly balances gains over time. This
arrangement also limits the absolute amount of gains during
any one period. The more even balance of gains over time may
alleviate to some degree the risks of major losses occurring
in consecutive quarters. The period of January 1967 to
January 1968 would be one entirely of losses under pricing

Formula I (see Figure 4.2); but under Formula II, some gains

 

1Here we mean fair in the sense that over time, the
sum of the gains and losses to the parties is zero.

72

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73

are registered which offset to some extent the losses
occurring during this period.

A major possible drawback to a pricing scheme, such
as Formula II, is that it seems salable to farmers only in
periods when market prices are at or near the $19.00 base
level. While the arrangement may be fair over time, it may
appear unfair to farmers who see that they begin to lose
immediately after prices reach $19.00 per hundred.

This Obstacle to Formula II is partially alleviated
in Formula III. As illustrated in Figure 4.4, Formula III
combines a floor price with a range where market and con—
tract prices are equal, followed by a range of diminishing
shares going to producers. This formula decreases.the possi-
bility that farmers will feel cheated by the immediate
incidence Of a sharing arrangement, but raises the price
level at which packers begin to gain from the contracting
arrangement. It also distributes the gains to packers more
evenly over the hog cycle than Formula I.

An almost infinite number Of possible pricing for—
mulae could be explored. The three discussed above were
selected because they were typical of those which had been
used or were being considered by the case firm. Each Of
the formulas discussed represent a philosophy expounded by
the case firm and basic to their approach to long term con-
tracting. This philosophy is best described by saying that

the case firm feels that below a certain price, farmers are

74

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75

not making a fair return on their investment; and above a
certain price, meat packers are not making a fair return
on investment. Between these pricing levels, the market
should provide the pricing mechanism. The case firm
personnel thought that a contract of the Formula III type
represented an Opportunity for producers to share their
benefits from very high prices in exchange for packers
accepting the risk of very low prices. This type of con—

tract makes it possible for the parties of this longer term

 

agreement to negotiate a lower and upper bound and a shar— I
ing arrangement beyond these points which distributes the
risks more evenly between the parties. It should be pointed
out that this may not mean an exact split Of price gains
and losses, such that the net gain or loss to each party is
zero. The fact that either farmers or meat packers may
perform additional services associated with the contract
agreement will also affect the equity of any specific pric—
ing formula. It is important from an equity viewpoint that
both parties to the contract be made aware of the possible
gains and losses to them from entering into this agreement.
While these comparisons of contract versus market
prices over time give a preliminary View of the pricing
benefits and costs of contracting, a more detailed compari-
son was felt desirable. In this comparison, the possible
starting dates and duration of contracts containing the

different pricing formulae were examined under the assumption

76

that the case firm would contract for ten percent of its
market share. The cost of buying all hogs at the seven
market average price was matched with buying 10 percent of
the firm's supply through contract and 90 percent at the
seven market average price. The difference between these
costs was the loss or gain from contracting. These losses
or gains were computed monthly and summed over different
possible contract periods: 12 months, 24 months, 36 months,
and the entire four-year period.

The results of this analysis are presented in

 

Table 4.3. The time periods chosen represent two periods

Of gradually falling market prices (starting 12/65 and 5/66),
a period of stable prices (starting 4/67), a period of
generally rising prices (starting 12/67), a period Of rapid-
ly falling prices (starting 6/70), and a period encompassing
an entire hog cycle (12/65 to 2/70). It is clear from

Table 4.3 that all three contracts produced losses in the
short run period from June 1970 to June 1971. This illus-
trates what could happen if a firm entered such fixed floor
price contracts during a period of rapidly falling prices
and terminated its commitment after only one year. All
three Of the contract pricing formulae produced gains when
the contract was for an entire cycle of high through low to
high hog prices. The only time period in which all three
contracts were unprofitable was the two-year period begin-

ning April 1967. This period of roughly stable prices

77

 

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78

produced losses because the contract floor was at or near
the mean price level for this period while the contract
ceiling was, in two cases, above the range Of price fluctua-
tions during this period. All of the three-year contracts
that started on the 4/67 date produced gains. It is clear
that the last year Of this three-year contract contained
sufficient periods of high prices to more than balance the
low prices during the first two years.

It should be clear to both meat packers and pro-
ducers that a simple analysis of the type presented above
indicates the equity Of longer term contracts. When pricing
formulae are used which place floors or ceilings on contract
prices, there is always danger that a short-term contract
will isolate one Of the parties on the losing or winning

side relative to Opportunities in other markets.

Production Contract Economies

As was mentioned above, the case firm had been
involved in one type of contract where they owned feeder
pigs and paid individual farmers to fatten these pigs to
market weights. In order to compare the price of hogs
purchased under this arrangement with the price Of hogs
purchased through other market channels, it was necessary
to estimate a price paid under the production contract. The
estimate was arrived at using a combination of secondary

data and cost estimates furnished by the case firm.

79

Data on feeder pig prices was collected from weekly
Livestock, Meat and Wool Statistics as published by the
U.S.D.A. [33] for the period from February 1966 through
March 1972. This data would have been collected from
December 1965, as was the data for the other contract
analyses, but feeder pig prices were not reported prior tO
the February 1966 cutoff date. These weekly estimates were
converted to monthly estimates using a simple averaging
procedure. This procedure involved averaging the weekly
price quotations equally weighted, to arrive at the monthly
average. Weeks ending on the first, second or third day of
any month were included in the previous month for averaging
purposes. The feeder pig prices used in the analyses were
those for U.S. 1-2 (a few 3) grade feeder pigs weighing
40—50 pounds for the Illinois reporting area. It was
assumed that these pigs would be fed in feedlots in the
Missouri or Illinois area.

Given the cost Of feeder pigs to the packers as
the prevailing market price as indicated by the above data,
the contract specified that the packer would be responsible
for several other costs. These included: transportation
to the feedlot, interest expense on capital invested in
feeder pigs, veterinary cost, transport cost, feed adjust-

ment cost, transportation to market, and feeding charge.

80

Transportation to and from the feedlot was estimated
by personnel at the case firm to be $1.00 per animal each
way. Veterinary costs were estimated at $0.75 per animal
by case firm personnel. The case firm personnel considered
the prime rate to be the appropriate cost Of capital tied
up in feeder pigs. Feeding charge was fixed in the contract
at $14.65 per hundred weight, but a feed adjustment cost was
calculated according to the terms Of the contract based on
a base price for 44 percent unrestricted soy bean Oil meal
Of $72.00 per ton and a base cost of corn at $1.15 per
bushel. These were to be mixed in a ration Of 80 percent
corn and 20 percent soy bean Oil meal. The total pounds of
feed used was to be certified by the feeder to the case at
the end Of each month. Based on this feed consumption rate
and prevailing feed prices at designated points, the feeder
was further compensated or penalized depending on the move-
ment of feed prices. This contract provision prevents the
feeder from gaining if feed prices fall during the contract
or losing if feed prices increase. The feed adjustment
provision insures that the Operator is compensated for
changes in his production cost.

In order to include fluctuations in the price of
feed in the cost Of hogs produced under this contract, price
estimates for 44 percent unrestricted soy bean Oil meal at
Decatur, Illinois as reported in Feed Market News [32] and

prices of Number 2 yellow corn at St. Louis, Missouri, as

81

reported in Gran Market News [31] were used. Fluctuations
in the prime interest rate were accounted for using the
historical Prime Rate Charged by Banks as reported in the
Federal Reserve Bulletin [9]. Feed price estimates used
were monthly. The prime rate was adjusted in accordance
with the historical pattern of its movements.

Using these data and data on case firm market share,
federally inspected slaughter, average weight Of barrows
and gilts sold under federal inspection, and prices for
U.S. No. 2-3 market hogs at St. Louis, a comparison Of
market prices and contract prices was accomplished. The
first step in this comparison was estimating the contract
price of hogs produced under contract. This contract price

was estimated by the following equation:

(FP+T+V+D+I+FC+FA)
Contract Volume in Pounds

 

Contract price = x 100

where: FP = feeder pig cost based on the assumption that
all pigs are purchased at 50 pounds, and that
the number Of pigs purchased is determined as
10 percent or 20 percent of the plant market
share Of federally inspected slaughter four
months in the future.

T = transport cost calculated as $1.00 per head

times the number Of feeder pigs purchased plus
$1.00 per head times .965 times the number of

feeder pigs purchased.

 

Contract
Volume

FC

82

veterinary cost calculated as $0.75 per head
of feeder pigs purchased.

death loss calculated as 3.5 percent of feeder
pigs purchased for purposes of calculating the
effects Of this death loss; it was assumed
that half of the death loss occurred during
the first month and half occurred during the
second month.

interest cost for money invested in feeder
pigs calculated as the prevailing prime rate

times total feeder pig cost times one fourth.

was calculated assuming that the case firm
knew several months in advance what its plant
volume would be and that they would contract
for 10 percent of that volume. It was further
assumed that they would not estimate death
loss as part of this volume and therefore
actual contract volume would be less than
desired volume. Thus, final contract volume
is .965 times number of feeder pigs times
average weight of barrows and gilts under
federally inspected slaughter.

feeding charge calculated as 14.65 per hundred
times the net gain. Net gain was calculated

as the difference between the total weight Of

FA

83

starting feeder pigs at fifty pounds each and
.965 times the starting number of feeder pigs
times the average weight of barrows and gilts
under federally inspected slaughter for the
appropriate month.

feed adjustment calculated based on the assump-
tion that feed per pig consisted of the follow-

ing monthly amounts:

1 2 3
Pounds Consumedl

Corn 120.96 170.08 264.96
SBOM 30.24 47.52 66.24

 

1These estimates were calculated

based on consumption pattern esti-
mates furnished by Roy Black,
Extension Economist, Dept. Of Ag-
ricultural Economics, Michigan
State University.

These data were expanded by the appropriate
number of pigs on feed during each month
taking death loss into account. Total monthly
feed consumption was calculated and market
prices for corn and soybean Oil meal were
applied to the total consumption each month.
This was compared to the base feed cost times
monthly consumption. The difference between
the market cost over the period and the base

feed cost over the period.

 

ll

84

Figure 4.5 shows the relationship between contract
prices and market prices over the time period frOm April
1966 to March 1972. It is again clear that the production
contract is a source of savings in periods Of rapidly rising
prices, but results in losses during periods of declining
or steady prices. A comparison similar to that used for
the three pricing systems examined is contained in Table
4.4 Again, in the results presented, we see the case
where two—year contracts which show losses (those starting
5/66 and 4/67) became the source of gains when another year

was added to their duration.

TABLE 4.4

COMPARISON OF LOSSES OR GAINS FROM A PRODUCTION CONTRACT
FOR SELECTED PERIODS AT 10 PERCENT CONTRACT
LEVEL FOR ONE PLANT OF THE CASE FIRMa

____r

 

 

Time Period Starting Date Loss/Gain
36 Periods 5/65 -293,l48.32‘
36 Periods 4/67 439,313.90
36 Periods 12/67 322,015.89
24 Periods 5/66 —311,348.40
24 Periods 4/67 -137,l73.97
24 Periods 12/67 319,920.11
12 Periods 6/70 ~479,896.15

 

aCalculated from data found in Tables A.2 and A.3.

85

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86

As was stated earlier, this contract was terminated
by the case firm because Of management problems. These
problems involved higher rates of death loss and lower feed
efficiency than was calculated. This resulted in signifi-
cantly higher costs than were anticipated by the case firm.
It was the general belief Of case firm personnel that this
contractural procedure would not succeed for them. They
felt from their initial experience that the management Of
feeding Operations was better handled by individual farmers
who owned the livestock and had a vested interest in effi-

cient management.

Benefits from Procurement Leverage

Personnel with the case firm thought that other
possible benefits from purchasing hogs through contracts
were effects this might have on the price paid for hogs
purchased in other markets. Their reasoning was that, with
a given volume of hogs contracted for delivery during a
certain week, they could enter the market under less pres-
sure to purchase hogs. This,.they believed, would enable
them to hold back when prices were rising or to be more
selective in.their hog purchasing. This might be illustrated
graphically as in Figure 4.6 where the daily hog supply is
fixed at 00. The market demand for hogs before the firm
began contracting was DO and the market clearing price is

P0. The case firm enters contractural agreements for 20'

87

PRICE

PER UNIT ‘\\\

   
    

 

l

 

 

 

l
l
I
l \
l
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1 Q0 QUANTITY omen

Figure 4.6. Hypothetical Supply and Demand Curves for a Local
Hog Market in the Short Run.

88

percent of its daily supply. This may cause market demand

to shift downward to D resulting in a new equilibrium

1'
price at P1' The case firm reasoned that this shift in
market prices results in a lower hog cost on those hogs
purchased outside the contract.

This analysis assumed, Of course, that the contrac-
ting by the case firm had no effect on market supply. In
fact, if the hogs contracted for were contracted in the
firm's normal market area, there is a good possibility that
market supply also shifted as a result Of contracting. For
example, if the firm's contracting efforts resulted in a
supply shift from SO to 51' then the market clearing price
remains at P0. The only thing that changed in the second
situation was the channels through which hogs moved.

An attempt to test the existence Of procurement
leverage as explained above was undertaken. A market in
which the case firm had done substantial contracting
(contract volume reached over 20 percent of plant purchases
in some weeks) over a three-year period and in which a
terminal market also served as a major source Of hogs was
used. The procedure adopted was similar to that used by
Love and Shuffet in their attempt to examine the effects
on market prices of a shift in market structure [15]. It
was expected that if procurement contracting had an effect
on market prices in this case, the relationship of prices

in this market to prices in other markets would be

89

significantly altered. Weekly price data were collected
from "Livestock Meat and Wool Market" news on prices Of
U.S. 1-2, 200-220 pound market hogs for 104 weeks preceeding
and 105 weeks after the incidence of contracting. The time
period covered by this analysis was March 1966 to March
1970. Price differences were calculated between the case
market and three other major terminal markets. These

other markets were chosen because Of their presence as
centers of pricing, their proximity to the case market, and
the availability Of data on price movements. A comparison
of the price differences among the markets is found in
Table 4.5.

It is clear from Table 4.5 that there were no
economically significant changes in price relationships
between the markets considered. In only one case would the
price relationship change between the two periods have been
statistically significant at the five percent probability
level. In this case, the (market 1 versus market 3) differ-
ence between periods was only 5.3 cents per hundred pounds.
This does mean that market prices in the case market were
lower relative to those in market 3 during the period of
contracting. The amount Of difference (5.3 cents per hunw
dred pounds) is not economically significant in markets
where price movements generally occur on 25 cent intervals.

The accuracy of data reporting and the system Of computing

averages also could account for a difference of this size.

90

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91

In the case of market 1 versus market 2, the difference
would have been significant at the ten percent level. Again,
the absolute amount of the difference could be considered “a
economically insignificant. In the case of market 1 versus
market 4, the probability Of a difference of this size

(8.8 cents per hundred pounds) occurring by chance alone

is just over ten percent.

An examination of the differences among the three
conparison markets supports a contention that there was no
significant alteration in their relationships between
periods. This also may lend support to our contention that
any alterations in relationships between market one and the
other markets were due to changes within market one. A
complete historical sketch Of these four markets would be
desirable to eliminate the possibility that some other
structural change has affected prices more than the incidence
of contracting.

The strongest conclusion that can be drawn from the
analysis is that there was a difference in pricing patterns
when a period of contracting was compared to a period without
contracting. Further, the difference was of insufficient
magnitude as to be economically significant. An examination
of case firm records on the location of contractors indi-
cates that most Of the hogs contracted for did come from

the normal market 1 market area. This may have resulted

92

in the situation described earlier where not only was market
demand reduced, but market supply was reduced, thus limiting
the price effect Of contract procurement.

Benefits from Supply Scheduling,

Improved Qualityp and
Increased Sales

 

To examine possible benefits from improved sched-
uling and improved quality of hog run, a linear programming
model Of plant Operations was used. This model is in use
weekly by the case firm. The model utilizes weekly esti-
mates Of the prices and availability of inputs and estimates
of the potential sales volumes and prices. The model deter-
mines the profit maximizing combination Of hogs to buy in
several weight and grade classifications given certain
transformation functions and the forcast sales.

This linear programming model maximizes within the
constraints of limited hog supplies, estimated product
demand, available labor and facilities (including a fixed
chain speed specified by the model Operator), and the
technical relationships which specify the rates at which
each grade and weight category of hogs produce specific
primal cuts. These rates or transformation functions from
live hogs to primal cuts are updated periodically as the
case firms hog supply changes. Thus an effort has been
made by the case firm to keep the model technically up to

date.

93

In order to Operationalize the model results in
decision making weekly "model meetings" are held by plant
personnel. At these meetings industrial engineering per-
sonnel explain the Optimal Operating strategy as indicated
by the model and compare the previous week's results with
actual results in the previous week. Other firm personnel
(plant manager, hog evaluation officer, chief buyer, product
manager, and others) are then given an opportunity to dis-
cuss the model results and interject their estimates Of the
reliability Of the supply and demand assumptions which
conditioned the model results. In this way the case firm
has built a high degree of confidence in the model as a
management aid. Industrial engineering personnel also
indicate that a comparison of actual Operating margins and
model Operating margins over time indicates a high degree
Of accuracy.

An initial examination of the case firm model indi-
cated that there were several ways to reflect potential
contract benefits in the model: 1) Increased available
supply Of high quality hogs, 2) Improved transformation
functions or yield of primal cuts from selected grade and
weight classes, and 3) increased available sales because
of higher quality and more consistently available products.

Available resources at the case firm limited the
use Of their model to evaluating the effect of an increased

available supply of high quality hOgs. It was possible to

94

use the results of other modeling efforts to examine other
potential contract benefits.

After initial consultation with case firm personnel
at the corporate headquarters, it was determined that it
would be desirable to discuss proposed model alternations
with plant personnel who were running the model. Included
in these sessions were the manager Of pork evaluation, the
industrial engineering personnel who ran the model, the
head hog buyer for the plant, and the corporate chief of
Operations research. In consultation with these individuals,
a plan was formulated for running the model to simulate
possible changes occurring due to increased contract pro-
curement of market hogs.

Initial adjustments in the model involved changes
in the available supply of hogs in selected categories.

The model was first run using actual weekly receipts for

a representative week in July. July was chosen because of
the generalized scarcity Of market hogs in this month; thus
contract supplies would likely be most beneficial at this
time. When the week to be used had been determined, histor-
ical data on actual weekly receipts Of market hogs and sows
was collected. In addition, appropriate data on prices and
sales quantities were also collected. These data were used
to simulate a profit maximizing solution for the week
selected, given actual receipts for that week. This Optimal
solution was used as a benchmark for the modifications made

relative to contract procurement.

95

The benefit Of contracting to be tested using this
model was an increased availability of hogs in certain grade
and weight categories. It was reasoned that a major motive
of contracting is to smooth out the seasonal fluctuation
in hog supplies. Further,case firm personnel indicated
that they could see no reason for contracting without
improving quality. Given these factors, it was determined
that to simulate the effects Of contracting, the availabil-
ity of market hogs was increased and concentrated in specific
high yield grade and weight classes. Table 4.6 shows the
distribution Of the hypothesized increase in availability
of 4,000 head of high quality hogs per week. Using esti-
mates by the firm's hog evaluation officers, based on
experience with past contracts, it was expected that 75
percent Of the contracted hogs would be in the 200 to 240,
pound range with the remainder in the 240-270 pound range.
It was further expected that 90 percent Of the hogs con-
tracted for would be grade number 2 with the remainder
grade 3.

When the raw materials available to the model were
increased in the manner described in Table 4.6, several
important changes in the Optimal procurement mix occurred.
These changes (Shown in Table 4.7) were approximately what
was anticipated. The model found that with an increased
supply of high quality butcher hogs available, it was

profitable to replace some of the sows purchased in the

96

earlier period with butchers. Thus, the Optimal solution
reflects a decrease in sow purchases Of 866 head. The
largest portion of these sows came from the medium weight
grade 2 to 3 animals. The model also found it more profit-
able not to purchase as many light weight butchers or lower
grade butchers in the medium weight categories. While the
model did not find the Optimal increase in butcher purchases
to be the full four thousand head, it was profitable to
purchase an additional 3,224 head. Thus, 776 head would
not be required from traditional supply sources because Of

contract supplies.

TABLE 4.6

DISTRIBUTION OF ADDITIONAL AVAILABLE HOG SUPPLY
RUN 2, CASE FIRM HOG MODEL

 

 

 

Grade Weight Number
#2 201/220 1350
#3 201/220 150
#2 221/240 1350
#3 221/240 150
#2 241/270 900

#3 241/270 100

 

97

TABLE 4.7

DIFFERENCES IN OPTIMAL HOG PROCUREMENT MIX
WITH ADDITIONAL AVAILABLE HOG SUPPLY,

CASE FIRM MODEL

 

 

Number to Buy

 

 

Grade-Weight Category Run #1 Run #2 Difference

Butchers
#3 - 181/200 916 750 - 166
#4 - 181/200 11 0 - 11
#2 - 201/220 3465 4815 1350
#3 - 201/220 1428 1000 - 428
#4 — 201/220 44 30 - l4
#6 - 201/220 37 30 - 7
#2 - 221/240 4162 5512 1350
#3 - 221/240 1104 1254 150
#2 - 241/270 3823 4723 900
#3 - 241/270 1214 1314 100

Butchers Total Head 20307 23531 3224

Sows
#3 - 361/400 250 80 - 170
#4 - 361/400 21 10 - ll
#2 - 401/450 520 500 - 20
#3 - 401-450 248 80 - 168
#2 - 451/500 836 400 - 436
#4 - 451/500 60 20 - 40
#2 - SOl/Over 807 786 - 21

Sows Total Head 5864 4998 - 866

 

 

 

 

98

An examination of the changes in sales and expenses
in the two solutions provides further understanding Of the
possible contributions Of additional high quality hog
supplies (Table 4.8) It is apparent that the change in
Operating margin is small at 0.33 percent; but it is an
increase. The most drastic changes from Run #1 to Run #2
are the decreases in inter-company and outside purchases
made available by these additional hogs. The increase in
surplus accumulation indicates that the firm was unable to
turn some of the increased supplies into current sales.
This causes a lower increase in Operating margin than would

have been the case had the firm been able to boost sales
through advertising or promotion. The sales estimates
built into the model are not geared to this increased
availability Of raw materials and thus unfairly limit the
contribution to sales available from the increased supplies.
With all other things held equal, the increased availability
of four thousand high quality butcher hogs produced an
increased return Of only 21 cents per head. This assumed
that these animals could be purchased at prices equal to
those prevailing for hogs not purchased under contract with
the same weight and grade characteristics. As we have seen
earlier, this assumption depends on the particular contract

being considered.

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100

Studies at Purdue University using a similar linear
programming model synthesized from industry-wide data tested
several possible contract benefits [23]. Included were
benefits from improving the quantity and quality of hog
run, better scheduling Of hogs, and improved sales due to
higher quality branded products. When hog availability was
80 percent of their base solution return on investment was
negative 4.7 percent while with hog availability at 120
percent of the base situation return on investment was 19.3
percent [23-p. 37]. This profit volume relationship is
consistent with statements made by case firm personnel and
bears out their concern over low profit levels during the
low volume periods of the hog cycle. Further efforts to
simulate the relationship between profitability and weekly
scheduling resulted in the following: if the simulated
plant could be Operated for a full 52 weeks at 100 percent
of the base schedule volume, return on investment was 10.4
percent; if the firm operated at 100 percent of base volume
for 25 weeks, 90 percent of base volume for 13 weeks, 80
percent of base volume for 12 weeks and 70 percent of base
volume for 2 weeks return on investment dropped to 4.2
percent [23-p. 41]. Both of the above analyses took the
final product profile as given. To simulate the possibility
of branding certain products it was assumed that certain
branded products could be sold at a higher price. Under

the assumptions used, branding increased the value Of a

101

grade one 200-220 pound hog from $20.75 to $25.14 [23-p. 43].
Carcass quality and product branding are closely interre-
lated. Improvements in hog quality through improved con-
tract purchasing would increase the possibility Of product
branding.

An unpublished study at Michigan State University
used a synthetic firm model constructed from engineering
design data to evaluate the change in total unit cost of
slaughter with varying degrees of control over seasonal and
daily fluctuation in hog supply [3]. The study considered
a full line slaughter processing plant and used historical
data on seasonal supply patterns to estimate a generalized
pattern of seasonal and daily fluctuations in hog supply.
The study examined the effect of systematically reducing
both the daily and seasonal variation in supply in varying
plant levels. At the plant capacity similar to that for
one case firm plant in this study, the results (Table 4.9)
show that the elimination Of daily variation without a
reduction in seasonal variation is worth only $0.21 per
head. While an elimination of seasonal variation without
a reduction in daily variation is worth $0.84 per head.
This may indicate that the uniform utilization Of facilities
over a longer run is the source Of economies in excess Of
short run optimization. Elimination Of all variation
seasonally and daily lowered total unit cost by $1.02 per

head indicating that a packer in circumstances similar to

102

those simulated could afford to pay up to $1.02 per head
more for the hogs purchased if he could eliminate varia-

bility in supply.

TABLE 4.9

TOTAL UNIT COST OF 600 HEAD PER HOUR SLAUGHTER
PROCESSING PLANT AT SELECTED LEVELS
OF SUPPLY VARIATION

 

 

Percent of Normal

 

Seasonal Variation Percent of Normal Daily Variation
Seasonal Variation 1.000 0.707 0.500 0.000
----- Dollars Per Head— - - - -

100.0 10.47 10.39 10.34 10.26

70.7 10.23 10.10 10.04 9.96

50.0 9.99 9.90 9.85 9.77

00.0 9.63 9.53 9.50 9.45

 

Source: Unpublished Ph.D. thesis, Hernan Barreto, Michigan
State University, Department Of Agricultural
Engineering, in process.

The study did not consider the costs Of implementing
a supply control system which would result in the reduced
variability tested. Nor did the study consider the costs
of changing consumption patterns sufficiently to meet the
new hog supply pattern. Given the results Of the study,
these costs would have to be less than $1.02 per head for
the zero variability case in order for this plan to be

profitable.

103

A more realistic short run reduction in variability
may be the reduction of seasonal and daily variation to half
Of their present levels. In this case, the savings in total
unit cost would allow up to $0.62 per head to be spent on
supply control and demand alteration programs.

The importance of demand fluctuations in plant
profitability was illustrated in a study at Iowa State
University [7]. Plant slaughter costs were compared with
various conditions Of weekly slaughter variation. A yearly
slaughter capacity was determined and a fixed weekly
slaughter rate calculated. This weekly slaughter rate was
then varied corresponding to fluctuations Observed in feder-
ally inspected plants in the northwest subregion of the
North Central Region. Researchers found cost savings of
from 7 to 13 cents per head for a 310 head per hour slaughter
plant. They conclude that consistent with previous studies,
slaughter cost was reduced when fluctuation in weekly supply
was reduced. They go on, however, to examine the profit
impacts of slaughter stabilization considering demand
fluctuations and supply availabilities. Density of avail-
able livestock supplies, the price of live hogs at the
plant, and the wholesale carcass price were considered.

When these factors were coupled with a fixed Optimal weekly
output determined without consideration for the above
variables, profit reductions of $0.26 to $0.46 per head

resulted. These profit reductions resulted because of the

104

inability of the firm to adjust to changes in these demand
and supply factors.

The important conclusion of the Iowa study is that
without stabilization of supply markets SEQ product markets,
the profit maximizing firm may rationally choose a position
of instability over one of stability. This may limit dras-
tically the efforts Of any one firm toward stabilizing plant
throughput. The researchers in the Iowa study conclude that
a firm would only want to stabilize plant Operations if the
industry were stabilized.

From study of the case firm and the other studies
mentioned above, it is clear that there are limited econo-
mies to be gained in hog slaughtering with improved sched—
uling of throughput under current industry conditions.

From conversations with personnel at the case firm, it
became apparent that they implicitly recognize the need

for flexibility in their industry. Case firm personnel
interviewed were unanimous in their feeling that twenty per-
cent Of supply was the maximum contracted supply they would
consider. This was based on what they felt was an industry
norm that twenty percent tied to any single source either
for supplies or sales was a limit beyond which it was unsafe
to go. The safety of such commitments was related to their
ability to adjust to the dynamic markets in which they

Operate.

105

This twenty percent rule of thumb may well reflect
the oligOpolistic structure of meat packing, wholesaling,
and retailing. The firms Operating at these levels in the
Hog-Pork subsector are very conscious of their interde—
pendence. Thus they stress the desirability of Operating
policies which allow them tO react rapidly to actions Of
their competitors, suppliers, and customers. These flex-
ible Operating procedures reduce the possibility of short
term losses if normal Operating arrangements are disrupted
by unexpected market behavior, but at the expense of longer
run planning and corresponding potential profits.

Meaningful estimates Of the operation Of a system
completely coordinated by contracts were beyond the exper—
ience of case firm personnel. While they felt that contract
procurement would continue to grow, they did not conceive
that it would become the dominant method of marketing live
hogs.

Economies Through Improved
Procurement System

 

 

The case firm personnel also believed that a source
of possible economies from contract procurement was the
ability to replace their more costly sources of supply. It
was expected that hogs purchased through contracts could be
purchased less expensively than hogs from some other sources.
An examination Of firm records on procurement patterns and

cost Of different sources indicated a wide range of

106

procurement cost. In Table 4.10 there is a difference Of
nearly $2.00 per hundred between those hogs purchased most
effectively and those hogs purchased least effectively. A
comparison of the buying margin for futures contract hogs
and hogs purchased through the bargaining group contract
shows the differential possible in procurement cost between
different types of contractual arrangements. It was the
case firm's expectation that with contracting they could
replace some or all of the hogs purchased from sale barns

or the terminal market. Relative savings by replacement

of terminal market hogs with hogs purchased under a contract
whose buying margin was equal to that Of the bargaining
group contract would be $0.24 per hundred pounds live weight.
For hogs purchased at sale barns, the replacement savings
under similar circumstances would be $0.28 per hundred pounds
live weight.

It is easy tO understand why the case firm has
tended to prefer more direct purchasing given the relative
buy margins for less direct sources of hogs. It is also
apparent that while there are potential cost savings through
elimination of poor procurement sources, these cost savings
could be achieved with or without contracts. It is further
clear that in the case of the bargaining group contract in
which the case firm was involved, the hogs could have been
more efficiently purchased through direct plant purchases

than through the procedure used.

107

TABLE 4.10

RELATIVE PROCUREMENT COST FOR DIFFERENT
SOURCES OF LIVE HOGS CASE FIRM
1971

 

 

Total Buying Margina Average
Category Dollars/Hundred Live Weight

 

Grade and Yield Including

Futures Contract 1.00 227

Plant Purchase - .38 234
Country Buying Stations — .41 235
Dealers - .48 239
Bargaining Group Contract — .58 231
Miscellaneous - .77 235
Terminal Market - .82 250
Sale Barns - .86 243

 

aThis represents the cost gain or loss due to
differences in yield, price,sorting, grading, and rate of
dead and condemned for a particular procurement source
relative to firm standards which change over time.

Summary Of Case Firm Analysis

 

The experience of the case firm indicates that the
following benefits from contracting were possible: price
savings through advantageous longer run pricing formulae,
more efficient purchasing, reductions in slaughter cost
through more even product flow through the plant, increase
in profit through improved yield of hogs purchased, and

improved sales and possibility of branding products because

108

Of a higher quality, more even flow of pork products. It
was found that procurement leverage (price savings because
of the ability to wait out market fluctuations) had not
been significant for the case firm. The limitations to
contract procurement were found to involve costs of record
keeping on contracted hogs (generally associated with grade
and yield buying), premiums required to obtain specific
delivery dates, lack of specialization in hog raising which
prevents farmers from delivery at specific busy farming
periods, the industry rule of thumb not to contract for
more than twenty percent Of supply, the inability Of meat
packers to control product demand while controlling supply,
and (in the case of the feeder pig production contract) the
inability to secure the degree of management necessary at
the production level.

Comparison and Contrasts With
Other Meat Packers

In order to determine if the conditions and Opinions
found for the case firm were typical of major meat packers,
a comparative survey was undertaken. This survey involved
interviews in person or via telephone with personnel at
four major meat packing firms. All of these were among the
top eight hog slaughtering firms in the nation in 1965 [20].
The interviews were structured so as to determine the extent

of changes which the firms had made in contracting since

109

an earlier survey was completed and to derive comparisons

to current activities of the case firm.

Changes in Contracting Patterns

Two of the meat packing firms contacted in this
survey had not changed their.posture toward contracting.
They remained generally uninterested in expanding their
current contract Operations. These consisted Of Offering
futures market contracts similar to those Offered by the
case firm and other firms in the hog slaughtering industry.
An executive from one Of these firms expressed the Opinion
that for his firm "contracting is a very expensive way to
buy hogs." His reasoning was that the bookkeeping function
was currently quite costly. He believed, however, that
when computerized accounting systems had been worked out,
this cost would be substantially reduced.

The other two firms interviewed had changed their
contracting programs substantially. In one case, the firm
had gone from a position of no contracts to use of a futures
market related contract. Their contract is similar to those
discussed earlier with the producer specifying whether his
hogs are tO be graded on a live or carcass basis. Producers
are required to give 24 hours notice before delivery. In
the other case, the firm had substantially reorganized its
contracting efforts. Here, the firm had been involved in

breeding operations, feeder pig production and market hog

110

production--all controlled through service contracts. This
firm had owned all the livestock throughout the cycle from
gilt through breeding, farrowing and finishing. At the
various stages, these animals were placed out with farmers
on a contract feeding or production basis. The firm in
question has decided to eliminate much of the contract
feeding and production it has done. It is currently re-
thinking this process and has not completely firmed up its
plans. Reasons for dropping these production contracts
were management problems similar to those experienced by

the case firm in it's production contract.

Attitudes Toward Contracting

 

The attitudes of personnel interviewed at the four
other meat packing firms varied widely. At two Of the firms,
personnel seemed to take a reserved position. They expressed
a concern over the cost Of Operating contract programs or
evaluated the potential benefits for their firm as being
very slim. Another of the firms which had recently taken
their first steps into contracting for market hogs expressed
concern over the need for strict legal agreements. They
apparently prefer a voluntary handshake type of arrangement
and believe that farmers also prefer this. The fourth firm
expressed real interest in contract procurement. In spite
of some problems with past contracting efforts, they believe

that the benefits possible to their firm made contracting

111

a very attractive alternative to be explored. They also
thought that there were possibilities through new contract
methods for alleviating some of the cyclic nature of hog

production.

Contract Benefits Expected

 

The major benefit expected by two Of the firms
interviewed was customer satisfaction. These firms were
Offering contracts on a "when asked for" basis rather than
promoting them vigorously. Another of the firms inter-
viewed believed that they benefited only slightly from
procurement leverage, if at all. They thought that improved
scheduling might contribute ten cents per hundred pounds,
but that would be close to an upper limit. They believed
that the benefits Of an assured supply would be hard for
them to capture. They are already in an area with suffi-
cient supply of hogs; on days when deliveries are restricted
due to weather or for other reasons of this type, it will
also be difficult for farmers with contracts to deliver.

One potential hazard they saw in contracting as a major
source of hogs was the consequences if contracts were not
renewed. They thought that if a major commitment to con-
tracting led to closing some Of their other procurement
sources that these sources could not be readily reestab—
lished if contracts were not renewed. In terms of the

possibilities for premium quality product as a result of

112

upgrading hogs through contract, they believed that.major
determinants of product quality were cutting and trimming
standards and shelf life, both Of which are under internal
control.

The fourth firm interviewed believed that they
would need to have at least 20 percent Of plant capacity
contracted if they were to affect plant scheduling. They
thought that an indirect benefit to them was that their
farmer contractees would be better candidates for feed firm
financing; thus, their contracts would be more attractive
to farmers. They didn't see that there was any price
leverage benefit to be gained over the long run. They
believed that any short run gains in this area would prob-
ably be eliminated by the high degree Of competition for
noncontracted hogs if several firms were in the market.

This firm believed that by working with pricing
formulae that encouraged farmers and meat packers to stab-
ilize supply and demand for pork products, the size Of
fluctuations in the hog cycle could be reduced. They felt
that limiting hog cycle fluctuations would enable their
firm to reach much more efficient plant utilization levels.
This firm had been successful in producing higher quality
hogs through their earlier contract programs. They also
found, however, that the overall quality Of hogs has in-
creased to a level far above that at the time they began

contracting. This limits the differential in quality

113

available through contracting. This firm believed that
over time they would need to offer a "cafeteria style"
choice of several possible contracts to farmers so that

each could choose what best suited his position.

Problems with Past Contracts

As was mentioned earlier, one Of the packers inter-
viewed found the accounting system necessary with contracts
to be expensive and cumbersome. This he thought would
soon be solved by application Of computer technology to
this accounting problem. Another of the packers estimated
that the differences in accounting cost from contract pro-
curement were about equal to differences which resulted
from grade and yield buying. He believed that the fixed
costs of personnel in the buying Operation were the same
as in current procurement programs but that contracting
did require some additional record keeping cost.

A major problem faced by the firm who had owned
hogs and contracted for finishing on a fee basis was similar
to that experienced by the case firm. This involved the
management capabilities and management performance of
contractees. In some cases, this firm found that the
husbandry Of animals they owned was not at a level they had
expected. In other cases, they found themselves being
called upon whenever there were health problems with their

animals. In still other cases, they made mistakes in who

114

they allowed to care for their animals. All these factors
combined with the timing Of their entry into this Operation
resulted in substantially lower than expected profit levels.
These low profit levels along with a general dissatisfaction
with the contracting program in its past form has lead the
firm to phase out most of its contract production.

Another problem faced by all the firms interviewed
was producer failure to deliver on contract agreements.
This has not been a large problem for any of the firms, but
caused some concern for all of them. A hog buyer at one
firm expressed surprise that more problems had not occurred,
especially with regard to the futures contract. He had
Viewed several situations in which farmers delivered hogs
at contract prices as much as ten dollars below current
cash prices. He believed that these cases substantiated
the common industry trust in its farmer suppliers. This
is not to say that all contracts had been delivered on.
In fact, one firm had experienced a situation where indi-
viduals had sold hogs on a futures contract, accepted the
guarantee money, but did not own any hogs or intend to feed
any hogs. All firms expressed a firm stand on such tactics
emphasizing that they are interested in purchasing hogs and
would prosecute to the limit in cases where there was not
good cause for failure to deliver. One Of the firms was
attempting.to develop a pay back mechanism to allow producers

to buy out of their contracts. It was clear that these

115

meat packing firms did not want to alienate potential
farmer customers through excessively strict delivery

enforcement.

Contract Pricing Formulae

 

The futures contract pricing formula used by all
of the firms interviewed has the same essential provisions.
Contract price is equal to live hog futures market price
less a transportation differential. The farmer receives
an initial payment of five to ten dollars per head which
is deducted from his final payment.
One of the firms was considering a pricing system
on proposed marketing contracts similar in many respects
to those being experimentally tested by the case firm.
This pricing formula specified a base price and a ceiling
price with contract price equal to market price between
these limits. Like the contracts discussed for the case
firm, this contract formula specified a sharing Of price
increases above the upper limit. Unlike the contract for-
mulae of the case firm, this formula specified a sharing
of price decreases below the lower limit. The pricing
formula being contemplated was of the following type:
If M.P. < $19.00, then C.P.==M.P.4-.25 (19.00-M.P.)
If 19.00 5 M.P. 23,00, than c.p. - M.P.
If M.p. 3 23.00, than c.p. =23.00+ .75 (M.P. - 23.00)
While the upper and lower prices are not exactly those

offered by the firm, the basic pricing formula is the same.

116

A comparison of market and contract prices using
this pricing formula appears in Figure 4.7. An examination
Of this figure shows that the losses which occur under this
formula are considerably less than the losses occurring
under the formulae examined earlier (See Figure 4.1).

The firm which was contemplating this type of
pricing formula expected that the general dampening effect
of such a formula would discourage entry on the high price
side Of the cycle and discourage exit on the low price
side of the cycle. They also thought that the penalty to
the packer on very low prices (below $19.00) would dis-

courage efforts to push prices downward.

Other Contract Provisions

 

The firm considering the contract formula discussed
above (contract formula IV) was anticipating offering this
pricing scheme as part of a four-year contract. This con—
tract, they reasoned, would coincide with the length of the
hog cycle and thus serve to affect the cycle over its entire
range. In addition to the four-year provision, farmers
would be asked to specify the annual volume to be delivered,
as well as the quarterly volumes to be delivered. There
would be allowable bounds on these delivery volumes beyond
which penalties would occur.

This four-year contract was the longest anticipated

by any of the firms interviewed and has substantial

117

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118

potential for improved long term planning not possible with
shorter contracts such as the futures market contract. In
addition, the firm considering this contracting scheme was
considering it for offer at all of its plants. While they
were most interested in large volume customers, they were
very willing to consider anyone who was seriously in the
hog production business. They were specific in their
intention Of signing contracts only with persons who had
legal claim to the hogs contracted either through ownership
or another form of contract. They are trying to protect

themselves from contract default.

Product Promotion and Contracting

Only one of the firms.interviewed had begun a pro-
gram of product promotion tied to its contracting efforts.
This firm had started a merchandising program for fresh

pork in conjunction with their initial contracting efforts

They were depending on their contract hogs to supply the
high quality cuts necessary to fulfill the program commit-
ments. While their contract hogs were of high quality,

they also found that there were hogs available from tradi-
tional sources which met the quality standards they needed.
This firm found that with a procurement strategy which re-
warded quality, they could Obtain the volume of high quality
hogs which they needed. This strategy required a program

which encouraged their personnel to pay premium prices for

119

premium hogs. It also required care that the overall market

price was not bid up by paying premium prices for average
or poor quality hogs. This required a more accurate esti-

mate Of hog quality to prevent inaccurate pricing.

Carcass Grade and Yield Buying

Most Of the contracts being tried or considered by
the firms interviewed specify carcass grade and yield buy-
ing. In all the contracts being tried or considered by
these firms there is some effort made to stress more accu-
rate purchase systems than the frequently used average
weight pricing system. The packers interviewed were all
interested in paying for hogs in relation to their quality
as accurately as was economically feasible. This prompted

several packers to sponsor grade and yield programs even

before they incorporated them into their contract purchases.

Producer Participation

 

The firms interviewed generally felt that producers
participating in their contract programs were interested in
the security provided by the contracts. They felt this
added security helped some farmers get financial assistance
for production inputs and feeder pigs. These firms found
that there was no hard and fast rule defining what size or
type farmer was interested in contract selling. Two Of the

firms pointed out that not all farmers were interested in

120

the added security of contracting. They pointed out that
some farmers who raised high quality hogs were willing and
able to sustain losses in the low price periods of the hog
cycle in order to capture gains during the high price
periods. The meat packing firms interviewed felt that
there would always be farmers in this situation with high
quality hogs to sell who would not be interested in con-
tracting. All the firms interviewed including the case
firm have found farmer demand for contracts sufficiently
high to Offer the futures contract and experiment with other
contracts.

Summary and Implications
of Procurement Contracting

Among major meat packers surveyed, procurement
contracts related to the Chicago Mercantile Exchange live
hog futures market are most widely used. These contractural
arrangements typically provide provisions for grade and
yield selling with the base price related to the futures
price at the time the contract is signed. These arrangements
also typically result in a small initial payment to the
farmer to indicate the earnest intention Of the packer tO
purchase according to the terms Of the agreement. The far-
mer determines the delivery data within the contract month,
thus limiting the packer's ability tO schedule slaughter.
Any risk sharing involved in this type Of contract could be

gained through the live hog futures market independent of

121

the contract. Meat packer's greater familiarity Of hedging
in the futures market may explain why farmers choose packer
procurement contracts Of this type rather than hedging
themselves. Farmers who sign contracts of this type are
Often seeking the security of a guaranteed market price in
order to secure production financing. The short run nature
of these contracts makes them Of limited value in increasing
the stability of hog production.

Other experimental attempts at procurement contrac-
ting have stressed the determination of a pricing formula
which would limit potential losses tO the contracting par-
ties. The fairness Of these formulae depends on several
factors including: length of contract, delivery specifica-
tions, cost Of Operating the program, actual market price
levels, and.opportunity Of renegotiations. At the current
contracting volume, the major concern among packers is the
pricing advantage to be gained from these contracts. There
are also economies to be gained at the plant level from
reduction in the weekly and seasonal fluctuation in hog
supplies. These gains are, however, dependent on the ability
to reduce the demand fluctuations facing individual plants
through improved vertical coordination Of the wholesale
and retail levels.

The costs of Operating contract programs appeared
to lie mainly in accounting and bookkeeping costs and in

higher prices paid during some contract periods according

122

to the firms interviewed. Some firms saw possible additional
problems if they allowed contracts to become substantial
sources of supply. The general upper limit for contract
procurement was believed to be twenty percent of total
purchases. This industry norm was expressed by several
packers and may provide a restraining effect on contract
procurement. There was sentiment among some firms inter-
viewed that while contracting may become increasingly impor-
tant, other market channels will continue to be used.

This feeling is supported by the experience Of two
of the packers interviewed in achieving similar results
through other procurement stategies. These firms found that
accurate and agressive pricing of hogs resulted in suffi-
cient quantity of high quality hogs to support merchandising
programs for high quality pork products. Firms also reported
that increased use of grade and yield buying had improved
hog quality. Firms in the study also pointed out that some
of the seasonality of live hog supplies is due to the non-
specialized nature of some hog farms. Thus, the degree Of
delivery specification possible is limited by the diversion
Of farmers' attention and energies to other enterprises at
harvest and planting.

The examination of the effects of contracting on
local market prices provides evidence of the ability Of
market forces to adjust to structural changes over time.

However, short run price leverage may be possible through

123

limited contract procurement programs. The evidence pre-
sented earlier is also conditioned by the scale Of con-
tracting, and market structure prevailing at the time Of
this study. As buyer concentration levels and the degree
of contracting change the effect on market prices is not
entirely clear. As the percentage Of hog supplies sold
through contracts increases, the way in which contract
pricing provisions are determined becomes more and more
important. So long as terminal markets, auctions, and
local dealers remain highly competitive focal points for
price making, they probably provide a fairly accurate pic-
ture Of supply and demand conditions. In this context,
they may provide accurate bases for contract pricing formu-
lae. If these traditional price discovery points become
the markets of last resort for hogs of lower quality and
for buyers with lower quality standards, then the relevance
of market prices established there for high quality hogs
sold direct or through contracts is questionable. If this
becomes the market situation Of the future, then contract
prices may have to be directly related to wholesale or
retail product prices.

Related to this pricing accuracy problem is the
problem of contract price reporting. At this stage, packers
are generally reluctant to report specific details Of their
contracting activities, especially soon after initiation.

In some cases, packers consider particular contracting

124

methods including pricing and delivery provisions to be
valuable competitive information. The time and effort
required by a packer to develop a contract scheme which
suits his and his customers' needs produces a valuable
asset. Packers naturally attempt to protect that asset.
The fact that the contract terms Offered by individual
packers currently are not widely available does limit far-
mers in attempts to accurately choose alternative market
outlets and evaluate their position at the time Of contract
renewal. The increased incidence of procurement contracting
may result in the development of a set Of standardized con-
tract provisions which could be fairly accurately compared
between firms. The current evolution of pricing arrange-
ments for procurement contracts supports this conclusion.
This is also supported by the general uniformity of con—
tracts in poultry production and marketing.

The feasibility of establishing a computerized for-
ward contract market for slaughter hogs has been explored
by Holder [12]. This study found that a computerized market
for standardized forward contracts could result in reduced
production and slaughtering costs and further that if such
a market could reach an annual volume Of five million head
or more, it's Operating costs would be substantially below
those of current spot markets [12-p. 225]. The likelihood
Of such a market being developed may be discouraged by the
offer Of several different kinds Of contracts by meat

packers.

125

The effects of procurement contracting.on the
cyclic nature Of hog production is crucially affected by
farmer reactions to contract Offers and contract provisions.
The history of procurement contracting indicates that in
many cases the initiative has come from farmers or farm
groups. All Of the firms Offering contracts related to the
live hog futures market indicated that these are Offered in
response to farmers' demands for this service. In this
context there has not been a major meat packer effort to
"sell" contract programs. There is some indication from
our interviews and cursory examination of the farm press
that this may be changing.

Farmers who had been involved in marketing or pro-
duction contracts in Indiana and Missouri [5, 21] reported
similar reasons for their involvement. These reasons
included: more certainty of prices and gross returns, a
source of production credit, technical assistance for pro-
duction and marketing, and receiving "top dollar" for market
hogs without continually checking a number Of markets
[5-p. 19]. These reasons are similar to those indicated
by meat packing firms surveyed as reasons for contracting.
One firm indicated the need to provide contracts for all
types of farmers, including those who did not want the risk
sharing provisions involved in contracting.

There is little information available on farmer

reactions to the length Of marketing contracts. This factor

126

has been shown to be crucial to the fairness Of pricing
formulae and the ability to affect the cyclic nature of hog
production. In this context, the increased capital avail—
ability implied as a feature Of some marketing contracts
may enable farmers who would otherwise be unable to enter
hog production to do so. Short term contracts will permit
these farmers to enter and leave production in a way that
accentuates the hog cycle. Longer term contracts may limit
entry and exit and thus stabilize production levels. In
this respect, meat packers who Offer both short and long
term contracts may have little net effect on the cyclic
production of hogs.

Meat packers seemed to be reluctant to commit their
firms to sustained efforts to limit the hog cycle. As a
general rule, firms Operate in a manner.so as to benefit
from swings.in the cycle. This occurs in spite Of the
realization that all firms might be better Off if the cycle
were limited. The subsector as a whole seems trapped in
the situation where short run decisions that are desirable
lead to the perpetuation Of an undesirable long run
situation.

TO summarize, the experiences of major meat packers
interviewed in this study results in the following list of
potential contract procurement benefits:

1) Improved scheduling Of hog supplies and thus in-

creased efficiency in slaughter plant Operations,

127

2) Some pricing formula would tend.to.stabilize the
rates of return in both meat packing and farm
production,

3) Savings because Of more efficient pricing and pro-
curement systems,

4) Increased product sales volume and revenue because
of improved product quality,

5) Reduction in the price and product fluctuations
which have characterized U.S. hog production, and

6) Increased satisfaction Of farmers because of the
increased availability of production capital.

These benefits occur in the presence of several
limitations:

1) Stability in plant Operations is of greatest bene-
fit when there is stability in pork product.markets.

2) Delivery Of contracted supplies are affected by
such factors as weather, just as are other market
supplies.

3) An overall increase in the quality of hogs available
has limited the quality differential to be expected
from contracting.

4) The ability to encourage high levels of management
at the farm level through contracts has been limited.

5) The prevalence of diversification in farm production

of hogs increases the premium necessary to get hog

delivery during certain seasonal periods.

6)

7)

8)

9)

128

There are opportunities for increases in procure-
ment efficiency without contracts.

Accounting costs of contracting are substantial,
given current bookkeeping systems.

Shifts to contracting from other procurement sources
may not be reversible if contract renegotiations
fail.

Contracting at levels above twenty percent of plant
capacity is thought to limit the opportunity for

rapid adjustment to changing market conditions.

CHAPTER V
SOW LEASE PROGRAMS: A SURVEY

Introduction

According to an earlier survey [11] sow lease
programs were the major type of contract vertical coordi-
nation involving feed manufacturers occurring in the hog-
pork subsector. The sows are owned by the feed manufacturer
and leased (along with boars) to farmers. The farmers pay
a direct lease fee that is usually associated in some way
with the market price for hogs. At the end of the pro-
duction life of the leased animals, they are sold and the
proceeds from the sale are returned to the leasing company
in the typical sow lease program.

From the farmer's viewpoint, these programs provide
high quality breeding animals at a low initial investment
cost. The farmer does not need to have as much available
capital to purchase breeding animals. But, needs to have
available production facilities and working capital suffi-
cient to cover variable expenses beyond the cost of live-
stock. In some cases, the leasing firm will also give
credit to the farmer to purchase feed and other supplies.

From the viewpoint of the lease firm, these arrangements

129

130

offer the Opportunity for profits from the lease arrange-
ments and the opportunity for increased sales of feed and

other supplies sold in association with the lease.

Procedure

In order to identify the major develOpments which
have recently occurred in sow lease programs and evaluate
the likely future of sow lease programs, in—depth personal
interviews were conducted with representatives of the three
largest sow leasing firms in the United States. These
three firms are each associated with one of the three lead-
ing feed manufacturers in the United States.

It was hoped that the interviews would provide an
in-depth view of the advantages and disadvantages of sow
leasing from a feed firm perspective. While the survey
results did not produce a detailed comparison of costs and
benefits, they did provide a clear picture of the evolution
05 sow-leasing, and the rationale for recent changes in the
involvement of the three largest United States feed manu-
facturers in sow leasing and the production of breeding

swine.

Results of an Earlier Survey

An initial pork industry survey [ll-p. 19] found
sow leasing to be a popular concept among feed manufacturers.

The focus of these contractural arrangements was the

131

development of relatively captive markets for feed and
associated services. The firms commenting on the profit-
ability of sow leasing felt that it was a profit center in
its own right, was projected tolxm or had potential return
on investment only slightly below other alternatives.

At the time of the initial survey (1970), there
was considerable interest in sow leasing. Six of the eight
firms surveyed were either in sow leasing or had been given
the corporate go ahead to start [ll—p. 19]. The researchers
conducting this initial sow lease survey felt the presence
of the leading feed manufacturing firms in sow leasing was
one important cause of the flurry of sow lease activity in
the feed industry.

With this follow-the-leader hypothesis in mind, the
history and current development in sow lease programs for
the leading feed manufacturers becomes an important part of
predicting the future of these arrangements and the likely
organization of the hog-pork subsector. The current survey
of the three largest feed manufacturers gives some insight
into their motivations, actions, and evaluation of sow

lease programs.
Survey Results

Reasons for Enterinngow Leasing

All three of the firms interviewed were interested

in sow leasing as an independent profit center within their

132

firm. Two firms acknowledged that the acceptable rate of
return was less than other projects because of the increase
in feed sales from sow leasing. One firm indicated that
the increased feed sales generated by sow leases was their
primary interest. Other reasons for leasing mentioned by
firm personnel were: gaining information on problems of
large-scale commercial hog production through their breed-
ing herd operations, to help increase pork productivity in
terms of litter size, to improve pork as a product, and to
make credit available to farmers.

All of the reasons for entering sow leasing given
by firm personnel revolve around increasing the firm's
volume of feed sales. This may be a direct increase due to
new feed accounts generated by the lease, or it may be an
indirect increase from an overall increase in consumption
and production of pork. The firms interviewed reasoned
that if they can provide farmers with high quality breeding
stock which results in better quality pork and higher pro-
fits to bog farmers, then the industry will grow and their

firm will share in this growth.

Supporting Facilities for Leasing

Two firms reported substantial production facilities
constructed and operated by their firm for the production
of breeding animals. These firms felt that this was neces-

sary to achieve the degree of health and sanitation which

133

they required. In addition, this gave the firms a high
degree of control over the husbandry of the leased animals.
The third firm interviewed relies mainly on contracts with
top level farmers to produce the breeding stock they lease.
One firm used only animals produced by their personnel as
part of their lease herd. In the other cases, contracts
with individual farmers to grow breeding animals were used.
In both of these cases, the health, sanitation, and hus-
bandry requirements were quite stringent.

Two firms were involved with substantial research
programs using their breeder herds both as examples of
commercial hog operations and for genetic and other basic
research. Two firms had found their experiences in man-
aging their breeder herds to be helpful in understanding
problems facing commercial hog producers, and adjusting

their products to meet producers need.

Lease Contract Terms

 

The leases used most recently contain similar

general provisions which are outlined below.

Length of Lease

In two cases, the length of the lease was specified
as four farrowings with option to renew for a fifth and
sixth farrowing. In the other case, the contract length

was twenty-seven months after delivery of first lot of

134

leased animals. This lease also contained an option for
renewal. The leases often also contained the stipulation
that the lease terms will remain in effect until all off-
spring of the leased swine have been sold. This insures
the lease firms ability to exercise their rights to payment

or animals in lieu of payment.

Lease Payments

All of the leases required a deposit at the time
the lease was agreed to. The actual lease fee generally
depends on the value of market hogs at specified time
intervals into the lease. The following formula is typical:
lst yearly rental = 90% x Practical Top Market Price
x Number of Gilts
Leased, computed 12 months after delivery of animals
2nd yearly rental = 81% x Practical Top Market Price
x Number of Gilts
Leased, computed 24 months after delivery of animals
3rd yearly rental = 35% x Practical Top Market Price
x Number of Gilts
Leased, computed 36 months after delivery of animals
The percentages in this formula reflect the general
tendency but are not exactly those of any one firm. Prac-
tical TOp Market Price is defined as the price generally
regarded as the highest paid by a nearby terminal market

for slaughter hogs, but not the absolute highest paid for

135

small numbers of top quality swine. The fact that the
rental payments are related to the price of slaughter swine
at some future date places the lease firm in a risk sharing
position with farmers.

All of the leases examined required farmers to keep
gilts between 45 and 60 days before breeding. This means
that the first offspring of these gilts would go to market
approximately one year after signing the lease. Farmers
then pay for breeding stock at prices related to the sale
price of hogs produced. This means that when market hog
prices are high, the cost of leased animals is high; when
market prices are low, the cost of leased animals is low.
This means that the returns to the leasing corporation are
related to market hog prices. The leasing corporation is
thus sharing the risk with the leasor.

As in other risk sharing arrangements, gains to the
producer are limited as well as losses. This limitation on
gains when hog prices are high diminishes the attractive-
ness of leasing arrangements to farmers who have the capital
capacity to weather periods of low prices.

One of the firms had experimented with a leasing
fee system where the payments were fixed at the time the
animals were delivered. This arrangement related the
lease fee to current market prices and did not embody the

same degree of risk sharing as the other leases. This

136

uniform payment system also specified semi-annual as Opposed
to annual payments. This diminished the time which lease
firm capital was tied up without return.

A look at figure 5.1 shows the difference between
these two arrangements. Under the risk sharing scheme,
a farmer who took delivery of gilts in January 1966 would
make this first payment based on market prices in January
1967 and his second payment based on market prices in
January 1968. In the fixed payment scheme, the producer
who took delivery of gilts in January 1966 would have pay-
ments based on the market price prevailing at that time.
It is clear that for these particular dates, the producer
would have been better off under the risk sharing scheme.
He would have paid lease fees based on a relatively low
price for market hogs which prevailed at the time he sold
his first and third batches of pigs. If the producer had
taken delivery of gilts in December 1967, the tables would
be turned. In this case, the fixed payment scheme would
be based on the relatively low market price prevailing at
the time of delivery. The risk sharing arrangement would
result in payments based on the relatively higher market
prices prevailing in December 1968 and December 1969.

In terms of the profit impact on the farmer signing
the two types of lease agreements, it is not possible to
tell absolutely which would have been more profitable over

both periods. It is possible to say that the risk sharing

137

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arrangements would result in more stable profit levels to
the farmer. The fact that this form of lease payment
matches the cost of breeding stock to market prices at the
time when offspring are sold results in more stable levels
of return on investment over time. The risk sharing form
of payment produces less stable profit levels for the sow
leasing firm. This results because the gilts delivered to
the farmer by the leasing firm are produced at an oppor-
tunity cost reflected in market prices at the time of
delivery. Thus, the leasing firm will probably prefer a
fixed payment plan based on market prices at the time of

delivery.

Ownership and Disposal of Animals

All of the leases examined specify that the leasing
firm remains the sole owner of breeding stock leased. Pro-
ducers agreed to notify leasing corporation prior to sale
of any of the breeding animals.

All leased swine are required to go to slaughter
unless previous arrangements for renewal of the lease have
been made. This provision protects the lease firm from
further use of its breeding stock without compensation.

The proceeds from the sale of leased swine go to the leasing
firm. In some cases, the producers' deposit is refunded

from these proceeds.

139

In all the leases examined, the producer is the
owner of all progeny from the leased swine. In all cases
examined, the lease firm retained a lien on all progeny
and usually retained option to purchase any progeny at
current market prices. In two of the leases, the producer
was required to send all progeny to slaughter. In the
third case, the producer could use the progeny for breeding
purposes, but only after payment of a royalty to the leasing
Operation.

In two leases, the producer was responsible for
any death loss or culling of delivered swine for whatever
reason. The exception to this is the case of non-breeding
boars which were to be replaced by the leasing firm. In
all the leases, producers were required to breed leased

swine to boars leased from the leasing firm.

DepOpulation

Two leases required that there be a period of approx-
imately six weeks in which no swine shall have been on the
premises to be occupied by the leased swine. All leases
required that the producer keep only leased swine on the
premises and that the leased swine be isolated from all
other swine by at least one hundred yards.

Management, Health Requirements,
and Costs

All of the leases examined featured provisions

specifying a management program to be followed by the

140

producer. The firms indicated that this program for feed-
ing leased swine and their offspring generally recommended
their own firm's feed. In only one case did a firm require
that animals be fed exclusively their feed. In this case,
the firm required this only for the leased swine. This
firm indicated that they felt their ownership of these
swine legally entitled them to specify this level of care.

The leases examined generally specify that producers
will be responsible for paying all expenses of maintaining,
raising, and selling leased swine. These expenses would
include feed, prOperty, transportation expenses, selling
expenses, and veterinary expense. In some of the leases,
there is a specific stipulation indicating the producer
will pay all taxes on leased animals.

All the leases specified that the producer would
vaccinate the leased swine for erysipelas and leptospirosis

at appropriate intervals.

Warranties by the Lease Firm

In only one of the leases examined did the leasing
firm specify what warranties were implied by the lease.
These warranties specified the average weight of delivered
swine, guaranteed delivery of a health certificate on all
leased swine, guaranteed boars to be breeders, guaranteed

gilts not to be bred at time of delivery, and guaranteed

141

the delivered swine to be free of certain diseases. All
the leases contain a disclaimer concerning profitability

or performance Of leased swine.

Other Provisions

The provisions described above are general to all
the lease agreements examined. Some other provisions
included in leases were a provision for producers electing
to sell progeny as feeder pigs, a provision for producers
to replace their original leased swine with their progeny,
and minimum number of animals leased.

One firm was making initial attempts at a marketing
program for progeny of their leased swine. Farmers would
deliver their swine to a central collection point. Farmers
were paid a price $.50 above the nearest terminal price
quotation for U.S. grade l-3 hogs. There were no yardage
charges. Title to the hogs passes to the feed manufacturer
at the collection point. The hogs were then shipped to
packers. The price received by the feed manufacturer was
determined by a formula previously agreed to through dis-
cussion with the packer. This feed manufacturer felt that
they could offer a valuable service to packers by providing
a quality product. He felt that this was particularly
important to packers located in deficit production areas.
He reasoned that, if a packer must ship in hogs to operate

his plant, he is better off to ship in high quality hogs.

142

Promotion and Management of Sow Leases

All firms interviewed handled their sow lease pro-
grams in association with local feed dealers. Only one
program involved the local dealer as a party to the lease
agreement. In this program the local dealer leased the
animals from the home firm, then sub—leased them to farmers.

None of the programs involved payment of a fee to
the dealer either for placing or for servicing accounts.
The sole incentive for dealer participation in the programs
was their Opportunity for new sales of feed and associated
products.. While the sow lease programs did offer local
feed dealers opportunity to offer their customers a new
service, they were not directly rewarded for this. Many
local feed dealers have served as information exchanges,
often locating breeding stock for farmer customers. Usually
without the formality and complications involved in leasing
programs. An impression gained from the interviews was
that local feed dealers often resisted the demands placed
on them to service and supervise leased animals.

Only the case where sows were leased directly to
dealers did the farmer leases contain terms and specifica-
tions on financing of feed and other inputs. While other
leases carried an implicit offer of financing for variable
production expenses, the terms were left up to the local

dealer. It was thus impossible to determine from our

143

interviews whether lease holders were treated differently

with respect to feed prices than other customers by local

dealers.

Results of Sow Lease Programs

All three firms interviewed found that sow-leasing
was profitable for their firm. However, two firms had found
that the ability of sow lease programs to match investment
alternatives was limited. In both these firms, sow leasing
had been evaluated as a separate profit center as well as
a feed sales generator. In the remaining firm which had
emphasized sow leasing as a generator of feed sales, the
program was valued highly.

Two firms estimated 90 percent of sow-lease custo-
mers were also their feed customers. All firms interviewed
thought that approximately 50 percent of their sow lease
customers were new feed customers for their company. The
firms did expect the new feed sales generated by sow leas—
ing to decline as more firms entered the leasing or breeding
stock market; it would be more difficult to attract feed
customers away from their current supplier if that supplier
also offered sow leasing as a service.

Two of the firms interviewed had recently made
decisions to limit the emphasis on leases and move to direct
sales of breeding stock. The third firm was committed to

leasing as a viable way to increase feed sales. It is

144

interesting to note that the two firms de-emphasizing
leasing are firms who stressed the profitability.of.lease
operations independent of feed sales. These firms felt
that selling breeding stock offered a return on. livestock
more nearly in line with other corporate Opportunities and
effects on feed sales similar to leasing.

While it is impossible to give very precise esti-
mates of the scale of leasing operations, a ball.park
estimate for these three firms combined is 100,000 animals
currently on lease. This is a decline from a combined
total of approximately 150,000 animals prior to the de-

emphasis of leasing by two firms.

Problems Encountered in Sow Leasing

 

All firms interviewed had encountered problems with
their leasing programs. The problems discussed here are
those which might characterize any leasing program, not
those peculiar to a single firm.

Two firms found that lease holders expected more
assistance with animal health than was implied in the lease.
When their animals got sick, the feed manufacturer was
asked to care for them in spite of lease terms which placed
this responsibility with the farmer.

Two firms reported that between five and ten-per-
cent of the leaseholders had some.difficulty in meeting pay-

ment schedules. They were quick to point out that there

145

were usually extenuating circumstances for these delays.
They felt that the incidence of fraud or misrepresentation
was minimal.

Two firms indicated a concern over the length of
time their capital was tied up in a lease. This prompted
one Of the firms to change the length and payment provisions
of its lease. This seemed also to be a major factor in
prompting firms to favor fixed payment leases or sales
agreements compared to leases with fees related to the
slaughter hog market.

All firms reported some difficulty with dealer
servicing of leases. This included failure of dealers to
accurately checkout prospective lease holders and dealer
reluctance to follow up lease arrangements with inspection
and supervision. This problem had prompted both firms con-
templating breeding stock sales to offer commission pay-
ments to dealers as part of the sales program.

All firms reported some difficulties in receiving
salvage returns from sale of leased animals. Some farmers
reported death loss when animals were actually kept or sold.
Similarly, some farmers attempted to skirt lease provisions
by keeping progeny from leased animals for breeding stock,
mixing owned and leased animals, or keeping leased and other
animals on the same property. One firm believed that the

lease requirement for farm depOpulation severely limited

146

their market for leased animals. In some cases the require-
ment encouraged leasors who were inexperienced in hog pro-
duction or those who had been forced to liquidate their

herd because of disease. The requirement that the lease
holder keep only leased swine may.have prevented hog pro—
ducers with established breeding.herds and strong manage-
ment capabilities from taking part.in the program.

All firms reported problems in selection of lease
holders. The requirements for depOpulation and exclusively
using leased breeding swine at any one location contributed
to these problems. They felt the basic problem, however,
was finding farmers who were willing to meet the terms of
the leases. One firm expressed an overall dissatisfaction
with it's ability to communicate with lease holders what
was expected of them and what they could expect from the
lease firm. The large staff for paperwork and control of
leases was seen as a problem by one firm. In fact, person-
nel at this firm felt that sow leasing might work better
for a small firm with a smaller volume of leased animals
which could more easily be supervised.

One firm mentioned some.legal difficulties that
had occurred in trying to operate over several states.
These problems involved meeting local requirements for
legally repossessing leased animals in cases where they
were improperly cared for or other terms of the lease were

not met. Another firm had mentioned that successive

147

refinements of it's lease were made with references to
greater security. Thus, later.versions of their lease
specified exactly the rights and responsibilities of the
parties.

Summary of Benefits and Problems
in Sow Leasing

 

 

Among the firms surveyed the following major bene-
fits Of sow lease programs were mentioned: 1) Profits from
rental fees, 2) Increased feed sales, 3) Increased know-
ledge of hog production, feeding, and breeding, 4) Reduced
cost of feed production because of increased sales, and 5)
improved quality of pork as a product.

These benefits were accompanied by several problems
including: 1) High required capital investment and capital
cost in animals and facilities, 2) High costs of assisting
lease holders with disease problems and other management
problems, 3) Difficulty in recovering leased animals, 4)
Difficulty in encouraging dealers to service leases, 5)
High accounting, record keeping, and legal expenses in
operating lease programs over a wide area, and 6) Limited

problems with lease holders not making rental payments.

Conversion From Leasing to Selling

 

Two of the firms interviewed were beginning to sell
breeding stock as well as lease them. An obvious reason for
this was the current high market price for slaughter hogs

and breeding stock.

148

One firm had already converted their lease program
to a uniform payment system related to current prices for
market hogs. The sales programs offer firms an opportunity
to get faster returns on their invested capital. They also
offer firms returns more in proportion to Opportunity costs
of the gilts sold than did future payment lease programs.
Both firms contemplating sales of breeding stock expected
additional feed sales to be about the same as under leasing
programs. In both cases, these firms were planning to pro-
mote their breeding stock sales through their feed dealers.
One firm planned to give local dealers a small commission
on the livestock sales. In addition, local dealers would
get the initial contact enabling them to promote their
feeding program to the farmer.

They expected selling of breeding stock to be as
profitable for the feed business as leasing was, while
significantly reducing the accounting and supervising
costs. These firms seemed very interested in providing
the same high quality hogs provided under the lease, but
transferring ownership responsibility to the farmer. They
felt that this would significantly reduce their problems
associated with ownership and remove them from the risk
sharing provision of some leases.

The transformation from leasing to selling will be
accompanied by arrangements for financing. While both

firms agreed that they did not want to be in the banking

149

business, each of them had plans available to finance the
purchase of their gilts in cases where outside financing

may be difficult to obtain.

Farmer Reaction to Sow Leasing

 

The future of sow lease programs and breeding sales
programs depend to a large degree on farmer reaction. Three
studies of sow lease contractees ll, 5, 21] have shown that
farmers entering these contracts were interested in access
to quality inputs, source of credit for production expenses
or expansion, more certainty of gross returns, and technical
assistance with production or marketing [21~p.2f7and 55p.19].
Problems which sow lease contractees had experienced were
lack of COOperation, poor quality of health of hogs, loss
of independence, compulsory involvement of feed firm,
inexperienced fieldmen, complicated or vague contract, and
cost relative to independent production[Zl-p. 20]. In
addition, one study found that many of the contractees had
not read or were unfamiliar with the terms of their contract
[Zl-p. 21].

Interestingly, three Of the items sought by farmers
in sow lease contracts are available from other independent
sources. High quality breeding stock, production capital,
and technical assistance are all available from independent
market sources. Certainty Of returns, or at least some

risk reduction, is available through hedging. The

150

availability of these services, along with farmers' dislike
for loss of independence, and compulsory involvement of
feed firms in contracts as cited above, may mean that firms
Offering breeding stock and offering financing.when neces-
sary are meeting the needs of most farmers.

The leases examined in this study were often hard
to understand or vague. These features, along with the
high incidence of farmers who did not read their leases,
indicates that this form of coordination may be little
better than current alternatives as a means of communica-
tion. Farmers in general have dealt often with oral or
very simple written agreements and are not geared to highly
specified terms or legal language. At the same time, sow
leasing firms are attempting to protect themselves from
future legal complications and specify clearly the behavior
and performance expected. The communication problem
created by these circumstances may limit the success of

production contracting for all parties.

Implications of Sow Leasing

 

Perhaps the most significant implication of sow
leasing for the hog-pork subsector is its effect on breed-
ing stock production. Sow leasing firms, along with several
other firms, have applied genetic principles to improving
breeding stock production on a very large scale. The esti-

mate of 100,000 hogs on lease for the three firms interviewed,

151

while representing less than two percent of the United
States breeding herd, may lead to a substantial incremental
change, ultimately, in the genetic background of the swine
pOpulation.

The application of sophisticated breeding technology
to hog production is producing a new market situation for
breeding animals. Whereas previously farmers have relied
on pure bred herds for boars to upgrade their own breeding
herds, farmers have tended to rely on gilts kept from
their own herds. The availability of high quality gilts
backed by rigid health programs may be changing the pattern
Of farrowing management. Sow leasing may have contributed
to changing farmer patterns by offering farmers an Oppor-
tunity to work with these new types of breeding animals at
reduced costs compared to outright purchase. In fact, the
major benefit of sow leasing to some firms may be the wide
publicity given to the breeding hogs they had developed.

It is too early to determine the rate at which the
new cross breeds being developed will be adopted. It was
clear from the firms interviewed that they believed they
were making a contribution to the overall improvement of
pork through the development of better breeding animals.

Those firms switching their emphasis from leasing
to selling breeding stock were clearly not satisfied with
the risk sharing payment plans of their leases. While

these provisions were desired by farmers, both firms were

152

unwilling to continue sharing the risk of future fluctua-
tions in slaughter hog prices on such a direct basis. All
swine feed firms are affected by slaughter hog prices to
the extent that prices affect profitability of hog produc-
tion and thus affect the overall market for hog feed. The
pricing arrangements in several of the leases resulted in
direct risk sharing. While this direct risk sharing had
potential for damping the hog cycle through more stabilized
returns for farmers, feed firms were apparently unwilling
to absorb possible short run losses due to low market
prices to gain longer run stability. The small scale of
these risk sharing arrangements relative to total United
States hog production may have been a discouraging factor.
A successful effort to stabilize hog production may require
a total readjustment for the subsector. This condition
exists because the degree of control which one firm can
exercise is not sufficient to change the overall pork
production pattern. Thus even though one firm tries to
stabilize pork porduction, the industry remains unstable
and many of the potential benefits of stable production to
the firm are not achieved. It seems likely from the above
example that the current organization of the subsector is
geared to cyclic production and does not provide sufficient
incentives to any one firm or group of firms for a sub-

stantial reorganization to occur.

CHAPTER VI

SUMMARY, IMPLICATIONS, AND
SUGGESTED RESEARCH

Meat packing firms and feed manufacturers have been
using procurement contracting and sow leasing in attempts
to improve their profitability through better control over
their input supply or increased sales of their output.
Among those firms interviewed in this study, the use of
these vertical coordination arrangements has ranged from
experimental to substantial. Evidence found in this study
indicates that while meat packers have experienced some
difficulties with contract procurement the outlook for
expanded use of this procurement method is good. The
degree of expansion will be limited by the hesitance of
packers to contract for more than twenty percent of their
supply requirements. Current plans for implementation of
contract programs are hampered by current high price levels
which limit the attractiveness of contract selling from
the farmer's viewpoint. As hog prices decline over the
next two years, there will probably be an effort by at
least two of the firms surveyed to expand their contract
procurement programs. The remaining firms currently are

taking a wait and see posture. Their entry into major

153

154

contract programs will be conditioned by the success of
their competitors and the requests of their suppliers.

Feed manufacturers interviewed were mixed in their outlook
for sow lease programs. Two firms were de-emphasizing
leasing in favor of breeding stock sales while the third
firm was expanding its breeding stock program. It is clear
from our interviews and other develOpments in breeding
stock production and sales that several large firms will be
Offering breeding stock for sale to farmers. The future
importance of leases in the market for breeding stock is
not clear.

Meat packers and feed manufacturers have experienced
problems in attempts at production contracting. In these
vertical coordination arrangements where the meat packer or
feed manufacturer owned the livestock and the farmer pro—
vided labor, facilities, equipment, and variable production
inputs the results had been unsatisfactory to the integra-
ting firms. These integrating firms were unable to achieve
the degree of control they desired at an acceptable cost
level. They were apparently unable to structure their con-
tractural agreements with sufficient incentives for farmers
to give the desired level of care to the animals owned by
the integrating firm. Many of the firms expressed the
belief that the performance generated when farmers owned

the animals was superior. The benefits and experience of

155

meat packers and feed manufacturers with production.con-
tracting and sow leasing have conditioned.some of them to
shun coordination arrangements of this type.

Feed manufacturers have apparently found-that they
can profitably manage the highly specialized production of
breeding stock. While efforts to manage large scale sow
leasing programs have been abandoned or de-emphasized by
some firms, they are continuing to produce breeding stock
using contract production to increase the size of their
breeder herd. In this case, profits from the sale of
breeding stock are high enough to cover the management
costs of the breeder herd program which are reduced because
of the small number of contracts involved.

Sow leasing programs have evolved for some feed
firms into a major effort to produce and sell breeding
stock. They feel that this new effort will afford them
similar gains in feed sales without the high accounting,
servicing, and financing costs encountered in leasing sows.
All the firms interviewed felt that the contribution to feed
sales from this service would decrease as more feed manu-
facturers entered sow leasing or breeding stock sales.
These feed manufacturers may find that they have a competi-
tive advantage over other firms entering the breeding stock
market. The ability of feed manufacturers to Offer a
complete package of swine production inputs through their
local dealers may give them an edge in breeding stock sales

over more specialized firms.

156

While sow lease programs at a very large scale may
not present a profitable alternative, the experience of
one firm interviewed (supported by views of the other firms)
indicates that small scale sow leasing or similar arrange-
ments are feasible. A key constraint on the size of sow
lease Operations from the feed firms vieWpoint was the
high capital requirement. This high capital requirement
along with the relatively slow pay back rate was a major
reason firms had changed payment provisions in their leases.
Firms with available capital and more limited investment
alternatives may find sow leasing attractive.

Both packer procurement contracting and sow leasing
work as competitive services differentiating firms adOpting
them from their rivals. In this light, they place firms
Offering these arrangements along with other services at
an advantage over other firms. There are few indications
from this study or the others surveyed that any one firm
size has advantages in offering either of these arrange-
ments. There are some indications that procurement con-
tracting may be facilitated by the existence of on-going
grade and yield procurement programs and the associated
record keeping services. Similarly there was some indica-
tion that sow leasing was limited in scale by the high
level of supervisory management required. Firms inter-
viewed were not particularly geared to service farmers at

any particular contract volume. There was some evidence

157

that many of the initial contracting efforts that had been
attempted involved large volume producers or producer groups.
This was primarily due to the experimental nature Of these
efforts. Large scale producers would have the ability to
Offer packers substantial numbers of hogs for delivery at
specific times. This advantage may be eroded by the packers'
resistance to putting all his eggs in one basket. The
generally expressed desire to serve their farmer suppliers
indicates that packers will generally not limit contract
agreements to large scale producers.

The entry of major feed manufacturers and other
large agribusiness firms into the production and sale of
breeding swine may place smaller scale swine breeders at an
initial disadvantage. If, as has been suggested earlier,
these large firms are successful in changing farmers patterns
of breeding swine selection, this may open new opportunities
for all swine breeders. It is certain that the availability
of breeding swine from these firms creates the need for an
increased dissemination of information on breeder swine
prices. The market for breeding animals could develop into
a highly competitive one. There is some danger, however,
that the competition in this market will take place in an
atmosphere clouded by performance claims that farmers are
unable to verify or evaluate. The need for consumer pro-
tection may be as great in this market as in any other where

the manufacturers claims are not easily tested by buyers.

158

Wholesalers and retailers of pork products can look
forward to efforts on the part of meat packers to add sta—
bility to this side of their market. Some meat packers
have already taken steps toward branding and promotion of
fresh pork products. The evidence presented here on the
returns available from reduced supply fluctuation indicate
the need to stabilize product demand in order to take full
advantage of scheduling economies. While some meat packers
already experimented with contract sales via verbal agree-
ments, these have not been widespread. The incidence of
sales contracting among major meat packers may be encour-
aged by their inability to enter retailing directly because
of antitrust restraints. For smaller meat packers these
restraints have not been so specific; thus there may be
efforts by these packers to enter some phases of whole-
saling and retailing. Centralized cutting and packaging
Of pork may become an effective way for some packers to
improve product quality and both stimulate and stabilize
product demand.

Consumers as well as wholesalers and retailers can
look forward to more uniform quality pork. The efforts at
improved breeding stock production along with packer eval-
uation indicating an improved quality Of hogs being produced
indicates a general improvement in pork quality. This
improvement in quality will be encouraged by grade and

yield purchase programs within or outside contracting. The

159

possibility of passing along substantial cost savings from
improved regularity in the production and.marketing of hogs
seems unlikely in the gear future. Procurement contracts
do afford an opportunity for improved communication of
consumer preferences to producers. While the contracts
examined here don't contain the specific size of pork.chops
to be produced, they do provide quality evaluation systems
which more accurately communicate and reward demanded pork
characteristics than have traditional market price coordin-
ation systems.

Implications for Subsector
Performance

In an earlier section we discussed four performance-criteria
which were particularly applicable to the Hog-Pork.sub-
sector. It is important to assess the effects of sow lease
programs and packer procurement contracts, as they are

evolving, on these dimensions of performance.

Efficiency

 

Sow lease programs and packer procurement contracts
both offered opportunities for improved productivity and
improved communication of consumer preferences. .At the
feed manufacturer level sow lease programs have not and
likely will not reach volume levels which might lead to
substantial economies in feed production. While the pro-

duction of breeding stock may lead to improved utilization

160

of some of the excess capacity in feed manufacturing the
savings generated at current production levels are limited.
Breeding stock production may however produce a better
degree of communication between feed manufacturers and
farmers and lead to more rapid adjustments in feed products
in response to changing requirements of hog production.
Feed manufacturing will probably have a greater increase in
efficiency if the efforts of meat packers to stabilize
production through procurement contracts are successful.
This stabilized production of hogs would make possible the
organization of feed manufacturing facilities at efficient
scales without the need for a wide range in feed production
capacity.

At the farm level sow lease programs and breeding
stock sales by feed manufacturers offer the farmer the
benefits of extensive genetic research and development and
thus a potential improvement in production efficiency.
Packer procurement contracts offer farmers the opportunity
to produce for a predetermined or stabilized price and at
a specified quality level. The grading and evaluation
systems associated with these contracts give the farmer a
more direct and accurate indication of value of his hogs to
consumers and thus improves pricing efficiency.

At the meat packer level there is an increase in
productivity possible if supply of hogs can be stabilized

through procurement contracts. It is also possible that

161

improved quality hogs through the efforts of feed manufac-
turers and other breeding firms will result in higher
transformation rates of pigs into pork.

At the wholesale retail level packer procurement
contracts and breeding stock production are potential
sources of a more uniform quality and more stable quantity
of pork products. This may allow.firms to rationalize
production levels and capital investments at more efficient
levels. Procurement contracts also Offer wholesalers and
retailers the potential for increased specification pur-

chasing for specialized markets.

Equity

The degree to which benefits and costs of improved
vertical coordination through procurement contracting or
sow leasing will be equitably distributed is difficult to
predict. As these arrangements have evolved they have been
primarily controlled by the meat packers or feed manufac-
turers offering the particular program. The increasing
concentration in hog purchasing produces a situation in
which meat packers could potentially Offer contracts with
inequitable terms on a take it or leave it basis. Under
present market conditions there are adequate alternatives
for farmers such that an inequitable contract would be
passed up by farmers because of better available market

alternatives. If buyer concentration increases, this degree

162

of competition may disappear as the number of available
alternatives disappear. This may indicate as has been
suggested earlier the need for contract standardization
and a national market for these standardized contracts to
offset local oligopsony. The general tendency of farmers
not to read or understand the contracts they were leasing
or producing under also indicates the possibility of
inequitable treatment. It is desirable in this context to
explore the overall legal sophistication of farmers and
provide extension aid to insure that farmers are aware of
the performance expected in the agreements that they sign.
In a similar vein it may be necessary to insure that con-
tracts are available uniformly to farmers who can meet the
contract performance standards.

In the market for breeding swine there are possi-
bilities that small scale breeders will suffer from the
competition of large firms both in and outside feed manu—
facturing. In this context it may be desirable to encourage
a government-sponsored breeding stock "certification" and
price intelligence program to insure a high degree of
competition in this market. This would insure that farmers
had an equal Opportunity to compare quality and price of

breeding stock from different firms.

163

Stability

 

Major improvements in the stability of hog pro—
duction are also a potential benefit of improved vertical
coordination. Only two of the contract procurement pro-
grams being tried or considered by meat packers offer
incentives for increased production stability. In both
of these programs there are pricing mechanisms which would
tend to discourage the peaks and valleys in the hog cycle.
These contracts also call for a two to four year commitment
to produce hogs at specified rates. The major limitations
to these contracts is their limited extent of coverage in
terms of total hog production. There also may be a ten-
dency for these contracts to attract farmers who are
already primarily committed to hog production and thus
currently produce at stable levels. This tendency could
limit the effectiveness of such contract programs in
stabilizing the "in and out" hog producers.

If sow lease programs continue a trend toward
selling or shift to rental payment systems which are not
risk sharing in nature, then their effects on hog produc-
tion stability will be diminished. The attitudes toward
risk sharing expressed by feed manufacturers in our survey
indicate that a move away from risk sharing arrangements

is likely.

164

In terms of overall system stability, the current
Operating procedures at the various levels within the
system are geared to an unstable cyclic production pattern.
The reactions of firms interviewed in this study indicate
that, even in their efforts to reduce this system insta-
bility, these firms hedge against fluctuations. The upper
limit on contracting as a percentage of total procurement
indicated by meat packers is an example of this. This
tendency is accentuated by the inability of a single firm
to exercise control over the production cycle and capture
the benefits of such control. Thus firms attempting control
systems to increase stability are often disappointed in the
returns to these Operations.

Offsetting these experiences is a realization and
belief (among at least two of the packers and one of the
feed manufacturers interviewed) that there are substantial
benefits to be gained if the system can be stabilized.

This belief will encourage these firms to continue efforts
to stabilize the system.

The major effects of sow leasing and packer pro-
curement contracting on the price of pork products will be
on production costs. In as much as these arrangements
result in higher quality, more efficient hog production and

marketing, they will slow price increases for pork products.

165

Progressiveness

Both sow leasing and packer procurement contracting
will likely encourage a faster rate of acceptance of new
production technology and new product develOpment. The
entry of feed manufacturers into the production of breeding
swine has focused a substantial amount of new capital and
energy into this area. This will likely result in a more
rapid rate of develOpment of genetically superior swine.
The large scale production of these high quality animals
coupled with an agressive and wide spread promotional cam-
paign will likely result in their more rapid adoption by
farmers.

The develOpment of a large scale breeding swine
industry coupled with the incentives for production of high
yielding hogs found in packer procurement contracts may
result in a more rapid increase in the overall quality of
pork produced. This increase in overall hog quality and
thus the increased availability of high quality pork cuts
may encourage packers, wholesalers, and retailers to
develop new products and merchandising programs. These
new products will likely involve new pork cuts which were
unavailable in sufficient quantity to be profitably marketed

in the past.

166

Suggested.Research

The conclusions and.implications presented above
reveal a need for a better understanding.of some of the
complex economic interactions in the.Hog-Pork-subsector.
Feed manufacturers, farmers, meat packers, wholesalers,
retailers, and consumers could benefit.from a better under-
standing of those factors which will shape the future of
the pork production and marketing system. Some of the
research topics which require further study are presented
below classified according to the industry or level in the

subsector at which they occur.

Feed Manufacturing

 

At the feed manufacturer level there are several
important research areas. The market for feed and asso-
ciated services at the farm level has received only limited
attention. There is a current need to explore the structure
and performance of the feed industry at the local market
level. It seems likely that this industry is characterized
by high degrees of service competition, excess capacity,
and increasing concentration. Documentation of these
trends, if they exist at the local market level, would pro-
vide better insight into the effect these firms will have
on the organization of the livestock subsector.

There is a need to examine the compatibility of

feeding technology being developed by feed manufacturers

167

with the pork products demanded by consumers. The entry

Of feed manufacturers into swine breeding opens the possi-
bility for the promotion of input combinations (feed and
livestock) which will result in pork products not meeting
consumer demands. This possibility should be examined in
the context of discovering how farmers react to advertising,
promotion, pricing, and financing of feed and breeding
stock.

The issue of credit availability runs throughout
the Hog-Pork subsector. Access to production financing
was a primary consideration in farmers choosing to lease
breeding stock. The role of feed firms in financing produc-
tion, the control over production implied in these financial
agreements, the application of "truth in lending" principles
to these agreements, and effect on farm organization of
feed firm financing are all important research topics.

The industry's internal firm Operating procedures
need to be identified, as the degree to which they effect
success or failure of particular ventures needs to be
estimated. Because of departmentalization, the combined
benefits of the program weren't being added together, except
perhaps informally. In sow leasing, it was difficult under
current operating procedures for firms to count the total
benefits from sow lease programs as independent profit
centers and as increased sales of hog feed. Current account-

ing systems forced an evaluation of these programs on one

168

of these bases or the other. This seems to imply that
programs with multiple benefits to several areas of firm
Operations are penalized relative to clearly independent
ventures. The effect of these considerations on possible
diversification or vertical integration may discourage some
divisions within firms from instigating complementary
enterprises or doom those enterprises to poor evaluation
and ultimate "failure" whether it's deserved or not.

A detailed description of the market for breeding
swine along with a study of the feasibility of develOping
an accurate information system for wisespread dissemination
of prices and product characteristics in this market is
needed. This would make possible an accurate evaluation
of the impact of the entry of large scale firms into the
breeding swine market and provide farmers and policy makers
with an estimate Of the costs of an improved information

system in this market.

Pork Production on Farms

 

Perhaps the greatest research need pointed out by
this study would be an increased understanding Of how farm-
ers evaluate pricing information, risk, and uncertainty.
These factors and farmers' reaction to them are crucial in
determining the effects of contracting arrangements on pork

production. Until we identify the rule under which farmers

169

decide to enter or change the scale of their hog enter-
prises, we can only speculate about some effects of particu-
lar length contracts, particular pricing arrangements and
other contract terms.

The experience of both feed manufactuers and meat
packers in production contracting highlights the need to
determine the difference in the way farmers react to
contractural incentives versus the way they react when
they own the livestock being cared for. There may be dif-
ferences in these reactions between farmers entering hog
production for the first time and those who are established
hog producers. The ability of contracting firms to provide
incentives for high levels of management input by farmers
is crucial to the future of production contracting. This
problem is accentuated in hog production where current
technology for disease control requires high management
levels.

There is also a need to understand the incentives
necessary to produce delivery timing and product quality
desired in procurement contracting by meat packers. Since
general farmers are occupied during certain seasons with
other crop and livestock enterprises, the payment or reward
required to get specific delivery during these seasons may
be higher than during slack periods. The level of incen—
tives required will determine the profitability of contract—

ing for packers and the kind of producers willing to contract.

170

There is also a need for an in depth study of the
effect of contract selling or production on internal organ—
ization of farm firms and their growth patterns over time.
Risk reduction, capital availability, improved input quality,
and management assistance are factors associated with con-
tracting which may change internal firm management and

growth patterns.

Meat Packing

 

One research area is the description and analysis
of particular market characteristics which favor or inhibit
an increase in contractural arrangements. This might in—
volve a study of selected market areas throughout the United
States to determine how factors such as buyer concentra-
tion, alternative market channels, average volume of hogs
sold, location, strength of farmer bargaining groups and
other factors have effected farmer and meat packer attitudes
and the growth of contract procurement in different markets.

The increasing incidence of contracting Opens a
whole series of questions on the bargaining relationships
between farmers and meat packers. It was unclear from our
packer interviews what role farmer bargaining groups would
play in future contract hog procurement. Packers were
concerned that those with whom they contracted have clear
title to hogs either under their ownership or through

contracts. The advantages and disadvantages for packers

171

and farmers of contracting with bargaining associations
could be a productive research topic. Along with this,
the examination of effective bargaining-strategies.for
individual farmers in their negotiations with packers may
require further study of renegotiation provisions.and
resulting terms of trade in standardized contracts.

The effect Of contracting on market prices and the
examination of terminal market prices as accurate bases
for pricing formulae are topics of continuing interest.
The study of alternative methods of establishing price
bases when terminal market prices became suspect would be
useful.

Wholesaling, Retailing, and
Consumption

 

 

This study has concentrated on vertical coordina-
tion among feed manufacturers, farmers, and meat packers.
There have been some limited retailer and wholesaler inte-
gration into meat packing, and pork processing. Retailers
and wholesalers may however possess unique advantages in
coordinating the system because of their proximity to the
consumer and the possibility of effecting demand for pork
products through promotion. It is important to attempt to
understand current vertical coordination systems between
wholesalers, retailers, and meat packers including the possi-

bility and effects of long and short term contracts,

172

specification buying, working agreements, and open markets
as they are currently organized.

Technological developments in cutting and packaging
of meat may also put increasing pressure on firms to
develOp new vertical coordination systems. In this context
the understanding of the economies of centralized cutting
and packaging of meat at the packer versus retailer level
may indicate the level in the vertical system at which
changes will most likely occur.

There was an impression gained from feed manufac4
turers and meat packers that consumers were ill informed
about the role of pork, fresh and processed, in a balanced
diet. They felt that consumers maintained an image of pork
as a fatty food high in calories and cholestrol and perhaps
hazardous to their health. There may be a need in this
context for research on the properties Of modern pork
products in providing nutritional needs. This does not
imply the need to promote pork as a food but the need for
an accurate evaluation of its characteristics in providing
protein, carbohydrate, and fat as part of a well balanced

diet if such an evaluation does not already exist.

LIST OF REFERENCES

LIST OF REFERENCES

Babb, E. M. and D. G. Frahm. "Hog Contracting, An
Alternative System of Coordination". Purdue University
Seminar on Role of COOperatives in the Pork Industry,
March, 1972.

Bain, Joe S. Industrial Organization. New York:
John Wiley & Sons, Inc., 1959.

 

Barreto, Hernan. "Cost Savings Via Live Hog Supply
Control". Unpublished Ph.D. Dissertation, Michigan
State University.

Bursch, William G. Pricing Structure and Service Costs
in the Retail Feed Market in IllinOis. Department of
Agricultural Economics, Agricultural Experiment Station,
University of Illinois, Urbana, Illinois, AERR-lOO,
Sept., 1969.

 

. "Sow Leasing and Contract Hog Feeding: Pro-

ducer Motivations and Characteristics". Preliminary

Report, Purdue University, Department of Agricultural
Economics, Lafayette, Indiana, March, 1972.

Caves, Richard. American Industry: Structure, Conduct,
Performance. (Second Editibn), Englewood Cliffs, New
Jersey: Prentice Hall, Incs., 1967.

 

 

Dallenback, Lawrence A. and Lehman B. Fletcher.
"Effects of Supply Variations on Costs and Profits Of
Slaughter Plants". American Journal of Agricultural
Economics, 53/4: 600-607, November, 1971.

 

Edwards, Corwin. "Vertical Integration and the Mono-
poly Problem". Journal of Marketing, 10617, No.4:
404-4l0, April, 1953.

 

Federal Reserve Bulletin, Board of Governors, Federal
Reserve System, Washington, D. C., April 1972.

173

10.

11.

12.

13.

14.

15.

16.

17.

18.

19.

174

French, B. C., L. L. Sammet, and R. G. Bressler.
"Economic Efficiency in Plant Operations with Special
Reference to the Marketing of California Pears".
Hilgardia, University of California, Berkeley,
California, 24/19, July, 1956.

 

Hayenga, Marvin L., et al. Vertical Coordination in
the Pork Industry. Department of Agricultural
Economics, Michigan State University, East Lansing,
Michigan, Agricultural Economics Research Report No.
194, February, 1972.

 

 

Holder, David Lawrence, "The Economic Feasibility of
Computerized Forward Contract Market for Slaughter
Hogs", Unpublished Ph.D. Dissertation, Michigan State
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Kaysen, Carl and Donald F. Turner. Antitrust Policy.
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Logan, Samuel H. "A Conceptual Framework for Analyzing
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Love, Harold G. and Milton Shuffet. "Short Run Price
Effects of a Structural Change in a Terminal Market",
Journal of Farm Economics. 47/3: 803-812, August,

 

1965.

Matthes, R. C. "A Management Information and Control
System for Hog Fabrication", Unpublished Ph.D. Disser-
tation, Purdue University, 1970.

Mighell, Ronald L. and Lawrence A. Jones. Vertical
Coordination in Agriculture. Farm Economics DiV151on,

 

Economic Research Service, U.S. Department of Agricul-
ture, Agricultural Economics Report No. 19, February,
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Mueller, Willard F. "Vertical Integration and Public
Policy Toward Vertical Mergers. Paper prepared for
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Business Administration, University of California,
Los Angeles, March 13, 1968.

National Association of Food Chains. "Improving
Profits in Marketing and Distribution of Meat",
NAFC-AMI, Management Clinic on Meat, Hollywood Beach,
Florida, February 25, 1964.

20.

21.

22.

23.

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26.

27.

28.

29.

175

National Commission on Food Marketing. "Organization
and Competition in the Livestock and Meat Industry".
U. S. Government Printing Office, Technical Study

No. 1, Washington, D. C., June 1966.

Newcome, Steven, et al. "Producing and Marketing Hogs
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University of Missouri, Columbia, Missouri, Special
Report 135, September, 1971.

Sichel, Werner. "Vertical Integration as a Dynamic
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Snyder, James C. and Wilfred Candler. "A Normative
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Sosnick, Stephen H. "Toward a Concrete Concept of
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Stout, Thomas T., Ed. "Long Run Adjustments in the
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199, Ohio Agricultural Research and Development Center,
Wooster, Ohio, March, 1970.

U.S. Bureau of the Census, Census of Manufacturers,
1967, Volume II Industry Statistics, Part I, Major
Groups 20-24, U.S. Government Printing Office,
Washington, D. C., 1971.

U.S. Bureau of the Census, Census of Manufacturers,
"Summary and Subject Statistics, Volume I". U.S.
Government Printing Office, Washington, D. C., 1971.

U.S. Department of Agriculture. "The Formula Feed
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Research Service, ERS 494, Washington, D. C., November,
1971.

U.S. Department of Agriculture, Livestock and Meat
Statistics., Statistical Reporting Service, Consumer
and Marketing Service, Statistical Bulletin No. 333,
Annually, 1965 through 1972, U.S. Government Printing
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30.

31.

32.

33.

34.

35.

176

U.S. Department of Agriculture. "Pork Marketing
Report, A Team Study". Farmer Cooperative Service,
Washington, D. C., August, 1972.

U.S. Department of Agriculture. Grain Market News.
Grain Division, Consumer and Marketing Services,
Weekly, Independence, Missouri.

 

U.S. Department of Agriculture. Feed Market News.
Grain Division, Consumer and Marketing Service,
Weekly, Independence, Missouri.

 

U.S. Department of Agriculture. Livestock, Meat,
Wool Market News. Livestock Division, Consumer and
Marketing Service, Weekly, Washington, D. C.

 

 

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New York, Midwest Edition, Commodities Page, January
10, 1973.

Williams, Willard and Thomas T. Stout. Economics of
the Livestock and Meat Industry. New York: The
Macmillan Company, 1964.

 

 

 

 

 

APPENDIX

 

177

TABLE A.1

SEVEN MARKET AVERAGE PRICES ANIDCINTFACT PRICES FOR SLAUGHTER HOGS
[Ellfliiifl 1965-840424 1972

 

 

 

ltlfllux
a./ Cmtmct Cmtract Calumet Contract
met— 09 Price Price Price
Year Pknth Price I 11 111 IV
1965 12 28.07 25.00 25.80 26.25 26.80
1966 1 27.93 25.00 25.70 26.45 26.70
1966 2 27.80 25.00 25.60 26.35 26.60
1966 3 24.41 24.41 23.06 23.93 24.06
1966 4 22.26 22.26 21.44 22.23 22.26
1966 5 23.16 23.16 22.12 23.04 23.12
1966 6 24.72 24.72 23.29 24.18 24.29
1906 7 25.09 25.00 23.57 24.47 24.57
1996 8 25 75 25.00 24.06 25.00 25.06
1966 9 23.16 23.16 22.12 23.04 23.12
1966 10 21.57 21.57 20.93 21.57 21.57
1966 11 19.87 19.87 19.65 19.87 19.87
1966 12 19.67 19.67 19.50 19 67 19.67
1967 1 19.46 19.46 19.35 19.46 19.46
1967 2 19.38 19.38 19 28 19 38 19.38
1967 3 18.43 19.00 19.00 19 00 18.57
1967 4 17.62 19.00 19.00 19 00 17.96
1967 5 21.83 21.83 21.12 21.83 21.83
1967 6 22.89 22.89 21 92 22.80 22.89
1967 7 22.58 22.58 21.68 22.52 22.58
1967 8 21.04 21.04 20.5 21.04 21.04
1967 9 19.46 19.46 19.35 19.46 19.46
1967 10 18.16 19.00 19.00 19.00 18.37
1967 11 17.36 19.00 19.00 19.00 17.77
1967 12 17.29 19.00 19.00 19.00 17.72
1968 1 18.31 19.00 19.00 19.00 18.48
1968 2 19.41 19.41 19.31 19.41 19.41
1968 3 19.07 19.07 19.05 19.07 19.07
1968 4 19.00 19.00 19.00 19.00 19.00
1968 5 18.88 19.00 19.00 19.00 18.91
1968 6 20.43 20.43 20.07 20.43 20.43
1968 7 21.48 21.48 20.86 21.48 21.48
1968 8 20.08 20.08 19.81 20.08 20.08
1968 9 19.93 19.93 19.70 19.93 19.93
1968 10 18.29 19.00 19.00 19.00 18.47
1968 11 17.92 19.00 19.00 19.00 18.19
1968 12 18.76 19.00 19.00 19.00 18.82
1969 1 19.77 19.77 19.58 19.77 19.77
1969 2 20.41 20.41 .06 20.41 20.41
1969 3 20.69 20.69 20.27 20.69 20.69
1969 4 20.38 20.38 20.03 20.38 20.38
1969 5 23.14 23.14 22.10 23.03 23.10
1969 6 25.16 25.00 23.62 24.53 24.62
1969 7 26.05 25.00 24.29 25.04 25.29
1969 8 26.91 25.00 24.93 25.68 25.93
1969 9 25.94 25.00 24.21 25.15 25.21
1969 10 25.53 25.00 23.90 24.82 24.90
1969 11 25.77 25.00 24.08 25.02 25.08
1969 12 26.93 25.00 24.95 25.70 25.95
1970 1 27.40 25.00 25.30 26.05 26.30
1970 2 28.23 25.00 25.92 26.36 26.92
1970 3 25.94 25.00 24.21 25.15 25.21
1970 4 24.02 24.02 22.76 23.62 23.76
1970 5 23.53 23.53 22.40 23.38 23.40
1970 6 24.04 24.04 22.78 23.63 23.78
1970 7 25.13 25.00 23.60 24.50 24.60
1970 8 22.12 22.12 21.34 22.11 22.12
1970 9 20.35 20.35 20.01 20.35 20.35
1970 10 17.91 19.00 19.00 19.00 18.18
1970 11 15.69 19.00 19.00 19.00 16.52
1970 12 15.67 19.00 19.00 19.00 16.50
1971 1 16.25 19.00 19.00 19.00 16.94
1971 2 19.43 19.43 19.32 19.43 19.43
1971 3 17.13 19.00 19.00 19.00 17.60
1971 4 16.19 19.00 19.00 19.00 16.89
1971 5 17.43 19.00 19.00 19.00 17.82
1971 6 18.38 19.00 19.00 19.00 18.53
1971 7 19.84 19.84 19.63 19.84 19.84
1971 8 19.05 19.05 19.04 19.05 19.05
1971 9 18.91 19.00 19.00 19.00 18.93
1971 10 19.80 19.80 19.60 19.80 19.80
1971 11 19.39 19.39 19.29 19.39 1939
1971 12 20.98 20.98 29.49 20.98 20.98
1972 1 24.84 24.84 23.38 24.27 24.38
1972 2 25.61 25.00 23.96 24.89 24.96
1972 3 23.56 23.56 22.42 23.40 23.42

 

g/Prlee per 11mm panda for U.S.D.A. No. 2-3, Bum and 0116:, 220440 palm.

Source: tinted States Wt 01' Agdculture, livestock at! he: Stadatiee, Statistical

 

Bulletin 333, We Research Service, Wm, D.C.

1.7é3

 

.893 .um .88» 88 88382 .858 osNuONN .TN .oz .320 98 26.56 .958 60.852 .86 8E}.

 

.o.n .copwcHnma: .moHpnam
5882 686860 .mmm .62 59.53 gfimufim «83238.0 68: 98 68693 .vusHaog .8 6:05.88 6330 835 "8.58

 

 

sm.mH mN.mN H NHmH ms.NN os.mN N ONNH HN.NH ms.aH m mmmH
mm.mH NG.HN NH HHaH mm.NN oe.eN H oemH em.mH mm.mH N momH
Nm.mH OH.ON HH HHmH me.HN NG.NN NH momH mo.0N No.mH H momH
mm.mH mN.0N OH HHNH om.HN oa.mN HH momH mm.0N :G.NH NH NmmH
mo.oN mo.mH m HemH Gm.HN mm.mN OH momH mm.0N mm.eH HH emmH
mN.HN me.mH m HNmH mm.HN No.0N m momH NG.ON mm.mH oH HomH
mH.HN em.0N e HemH Hm.NN sN.HN m mmmH GH.HN os.mH m NGNH
HG.ON mN.mH m HNNH NH.NN mm.GN e momH om.HN so.HN w HomH
GN.ON sm.eH m HemH mm.ON ss.mN m momH 5N.HN em.NN N HemH
mH.mH mm.mH s HemH om.mH HG.MN m mmmH mN.HN mo.NN m HGNH
me.mH NN.HH m HHaH m=.mH 20.0N s momH Ho.HN mo.NN m HGNH
03.0N em.mH N HemH ms.mH om.o~ m mmmH HH.HN mm.NH : HomH
mo.HN HG.GH H HHNH am.mH sG.ON N mme em.HN om.mH m HomH
Nm.HN mH.mH NH oemH No.0N ON.ON H meH mH.HN mm.aH N HomH
Hm.HN m=.mH HH oemH as.ON NH.mH NH momH mm.HN HH.NH H NGNH
Ho.mN MN.mH OH oemH Hm.mH Nm.wH HH moaH oN.NN No.0N NH momH
mo.=N mm.ON m oemH mm.mH Ne.mH 0H momH mm.NN HH.0N HH oomH
GH.mN H:.NN m oemH :N.ON w=.ON m @25H No.MN sm.HN OH oomH
so.oN Ho.mN e oemH No.HN mo.oN m momH Hm.=N 0N.mN m GmmH
mo.mN mm.sN o oemH Nm.ON oo.NN H momH om.mN =G.mN m omaH
Nm.sN Nm.=N m oemH HH.ON MH.HN o momH He.=N HH.mN H @65H
.3. N Nm. :N s 03H Ne. H 9.3 m 33 BEN H. mm o womH
5 . MN ms. 8 m 08H mm . mH om. mH : momH mm. :N me. mm m 83
033m 005 582 .80» 00E 03pm 5:2 .80» 005 005 5.5a .80»
68.580 86025.. 68.880 \mfifias 88680 8.6092...

 

 

 

 

NHmH sm<az<eummmH H<z .stezus

mmUHmm 6% Eggm 92¢ WBHME g WHDQH .Bm

N.< MESH.

1.759

TABLE A.3

PRICESANDDFEIESTRMELEDINCWMGHDMGJWCPPRIE
W , EBRUARY 1966-113m 1971

 

 

 

Feeder Inter- Feeder Inter-
Pi 5804‘ Corn est Pi 8801 Com est
Year' nut: Ekice—- Price—[r Prices! Rateg/ Year' 981: Price- Price—/ Prices! Rateg/
1966 2 25.19 77.30 1.35 5.00 1969 1 14.57 69.80 1.20 6.75
1966 3 25.02 71.50 1.33 5.50 1969 2 15.34 69.90 1.18 7.00
1966 4 23.19 75.50 1.35 5.50 1969 3 16.81 76.60 1.19 7.00
1966 5 23.44 80.30 1.35 5.50 1969 4 18.85 73.30 1.25 7.50
1966 6 21.30 92.70 1.38 5.50 1969 5 19.13 76.10 1.33 7.50
1966 7 17.69 97.20 1.48 5.75 1969 6 18.19 77.50 1.33 7.50
1966 8 17 .59 97 .20 1 .55 5 .75 1969 7 17 .85 77 .30 1.31 8.50
1966 9 17.94 97.90 1.51 5.75 1969 8 18.69 76.90 1.28 8.50
1966 10 17.56 82.20 1.48 6.00 1969 9 19.85 72.70 1.22 8.50
1966 11 16.70 78.90 1.42 6.00 1969 10 20.91 75.40 1.23 8.50
1966 12 16.12 84.60 1.46 6.00 1969 11 20.10 69.90 1.21 8.50
1967 1 15.56 81.70 1.46 6.00 1969 12 23.00 82.90 1.23 8.50
1967 2 15.84 79.50 1.46 5.62 1970 1 25.06 87.50 1.26 8.50
1967 3 16.35 76.60 1.47 5.62 1970 2 26.56 85.25 1.28 8.50
1967 4 16.22 74.50 1.39 5.50 1970 3 28.09 71.80 1.27 8.50
1967 5 17.10 73.70 1.43 5.50 1970 4 27.60 74.60 1.30 8.00
1967 6 16.32 78.10 1.42 5.50 1970 5 24.25 71.20 1.31 8.00
1967 7 16.03 78.20 1.38 5.50 1970 6 21.19 74.70 1.37 8.00
1967 8 16.15 78.70 1.28 5.50 1970 7 18.72 82.90 1.42 8.00
1967 9 16.92 79.20 1.24 5.50 1970 8 15.91 84.00 1.51 8.00
1967 10 16.29 71.80 1.22 5.50 1970 9 16.17 81.20 1.53 8.00
1967 11 14.81 71.90 1.13 5.50 1970 10 14.81 77.25 1.46 7.50
1967 12 15.00 73.40 1.20 6.00 1970 11 12.72 77.90 1.45 7.50
1968 1 14.40 75.10 1.20 6.00 1970 12 11.18 82.00 1.52 7.00
1968 2 15.40 74.50 1.19 6.00 1971 1 10.28 80.25 1.59 6.75
1968 3 16.32 75.00 1.18 6.00 1971 2 13.03 77.50 1.57 6.00
1968 4 16.62 74.60 1.17 6.00 1971 3 13.82 77.00 1.55 5.75
1968 5 17.29 75.00 1.18 6.50 1971 4 14.50 74.25 1.52 5.25
1968 6 15.84 79.50 1.17 6.50 1971 5 14.78 78.25 1.48 5.37
1968 7 15.06 82.80 1.16 6.50 1971 6 13.72 81.50 1.55 5.50
1968 8 15 .75 84.40 1.09 6 .50 1971 7 13.13 84.25 1.45 5.50
1968 9 17.16 85.10 1.09 6.50 1971 8 14.25 78.75 1.22 6.00
1968 10 16.25 78.20 1.10 6.12 1971 9 13.80 73.25 1.06 6.00
1968 11 14.81 73.50 1.16 6.12 1971 10 15.44 74.75 1.01 6.00
1968 12 14.67 71.60 1.16 6 .25 1971 11 16 .22 78.50 1.07 5.75
1971 12 17.90 86.00 1.07 5.37

 

 

yFeechr pig prices are per head as reported for central Illinois, U.S.D.A. No. 1 and 2,
few 3, 160-50 pomds.

E/ Soybean oil neal prices are per ton, 44 percent mrestricted, Decatur, Illinois.
E/Com prices are per bushel, No. 2 yellow, at St. Louis, Missouri.
9! Interest rate is the prime rate as charged by naJar banks to their best custarers.

Sources: lhited States Department of Agriculture, Livestock, that, Wool fight Newa, livestock
Division, Consumer and Mating Service,Wm, D. 0.

United States Departmnt of Agriculture, Feed Market News, Grain Division, Cmsuner and
briefing Service, Washingtm, D. C.

Lhited States Department of Agriculture , (rain West News, Grain Divisim, Canwer and
Meeting Service, Washingtm, D. C.

Board of Governors, deeral Reserve System, FEderal Reserve BulletinJ April, 1972,
Washingtm, D. C.

   

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