Agricultural Marketing ECON 337: Agricultural Marketing Lee Schulz Assistant Professor lschulz@iastate.edu 515-294-3356 1

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

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

Efficiency of the industry relative to other livestock industries Efficiency of the industry relative to food industries outside the livestock sector Efficiency of the industry relative to other livestock industries Efficiency of one producer relative to others in the (e.g., beef) industry Efficiency of production + Greater return on investment + Expansion or new participants = Increased production = Lower costs to consumers = Greater consumption Main source of long-term profitability for a producer lies in their efficiency relative to other producers

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

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

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

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

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

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

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

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

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

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

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

Why do profits tend to run in cycles?

Data Source: USDA-NASS Livestock Marketing Information Center

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Number of Cattle and Calves Sold: 2012 CATTLE, ON FEED - OPERATIONS WITH SALES FOR SLAUGHTER, 2012 Rank State County Value Change vs 2007 1 MN STEARNS 494 NC 2 PA LANCASTER 396 3 WI GRANT 287 4 IA SIOUX 272 +1 7 LYON 254 +8 16 PLYMOUTH 136 Number of Cattle and Calves Sold: 2012 CATTLE, ON FEED - SALES FOR SLAUGHTER, HEAD, 2012 Rank State County Value Change vs 2007 1 TX DEAF SMITH 675,448 NC 2 PARMER 609,759 +2 3 CO WELD 560,252 14 IA SIOUX 352,485 -1 34 LYON 128,321 +11 57 PLYMOUTH 58,645 +6

Data Source: USDA/NASS, Census of Agriculture

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

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

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

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

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

2013

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

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

Basic Pork Definitions

Basic Pork Definitions

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

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

Data Source: USDA-NASS Livestock Marketing Information Center

Data Source: USDA-NASS Livestock Marketing Information Center

Data Source: USDA-NASS Livestock Marketing Information Center

Data Source: USDA-NASS Livestock Marketing Information Center

Data Source: USDA-NASS Livestock Marketing Information Center

DECEMBER 1 BREEDING HOGS AND PIGS CHANGE 2007 - 2017 (1000 Head) -120 -80 -60 -37 -30 -25 -20 -19 -18 -16 -15 -10 -8 -5 -3 -2 -1 1 3 5 7 16 20 30 35 50 60 65 75 -120 to -5 -5 to 0 0 to 5 5 to 76 WA& ID DECEMBER 1 BREEDING HOGS AND PIGS CHANGE 2007 - 2017 (1000 Head) Livestock Marketing Information Center Data Source: USDA-NASS

DECEMBER 1 BREEDING HOGS AND PIGS 2017 (1000 Head) 1 2 3 4 5 6 10 17 22 23 25 32 35 45 48 51 80 110 120 140 150 165 190 215 260 430 450 460 530 570 900 1000 0 to 2 2 to 23 23 to 165 165 to 1001 DECEMBER 1 BREEDING HOGS AND PIGS 2017 (1000 Head) Livestock Marketing Information Center Data Source: USDA-NASS

DECEMBER 1 MARKET HOGS AND PIGS CHANGE 2007 - 2017 (1000 Head) WA& ID -1080 -230 -210 -167 -165 -135 -122 -110 -100 -91 -44 -33 -20 -15 -10 -8 -7 -6 -5 -3 -2 -1 1 3 30 50 65 90 130 175 185 209 235 360 830 950 1040 3480 -1100 to -33 -33 to 0 0 to 90 90 to 3481 DECEMBER 1 MARKET HOGS AND PIGS CHANGE 2007 - 2017 (1000 Head) Livestock Marketing Information Center Data Source: USDA-NASS

DECEMBER 1 MARKET HOGS AND PIGS 2017 (1000 Head) 1 2 3 4 6 8 11 12 21 42 47 58 83 91 112 143 154 175 212 230 255 360 460 519 600 890 1060 1130 1345 1740 1935 2710 2950 3170 3740 4820 7930 8100 21800 0 to 80 80 to 500 500 to 2500 2500 to 21801 Livestock Marketing Information Center Data Source: USDA-NASS

Integrated Production Both pork and poultry are primarily large scale vertically integrated sectors Hogs and birds produced under contract for integrators There are independents and small producers, but they comprise smaller share of market

Contract Arrangements Producer – the individual who cares for hogs / birds Integrator – company with contract who will market hogs / birds

Producer Responsibility Operate like independent contractors Facilities – land, builds, and maintains houses, equipment, etc. Operating costs – utilities, supplies, labor Monitoring and controlling health Biosecurity – who gets in Record keeping Manure management (value)*

Integrator Role Own hogs / birds Purchase all feed Provide technical health and nutrition consultation Make marketing decisions When to sell, etc.

Why is this Attractive? Producer? Integrator? No market (price) risk, steady income, access to manure, etc. Integrator? No capital investment, guaranteed supply, etc. Who bears the risk of rising feed prices? Who bears the risk of decreasing output prices?

Trends in meat consumption Less red meat, more poultry Consumption is primarily a measure of production Consumption is not demand Demand – WTP Consumption – heavily influenced by price

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

Data Source: Bureau of Economic Analysis & USDA-ERS, Compiled by LMIC Livestock Marketing Information Center

What is Demand? Critically Important, Yet Often Confused Demand strength Reflects consumer valuation of beef, pork, poultry, etc. underlies total $ available for the industry » drives prices and profitability for all

Example to Think About When shopping for steak and you observe a buy-one-get-one free sale, do you ever buy more than just one steak? The money in your wallet, the physical characteristics of the steak, etc. did not change Yet, your “per capita consumption” of steak increased if you bought 2 rather than 1 steak EXAMPLE OF DEMAND NOT CHANGING » You bought more solely because of lower prices

What is Demand? Per Capita Consumption is NOT Demand = (Domestic Production + Imports – Exports + Cold Storage Adjustments ) / Population All quantity values; no prices in derivation

What is Beef Demand? Demand Quantity Demanded Schedule of quantities consumers would purchase over a range of prices Refers to the “demand curve” economist speak of Quantity Demanded Quantity consumers will purchase at a given price Refers to a point on the demand curve

Standard Supply-Demand Diagram

What Does a Demand Index Tell Us? Demand index indicates how a demand curve moves from one year to the next Measures shifts in demand over time relative to a base year (i.e., 1990=100) Provides no explanation for why demand may have changed » Only indicates that changes have occurred

2017: Per Capita Consumption = -0.004% (Year‐over‐Year) Real Pork Prices = ‐1.1% IF Real Pork Prices +0.006% = 0% Demand Change

Global demand growth critical for U.S. producers 2017: Exported 2.45 mil metric tons of pork & pork variety meat, $6.49 billion 2017: Equated to $53.47/head of each hog processed 2017: 26.6% of U.S. pork and variety meat production exported 2017: Exported 1.26 mil metric tons of beef & beef variety meat, $7.27 bil 2017: Equated to $286.38/hd of each steer & heifer processed 2017: 12.9% of U.S. beef & beef variety meat production exported Data Source: USMEF

Data Source: USDA-ERS & USDA-FAS, Compiled and Forecasts by LMIC Livestock Marketing Information Center

Data Source: USDA-ERS & USDA-FAS, Compiled and Forecasts by LMIC Livestock Marketing Information Center

Data Source: USDA-ERS & USDA-FAS, Compiled and Forecasts by LMIC Livestock Marketing Information Center

Data Source: USDA-ERS & USDA-FAS, Compiled and Forecasts by LMIC Livestock Marketing Information Center

Data Source: USDA-ERS & USDA-FAS, Compiled and Forecasts by LMIC Livestock Marketing Information Center

Data Source: USDA-ERS & USDA-FAS, Compiled and Forecasts by LMIC Livestock Marketing Information Center

Data Source: USDA-ERS & USDA-FAS, Compiled and Forecasts by LMIC Livestock Marketing Information Center

What types of things can affect trade? Trade rules - regs, tariffs, subsidies, etc. Production levels in importing and exporting countries Demand differences between countries Price levels Value of the U.S. dollar

How Can Exchange Rates Impact Trade A change in exchange rate works much like a change in price Weakening U.S. dollar – price decrease for importing countries Strengthening U.S. dollar – price increase for importing countries

Simple Trade Scenario Exchange rate: 1 U.S. Dollar: 5 foreign currency Beef in U.S. costs $5 per pound 25 units foreign currency Importing country import levels based on 25 unit price

Dollar Appreciates Exchange rate: 1 U.S. Dollar: 6 foreign currency Beef in U.S. costs $5 per pound 30 units foreign currency Importing country import levels decrease based on 30 unit price

Dollar Depreciates Exchange rate: 1 U.S. Dollar: 4 foreign currency Beef in U.S. costs $5 per pound 20 units foreign currency Importing country import levels increase based on 20 unit price

How do we classify industries by competition? Perfect competition Monopoly Monopolistic Competition Oligopoly

Competition and the Industries Cow-calf and backgrounding are closest to perfect competition Feedlots are still very competitive, but more concentrated than cow-calf Packing and retailing probably closer to monopolistic competition or oligopoly

What do we know about Competitive Markets? Large number of firms Can’t affect price individually No barriers to entry Homogeneous products What is profit in long-run?

In Competitive Markets… Producers are price takers Price is largely outside of their control Economic profit is zero in long-run Economic profit won’t persist How do we spoil our own markets in commodity agriculture?

Class web site: http://www2.econ.iastate.edu/faculty/hart/Classes/econ337/Spring2018/index.htm