1. Econ 337, Spring 2013 ECON 337: Agricultural Marketing Chad Hart Associate Professor chart@iastate.edu 515-294-9911 Lee Schulz Assistant Professor lschulz@iastate.edu 515-294-3356

2. Econ 337, Spring 2013 Today’s Topic More on Livestock Marketing

3. Econ 337, Spring 2013 Market Timing  Cycles  Seasonals  Marginal costs and returns

4. Econ 337, Spring 2013 What Causes Cycles  Response to economic signals  Time lag  Psychology  Biology  Investment  Livestock production  Crop production  Land development

5. Econ 337, Spring 2013 Livestock Marketing Information Center Data Source: USDA-NASS

6. Econ 337, Spring 2013 Livestock Marketing Information Center Data Source: USDA-NASS, Compiled & Analysis by LMIC

7. Econ 337, Spring 2013 Livestock Marketing Information Center Data Source: USDA-AMS & USDA-NASS, Compiled & Analysis by LMIC

8. Econ 337, Spring 2013

9. Seasonal Price Patterns  Patterns that repeat themselves with some degree of predictability within a year’s time frame.  Driven by supply and demand factors that are impacted by time of year  Weather  Holidays  Input prices

10. Econ 337, Spring 2013 Seasonal Pricing Patterns Source: USDA, NASS, Monthly Price Data 1980-2011

11. Econ 337, Spring 2013 Livestock Marketing Information Center Data Source: USDA-AMS, Compiled & Analysis by LMIC

12. Econ 337, Spring 2013 Average Profit per Head 2002-2011 (ISU Estimated Returns -- Farrow-to-Finish) May = $16.74 Jun = $15.66 Jul = $13.73 Aug = $12.66 May through Aug = $14.70 Rest of the time = -$2.38 Jan = -$4.57 Feb = $1.03 Mar = -$0.98 Apr = $3.16 Sep = $3.59 Oct = -$2.71 Nov = -$10.07 Dec = -$8.48

13. Econ 337, Spring 2013 Average Profit per Head 2012 (ISU Estimated Returns -- Farrow-to-Finish) May = -$10.17 Jun = $22.85 Jul = $16.51 Aug = -$14.05 May through Aug = $3.78 Rest of the time = -$8.38 Jan = -$1.56 Feb = $3.42 Mar = $1.18 Apr = -$8.82 Sep = -$53.63 Oct = -$30.78 Nov = -$38.46 Dec = -$31.22

14. Econ 337, Spring 2013 How to Calculate Seasonal Index  Pick time period (number of years)  Pick season period (month, quarter)  Calculate average price for season  Calculate average price over time  Divide season average by over time average price x 100

15. Econ 337, Spring 2013 U.S. Cattle Prices, Cattle 500 Lbs. or Higher JanFebMarAprMayJunJulAugSepOctNovDecAnnual 200267.4070.0070.6067.3065.1064.0063.7064.4064.5064.6067.3070.4067.40 200372.9073.9072.6074.5075.5074.9075.8079.3084.9091.5093.4090.4072.90 200481.1078.5083.7084.9088.5089.8088.0087.6085.9086.5085.3086.7081.10 200589.1088.8091.0093.7092.1088.0085.0084.4088.0090.4090.8093.3089.10 200695.0092.4087.9084.8082.2084.0085.8087.2090.0088.3084.4083.1095.00 200783.7086.1091.6093.7092.8088.8089.0091.4093.1090.9089.9089.2083.70 200887.5089.0087.9086.8091.3091.9095.0095.8094.2087.4084.3079.7087.50 200980.1078.9079.1083.8083.2080.1080.9080.4080.5079.2079.6078.5080.10 201082.3085.7090.4095.6094.7090.4091.7093.5094.1093.1094.0098.1082.30 2011107.00108.00115.00119.00112.00107.00111.00 112.00117.00120.00 107.00 Avg.84.6185.1386.9888.4187.7485.8986.5987.5088.7288.8988.9088.9487.36 Ratio96.9%97.4%99.6%101.2%100.4%98.3%99.1%100.2%101.6%101.8%

16. Econ 337, Spring 2013 Using Seasonal Index to Forecast  Observe price in time t 1 P 1  Forecast price in time t 2 P 2  Start with P 1 / I 1 = P 2 / I 2  Then P 1 x I 2 / I 1 = P 2  Assume that cattle are selling at $125/cwt in February. What is the forecast of July?

17. Econ 337, Spring 2013 Cost of Production  Raised livestock  Farrow to finish, Cowherd to finish  Accumulate cost from birth through finish  Relatively stable cost over time  Impacted by input prices and production  Feed is typically 60-70% of cost  Low productivity increases the cost of those that make it to finish because the fixed costs are divided by a smaller number.

18. Econ 337, Spring 2013 Cost of Production  Purchased feeder livestock  Derived demand for feeder animal  Highly variable price  Depends upon  Expected selling price for finished animal  Feed costs

19. Econ 337, Spring 2013 Cost of Production Budgets  Starts with production function  Incorporates input prices  Project cost per unit sold  Variable $/unit  Total $/unit  http://www.extension.iastate.edu/agdm/livestock/html/b1-21.html http://www.extension.iastate.edu/agdm/livestock/html/b1-21.html

20. Econ 337, Spring 2013

22. Using Budgets in Planning  Project a breakeven “point estimate”  Sensitivity analysis for key variables  Back calculate from revenue to what you can afford to pay for feeder animal  Economic versus financial costs

23. Econ 337, Spring 2013 Objective Based Pricing Strategy 550# steer calf fed to 1200 slaughter weight Cost/hd$/cwt

24. Econ 337, Spring 2013 How Much to Pay for Feeder Animal Work back from total revenue 550# steer calf fed to 1200 slaughter weight Cost/hd$/cwt

25. Econ 337, Spring 2013 http://www.iowabeefcenter.org/Software/Cattle_feeding_budgets.xls

26. Econ 337, Spring 2013 Contractual Relationship  Focus today is not on internal transfer  Only relationship is the marketing contract  Typically 3-10 years in length or evergreen  Defines delivery schedules, carcass specifications, pricing, and in some cases production practices  Small portion of contracts have risk sharing provisions

27. Econ 337, Spring 2013 Contract Specs  Product specifications  PQA, Right to approve inputs  Method of pricing  Which markets and formula  Delivery scheduling  Short and long term  Exemptions

28. Econ 337, Spring 2013 Types of Contracts  Formula  Most common contract  Price tied to another market, typically spot  No risk share  Examples:  3-Day rolling average of ISM weighted average +$1.50  Last week’s average excluding the high and low  92% of the previous day pork cutout value  Packer does not share risk

29. Econ 337, Spring 2013 Types of Contracts  Fixed window  Formula tied to cash price  Predetermined upper and lower bounds  Share pain and gain outside window  Example: $50 and split 50/50 above and below  Floating window  Formula tied to cash price  Boundaries move with feed prices  Do not share outside of window  Packer shares risk

30. Econ 337, Spring 2013

31. Types of Contracts  Cost-Plus  Price direct function of feed prices  Fixed amount for non-feed costs + known margin  Packer assumes all price risk  Ledger  Floor price is fixed or based on feed prices  Producer is “loaned” the difference between floor and lower cash prices  Loan is repaid at higher cash prices  Packer provides line of credit but not risk share

32. Econ 337, Spring 2013

33. Contract Examples  Iowa Attorney General  http://www.state.ia.us/government/ag/working_for_farmers/contracts/index.html http://www.state.ia.us/government/ag/working_for_farmers/contracts/index.html

34. Econ 337, Spring 2013  Consumer satisfaction  Moisture enhanced pork  Preference for attributes  Growing interest in safety and production  Spot market not sufficient  Premiums and discounts  Market access and risk Motivations for Vertical Linkages

35. Econ 337, Spring 2013  Traditional IO theory  Avoid market power, reduce price volatility, technology complements, minimize transaction costs  Agency theory  Integrate rather than contract to avoid opportunism and shirking by contract partners Motivations for Vertical Linkages

36. Econ 337, Spring 2013  Asset specificity  Firms with more significant relationship-specific investments (RSI) benefit from predictable throughput and prices  As assets become more specialized, the costs of using the spot market increases  Costs are particularly high when food safety and product quality problems occur encouraging greater process control Motivations for Vertical Linkages

37. Econ 337, Spring 2013  The information and characteristics that consumers are demanding may require tighter vertical linkages.  Can the spot market provide the non- measurable process control for consumers?  If so, at what cost?  Who will pay the added costs?  Will greater control speed consolidation? Role for Economists

38. Econ 337, Spring 2013  The great success of formula pricing contracts is likely to lead to its demise.  Producers want an agreement, but fear thin markets.  How much volume is needed for satisfactory price discovery?  Where should it take place?  Who should be involved? Role for Economists

39. Econ 337, Spring 2013  Concerns about contract linkages negatively affecting prices  Research is inconclusive on price impacts.  Thin market implications.  Arguments have been greater in the industry where there is less contracting.  Politically charged debate. Role for Economists

40. Econ 337, Spring 2013 Summary  Marketing contracts are common in hog market  Most common is tied to dwindling cash market for price discovery  Less common but widely used in fed cattle marketing  USDA GIPSA has proposed rules that will restrict and possibly prohibit use of contracts

41. Econ 337, Spring 2013 Class web site: http://www.econ.iastate.edu/~chart/Classes/econ337/ Spring2012/ Have a great weekend!