1. Livestock Marketing uPrice discovery uPricing methods uMarketing decisions uSupply and demand

2. Price Determination and Discovery uPrice Determination is the broad forces of supply and demand establishing a market clearing price for a commodity. uPrice Discovery is the process by which buyers and sellers arrive a a specific price for a given lot of produce at a given location for a specific time period.

3. Price Discovery uA human process, subject to relative bargaining power of the buyer and seller. uTwo stage process Evaluate S&D and Pe Estimate the price for the specific trade.

4. Price Determination and Price Discovery S D P Q PePe QeQe

5. Centralized pricing uAll buyers and sellers in one place at one time. + Full and immediate information + Competitive bidding + Equalizes market power - Transaction cost - Physical movement of product

6. Decentralized Pricing uOne-to-one negotiations + Reduced transportation cost + Reduced transaction cost - Depends on skills and information - Higher search cost

7. Hybrid markets uElectronic markets Centralized pricing Decentralized product movement uExamples Satellite auctions Electronic auctions Tel-o-auction E-commerce

8. Formula pricing uPrice discovery from elsewhere uFormula contracts Spot market Cutout price Futures uDo you trust the underlying market for price discovery?

9. Performance issues u“Least cost” method of price discovery uEffect of the mechanism on price behavior uMarketing v. pricing efficiency

10. Information and markets uPrice reporting Role of the government Collection and dissemination and timely reporting of prices that were discovered. Other private treaty buyers and sellers incorporate new information into their negotiation. Facilitates formula pricing

11. Livestock Marketing Decisions uWhat to sell Live, carcass, grid uWhere to sell Type of market Location uWhen to sell Weight, grade, costs

12. What to sell uLive weight One average price for all live pounds Negotiated price before delivery or at auction Weighing conditions important »Mud, shrink (fill, time, stress) Was most common for hogs but not now Still common in large cattle feedlots, less in Iowa Used for feeder cattle and feeder pigs

13. What to sell uCarcass weight (“in-the-meat”) One average price for all carcass pounds Negotiated price before delivery Dressing percent (also called yield) »Important to compare bids »Not important in determining value Farmer stands risk of trimming and condemnation Common for fed cattle in Midwest

14. What to sell uDressing percent DP = carcass weight / live weight DP hogs approximately 73-76% DP cattle approximately 61-64% uDP impacted by: Weighing conditions Shrink Fat thickness Genetics

15. What to sell uValue-based marketing Each carcass evaluated and priced individually Premiums and discounts determined ahead of delivery Base price may be negotiated or come from formula Carcasses are graded and values assigned Farmer stands grading risk Different buyers have different systems Nearly all hogs Increasingly popular for fed cattle

16. Hog Carcass Weight Discounts Carcass WeightRange 145#-27.70-8.16 155#-27.70-5.00 165#-10.39-0.67 175#-3.400.00 185#-1.360.00 195#-0.680.00 205#0.00 215#-3.001.36 225#-5.260.00 IOWA/MINNESOTA DAILY DIRECT NEGOTIATED HOG PURCHASE MATRIX LM_HG204, Fri, Aug 26, 2005, USDA Market News Des Moines, Iowa

17. Hog Carcass Price by Backfat and Loin Eye Area Hog Carcass Price by Loin Eye Area/depth (inches) Backfat4.0/1.45.0/1.76.0/2.07.0/2.38.0/2.7 0.40 62.0075.0563.5075.0065.0075.0066.0076.0066.0076.00 0.50 59.5075.0562.0075.0565.0075.0566.0075.0066.0076.00 0.60 59.5075.6062.0075.6063.5075.6065.0075.6066.0075.60 0.70 59.5075.6059.5075.6062.0075.6065.0075.6066.0075.60 0.80 57.5075.6059.5075.6062.0075.6063.5075.6066.0075.60 0.90 57.5072.1059.5072.1059.5072.5562.0073.0565.0073.80 1.00 56.5072.1057.5072.1059.5072.1062.0072.1063.5073.05 1.10 55.5067.9057.5068.0559.5069.0559.5070.2763.5071.66 1.20 55.5067.9056.5067.9057.5067.9059.5068.8762.0070.96 1.40 52.0064.0055.3464.7055.3466.0956.8667.4856.8668.87 IOWA/MINNESOTA DAILY DIRECT NEGOTIATED HOG PURCHASE MATRIX LM_HG204, Fri, Aug 26, 2005, USDA Market News Des Moines, Iowa

18. Comparing bids Price in appropriate $/cwt AB Bid Price (live)$44.50--- Bid Price (carcass)---$59.50 Lean premium---+1.25 Sort discount----.70 Dressing percentage74.574.5 Adjusted to live44.5044.73 Transportation-.85-.35 Net farm gate price$43.65$44.38

19. Value-Based Cattle Marketing Three factor impact premiums 1. Carcass Weights 2. Quality Grade Distribution (USDA Grader) Based on marbling, proxy for eating experience 3. Yield Grade Distribution (USDA Grader) Based on lean meat yield 4. Other specs: Product safety & quality assurance Acceptable color Youthfulness

22. Value-Based Cattle Marketing Common Ground for Targets 1. Carcass Weights550 - 950 lbs 2. Quality Grade > Se + or > Ch 0 3. Yield Grade1’s and 2’s

23. Carcass Merit Grid and Premium Trends Carcass Merit Grid and Premium Trends

24. Where are the Grid Rewards & Discounts? Where are the Grid Rewards & Discounts? Iowa Quality Beef Grid 2005 uBase: NE Wted Avg 65-80% Choice uPar: Ch YG3 =Base + $2.00 or Plant clean up which ever is greater uQuality Grade$/cwt Prime:$6.00 Certified Angus:$3.50 SelectUSDA Standard-$15.00 Commercial-$30.00 Dark Cutters-$30.00 Other-$30.00 Yield Grade$/cwt 1:$4.00 2:$3.00 3:Par 4:-$20.00 5:-$25.00 Carcass weights$/cwt Under 500-$40.00 500-549-$15.00 950-999-$8.00 1000 & up-$35.00

25. Comparing Bids ($/carcass cwt) Price in appropriate $/cwt AB Base bid price122.00121.00 Prime3%---+6.00 Top 2/3 Ch45%---+3.50 Select30%----8.00 Yield 1&260%---+2.50 Off weight3%----15.00 Transportation-.65-1.25 Net farm gate price120.35120.16 Bid A is a straight in the meat bid, Bid B is a valued-based bid.

26. Where to sell uTerminal markets have declined uAuction markets important when assembly is needed Feeder cattle and cull cows Growing interest in fed cattle in fringe areas uDirect sales Slaughter cattle and hogs Feeder pigs Growing in feeder cattle where source verification is important

27. Feeder cattle sales uLive weight sales Various weight classes In general, lower $/# and heavier weights uAuction is major market Assembly function important uVideo auctions uDirect trade uPremium paid for Large uniform lots Certification/verification ??????

28. Important market functions

29. Slaughter Cattle and Hogs uDirect sales most common Animals are delivered directly to the packing plant uSpot or cash market Seller contacts buyer when ready to sell Negotiate price and terms on each group uContract market May be for one group or an ongoing agreement between buyer and seller Terms and pricing method determined ahead of marketing date

30. Overview uDefine contractual relationship uEvolution and status of hog industry uDescribe marketing contracts uMotivation and concerns uRole for economists

31. Contractual Relationship uFocus today is not on internal transfer uOnly relationship is the marketing contract u Typically 3-10 years in length or evergreen u Defines delivery schedules, carcass specifications, pricing, and in some cases production practices uSmall portion of contracts have risk sharing provisions

32. USDA MPR Definitions  Negotiated: Purchased in the cash market for delivery within 7 days.  Swine or pork market formula: A formula tied to the cash market for hogs or pork cutout., i.e., weekly average price, 3-day rolling average, percentage of the cutout.  Other market formula: A formula tied to something other than the hog market or pork cutout, i.e., feed prices.  Other purchase agreement: Currently this includes window contracts.

33. Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009* Year9900010203040506070809 Hog or meat market formula 44.247.25444.541.4 39.941.838.337.141.2 Other market formula 3.48.55.711.85.77.210.38.88.511.07.9 Other purchase arrangement 14.416.922.88.619.220.615.416.615.213.411.6 Packer-sold 2.12.22.12.42.66.76.15.6 Packer- owned 16.418.117.121.42022.723.125.7 Negotiated - spot 35.825.717.316.713.511.610.610.28.69.28.1 Source; Grimes and Plain, University of Missouri http://agebb.missouri.edu/mkt/vertstud09.htm

34. Contract Specs uProduct specifications PQA, Right to approve inputs uMethod of pricing Which markets and formula uDelivery scheduling Short and long term uExemptions

35. Types of Contracts uFormula 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 uPacker does not share risk

36. Types of Contracts uFixed window Formula tied to cash price Predetermined upper and lower bounds Share pain and gain outside window Example: $50-60 and split 50/50 above and below uFloating window Formula tied to cash price Boundaries move with feed prices Do not share outside of window uPacker shares risk

38. Types of Contracts uCost-Plus Price direct function of feed prices Fixed amount for non-feed costs + known margin Packer assumes all price risk uLedger 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

40. uConsumer satisfaction  Moisture enhanced pork  Preference for attributes  Growing interest in safety and production uSpot market not sufficient  Premiums and discounts  Market access and risk Motivations for Vertical Linkages

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

42. u 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

44. Attitude Toward Marketing Contracts by Pork Producers with and without Marketing Contracts 1 = strongly disagree, 6 = strongly agree WithWithout Coordinate slaughter to better meet Industry needs3.72.9 Have caused lower cash market prices4.24.2 Producers with contracts have received higher prices3.93.5 Packers show preference in who was offered a contract3.53.5 Contracts should be made illegal by Congress2.73.1 Contracts should be more closely monitored by USDA4.04.0 Prefer to market all my hogs on the cash market3.04.1

45. u 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

46. u 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

47. u 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

48. Contract Examples uIowa Attorney General http://www.state.ia.us/government/ag/ag_contracts/ uContract concerns Will discuss more in market controversy section

49. Spot market price Often through a broker USDA report Formula pricing Based on observable price Spot market Hog futures maybe corn & SBM Feeder Pig Trade Price/head or live weight 40-60 pound classes Weaned pigs (10-12 pounds) Primarily direct trade Rapidly declining auctions Health and stress concerns Premiums for Large uniform, single source Genetic history

50. When to sell uClassic production function Optimal selling weight is where MC=MR The cost of the next pound = the price of the next pound uCost per pound decrease then increase with weight Costs are a function of »Genetic potential »Cost of diet »Opportunity costs of future production uPrice per pound increases then decreases Weight discounts outside optimal range Fatter carcasses are discounted Adding extra weight

51. Market timing uCycles uSeasonals uMarginal costs and returns

52. Biological and price cycles uCycle is a pattern that repeats itself over a period longer than a year in a relatively predictable pattern

53. Livestock Marketing Information Center Data Source: USDA/NASS

57. What causes cycles uResponse to economic signals uTime lag Psychology Biology Investment uLivestock uTree crops uLand development

58. Cattle Cycle and Timing uPrices are cyclical uHeifer cost impact profitability uCalf prices impact annual income uTwo alternatives Steady Size: Same number of heifers Dollar Cost Averaging: Same value of heifers

64. Seasonal price patterns uPatterns that repeat themselves with some degree of predictability within a year’s time frame. uDriven by supply and demand factors that are impacted by time of year Weather Holidays Input prices

66. MR MC Weight $

67. Cost of Production uRaised 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.

68. Cost of Production uPurchased feeder livestock Derived demand for feeder animal Highly variable price Depends upon »Expected selling price for finished animal »Feed costs

69. Cost of production budgets uStarts with production function uIncorporates input prices uProject cost per unit sold Variable $/unit Total $/unit uhttp://www.extension.iastate.edu/agd m/livestock/html/b1-21.html

72. Using budgets in planning uProject a breakeven “point estimate” uSensitivity analysis for key variables uBack calculate from revenue to what you can afford to pay for feeder animal uEconomic v. Financial costs

73. Objective Based Pricing Strategy 550# steer calf fed to 1200 slaughter weight Cost/hd$/cwt

74. How much to pay for feeder animal uWork back from total revenue 550# steer calf fed to 1200 slaughter weight Cost/hd $/cwt

75. Breakeven Purchase Price for 550# Steers Fed Cattle Price FCOG$81$83$85$87$89 24.72119123127131136 26.72117121125129133 28.72114119123127131 30.72112116120125129 32.72110114118122126 CornWDGShayintyardother $1.75$32.00$507%$0.30$30

76. Supply uDerived from cost function Production function Input - output relationship uAssume that firms seek to Maximize profits Minimize costs uSupply starts will individual firm

77. Market supply curves Qx Px S1S1 S2S2 A B C Move from A to B is a change in quantity supplied due to a price decline. Move from B to C is a shift in supply.

78. Supply Shifts from Change uin input prices uin returns for competing enterprises uin price of joint products uin technology on yields or costs uin yield and/or price risk uinstitutional constraints uSUPPLY DOES NOT CHANGE DUE TO A CHANGE IN PRICE OF THE OUTPUT

79. Demand considerations uDemand for meat by consumers uDerived demand for animal by packers uDerived demand for feeder livestock by feedlots and finishers

80. Law of Demand uAll else equal consumers will by more of a item at lower prices and buy less at higher prices. uDemand begins with individual consumer uInverse relationship between quantity and price Two dimensional, Price and Quantity

81. Downward Sloping Demand Curve Px Qx D A B PBPB PAPA QAQA QBQB

82. Livestock Marketing Information Center

83. Factors that Cause a Shift in Demand uPrice of substitutes uPrice of complements uConsumer income uTaste and preferences uPopulation and e xports uGovernment intervention uIS NOT FUNCTION OF THE GOOD’S OWN PRICE

84. Derived Demand Px Qx D farm D retail S P retail P farm Q D wholesale P wholesale Cuts of meat Carcasses Animals Vertical distance is the difference is price at 3 levels There is cost associated with moving from one level to the next

85. Derived Demand for Pork uAverage retail price $/lb$2.50 uValue of trim and scrap $/lb$0.10 uCosts from whlse -retail $/lb-$1.00 uThe most retail will pay $/lb $1.60 uRetail pounds per carcass 100 uThe most retail will pay $/head$160

86. Derived Demand for Hogs uWholesale carcass value $/hd$160 uValue hide and offal $/hd$25 uCosts to slaughter and fab $/hd-$20 uThe most packer will pay $/hd $165 uWholesale pounds per carcass 200 uThe most packer will pay $/lb$82.50