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Market Vertical Coordination Communication and distribution Historically relied upon price signals »Markets and spot negotiation Moving toward non-market transactions »Contracts and long term negotiation
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Trends Specialization »Producing or processing only one or a few products (Farming, Packing) Diversification »Multiple plants »Multiple products »Complementary products
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Trends Decentralization »Move away from central markets Drivers of trend »Transportation »Processing technology »Communication systems »Economies of scale
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Integration Vertical and horizontal Ownership »Mergers »Growth to include function Contract »Formal agreement
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Integration? Improved communication and control of the food supply to increase customer satisfaction? An attempt by processors to drive down farm level prices for short and long term gain?
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Reasons for Integration Profit potential Risk reduction Improved bargaining power Operational efficiency Improved communication
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Food Industry Alliances Preferred/exclusive suppliers Marketing contracts HyVee and Farmland pork
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Production Ag Integration Premium Standard Farms Smithfield Foods »Largest pork packer and producer Cargill »Nutrena, Production, Excel »Corn genetics, grain handling, processing US Premium Beef Iowa Quality Beef Supply Coop Farrow-Finish grain farm
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Johnson Amendment, 2001 Prohibits packers from owning, feeding, or controlling livestock for more than 14 prior to slaughter Amended to allow contracting »Farmer must materially participate Excludes coops and poultry Packers would divest in »Hogs 18 months »Cattle 180 days
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Contract Integration Market specification contracts »Forward contracts »Common and general Resource providing contracts »Prescribed inputs and management Management and income sharing »Greater integrator control
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Integration into farming Horizontal integration »Fewer and larger farms »Networking and alliances Vertical integration »Cooperatives »Input production »Grain and meat processing
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Value of Selected Commodities Produced under Production Contracts, 1997 Source: USDA, Economic Research Service, 1997 Agricultural Resource Management Study, special analysis
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Value of Selected Commodities Produced under Marketing Contracts, 1997 Source: USDA, Economic Research Service, 1997 Agricultural Resource Management Study, special analysis
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Types of contracts Market-specification terms »Product characteristics »Basis of price and payment Examples »Forward deliverable contracts Little management control by buyer
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Types of contracts Resource-providing terms »Inputs are specified by buyer »Little price protection Examples »Specialty grain »Processing vegetables High degree of management by buyer
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Types of contracts Management and income guaranteeing »Specifies characteristics and input use »Provides price and maybe production risk Examples »Hogs, poultry High degree of management by buyer
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Contract grain production Forward contracts for delivery Specialty grain »Seed corn, popcorn, white corn »Formula contract tied to another market Silage production Production for grain
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Cattle Production Contracts Commercial feedlots »Feedlot provides the management not the buyer or cattle owner Custom grazing »Cowherds »Stockers
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Cattle Marketing Contracts Captive supplies of cattle »Under the buyer’s control 14 or more days before delivery Marketing contracts »Forward contract for delivery »Formula contract Types of captive supplies, 1999 »Packer owned4% (now 6-8%) »Under contract28%
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Captive Supply Research Results 1993 KSU Study: Captive supply shipments associated with a $0.15/cwt to $0.31/cwt decline in cash fed cattle prices 1996 KSU - OSU Study: 1% contract delivery associated with $0.02/cwt to $0.03/cwt. cattle price 1% packer fed delivery associated with $0.13/cwt. to $0.19/cwt. cattle price 1% mktg agrmnt delivery associated with $0.04/cwt to $0.26/cwt. cattle price
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Hog Production Contracts Farmer is paid to provide building and labor Hog owner provides inputs and management Limited production risk, no price risk Currently 33-35% of hogs produced under a production contract
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Hog marketing contracts Relatively new - growth since 1993 »Open market was 87-89% in 1993 »Open market was about 15% in 2003 Product specification important »Genetics, inputs, food safety Delivery scheduling Types of contracts »Formula price »Share price risk
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Risk Sharing Contracts Window contract »Set upper and lower bound »Share the “pain and gain” outside Cost based price floor »Minimum price tied to feed price »Pay back “loan” »Give up part of higher prices
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Contract Examples Iowa Attorney General »http://www.state.ia.us/government/ag/ag_contracts/ Current research on web » Hogs: http://www.econ.iastate.edu/faculty/lawrence/HOGS.htm »Production and Marketing Characteristics of U.S. Pork Producers, 2000, »Understanding Hog Marketing Contracts - September 18, 1999 »Cattle: http://www.econ.iastate.edu/classes/econ135/lawrence/ »Packer Concentration, Captive Supplies and Fed Cattle Prices
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Packer Motivation for Increased Pork and Beef Marketing Contracts, 1999. a
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Producer’s Motivation for Entering Marketing Contract with Packer Access to capital and better financing Reduced price risk Assure a buyer Reduced marketing costs Improved prices or premiums
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Reasons for production integration Greater control »Product quality / specifications »Scheduling »Industrialization Risk management Access to resources
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Motivations and Implications Profit potential??? »Multiply management »Production efficiency and product quality Thin market concerns Encourages expansion by reducing risk
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So What???? How do you establish value in a system in which there is little or no open market activity? Do you need to? How do you determine returns to the various segments?
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Open market impacts Packer may have ability to call supplies Formula tied to cash market Potentially depress prices Potentially increase volatility Value-based pricing
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