Econ 337, Spring 2013 ECON 337: Agricultural Marketing Chad Hart Associate Professor Lee Schulz Assistant Professor

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

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

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

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

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

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

Econ 337, Spring 2013

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

Econ 337, Spring 2013 Seasonal Pricing Patterns Source: USDA, NASS, Monthly Price Data

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

Econ 337, Spring 2013 Average Profit per Head (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

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

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

Econ 337, Spring 2013 U.S. Cattle Prices, Cattle 500 Lbs. or Higher JanFebMarAprMayJunJulAugSepOctNovDecAnnual Avg Ratio96.9%97.4%99.6%101.2%100.4%98.3%99.1%100.2%101.6%101.8%

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?

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.

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

Econ 337, Spring 2013 Cost of Production Budgets  Starts with production function  Incorporates input prices  Project cost per unit sold  Variable $/unit  Total $/unit 

Econ 337, Spring 2013

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

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

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

Econ 337, Spring

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

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

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

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

Econ 337, Spring 2013

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

Econ 337, Spring 2013

Contract Examples  Iowa Attorney General 

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

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

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

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

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

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

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

Econ 337, Spring 2013 Class web site: Spring2012/ Have a great weekend!