“Nothing is changing in the food markets except everything”

 Specialization ◦ Producing or processing only one or a few products (Farming, Packing)  Diversification ◦ Multiple plants ◦ Multiple products ◦ Complementary products

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

 A human process, subject to relative bargaining power of the buyer and seller.  Two stage process ◦ Evaluate S&D and Pe ◦ Estimate the price for the specific trade.

Price Determination and Price Discovery S D P Q PePe QeQe

 Individual negotiations ◦ Also called private treaty sales ◦ Fed cattle, hogs, grain  Organized central markets ◦ Auctions, terminal, electronic  Formula pricing ◦ Eggs, wholesale meat, feeder pigs, hogs and cattle

HogsCattle Cash market27%65% Formula3220 Futures-based84 Risk share143 Packer owned185 Other13

Hog or meat market formula Other market formula Other purchase arrangement Packer-sold2.1 Packer-owned16.4 Negotiated – spot *2002 data based on USDA Mandatory Reports, based on industry survey. University of Missouri and National Pork Board*

 All buyers and sellers in one place at one time. ◦ Full and immediate information ◦ Competitive bidding ◦ Equalizes market power ◦ Transaction cost ◦ Physical movement of product

 One-to-one negotiations ◦ Reduced transportation cost ◦ Reduced transaction cost ◦ Depends on skills and information ◦ Higher search cost

 Decentralization ◦ Move away from central markets  Drivers of trend ◦ Transportation ◦ Processing technology ◦ Communication systems ◦ Economies of scale

 Electronic markets ◦ Centralized pricing ◦ Decentralized product movement  Examples ◦ Satellite auctions ◦ Electronic auctions ◦ Tel-o-auction ◦ E-commerce

 Vertical and horizontal  Ownership ◦ Mergers ◦ Growth to include function  Contract ◦ Formal agreement

 An attempt by processors to drive down farm level prices for short and long term gain. OR  Improved communication and control of the food supply to increase customer satisfaction.

 Profit potential  Risk reduction  Improved bargaining power  Operational efficiency  Improved communication

 Preferred/exclusive suppliers  Marketing contracts  HyVee and Farmland pork

 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

 Market specification contracts ◦ Forward contracts ◦ Common and general  Examples ◦ Forward Contracts  Little management control by buyer

 Market specification contracts ◦ Forward contracts ◦ Common and general  Resource providing contracts ◦ Prescribed inputs and management  Management and income sharing ◦ Greater integrator control

 Horizontal integration ◦ Fewer and larger farms ◦ Networking and alliances  Vertical integration ◦ Cooperatives ◦ Input production ◦ Grain and meat processing

Source: USDA, Economic Research Service, 1997 Agricultural Resource Management Study, special analysis

 Market-specification terms ◦ Product characteristics ◦ Basis of price and payment ◦ Examples  Forward deliverable contracts ◦ Little management control by buyer

 Resource-providing terms ◦ Inputs are specified by buyer ◦ Little price protection ◦ Examples  Specialty grain  Processing vegetables ◦ High degree of management by buyer

 Management and income guaranteeing ◦ Specifies characteristics and input use ◦ Provides price and maybe production risk ◦ Examples  Hogs, poultry ◦ High degree of management by buyer

 Forward contracts for delivery  Specialty grain ◦ Seed corn, popcorn, white corn ◦ Formula contract tied to another market  Silage production  Production for grain

 Contract of delivery ◦ Defines time, place, form  Tied to the futures market ◦ Buyer offering the contract must lay off the market risk elsewhere ◦ The buyer does the hedging for you

 Example grain forward contracts

 No margin accounts or calls  Working with local people  Flexible sizes  Known basis  Tangible and Simple

 Inflexible ◦ Replace price risk with production risk ◦ Difficult to offset ◦ Must deliver contract to specific location  Buyer “takes protection” ◦ Usually prices in a wide basis

 Hedge to Arrive (Futures Only) ◦ First: When favorable lock in price on futures exchange ◦ Second: When basis is favorable lock in basis and delivery period (may roll forward if basis does not turn favorable) ◦ Third: Deliver grain at contracted time

 Basis Contract ◦ First: When basis is favorable lock in basis and delivery period ◦ Second: When favorable lock in price on futures exchange ◦ Third: Deliver grain at contracted time

 Minimum Price Contract ◦ Lock in a minimum (or maximum) price on current futures prices ◦ Pay a fee per bushel ◦ Price moves higher  collect on improve price ◦ Price moves lower  let contract expire

 Floored Average Contract ◦ Lock in a minimum price on March futures price ◦ Pay a fee per bushel ◦ May establish basis at anytime ◦ Average price between harvest and February 1st moves higher  collect on improve price ◦ Price moves lower  guaranteed your minimum price.

 Commercial feedlots ◦ Feedlot provides the management not the buyer or cattle owner  Custom grazing ◦ Cowherds ◦ Stockers

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%

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

 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

 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

 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

 Iowa Attorney General ◦  Current research on web ◦ Hogs: ◦ Cattle:

 Access to capital and better financing  Reduced price risk  Assure a buyer  Reduced marketing costs  Improved prices or premiums

 Greater control ◦ Product quality / specifications ◦ Scheduling ◦ Industrialization  Risk management  Access to resources

 Packer may have ability to call supplies  Formula tied to cash market  Potentially depress prices  Potentially increase volatility  Value-based pricing

 Compare the farmers marketing task for poultry vs. corn

 What kind of regulation? ◦ Foreign nationals buying U.S. farmland ◦ Steel firm buying U.S. farmland ◦ Vegetable canner owning farms ◦ Farmers owning vegetable canner ◦ Farmers purchasing more farmland