Livestock Marketing • Price discovery • Pricing methods • Marketing decisions • Supply and demand
Price Determination and Discovery • Price Determination • is the broad forces of supply and demand establishing a market clearing price for a commodity. • Price Discovery • is the process by which buyers and sellers arrive a a specific price for a given lotof produce at a given locationfor a specifictimeperiod.
Price Discovery • 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 P Pe D Q Qe
Centralized pricing • 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
Decentralized Pricing • One-to-one negotiations • Reduced transportation cost • Reduced transaction cost • Depends on skills and information • Higher search cost
Hybrid markets • Electronic markets • Centralized pricing • Decentralized product movement • Examples • Satellite auctions • Electronic auctions • Tel-o-auction • E-commerce
Formula pricing • Price discovery from elsewhere • Formula contracts • Spot market • Cutout price • Futures • Do you trust the underlying market for price discovery?
Performance issues • “Least cost” method of price discovery • Effect of the mechanism on price behavior • Marketing v. pricing efficiency
Information and markets • Price 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
Livestock Marketing Decisions • What to sell • Live, carcass, grid • Where to sell • Type of market • Location • When to sell • Weight, grade, costs
What to sell • Live 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
What to sell • Carcass 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
What to sell • Dressing percent • DP = carcass weight / live weight • DP hogs approximately 73-76% • DP cattle approximately 61-64% • DP impacted by: • Weighing conditions • Shrink • Fat thickness • Genetics
What to sell • Value-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
Hog Carcass Weight Discounts IOWA/MINNESOTA DAILY DIRECT NEGOTIATED HOG PURCHASE MATRIX LM_HG204, Fri, Aug 26, 2005, USDA Market News Des Moines, Iowa
Hog Carcass Price by Backfat and Loin Eye Area IOWA/MINNESOTA DAILY DIRECT NEGOTIATED HOG PURCHASE MATRIX LM_HG204, Fri, Aug 26, 2005, USDA Market News Des Moines, Iowa
Comparing bids Price in appropriate $/cwt A B Bid Price (live) $44.50 --- Bid Price (carcass) --- $59.50 Lean premium --- +1.25 Sort discount --- -.70 Dressing percentage 74.5 74.5 Adjusted to live 44.50 44.73 Transportation -.85 -.35 Net farm gate price $43.65 $44.38
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
Value-Based Cattle Marketing Common Ground for Targets 1. Carcass Weights 550 - 950 lbs 2. Quality Grade > Se+ or > Ch0 3. Yield Grade 1’s and 2’s
Where are the Grid Rewards & Discounts? Iowa Quality Beef Grid 2005 • Base: NE Wted Avg 65-80% Choice • Par: Ch YG3 =Base + $2.00 or Plant clean up which ever is greater • Quality Grade $/cwt • Prime: $6.00 • Certified Angus: $3.50 • Select USDA • 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 -$35.00
Comparing Bids ($/carcass cwt) Price in appropriate $/cwt A B Base bid price 122.00 121.00 Prime 3% --- +6.00 Top 2/3 Ch 45% --- +3.50 Select 30% --- -8.00 Yield 1&2 60% --- +2.50 Off weight 3% --- -15.00 Transportation -.65 -1.25 Net farm gate price 120.35 120.16 Bid A is a straight in the meat bid, Bid B is a valued-based bid.
Where to sell • Terminal markets have declined • Auction markets important when assembly is needed • Feeder cattle and cull cows • Growing interest in fed cattle in fringe areas • Direct sales • Slaughter cattle and hogs • Feeder pigs • Growing in feeder cattle where source verification is important
Feeder cattle sales • Live weight sales • Various weight classes • In general, lower $/# and heavier weights • Auction is major market • Assembly function important • Video auctions • Direct trade • Premium paid for • Large uniform lots • Certification/verification ??????
Slaughter Cattle and Hogs • Direct sales most common • Animals are delivered directly to the packing plant • Spot or cash market • Seller contacts buyer when ready to sell • Negotiate price and terms on each group • Contract market • May be for one group or an ongoing agreement between buyer and seller • Terms and pricing method determined ahead of marketing date
Overview • Define contractual relationship • Evolution and status of hog industry • Describe marketing contracts • Motivation and concerns • Role for economists
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
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.
Contract Specs • Product specifications • PQA, Right to approve inputs • Method of pricing • Which markets and formula • Delivery scheduling • Short and long term • Exemptions
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
Types of Contracts • Fixed 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 • Floating window • Formula tied to cash price • Boundaries move with feed prices • Do not share outside of window • Packer shares risk
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
Motivations for Vertical Linkages • 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 • 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 • 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
Attitude Toward Marketing Contracts by Pork Producers with and without Marketing Contracts1 = strongly disagree, 6 = strongly agree WithWithout Coordinate slaughter to better meet Industry needs 3.7 2.9 Have caused lower cash market prices 4.2 4.2 Producers with contracts have received higher prices 3.9 3.5 Packers show preference in who was offered a contract 3.5 3.5 Contracts should be made illegal by Congress 2.7 3.1 Contracts should be more closely monitored by USDA 4.0 4.0 Prefer to market all my hogs on the cash market 3.0 4.1
Role for Economists • 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 • 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 • 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.
Contract Examples • Iowa Attorney General • http://www.state.ia.us/government/ag/ag_contracts/ • Contract concerns • Will discuss more in market controversy section
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 • Spot market price • Often through a broker • USDA report • Formula pricing • Based on observable price • Spot market • Hog futures maybe corn & SBM
When to sell • Classic production function • Optimal selling weight is where MC=MR • The cost of the next pound = the price of the next pound • Cost per pound decrease then increase with weight • Costs are a function of • Genetic potential • Cost of diet • Opportunity costs of future production • Price per pound increases then decreases • Weight discounts outside optimal range • Fatter carcasses are discounted • Adding extra weight