Evolving Producer-Packer-Customer Linkages

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Agricultural & Applied Economics Association

Evolving Producer-Packer-Customer Linkages in the Beef and Pork IndustriesAuthor(s): John D. Lawrence, Ted C. Schroeder, Marvin L. HayengaSource: Review of Agricultural Economics, Vol. 23, No. 2 (Autumn - Winter, 2001), pp. 370-385

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ReviewofAgriculturalEconomics-Volume23, Number2-Pages 370-385

Evolving Producer-Packer-CustomerLinkages in the Beef andPork Industries

John D. Lawrence, Ted C. Schroeder, andMarvin L. HayengaThe U.S.porkandbeef sectorsarerapidlymovingfromtraditionalcash marketsto formalverticallinkages.In 1999,27%of hogs and 65%of cattle were tradedin the cash marketand packersowned 18%of hogs and 5% of cattle;the restwere procuredvia marketingcontracts.Contraryto popularopinionthatplant efficiencyis the impetusfor the change,packers clearlyidentifiedqualityconcernsas the dominantreasonfor using marketingcontractsor self-production.Qualitystandardsand procurementsystemsto achievethemwill increasein importancewiththe introductionof morebrandedporkand beefproducts.

he U.S. beef and pork industries are undergoing marked transitions in theways livestock and meat products are marketed and the way price discoveryoccurs, stimulating reexamination of the coordination linkages selected by indus-try participants, and intensive state and national policy concerns and debates.

Emphasis is shifting from the once dominant negotiated cash markets in cat-tle and hogs to long-term contracts and marketing agreements, with the porkindustry rapidly becoming dominated by long-term contracts or vertical integra-tion. A number of cattle producers have voiced concerns about "captivesupplies"(marketing contracts longer than 14 days or cattle feeding by packers) for years,though the extent of contracting fed cattle is much less than in the pork industry.1Economists have documented lower cash market fed cattle prices associatedwith higher captive supplies, though the behavioral causes are still unclear(Schroeter and Azzam). However, tradeoffs that may offset potential concerns

* JohnLawrenceis an AssociateProfessor,Departmentof Economics,Iowa State Uni-versity.* TedC. Schroederis a Professor,Departmentof AgriculturalEconomics,KansasStateUniversity.* Marvin L. Hayengais a Professor,Departmentof Economics,IowaState University.


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EvolvingBeefand PorkIndustryProducer-Packer-CustomerLinkages

aboutlong-termcontractarrangementsin the beef and porkindustriesareoftenoverlookedin these debates.Perhapsthe cash marketingsystem has sufficientdrawbacksto warrantits replacementby contractsystems.Over the last 20 years,beef demand has declineddramatically,pork demandhas declined moderately,and poultrydemandhas increasedsubstantially(Pur-cell). Numerous reasons have been hypothesized for the increase in poultrydemandrelativeto competingmeats, includinghealth concernsassociatedwithred meat consumption.But there have also been persuasive argumentsthat thelackof effectiveverticalcoordinationin beefandporkmarketscomparedto poul-try has been an importantfactorcontributingto competitivecost and productinnovationadvantagesof the poultrysector.Thebeef and porksectors have notoffered consumersthe types of products they demand at lower relativeprices(Schroeder,Marsh,and Mintert).Improvingbeef and pork demand and chainefficiency-affectingrelativeproductprices-may requireimprovedverticalcoor-dination,especiallybetter informationflow,and more accuraterewardsfor valueenhancement.The purpose of this study is to determinecurrentpurchasingand marketingmethods being used by beef and pork packers,and documentpackers'moti-vations for changes that are occurring.Followinga brief discussion of verticalcoordinationin agriculture,the paper is arrangedin three main parts.First,thecurrentand projectedfuturemix of pricingmethods for fed cattle,markethogs,and wholesalebeef and pork productswill be estimated.Second,majorfactorsmotivating changingbeef and pork packer-producerand packer-customerlink-ages will be evaluated.Third,we do a comparativeanalysisof the beef and porkmarketingsystems.Theprimarydataare derivedfromsurveysof majorbeef andpork packersconductedduring spring2000.Results of this study will contributeto a better understandingof importantcoordinationmechanismsthat affect marketefficiencyand performancein thebeef and porkindustries,and offerinsightsinto theirchangingindustrialorgani-zation. Suchinsightswill be useful for strategicplanningby industrymembers.The complexitiesof mandatorylivestockand meatpricereportingnow requiredby law will become cleareras the varietyof methodsemployedin the marketingsystemare documented.Finally,informationfromthesesurveysshouldbe usefulin assessingissues raisedin courtcases alleging illegalitiesassociatedwith "cap-tive supplies"in the beef industry,andin evaluatingproposedlegislationto elimi-natepackerverticalintegrationand long-termcontractswith livestockproducers.Vertical Coordination in Agriculture

Agri-food system organizationand coordinationin the United States haveevolved over time. Traditionally,spot (cash)marketshave been the cornerstonesof price discovery and ownership transferfor many commodities. For mostperishablecommodities,centralizedmarketsgave way to direct marketingasproducersize increasedand improvedcommunicationand refrigerationallowedprocessorsof perishablecommoditiesto move closer to productionregions.Indi-vidualbuyersand sellersgravitatedtowardlonger-termrelationshipsthatreducethe numberof cash markettrades,yet still tied transactionpricesclosely to theexistingcash market.Theseverticalalliancesbetween producersand processors

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continueto evolve toward more formalcontractualrelationshipsor verticalinte-grationin the form of directownershipof processingby producers,or ownershipof productionby processors.Todate,verticalintegrationis not extensivein agriculture.In 1994,less than8%of agriculturalvolume was producedby farmoperationsthat were either ownedby or that own processorsor input supply businesses(U.S.Departmentof Agri-culture1994-1995).Thepoultry industry,primarilyeggs and turkeys,and somecrops, such as, sugar beets, sugar cane, potatoes,fresh marketvegetables,andsome fruits andnuts,had the greatestsharesof productioninvolvedin verticallyintegratedoperations.In addition,farmercooperativesare extensivelyinvolved in handlingor pro-cessing farmoutput of their member-owners(anotherform of verticalintegra-tion). USDA estimatesthat approximately30%of farmmarketingcash volumewas handled by cooperativesin 1998,with extremely high farmercooperativeinvolvementin dairy handlingand processing.Nearlyhalf of grain,oilseed,andcotton cashvolume was handledby agriculturalcooperatives,as were substantialvolumesof a numberof otherfarmcommodities(Kraenzle).Productionand marketingcontractsaremorecommon than directownership.The most recent 1998USDA-EconomicResearchServiceAgriculturalResourceManagementStudyfound thatcontractingis commonamongall types of farms,accountingfor 35.5%of total production.Over two-thirdsof contractvolumewas marketingcontractsand one-thirdwas productioncontractsin 1997.In 1993farmersurveys, marketingcontractsfor livestockcommoditieswere much lesscommonthan productioncontracts;they accountedfor 20%of farms and 42%of the totalvalue of productionundermarketingcontracts.In contrast,approxi-mately80%of the farms with marketingcontractsused them for cropcommodi-ties and these farms accountedfor about 58%of the value of productionundermarketingcontracts.Between 1991and 1997,marketingcontractuse increasedfrom 16 to 22%of farm production.Productioncontractuse showed no cleartrend,rangingbetween 10 and 15%of volume (Bankerand Perry).Severalrecentstudies havequantifiedtheamountsand/or impactsof processorcontrolof livestockpriorto slaughter(Ward,Koontz,and Schroeder;BarkleyandSchroeder;Hayengaet al.;Grimesand Meyer).The use of formalverticalcoordi-nation tools betweenpackersand producershas been increasing;however,moti-vationsbehind the trendsappearto be changing,and little is known about theupstreammarketingsystemand the motivationsfor coordinationsystem changescomingfrom customersof these industries.

Beef and Pork Packer SurveysDuringApril 2000,28 of the largestpork and beef packerswere surveyedtodeterminecurrentprocurementand merchandisingpracticesand discernpackerperceptionson why the value chains for these two sectorshave moved to moreformalagreements.Fourrespondingcompaniesprocessedboth hogs and cattle,but they completeda separatesurvey for each commodity.Fifteenof the largestU.S.beef packersand 13 of the nation'slargestpork processorswere surveyed.Surveyresponseswerecompletedby 10 of the 15 beef packingfirmsrepresenting

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EvolvingBeefandPorkIndustryProducer-Packer-CustomerLinkages

Table 1. Hog Procurement Methods, 1999ProcurementMethod PercentCashmarketpurchase,live basis 8Cash marketpurchase,carcassbasis 19Formula-pricedcontractbased on 32cashmarketFixedpricecontractbasedon futures 8Fixedagreementbasedon feed price 6Formulacontractwith window 8Otherpurchasemethods 1Selfproduction 18Total 100

72%of cattle slaughter and 11 of the 13 pork packers accounting for 77% of totalhog slaughter.The American Meat Institute initially contacted the packers and encouragedthem to cooperate in the project. Next, the authors contacted the processors,explained the research, invited them to participate in the study, and faxed them asurvey form. Two separate surveys were sent to each firm. One survey addressedcattle or hog procurement, and the second survey dealt with product marketing.We asked that the most knowledgeable individual(s) in each firm complete eachsurvey form. Firms that were slow to respond were reminded by telephone tocomplete the survey. Firms that did not respond to the survey indicated that theywould not do so.

Pork Packer Survey ResultsHog Procurement

In 1993, 87% of slaughter hogs were purchased in the cash market (Hayengaet al.). By early 2000, this number had fallen to 26% (Grimes and Meyer). Thissurvey found similar results. The 11 responding packers reported purchasing 27%of their hogs in the cash market in 19992 (table 1). Formula agreements basedon the cash market represented 32% of purchases. Agreements with some typeof risk management or cash flow smoothing feature accounted for approximately22%of purchases. Packers produced approximately 17%,and the remaining 1-2%was procured by other methods. Although recent trends are expected to continue,the few packers that provided estimates for 2004 expected only modest changesin procurement methods in the near future.The packers surveyed produced hogs that were processed in their own plants,and in some cases the hogs a packer produced were sold to a competitor'splant. Production by packers was equivalent to 22% of the slaughter volume intheir own plants, but 21% of the hogs produced by a packer or its subsidiarywere processed by a competing packer. So the net volume of packers' own hogsgoing through their own slaughter plants was approximately 18% of U.S. slaugh-ter as of spring 2000. Some production units are not located near a company-

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Table 2. Packer survey responses of importance of contract andmarketing agreement incentives to beef packersa

PackerUse ofMarketing PackerHogIncentive Agreement Production

Reduceplant operatingcostsbyimprovingplant scheduling 3.5 4.0Securehigherqualityof hogs 4.0 4.4Securemore consistentqualityof hogs 4.3 4.6Assure food safety 3.8 4.3Long-runpriceriskmanagement 3.0 3.3Week-to-weeksupply/price management 3.5 3.1Reducecostsof searchingforhogs 3.5 3.6Able to purchasehogs for lowerprice 2.3 1.9Captureprofitsfromhog production 3.2aScaleof 1 to 5, 1 = not importantto 5 = very important.

owned packing plant, are operated as separate profit centers making indepen-dent marketing decisions, or are operating under preexisting contracts with otherpackers.Motivations for the use of long-term marketing agreements were ranked bypackers on a 5-point scale, with 1 being not important to 5 being very important(table 2). The highest ranked factors were the need to secure a consistent supplyof quality hogs (4.3) and desire to secure higher quality of hogs (4.0). The abilityto assure food safety was rated next most important, receiving a ranking of 3.8out of 5. Reducing plant operating expenses, the cost of searching for hogs, andweek-to-week supply or price risk all rated 3.5. Long-run price risk management(3.0) and the ability to purchase hogs at lower prices (2.3) rated considerablybelow quality issues. All motivations for contracting except buying hogs at lowerprices were expected by survey respondents to become more important by 2004.Self-production of hogs by packers had slightly different motivations. In gen-eral, ensuring pork quality (4.0, 4.4) and food safety (4.6), plant scheduling (4.0),and long-run price risk management (3.3) were higher-ranked reasons for self-production than for marketing contracts. In contrast, week-to-week supply man-agement (3.1) and lower price of hogs (1.9) were lower-ranked for self-productionthan marketing contracts. Packers admit that they do not lower the cost of hogsprocessed by producing them, and place only moderate importance on profitsthat can be captured by producing hogs. The ability to secure consistently safe,high quality hogs is more important to packers than are hog production efficiencyand price considerations.In an open-ended question about the driving forces toward tighter coordina-tion, packers added another important element to the quality, consistency, andfood safety list; over half of the respondents identified demand for contracts byproducers as the impetus for their offering and entering into more long-term con-tracts. They also noted that prior knowledge of where their supplies were com-ing from and their expected quality allowed for them to enter into agreements

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Table 3. Packer survey responses of importance of contract andmarketing agreement incentives to hog producersaIncentive 1999 2004Secureshacklespacefor hogs 3.8 4.0Securea qualitypremium/discountmatrix 3.4 3.4Reducepricerisk 3.9 3.9Reducecosts of searchingfor a hog buyer 2.4 2.4Able to sell hogs for a higherprice 3.6 3.7Easierto get loans 4.6 4.7aScale of 1 to 5, 1 = not important to 5 = very important.

with customers who were requesting longer-term arrangements for higher qualityproducts. They asserted that cash market suppliers could not be relied upon tochange fast enough to meet their needs.Packers' perception of producers' reasons for wanting an ongoing relationshipwere reportedly to assure market access, to share information about consumerconcerns and to secure financing (table 3). Access to capital was seen as the great-est benefit to producers of marketing agreements (rating 4.6 out of 5). Reducedprice risk (3.9), securing a market outlet (3.8), ability to sell hogs at a higherprice (3.6), and the ability to secure a quality matrix3 (3.4) were the next mostimportant benefits to producers. These are generally consistent with recent pro-ducer survey results, though increased price received a slightly higher ranking bymedium-sized producers than access to capital, allowed staying in the hog busi-ness, or allowed expansion as reasons for being involved in marketing contracts.An earlier producer survey found assured shackle space to be especially impor-tant to very large hog producers, especially in the Southeast (Lawrence, Grimesand Hayenga).Production contract benefits perceived for producers were identified as increas-ing access to capital (4.7) and reducing financial risk (4.7), followed by increasedproducer income (4.5). In comparison, medium-sized producers reported addi-tional expansion, reduced risk, and access to capital as the leading rationale forcontracting when they were surveyed in 1998 (Lawrence et al.).

Pork MerchandisingIn 1999, the packers responding (with slightly less than half of U.S. slaughter4)sold 72%of their pork on the cash market for delivery within 21 days (table 4).Approximately 22.5% of sales were on a forward or formula price contract fordelivery in the future, and 6% represented long-term agreements not tied to thecash market. This degree of reliance on contract sales has not changed much overthe last 20 years.These relative shares are expected to change dramatically by 2004, althoughfewer packer responses to these questions allow only an indication of the directionof change, but not a precise indication of magnitude. Several packers alreadyhave or are beginning to establish their own branded fresh pork merchandising

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Table 4. Percent of pork sales by category, 1999Pork Packer Customer PercentRetailgrocerynonbrandedcommoditysales 14Retailgrocerybrandedvalue-addedproducts 14Food servicenonbrandedcommoditysales 8Food servicebrandedvalue-addedproducts 2Sold to domesticprocessorfor furtherprocessing 38Exportnonbrandedcommoditysales 6Exportbrandedvalue added sales 2Wholesaleror broker 12Other 5Total 100Percentagesmaynot sumto 100duetorounding.

programs, or are forming exclusive supplier arrangements with retailers. Cashmarket sales are expected to decline by over 50%. Forward pricing will expandgreatly, and long-term agreements not tied to the cash market are expected todouble.

A large share of pork is sold for further processing domestically, representing37.5%of 1999 sales (table 5). These products may become branded lunch meats,furtherprocessed products under the processor or retail label, or furtherprocessedproducts going into food service or export markets.Branded programs by packers have been rapidly growing, now 18% of currentmarket volume. By 2004, branded programs by packers are expected to representan even larger share of pork sold. Branded pork must carry a higher degree ofbrand reputation (or losses for the company if food safety problems occur) anddemands higher standards to consistently satisfy end-user expectations.Thus, packers report that their motivation for increased contractual links toproducers (or self-production) has been their need for increased quality controland consistency in hogs procured to meet rising demands from pork buyers andultimately final consumers.

Table 5. Pork marketing methods, share of total sales, 1999MarketingMethod PercentCashmarketdeliverywithin21 days 72Forwardfixedprice agreementfor delivery 10beyond21 daysForwardformulaprice agreementbased on 12currentcashmarketLong-runagreementbasisnot on cash market 6Total 100

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Table 6. Percentage of cattle procured via various methods, 1999ProcurementMethod PercentCash marketpurchaseson live weightbasis 36Cash marketpurchaseson a carcassweight or gridbasis 29Formula-pricedcontractpurchasesbasedon a reported 20live cashmarket,reporteddressedprice, plantaverage,CMEcattle futuresprice,quotedboxedbeef,or retailbeefpricePacker-fedcattle 5Fixedpriceor basiscontractpurchasesbased on 4CMEfuturesRisk-sharingcontractpurchases 3Otherpurchases 4Total 100Percentagesmaynotsumto 100due torounding.

Beef Packer Survey ResultsCattle Procurement

Packers are slowly shifting away from live cattle cash market purchases to morelong-term contractual and/or value-based grid purchases, yet negotiated cashmarket pricing arrangements remain dominant. Only 5%of cattle slaughtered bysurvey respondents were packer owned, while in the feedlot, little changed overthe last 15 years. Survey respondents reported 36% of cattle were purchased onthe cash market on a live weight basis, and 29% on a carcass weight or grid(carcassmerit) basis (table 6). Thus, approximately two-thirds of cattle slaughteredwere cash market acquisitions.Ongoing long-term formula-priced contracts linked to the cash market-suchas live cattle or wholesale beef prices reported by the USDA, plant cost aver-ages, retail beef prices or futures market prices-accounted for 20% of 1999 pur-chases. Four percent of cattle purchased were via short-term contract arrange-ments based on the Chicago Mercantile Exchange.5 Three percent of the cattlewere acquired under risk and profit-sharing6 marketing contract arrangementswith cattle feeders.Cash market purchases by packers are based on their expectations of prob-able carcass quality. However, a large number of cattle feeders still sell theirentire group of pens-perhaps with several owners in custom feedlots-at thesame live or carcass price, allowing little distinction for quality on a lot-by-lot letalone carcass-by-carcassbasis. Cash market purchases based on carcass merit areincreasing in the cash and contract markets. In 1999, at least 35% of cattle pur-chased on contract or in the cash market were priced based on carcass merit.7Most cattle fed by packers were also transferredto their packing operations basedon carcass merit.Packers were queried regarding the importance of specific reasons they andcattle feeders enter into contracts and marketing agreements. The packers' mostimportant reasons were to secure higher quality cattle (4.0), and to secure more


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Table 7. Packer survey responses of importance of contract andmarketing agreement incentives to beef packersa

20041999 ExpectedImportanceto Packers Average AverageReduceplant operatingcosts due to 2.9 3.5improvedslaughterplantcapacityutilizationSecurehigher qualitycattle 4.0 4.2Securemore consistentqualityof cattle 4.0 4.2Assure food safety 3.0 3.7Improvelong-runpriceriskmanagement 2.8 3.1Improveweek-to-weeksupply/pricemanagement 2.2 2.9Reducecosts of searchingfor cattle to procure 2.3 2.4Able to purchasecattlefor lowerprice 1.8 1.8aScaleof 1 to 5, 1 = not importantto 5 = veryimportant.

consistent quality cattle (4.0) (table 7). These were also expected to be moreimportant (4.2) in 2004. Improving price risk management (2.8), reducing plantoperating costs by improving slaughter plant capacity utilization rates (2.9), andassuring food safety (3.0) were the next most important reasons. All three alsoare expected to increase in importance, with 2004 ratings for food safety at 3.7and plant operating efficiency at 3.5. The low importance attached to the asser-tion that contracts enabled packers to purchase cattle for a lower price (1.8)may be because contracts and agreements do not enable packers to procurecattle at lower prices, as shown in recent USDA-sponsored studies (Schroeterand Azzam).Packers perceived that producers' primary incentives to enter into contracts andmarketing agreements were to secure a quality premium (4.0) and obtain a higherprice for cattle (3.8) (table 7). Providing detailed carcass data (3.4), reducing pricerisk (3.3), and making it easier to get loans (3.1) were the next greatest perceivedadvantages to producers. Securing a buyer for the cattle (2.6) and reduced searchcost to find a buyer (2.4) rated even less important. Packers felt that in the nextfive years, producers would benefit from marketing agreements primarily due tothese same reasons.

Beef MerchandisingPackers' largest customers for beef are retail grocery chains, wholesalers, anddomestic processors. These three groups accounted for 71% of survey respon-dents' 1999 beef sales, whereas export and food service customers each accountedfor approximately 10% of sales (table 8). Only 4% of packer sales were brandedbeef products, well below their pork competitors (18%from table 5). Cash market-ing dominated beef sales with 70% sold in the 1999 cash market (table 9), some-what higher than 20 years earlier (Hayenga and Schrader). Forward contractingand marketing agreements represented 20% of respondent beef sales during thesame period.

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Table 8. Packer survey responses of importance of contract andmarketing agreement incentives to cattle producersa20041999 ExpectedImportancefor Producers Average Average

Securea buyerfor cattle 2.6 2.8Securea qualitypremium/discount 4.0 4.0Reducepricerisk 3.3 3.3Reducecosts of searchingfor a cattlebuyer 2.4 2.8Able to sell cattlefor higher price 3.8 3.8Easyto get loans 3.1 3.4Providedetailedcarcassdata 3.4 3.6aScaleof 1 to 5, 1 = not importantto 5 = very important.

Not all survey responses were complete regarding future trends in merchan-dising. Nonetheless, available responses and other public information combineto suggest there will be substantial growth in branded merchandising programsin all major market segments, with much greater reliance on long-term contractswith customers. Price list, formula, and fixed price arrangements will likely grow,while cash market links will decline substantially in importance.

ConclusionsResults of the beef packer survey indicate that cash market arrangements aredominant, though slowly declining in the fed cattle market. Although cash mar-kets for beef products have increased in importance over the last 20 years, thisis reversing. Value-added, branded grocery and food service beef products are

expected to represent an increasing percentage of volume. Packers will probably

Table 9. Beef marketing practices in 1999, volume-weighted averageresponsesBeef PackerCustomer PercentRetailgrocerynonbrandedcommoditysales 28Retailgrocerybrandedvalue-addedproducts 2Food servicenonbrandedcommoditysales 8Foodservicebrandedvalue-addedproducts 1Soldto domesticprocessorfor furtherprocessing 19Exportnonbrandedcommoditysales 9Exportbrandedvalue-addedsales 1Wholesaleror broker 22Other 11Total 100Percentagesmaynot sumto 100due to rounding.

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reduce cash marketingand increaselong-termcontractingand marketingagree-ments with customers.Therewill be increased incentive for packersto securequalitybeef fromproducersin advance of slaughterto supply productfor value-addedbrandedproductmarketingagreements.Packersindicatecontractingand marketingagreementsare importanttools touse for securingconsistent,high qualitycattle.Suchmarketingarrangementsareexpectedto increasein importanceovertime,thushelpingassurethatfood safetyand capacityutilizationgoals aremet. Beefpackersperceivethat the most impor-tant reasonfor cattleproducersto contractand participatein marketingagree-mentsis to sell theircattlebasedon qualitypremium/discountgrids,andincreasepricesreceivedfor cattle.Whatwould the loss of packer-feedingand contractarrangementsdo? In theextreme,packersin fringeproductionareasmay shut down. They indicate thatcosts of operationwould increasesubstantiallywithoutsupply assurances.Mostotherswould be unable to capturethe often intangiblebenefitsfrom improvedquality and efficiency.Cattleproducerswho now appearto be capturingpartof those benefits in the form of higher prices for contract cattle would losethe reduced risk and higher payoffs for value received from contracts.Cus-tomers'abilityto captureany benefitsfromimprovedquality,new products,andmerchandisinginnovationsthat requirelower supply or qualityrisk would bereduced. Cash markets would increasein volume, value-addedpricing would

probablyexpand, albeit at a slower pace, to compensatefor contractloss, andincreasedrisks would be prevalentin the industry.Withlimitedpacker feedingnow or expectedin the future,and only a moderatevolume of cattle underlong-term contracts,eliminatingcontractarrangementswould be unlikely to signifi-cantly improvethe competitivenessof independentcattle feeders.

Compare and ContrastThe pork industryhas moved much more quicklythan the beef industrytovalue-based or grid marketing.Currently,more than 90% of the hogs are pur-chasedby methods otherthan a live weight cashpurchase,with mostbeing pur-chased on a carcassmeritbasis. The beef industryis beginningto move towardavalue-basedsystem,but progressin this areais not as extensive as forhogs. Beefpackers reportbuying 36%of their cattle on a live weight cash basis. Althoughbuyersvisuallyevaluatefed cattle,bids areplacedandprice(value)is determinedbefore cattle are gradedresultingin considerablepricing inefficiency(Schroederand Graff).The pork industryhas outpacedthe beef industryin sending infor-mationregardinganimalqualityto producers.This reinforcesthe conclusionsofSchroeder,Mintert,and Bresterthatthe pork industryis betterpoised to addressconsumerdemands than the beef industry.In 1999,65%of cattle were tradedin the cashmarketcomparedto 27%of hogs(tables1 and 6). Theshare of packerownershipwas higherforhogs, nearly18%versus 5%for cattle.Similarly,55%of hogs were contractedcomparedto 30%ofcattle.The most commoncontractfor both sectorswas a formulacontracttied tothe cash market,nearbyfutures,or the wholesalemeatprice.Packersclearlyidentifiedqualityconcernsas the dominant reasonsfor usingmarketingcontractsor self-productionas suggestedby Hayengaet al. (1996)for

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Table 10. Beef sales methods in 1999, volume-weighted averageresponsesBeef Sales Method PercentCashmarketsaleswith deliverywithin21 days 70Forwardfixedpricecontractfor deliverybeyond21 days 9Forwardformulapricecontractpricedoff currentcashmarket 8Long-runagreementbasis not on cashmarket 3Packersets priceand takesorders 7Packerbids for sales (bid-acceptance) 3Total 100

the pork industry. This finding runs contrary to popular opinion that plant effi-ciency through better capacity utilization has been the impetus for increased useof captive supply arrangements by packers. Quality standards, and a procure-ment system to achieve them, will increase in importance with the introductionof more branded pork and beef products.Pork has more branded value-added products than beef (tables 4 and 9), withmost bacon, sausage, and ham products being differentiated and branded prod-ucts. Twice the percentage of pork (38%)is sold for further processing comparedto beef (19%).Beef sells twice as much product (22%) through brokers as doespork (11%).Compared to beef, there is a preponderance of pork that is brandedby packers and/or further processed and branded by processors, with associatedadvertising and promotion programs. This suggests the pork industry has beenand is in a position to enhance pork demand at the expense of beef.These industries are most similar in their sales methods (tables 5 and 10), notsurprising since they are attempting to secure the same customers-retailers, foodservice, and export-include several of the same leading firms, and are competingagainst each other for shelf space. For both commodities, 70-72% of the productis sold as a cash sale for delivery within 21 days; an additional 9-10% is forwardpriced. Pork tends to have more formula-priced and long-term contract sales thandoes beef.

Conclusions and ImplicationsRecent surveys of the largest beef and pork packers offer some insights intochanging livestock procurement and meat product merchandising practices. Mar-keting contracts and vertical integration have dramatically increased as means ofprocuring hogs, but similar changes are occurring slowly in cattle markets. Thedriving force behind these changes is to assure higher and more consistent qualityproducts for branded product programs and other customers requiring productsmeeting tighter specifications. Producer desires for contract assurances are alsoimportant. Packer merchandising linkages with their customers are also evolving,but long-term contracts have been important for a considerable period of time.Growth in packers' branded product merchandising is expected to increase the

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demand for contractassurancesfor high qualitycattle and hog supplies in thefuture.Thepackers'willingnessto enter into long-termmarketingcontractswith pro-ducers,or investin productionfacilities,impliesthatpackerscannotachievetheirproduct qualitygoals relying solely on existingcash markets.Thissuggests thatinformationidentifying quality problemswas not effectively reaching produc-ers, marketincentivesprovidedare not sufficientto triggerneeded improvementin quality,or producers'adoptiontime is too slow relative to customerneeds.Thus, direct communicationto producerson quality attributesin the form ofa marketingcontractmay be more effectivethan the spot market informationand premium/discount systems in stimulating changes in producers'manage-ment decisions.Qualityassessmenttechnologycontinuesto evolve and will beimportanteven in closely coordinatedsupply chains.However,some consumer-demandedqualityattributessuch as how the animalwas raised,what it was fed,or its geneticscannotbe measuredat theplant.Theseemergingconsumermarketnichesprobablywill requireformallinkagesto assure the product specificationsare met.Withsuch a small percentageof hogs tradedin the cash market,and such alargepercentageformula-pricedoff of this smallvolume,concernsregardingcashmarketliquidityand price accuracyhave arisen.This trend is not as pronouncedin fed cattlemarkets,where more cash tradingoccurs.However,little tradingofcattle occurson many days duringthe week. If this patterncontinues,concernsabout fed cattle cash marketprice reportsbased on low tradevolumes will con-tinue to escalate.

Thinlytraded or thinlyreportedcashmarketsare a concern,as long-termcon-tractlinkages displaceshort-termcontractsinvolvedin cashmarkettransactions.Butlittle is knownabouthow manytransactionsor reportingfirmsare too few toaccuratelyreflectthe market.Yet,in the transitionand,perhapspermanently,bothcash and contractmarkets coexist. Theoretically,the marginalbuyer and sellerdetermine the cash marketprice or the contractterms, including price. Tomekargued that price variabilityincreases as the number of reportedtransactionsdecreases.Buyersand sellers alike are less confident that representativepricesarebeing discoveredfroma pricereporters'or reportingfirms'samplingprocess.Thisunderlyinguncertaintymight lead to inaccurateprices paid underformulapricingcontracts,and may contributeto inefficientresourceallocationdecisions.Policiesthat are intended to eliminate or slow the growthof marketingcon-tractsor self-productionwill jeopardizethe mutuallybeneficialcontractrelation-ships betweenpackersand producers.The developmentof innovative consumerproductsor merchandisingarrangementswill face greaterrisks or may not bepossiblewithout tightercoordinationthroughoutthe productionand processingchain. Theremay be a correspondingimpact on the pork and beef industries'efficiency,demand,and competitivenessrelative to that of poultryor pork andbeef fromcompetingcountries.Concernsthathave beenraisedregardingpossiblenegative impactsof "captivesupplies"and "thinmarkets"need to be weighedagainstbenefits of these arrangementsas policy makersand industrymembersdebatepolicies for the livestockand meat sector.

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AcknowledgmentsJournalPaperNo. J-18974of the Iowa Agriculturaland Home EconomicsExperimentStation,Ames, Iowa,ProjectNo. 3358,andsupportedby HatchAct and Stateof Iowa funds.Theauthorswould like to thankotherteammembersinvolvedin reviewingthesurveydesignandanalysisof the results:DermotHayes,TomislavVukina,ClementWard,WaynePurcell,and PhillipKaus.Thisstudywas supportedfinanciallyby theAmericanMeatInstituteandtheAgriculturalandHome EconomicsExperimentStationsin the authors'universities.

Endnotes1The pork and beef productmarketsinvolved substantialcontractuallinks much earlier thanlivestockprocurement-for example,25%of pork sales and 40%of beef sales by packersin 1978(HayengaandSchrader),thoughthe extentand thenatureof the arrangementshaschangedover theyears.2Grimesand Meyer reportedslightlylower cash marketreliance(26%)based on a smallersetof respondents,addingtheir estimatesof threenonrespondents'purchasingpractices,and includingsome transferpricesystemsfromhog-producingsubsidiariesin theircalculations.In oursurvey,somepackersalsomayhave reportedthe transferpricemethodforhogs producedwithinthecompanyorby a subsidiary,andreportedthemas self-produced.3A qualitymatrixdescribesa two dimensionalpremiumand discountschedulebased on leannessand carcassweightin porkand USDAqualityandyield gradesin beef.4Fewerpackers(seven)respondedto questionsregardingcurrentandfuturemerchandisingmeth-ods andmotivations.5Basiscontracts,or fixedpricecontractsbasedon futuresmarketprices,with deliveriestypicallyseveralmonthsin the future.6Risk and profit-sharingmarketingcontractsare relativelynew in cattlefeeding.They includesplittingprofitsor losses relativeto an agreedupon cost of productionbetween thebuyerand selleron a particulargroupof cattle andjointventureswherethe packertakespartialownershipof cattlein the feedlot and shares cattlefinishingand slaughter-processingprofitsor losses with the cattleproducer.7Somepackersdid not breakthat out in theirresponses.ReferencesBanker,D. andJ. Perry."Contracting:More FarmersManagingto Cut Risk."Agr.Outlook,January-February,1999,pp. 6-8.http://www.econ.ag.gov/epubs/pdf/agout/janfeb99/ao258a.pdf.Barkley,A.P.and T.C.Schroeder."Long-RunImpactsof CaptiveSupplies."Roleof CaptiveSuppliesinBeefPacking,pp. 1-51. Pub.No. GIPSA-RR96-3,USDA/GrainInspection,PackersandStockyards

Administration,WashingtonDC,May1996.Grimes,G. and S. Meyer.2000Hog MarketingContractStudy.Availableat: http://www.nppc.org/PROD/HogMarketContractStudy.htm.Accessedon April26,2000.Hayenga,M.,V.J.Rhodes,G.Grimes,andJ.Lawrence.VerticalCoordinationin HogProduction.GIPSA-RR96-5,May1996.http://www.usda.gov/gipsa/newsinfo/pubs/ packers/report5.htm.Hayenga,M.and L.F.Schrader,"FormulaPricingin FiveCommodityMarketingSystems."Am.J.Agr.Econ.62(November1980):753-759.Hayenga,M., T.Schroeder,J. Lawrence,D. Hayes,T.Vukina,C. Ward,and W. Purcell.MeatPackerVerticalIntegrationand ContractLinkagesin theBeefand PorkIndustries:An EconomicPerspective.May 22, 2000, American Meat Institute, Arlington, VA.Kraenzle,C.A.Co-ops'ShareofFarmMarketingsup Slightlyin '98,USDARuralBusiness-CooperativeService, 2000. http://www.meatami.org/indstructure-6700.pdf.Lawrence,J.,G. Grimes,andM.Hayenga,ProductionandMarketingCharacteristicsofU.S.HogProduc-ers, 1997-98, Iowa State University Department of Economics Staff Paper 311, December, 1998.http://agecon.lib.umn.edu/isu/isu311.pdf.Purcell,W.D.Measuresof Changesin Demandfor Beef,Pork,andChicken,1975-1998.Blacksburg,VA:ResearchInstituteon LivestockPricing,VirginiaTech,1999.Availableat:http://www.aaec.vt.edu/rilp/publications.html.AccessedMay15,2000.Schroeder,T.C.andJ.L.Graff."Valueof IncreasedPricingAccuracyin Fed Cattle."Rev.Agr.Econ22,1(2000):89-101.Schroeder, T.C., T.L. Marsh, and J. Mintert. BeefDemand Determinants.Report prepared for the BeefBoardJoint Evaluation Advisory Committee, January2000. Available at: http://www.agecon.ksu.edu/livestock/Extension%20Bulletins/BeefDemandDeterminants.pdf. Accessed May 15, 2000.

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Schroeder,T.C.,J. Mintert,and G.W.Brester.PositioningtheBeefIndustryfor the Future.CooperativeExtensionService,KansasStateUniversity,MF-2123,August1995.Schroeter,J.R.and A. Azzam. EconometricAnalysisof Fed CattleProcurementin the TexasPanhandle.USDA,GrainInspection,PackersandStockyardsAdministration.November1999.http://www.usda.gov/gipsa.Tomek,W.G."PriceBehaviorin a DecliningTerminalMarket."Am.J.Agr.Econ.62(1980):434-444.U.S.Departmentof Agriculture,EconomicResearchService.FoodMarketingReview,pp. 12-13. 1994-95.. ManagingRiskin Farming:Concepts,Research,andAnalysis,1998.. AgriculturalResourceManagementStudy,personalcommunication,1998.Ward,C.E.,S. R.Koontz,andT.C.Schroeder."ImpactsfromCaptiveSupplieson FedCattleTransac-tion Prices."J.Agr.ResourceEcon.23(December1998):494-514.

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