Livestock Marketing

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Livestock Marketing

• Price discovery
• Pricing methods
• Marketing decisions
• Supply and demand

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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 lot of produce at
  a given location for a specific time period.

3
Price Discovery

• A human process, subject to relative bargaining
  power of the buyer and seller.
• Two stage process
• Evaluate SD and Pe
• Estimate the price for the specific trade.

4

Price Determination and Price Discovery

S
P

Pe
D
Q
Qe
5
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

6
Decentralized Pricing

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

7
Hybrid markets

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

8
Formula pricing

• Price discovery from elsewhere
• Formula contracts
• Spot market
• Cutout price
• Futures
• Do you trust the underlying market for price
  discovery?

9
Performance issues

• Least cost method of price discovery
• Effect of the mechanism on price behavior
• Marketing v. pricing efficiency

10
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

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Livestock Marketing Decisions

• What to sell
• Live, carcass, grid
• Where to sell
• Type of market
• Location
• When to sell
• Weight, grade, costs

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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

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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

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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

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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

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Hog Carcass Weight Discounts
Carcass Weight Range Range
145 -27.70 -8.16
155 -27.70 -5.00
165 -10.39 -0.67
175 -3.40 0.00
185 -1.36 0.00
195 -0.68 0.00
205 0.00 0.00
215 -3.00 1.36
225 -5.26 0.00
IOWA/MINNESOTA DAILY DIRECT NEGOTIATED HOG
PURCHASE MATRIX LM_HG204, Fri, Aug 26, 2005, USDA
Market News Des Moines, Iowa
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Hog Carcass Price by Backfat and Loin Eye Area
Hog Carcass Price by Loin Eye Area/depth (inches) Hog Carcass Price by Loin Eye Area/depth (inches) Hog Carcass Price by Loin Eye Area/depth (inches) Hog Carcass Price by Loin Eye Area/depth (inches) Hog Carcass Price by Loin Eye Area/depth (inches) Hog Carcass Price by Loin Eye Area/depth (inches) Hog Carcass Price by Loin Eye Area/depth (inches) Hog Carcass Price by Loin Eye Area/depth (inches) Hog Carcass Price by Loin Eye Area/depth (inches) Hog Carcass Price by Loin Eye Area/depth (inches)
Backfat 4.0/1.4 4.0/1.4 5.0/1.7 5.0/1.7 6.0/2.0 6.0/2.0 7.0/2.3 7.0/2.3 8.0/2.7 8.0/2.7
0.40 62.00 75.05 63.50 75.00 65.00 75.00 66.00 76.00 66.00 76.00
0.50 59.50 75.05 62.00 75.05 65.00 75.05 66.00 75.00 66.00 76.00
0.60 59.50 75.60 62.00 75.60 63.50 75.60 65.00 75.60 66.00 75.60
0.70 59.50 75.60 59.50 75.60 62.00 75.60 65.00 75.60 66.00 75.60
0.80 57.50 75.60 59.50 75.60 62.00 75.60 63.50 75.60 66.00 75.60
0.90 57.50 72.10 59.50 72.10 59.50 72.55 62.00 73.05 65.00 73.80
1.00 56.50 72.10 57.50 72.10 59.50 72.10 62.00 72.10 63.50 73.05
1.10 55.50 67.90 57.50 68.05 59.50 69.05 59.50 70.27 63.50 71.66
1.20 55.50 67.90 56.50 67.90 57.50 67.90 59.50 68.87 62.00 70.96
1.40 52.00 64.00 55.34 64.70 55.34 66.09 56.86 67.48 56.86 68.87
IOWA/MINNESOTA DAILY DIRECT NEGOTIATED HOG
PURCHASE MATRIX LM_HG204, Fri, Aug 26, 2005, USDA
Market News Des Moines, Iowa
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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

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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
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Value-Based Cattle Marketing
Common Ground for Targets 1. Carcass Weights 550
- 950 lbs 2. Quality Grade gt Se or gt Ch0 3.
Yield Grade 1s and 2s
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Carcass Merit Grid and Premium Trends
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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
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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 12 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.

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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

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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 ??????

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Important market functions
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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

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Overview

• Define contractual relationship
• Evolution and status of hog industry
• Describe marketing contracts
• Motivation and concerns
• Role for economists

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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

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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.

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Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009 Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009 Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009 Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009 Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009 Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009 Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009 Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009 Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009 Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009 Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009 Percent of U.S. Hogs Sold Through Various Pricing Arrangements, January 1999-2009
Year 99 00 01 02 03 04 05 06 07 08 09
Hog or meat market formula 44.2 47.2 54 44.5 41.4 41.4 39.9 41.8 38.3 37.1 41.2
Other market formula 3.4 8.5 5.7 11.8 5.7 7.2 10.3 8.8 8.5 11.0 7.9
Other purchase arrangement 14.4 16.9 22.8 8.6 19.2 20.6 15.4 16.6 15.2 13.4 11.6
Packer-sold 2.1 2.2 2.1 2.4 2.6 6.7 6.1 5.6
Packer-owned 16.4 18.1 17.1 21.4 20 22.7 23.1 25.7
Negotiated - spot 35.8 25.7 17.3 16.7 13.5 11.6 10.6 10.2 8.6 9.2 8.1
Source Grimes and Plain, University of Missouri http//agebb.missouri.edu/mkt/vertstud09.htm Source Grimes and Plain, University of Missouri http//agebb.missouri.edu/mkt/vertstud09.htm Source Grimes and Plain, University of Missouri http//agebb.missouri.edu/mkt/vertstud09.htm Source Grimes and Plain, University of Missouri http//agebb.missouri.edu/mkt/vertstud09.htm Source Grimes and Plain, University of Missouri http//agebb.missouri.edu/mkt/vertstud09.htm Source Grimes and Plain, University of Missouri http//agebb.missouri.edu/mkt/vertstud09.htm Source Grimes and Plain, University of Missouri http//agebb.missouri.edu/mkt/vertstud09.htm Source Grimes and Plain, University of Missouri http//agebb.missouri.edu/mkt/vertstud09.htm Source Grimes and Plain, University of Missouri http//agebb.missouri.edu/mkt/vertstud09.htm Source Grimes and Plain, University of Missouri http//agebb.missouri.edu/mkt/vertstud09.htm Source Grimes and Plain, University of Missouri http//agebb.missouri.edu/mkt/vertstud09.htm Source Grimes and Plain, University of Missouri http//agebb.missouri.edu/mkt/vertstud09.htm
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Contract Specs

• Product specifications
• PQA, Right to approve inputs
• Method of pricing
• Which markets and formula
• Delivery scheduling
• Short and long term
• Exemptions

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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 weeks average excluding the high and low
• 92 of the previous day pork cutout value
• Packer does not share risk

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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

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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

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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

41
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

42
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

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Attitude Toward Marketing Contracts by Pork
Producers with and without Marketing Contracts1
strongly disagree, 6 strongly agree
With Without 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
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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?

46
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?

47
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.

48
Contract Examples

• Iowa Attorney General
• http//www.state.ia.us/government/ag/ag_contracts/
  
• Contract concerns
• Will discuss more in market controversy section

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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
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When to sell

• Classic production function
• Optimal selling weight is where MCMR
• 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

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Market timing

• Cycles
• Seasonals
• Marginal costs and returns

52
Biological and price cycles

• Cycle is a pattern that repeats itself over a
  period longer than a year in a relatively
  predictable pattern

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Livestock Marketing Information Center Data
Source USDA/NASS
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What causes cycles

• Response to economic signals
• Time lag
• Psychology
• Biology
• Investment
• Livestock
• Tree crops
• Land development

58
Cattle Cycle and Timing

• Prices are cyclical
• Heifer cost impact profitability
• Calf prices impact annual income
• Two alternatives
• Steady Size Same number of heifers
• Dollar Cost Averaging Same value of heifers

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Seasonal price patterns

• Patterns that repeat themselves with some degree
  of predictability within a years time frame.
• Driven by supply and demand factors that are
  impacted by time of year
• Weather
• Holidays
• Input prices

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MC

MR
Weight
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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.

68
Cost of Production

• Purchased feeder livestock
• Derived demand for feeder animal
• Highly variable price
• Depends upon
• Expected selling price for finished animal
• Feed costs

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Cost of production budgets

• Starts with production function
• Incorporates input prices
• Project cost per unit sold
• Variable /unit
• Total /unit
• http//www.extension.iastate.edu/agdm/livestock/ht
  ml/b1-21.html

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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 v. Financial costs

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Objective Based Pricing Strategy
Cost/hd
/cwt
550 steer calf fed to 1200 slaughter weight
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How much to pay for feeder animal

• Work back from total revenue

/cwt
Cost/hd
550 steer calf fed to 1200 slaughter weight
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Breakeven Purchase Price for 550 Steers Breakeven Purchase Price for 550 Steers Breakeven Purchase Price for 550 Steers Breakeven Purchase Price for 550 Steers Breakeven Purchase Price for 550 Steers Breakeven Purchase Price for 550 Steers
Fed Cattle Price Fed Cattle Price Fed Cattle Price Fed Cattle Price Fed Cattle Price
FCOG 81 83 85 87 89
24.72 119 123 127 131 136
26.72 117 121 125 129 133
28.72 114 119 123 127 131
30.72 112 116 120 125 129
32.72 110 114 118 122 126
Corn WDGS hay int yard other
1.75 32.00 50 7 0.30 30
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Supply

• Derived from cost function
• Production function
• Input - output relationship
• Assume that firms seek to
• Maximize profits
• Minimize costs
• Supply starts will individual firm

77
Market supply curves

S1
Move from A to B is a change in quantity supplied
due to a price decline.
Px
S2
A
B
C
Move from B to C is a shift in supply.
Qx
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Supply Shifts from Change

• in input prices
• in returns for competing enterprises
• in price of joint products
• in technology on yields or costs
• in yield and/or price risk
• institutional constraints
• SUPPLY DOES NOT CHANGE DUE TO A CHANGE IN PRICE
  OF THE OUTPUT

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Demand considerations

• Demand for meat by consumers
• Derived demand for animal by packers
• Derived demand for feeder livestock by feedlots
  and finishers

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Law of Demand

• All else equal consumers will by more of a item
  at lower prices and buy less at higher prices.
• Demand begins with individual consumer
• Inverse relationship between quantity and price
• Two dimensional, Price and Quantity

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Downward Sloping Demand Curve
Px
A
PA
B
PB
D
QA
QB
Qx
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Factors that Cause a Shift in Demand

• Price of substitutes
• Price of complements
• Consumer income
• Taste and preferences
• Population and exports
• Government intervention
• IS NOT FUNCTION OF THE GOODS OWN PRICE

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Derived Demand
Vertical distance is the difference is price at 3
levels There is cost associated with moving from
one level to the next
S
Px
Pretail
Pwholesale
Pfarm
Dretail
Cuts of meat Carcasses Animals
Dwholesale
Dfarm
Q
Qx
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Derived Demand for Pork

• Average retail price /lb 2.50
• Value of trim and scrap /lb 0.10
• Costs from whlse -retail /lb -1.00
• The most retail will pay /lb 1.60
• Retail pounds per carcass 100
• The most retail will pay /head 160

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Derived Demand for Hogs

• Wholesale carcass value /hd 160
• Value hide and offal /hd 25
• Costs to slaughter and fab /hd -20
• The most packer will pay /hd 165
• Wholesale pounds per carcass 200
• The most packer will pay /lb 82.50