Agricultural & Applied Economics Association

Evolving Producer-Packer-Customer Linkages in the Beef and Pork Industries

Author(s): John D. Lawrence, Ted C. Schroeder, Marvin L. Hayenga
Source: Review of Agricultural Economics, Vol. 23, No. 2 (Autumn - Winter, 2001), pp. 370-
385
Published by: Oxford University Press on behalf of Agricultural & Applied Economics Association
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 23, Number2-Pages 370-385
Economics-Volume
Reviewof Agricultural

Evolving Producer-Packer-Customer
Linkages in the Beef and
Pork Industries

John D. Lawrence, Ted C. Schroeder, and

Marvin L. Hayenga

The U.S. pork and beef sectorsare rapidlymoving fromtraditionalcash marketsto formal
verticallinkages.In 1999,27%of hogs and 65%of cattle were traded in the cash market
and packersowned 18%of hogs and 5%of cattle;the rest were procuredvia marketing
contracts.Contraryto popularopinion that plant efficiencyis the impetus for the change,
packersclearly identified quality concernsas the dominantreason for using marketing
contractsor self-production.Qualitystandardsand procurementsystems to achievethem
will increasein importancewith the introductionof morebrandedporkand beef products.

he U.S. beef and pork industries are undergoing marked transitions in the
ways livestock and meat products are marketed and the way price discovery
occurs, 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 pork
industry rapidly becoming dominated by long-term contracts or vertical integra-
tion. A number of cattle producers have voiced concerns about "captive supplies"
(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.1
Economists have documented lower cash market fed cattle prices associated
with higher captive supplies, though the behavioral causes are still unclear
(Schroeter and Azzam). However, tradeoffs that may offset potential concerns

* John Lawrenceis an Associate Professor,Departmentof Economics,Iowa State Uni-

versity.
* TedC. Schroederis a Professor,Departmentof AgriculturalEconomics,KansasState
University.
* Marvin L. Hayenga is a Professor,Departmentof Economics,Iowa State University.
 EvolvingBeefandPorkIndustryProducer-Packer-Customer
Linkages 371

about long-termcontractarrangementsin the beef and pork industriesare often

overlooked in these debates. Perhaps the cash marketingsystem has sufficient
drawbacksto warrantits replacementby contractsystems.
Over the last 20 years, beef demand has declined dramatically,pork demand
has declined moderately,and poultry demand has increasedsubstantially(Pur-
cell). Numerous reasons have been hypothesized for the increase in poultry
demand relative to competing meats, including health concernsassociatedwith
red meat consumption.But there have also been persuasive argumentsthat the
lack of effectiveverticalcoordinationin beef and pork marketscomparedto poul-
try has been an importantfactor contributingto competitive cost and product
innovationadvantagesof the poultry sector.The beef and pork sectorshave not
offered consumers the types of products they demand at lower relative prices
(Schroeder,Marsh, and Mintert).Improvingbeef and pork demand and chain
efficiency-affecting relativeproductprices-may requireimprovedverticalcoor-
dination,especiallybetterinformationflow, and more accuraterewardsfor value
enhancement.
The purpose of this study is to determinecurrentpurchasingand marketing
methods being used by beef and pork packers, and document packers' moti-
vations for changes that are occurring.Following a brief discussion of vertical
coordinationin agriculture,the paper is arrangedin three main parts. First,the
currentand projectedfuture mix of pricing methods for fed cattle, markethogs,
and wholesale beef and pork productswill be estimated.Second, majorfactors
motivatingchangingbeef and pork packer-producerand packer-customerlink-
ages will be evaluated.Third,we do a comparativeanalysisof the beef and pork
marketingsystems. The primarydata are derived from surveys of majorbeef and
pork packersconductedduring spring 2000.
Results of this study will contributeto a better understandingof important
coordinationmechanisms that affect market efficiency and performancein the
beef and pork industries,and offer insights into their changingindustrialorgani-
zation. Such insights will be useful for strategicplanning by industry members.
The complexitiesof mandatorylivestock and meat price reportingnow required
by law will become cleareras the variety of methods employed in the marketing
system are documented.Finally,informationfrom these surveys should be useful
in assessing issues raised in court cases alleging illegalitiesassociatedwith "cap-
tive supplies"in the beef industry,and in evaluatingproposedlegislationto elimi-
nate packerverticalintegrationand long-termcontractswith livestockproducers.

Vertical Coordination in Agriculture

Agri-food system organization and coordinationin the United States have
evolved over time. Traditionally,spot (cash) marketshave been the cornerstones
of price discovery and ownership transfer for many commodities. For most
perishable commodities, centralizedmarkets gave way to direct marketingas
producersize increasedand improvedcommunicationand refrigerationallowed
processorsof perishablecommoditiesto move closer to productionregions.Indi-
vidual buyers and sellers gravitatedtowardlonger-termrelationshipsthat reduce
the number of cash markettrades, yet still tied transactionprices closely to the
existing cash market.These verticalalliancesbetween producersand processors
372 Reviewof Agricultural
Economics

continueto evolve toward more formalcontractualrelationshipsor verticalinte-

grationin the form of directownershipof processingby producers,or ownership
of productionby processors.
Todate, verticalintegrationis not extensivein agriculture.In 1994,less than 8%
of agriculturalvolume was producedby farmoperationsthat were eitherowned
by or that own processorsor input supply businesses (U.S. Departmentof Agri-
culture 1994-1995).The poultry industry,primarilyeggs and turkeys,and some
crops, such as, sugar beets, sugar cane, potatoes, fresh marketvegetables, and
some fruitsand nuts, had the greatestsharesof productioninvolved in vertically
integratedoperations.
In addition, farmercooperativesare extensively involved in handling or pro-
cessing farm output of their member-owners(anotherform of vertical integra-
tion). USDA estimates that approximately30%of farm marketingcash volume
was handled by cooperativesin 1998, with extremelyhigh farmercooperative
involvementin dairy handlingand processing.Nearly half of grain,oilseed, and
cottoncash volume was handledby agriculturalcooperatives,as were substantial
volumes of a numberof other farmcommodities(Kraenzle).
Productionand marketingcontractsare more common than direct ownership.
The most recent 1998 USDA-EconomicResearchService AgriculturalResource
ManagementStudy found that contractingis common among all types of farms,
accounting for 35.5%of total production.Over two-thirds of contractvolume
was marketingcontractsand one-thirdwas productioncontractsin 1997.In 1993
farmersurveys, marketingcontractsfor livestock commoditieswere much less
common than productioncontracts;they accounted for 20%of farms and 42%
of the total value of productionunder marketingcontracts.In contrast,approxi-
mately 80%of the farmswith marketingcontractsused them for crop commodi-
ties and these farms accountedfor about 58%of the value of productionunder
marketingcontracts.Between 1991 and 1997, marketingcontractuse increased
from 16 to 22% of farm production.Productioncontractuse showed no clear
trend,rangingbetween 10 and 15%of volume (Bankerand Perry).
Severalrecentstudies have quantifiedthe amountsand/or impactsof processor
controlof livestockpriorto slaughter(Ward,Koontz,and Schroeder;Barkleyand
Schroeder;Hayengaet al.; Grimesand Meyer).The use of formalverticalcoordi-
nation tools between packersand producershas been increasing;however,moti-
vations behind the trends appear to be changing,and little is known about the
upstreammarketingsystem and the motivationsfor coordinationsystem changes
coming from customersof these industries.

Beef and Pork Packer Surveys

During April 2000, 28 of the largest pork and beef packerswere surveyed to
determinecurrentprocurementand merchandisingpracticesand discernpacker
perceptionson why the value chains for these two sectors have moved to more
formal agreements.Four respondingcompaniesprocessedboth hogs and cattle,
but they completeda separatesurvey for each commodity.Fifteenof the largest
U.S. beef packersand 13 of the nation's largest pork processorswere surveyed.
Surveyresponseswere completedby 10 of the 15 beef packingfirmsrepresenting
 EvolvingBeefandPorkIndustryProducer-Packer-Customer
Linkages 373

Table 1. Hog Procurement Methods, 1999

ProcurementMethod Percent
Cash marketpurchase,live basis 8
Cash marketpurchase,carcassbasis 19
Formula-pricedcontractbased on 32
cash market
Fixed price contractbased on futures 8
Fixed agreementbased on feed price 6
Formulacontractwith window 8
Otherpurchasemethods 1
Self production 18
Total 100

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

Pork Packer Survey Results

Hog Procurement
In 1993, 87% of slaughter hogs were purchased in the cash market (Hayenga
et al.). By early 2000, this number had fallen to 26% (Grimes and Meyer). This
survey found similar results. The 11 responding packers reported purchasing 27%
of their hogs in the cash market in 19992 (table 1). Formula agreements based
on the cash market represented 32% of purchases. Agreements with some type
of risk management or cash flow smoothing feature accounted for approximately
22% 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 changes
in 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's
plant. Production by packers was equivalent to 22% of the slaughter volume in
their own plants, but 21% of the hogs produced by a packer or its subsidiary
were processed by a competing packer. So the net volume of packers' own hogs
going 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-
374 Reviewof Agricultural
Economics

Table 2. Packer survey responses of importance of contract and

marketing agreement incentives to beef packersa

PackerUse of
Marketing PackerHog
Incentive Agreement Production
Reduceplant operatingcosts by
improvingplant scheduling 3.5 4.0
Securehigher qualityof hogs 4.0 4.4
Securemore consistentqualityof hogs 4.3 4.6
Assure food safety 3.8 4.3
Long-runprice risk management 3.0 3.3
Week-to-weeksupply/price management 3.5 3.1
Reducecosts of searchingfor hogs 3.5 3.6
Able to purchasehogs for lower price 2.3 1.9
Captureprofitsfromhog production 3.2

aScaleof 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 other
packers.
Motivations for the use of long-term marketing agreements were ranked by
packers 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 supply
of quality hogs (4.3) and desire to secure higher quality of hogs (4.0). The ability
to assure food safety was rated next most important, receiving a ranking of 3.8
out of 5. Reducing plant operating expenses, the cost of searching for hogs, and
week-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 considerably
below quality issues. All motivations for contracting except buying hogs at lower
prices 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-production
than marketing contracts. Packers admit that they do not lower the cost of hogs
processed by producing them, and place only moderate importance on profits
that can be captured by producing hogs. The ability to secure consistently safe,
high quality hogs is more important to packers than are hog production efficiency
and price considerations.
In an open-ended question about the driving forces toward tighter coordina-
tion, packers added another important element to the quality, consistency, and
food safety list; over half of the respondents identified demand for contracts by
producers 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
 EvolvingBeefandPorkIndustryProducer-Packer-Customer
Linkages 375

Table 3. Packer survey responses of importance of contract and

marketing agreement incentives to hog producersa

Incentive 1999 2004

Secureshacklespace for hogs 3.8 4.0
Securea qualitypremium/discountmatrix 3.4 3.4
Reduceprice risk 3.9 3.9
Reducecosts of searchingfor a hog buyer 2.4 2.4
Able to sell hogs for a higherprice 3.6 3.7
Easierto get loans 4.6 4.7

aScale of 1 to 5, 1 = not important to 5 = very important.

with customers who were requesting longer-term arrangements for higher quality
products. They asserted that cash market suppliers could not be relied upon to
change fast enough to meet their needs.
Packers' perception of producers' reasons for wanting an ongoing relationship
were reportedly to assure market access, to share information about consumer
concerns 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). Reduced
price risk (3.9), securing a market outlet (3.8), ability to sell hogs at a higher
price (3.6), and the ability to secure a quality matrix3 (3.4) were the next most
important benefits to producers. These are generally consistent with recent pro-
ducer survey results, though increased price received a slightly higher ranking by
medium-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, Grimes
and 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 increased
producer income (4.5). In comparison, medium-sized producers reported addi-
tional expansion, reduced risk, and access to capital as the leading rationale for
contracting when they were surveyed in 1998 (Lawrence et al.).

Pork Merchandising
In 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 for
delivery in the future, and 6% represented long-term agreements not tied to the
cash market. This degree of reliance on contract sales has not changed much over
the last 20 years.
These relative shares are expected to change dramatically by 2004, although
fewer packer responses to these questions allow only an indication of the direction
of change, but not a precise indication of magnitude. Several packers already
have or are beginning to establish their own branded fresh pork merchandising
376 Reviewof Agricultural
Economics

Table 4. Percent of pork sales by category, 1999

Pork Packer Customer Percent

Retailgrocerynonbrandedcommoditysales 14
Retailgrocerybrandedvalue-addedproducts 14
Food servicenonbrandedcommoditysales 8
Food servicebrandedvalue-addedproducts 2
Sold to domesticprocessorfor furtherprocessing 38
Exportnonbrandedcommoditysales 6
Exportbrandedvalue added sales 2
Wholesaleror broker 12
Other 5
Total 100

maynotsumto 100dueto rounding.

Percentages

programs, or are forming exclusive supplier arrangements with retailers. Cash

market sales are expected to decline by over 50%. Forward pricing will expand
greatly, and long-term agreements not tied to the cash market are expected to
double.
A large share of pork is sold for further processing domestically, representing
37.5% of 1999 sales (table 5). These products may become branded lunch meats,
further processed products under the processor or retail label, or further processed
products going into food service or export markets.
Branded programs by packers have been rapidly growing, now 18% of current
market volume. By 2004, branded programs by packers are expected to represent
an even larger share of pork sold. Branded pork must carry a higher degree of
brand reputation (or losses for the company if food safety problems occur) and
demands higher standards to consistently satisfy end-user expectations.
Thus, packers report that their motivation for increased contractual links to
producers (or self-production) has been their need for increased quality control
and consistency in hogs procured to meet rising demands from pork buyers and
ultimately final consumers.

Table 5. Pork marketing methods, share of total sales, 1999

MarketingMethod Percent
Cash marketdeliverywithin 21 days 72
Forwardfixed price agreementfor delivery 10
beyond 21 days
Forwardformulaprice agreementbased on 12
currentcash market
Long-runagreementbasis not on cash market 6
Total 100
 EvolvingBeefandPorkIndustryProducer-Packer-Customer
Linkages 377

Coordination Advantages
Packershad a difficulttime quantifyingthe cost and returnadvantagesfrom
hog productionor marketingcontracts.However, half of the respondentsnoted
that buying stationsand procurementstaffhad been reducedas the level of coor-
dination increased.In some cases, associated cost savings have been dramatic,
reducingthe numberof buyers 10-20%and the numberof buying stationsby as
much as 50%.At the same time, the qualityof hogs increased.Severalnoted that
lean percentageof hogs increased(in the range of 1.8 to 2.6 percentagepoints),
and cutting and processingyields improved significantly.These results are con-
sistentwith theirresponsesthat the value of coordinationwas in productquality,
consistency,and safety more than in plant efficiencyor lower priced hogs.
Packerswere asked their opinion of the likely impact of abolishing packer
ownershipor contractsallowing packercontrolof hogs. They indicatedsuch con-
straintswould eliminatecustomerand producerbenefits describedearlier.Pack-
ers would encounter increased difficulty in enforcing food safety and quality
control measures implementedvia managing their own productionor by con-
tract supply agreements.One packer suggested coordinatedsystems that have
evolved in the United Statesin responseto customerrequestswould emerge off-
shoreif banneddomestically.Otherscommentedslaughtercapacitywould decline
because of packer unwillingness to maintaintheir large investmentswithout a
reliablesupply of hogs. Two firms said they could not continuein business with-
out their currentarrangements.Most were uncertainabout the price impact of
ending such practices,but added that revokingexistingagreementswould penal-
ize many progressiveproducerswho have aligned themselveswith a processor.

Conclusions
Hog procurementpracticesare expected to continue to evolve toward tighter
coordinationsystems in order to satisfy strongercustomerdemands for consis-
tently high quality,safe pork products.More demandingconsumersare encour-
aging morebrandedretailand food serviceproductsclearlyassociatedwith their
firm,where productquality problemscan generategreaterlosses. Packersreport
greatersuccess in acquiringleaner,higheryielding hogs throughcoordinatedsys-
tems than are generallyavailablethroughtraditionalcash marketchannels.
Packersindicate that packer-producedhogs address concernsof quality,con-
sistency,and safety as well or better than marketcontracthogs. While capturing
profits or losses in the productionsector,packersadmit that their own hogs are
not lower cost than hogs purchased from producers.Increasedquality control
affordedthe integratedpackerappearssufficientto offset possible higher costs of
producingtheir own hogs.
At the other end of the pork chain, producersare asking for marketingagree-
ments in orderto securefinancingto continueor expandhog production,and for
purchasingprogramsthat rewardleaner,higher yielding hogs. Many producers
are reluctantto adopt new technology and invest in new facilities and genetics
without a formalarrangementto marketoutput. In an increasinglyrisky agricul-
tural marketplace where packercapacitylimits were reachedin 1994 and 1998,
long-termmarketingagreementsalso are a private sector responseto a potential
problem-producing without a place to sell.
378 Reviewof Agricultural
Economics

Table 6. Percentage of cattle procured via various methods, 1999

ProcurementMethod Percent
Cash marketpurchaseson live weight basis 36
Cash marketpurchaseson a carcassweight or grid basis 29
Formula-pricedcontractpurchasesbased on a reported 20
live cash market,reporteddressedprice,plant
average,CMEcattlefuturesprice, quotedboxed beef,
or retailbeef price
Packer-fedcattle 5
Fixedprice or basis contractpurchasesbased on 4
CMEfutures
Risk-sharingcontractpurchases 3
Otherpurchases 4
Total 100

maynotsumto 100dueto rounding.

Percentages

Beef Packer Survey Results

Cattle Procurement
Packers are slowly shifting away from live cattle cash market purchases to more
long-term contractual and/or value-based grid purchases, yet negotiated cash
market pricing arrangements remain dominant. Only 5% of cattle slaughtered by
survey respondents were packer owned, while in the feedlot, little changed over
the last 15 years. Survey respondents reported 36% of cattle were purchased on
the cash market on a live weight basis, and 29% on a carcass weight or grid
(carcass merit) basis (table 6). Thus, approximately two-thirds of cattle slaughtered
were cash market acquisitions.
Ongoing long-term formula-priced contracts linked to the cash market-such
as 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 cattle
were acquired under risk and profit-sharing6 marketing contract arrangements
with 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 their
entire group of pens-perhaps with several owners in custom feedlots-at the
same live or carcass price, allowing little distinction for quality on a lot-by-lot let
alone carcass-by-carcass basis. Cash market purchases based on carcass merit are
increasing 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.7
Most cattle fed by packers were also transferred to their packing operations based
on carcass merit.
Packers were queried regarding the importance of specific reasons they and
cattle feeders enter into contracts and marketing agreements. The packers' most
important reasons were to secure higher quality cattle (4.0), and to secure more
 EvolvingBeefandPorkIndustryProducer-Packer-Customer
Linkages 379

Table 7. Packer survey responses of importance of contract and

marketing agreement incentives to beef packersa

2004
1999 Expected
Importanceto Packers Average Average
Reduceplant operatingcosts due to 2.9 3.5
improvedslaughterplant capacityutilization
Securehigher qualitycattle 4.0 4.2
Securemore consistentqualityof cattle 4.0 4.2
Assure food safety 3.0 3.7
Improvelong-runprice risk management 2.8 3.1
Improveweek-to-weeksupply/price management 2.2 2.9
Reducecosts of searchingfor cattleto procure 2.3 2.4
Able to purchasecattlefor lower price 1.8 1.8

aScaleof 1 to 5, 1 = not importantto 5 = very important.

consistent quality cattle (4.0) (table 7). These were also expected to be more
important (4.2) in 2004. Improving price risk management (2.8), reducing plant
operating costs by improving slaughter plant capacity utilization rates (2.9), and
assuring food safety (3.0) were the next most important reasons. All three also
are expected to increase in importance, with 2004 ratings for food safety at 3.7
and 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 procure
cattle at lower prices, as shown in recent USDA-sponsored studies (Schroeter
and Azzam).
Packers perceived that producers' primary incentives to enter into contracts and
marketing agreements were to secure a quality premium (4.0) and obtain a higher
price for cattle (3.8) (table 7). Providing detailed carcass data (3.4), reducing price
risk (3.3), and making it easier to get loans (3.1) were the next greatest perceived
advantages to producers. Securing a buyer for the cattle (2.6) and reduced search
cost to find a buyer (2.4) rated even less important. Packers felt that in the next
five years, producers would benefit from marketing agreements primarily due to
these same reasons.

Beef Merchandising
Packers' largest customers for beef are retail grocery chains, wholesalers, and
domestic processors. These three groups accounted for 71% of survey respon-
dents' 1999 beef sales, whereas export and food service customers each accounted
for approximately 10% of sales (table 8). Only 4% of packer sales were branded
beef 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 contracting
and marketing agreements represented 20% of respondent beef sales during the
same period.
380 Reviewof Agricultural
Economics

Table 8. Packer survey responses of importance of contract and

marketing agreement incentives to cattle producersa

2004
1999 Expected
Importancefor Producers Average Average
Securea buyer for cattle 2.6 2.8
Securea qualitypremium/discount 4.0 4.0
Reduceprice risk 3.3 3.3
Reducecosts of searchingfor a cattlebuyer 2.4 2.8
Able to sell cattlefor higherprice 3.8 3.8
Easy to get loans 3.1 3.4
Providedetailedcarcassdata 3.4 3.6

aScaleof 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 combine
to suggest there will be substantial growth in branded merchandising programs
in all major market segments, with much greater reliance on long-term contracts
with customers. Price list, formula, and fixed price arrangements will likely grow,
while cash market links will decline substantially in importance.

Conclusions
Results of the beef packer survey indicate that cash market arrangements are
dominant, though slowly declining in the fed cattle market. Although cash mar-
kets for beef products have increased in importance over the last 20 years, this
is 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 average

responses

Beef PackerCustomer Percent

Retailgrocerynonbrandedcommoditysales 28
Retailgrocerybrandedvalue-addedproducts 2
Food servicenonbrandedcommoditysales 8
Food servicebrandedvalue-addedproducts 1
Sold to domesticprocessorfor furtherprocessing 19
Exportnonbrandedcommoditysales 9
Exportbrandedvalue-addedsales 1
Wholesaleror broker 22
Other 11
Total 100

Percentagesmay not sum to 100 due to rounding.

 EvolvingBeefandPorkIndustryProducer-Packer-Customer
Linkages 381

reduce cash marketingand increaselong-termcontractingand marketingagree-

ments with customers.There will be increased incentive for packers to secure
qualitybeef from producersin advanceof slaughterto supply productfor value-
added brandedproductmarketingagreements.
Packersindicate contractingand marketingagreementsare importanttools to
use for securingconsistent,high quality cattle.Such marketingarrangementsare
expectedto increasein importanceover time, thus helping assurethat food safety
and capacityutilizationgoals are met. Beef packersperceivethat the most impor-
tant reason for cattle producersto contractand participatein marketingagree-
ments is to sell theircattlebased on qualitypremium/discountgrids,and increase
prices receivedfor cattle.
What would the loss of packer-feedingand contractarrangementsdo? In the
extreme,packersin fringe productionareas may shut down. They indicate that
costs of operationwould increasesubstantiallywithout supply assurances.Most
others would be unable to capturethe often intangiblebenefits from improved
quality and efficiency.Cattle producers who now appear to be capturingpart
of those benefits in the form of higher prices for contract cattle would lose
the reduced risk and higher payoffs for value received from contracts.Cus-
tomers'abilityto captureany benefitsfrom improvedquality,new products,and
merchandisinginnovations that requirelower supply or quality risk would be
reduced. Cash markets would increase in volume, value-added pricing would
probablyexpand, albeit at a slower pace, to compensatefor contractloss, and
increasedrisks would be prevalentin the industry.With limited packerfeeding
now or expectedin the future,and only a moderatevolume of cattleunder long-
term contracts,eliminatingcontractarrangementswould be unlikely to signifi-
cantly improve the competitivenessof independentcattle feeders.

Compare and Contrast

The pork industry has moved much more quickly than the beef industry to
value-based or grid marketing.Currently,more than 90%of the hogs are pur-
chased by methods other than a live weight cash purchase,with most being pur-
chased on a carcassmeritbasis. The beef industryis beginningto move towarda
value-basedsystem, but progressin this areais not as extensive as for hogs. Beef
packersreportbuying 36%of their cattle on a live weight cash basis. Although
buyersvisually evaluatefed cattle,bids areplaced and price (value)is determined
before cattle are graded resultingin considerablepricing inefficiency(Schroeder
and Graff).The pork industry has outpaced the beef industry in sending infor-
mation regardinganimal quality to producers.This reinforcesthe conclusionsof
Schroeder,Mintert,and Bresterthat the pork industryis betterpoised to address
consumerdemands than the beef industry.
In 1999,65%of cattlewere tradedin the cash marketcomparedto 27%of hogs
(tables1 and 6). The share of packerownershipwas higher for hogs, nearly 18%
versus 5%for cattle.Similarly,55%of hogs were contractedcomparedto 30%of
cattle.The most common contractfor both sectorswas a formulacontracttied to
the cash market,nearbyfutures,or the wholesale meat price.
Packersclearly identified quality concernsas the dominant reasons for using
marketingcontractsor self-productionas suggested by Hayenga et al. (1996)for
382 Economics
Reviewof Agricultural

Table 10. Beef sales methods in 1999, volume-weighted average

responses

Beef Sales Method Percent

Cash marketsales with deliverywithin 21 days 70
Forwardfixed price contractfor deliverybeyond 21 days 9
Forwardformulaprice contractpriced off currentcash market 8
Long-runagreementbasis not on cash market 3
Packersets price and takes orders 7
Packerbids for sales (bid-acceptance) 3
Total 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 use
of captive supply arrangements by packers. Quality standards, and a procure-
ment system to achieve them, will increase in importance with the introduction
of more branded pork and beef products.
Pork has more branded value-added products than beef (tables 4 and 9), with
most bacon, sausage, and ham products being differentiated and branded prod-
ucts. Twice the percentage of pork (38%) is sold for further processing compared
to beef (19%). Beef sells twice as much product (22%) through brokers as does
pork (11%).Compared to beef, there is a preponderance of pork that is branded
by packers and/or further processed and branded by processors, with associated
advertising and promotion programs. This suggests the pork industry has been
and 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), not
surprising since they are attempting to secure the same customers-retailers, food
service, and export-include several of the same leading firms, and are competing
against each other for shelf space. For both commodities, 70-72% of the product
is sold as a cash sale for delivery within 21 days; an additional 9-10% is forward
priced. Pork tends to have more formula-priced and long-term contract sales than
does beef.

Conclusions and Implications

Recent surveys of the largest beef and pork packers offer some insights into
changing livestock procurement and meat product merchandising practices. Mar-
keting contracts and vertical integration have dramatically increased as means of
procuring hogs, but similar changes are occurring slowly in cattle markets. The
driving force behind these changes is to assure higher and more consistent quality
products for branded product programs and other customers requiring products
meeting tighter specifications. Producer desires for contract assurances are also
important. 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
 EvolvingBeefandPorkIndustryProducer-Packer-Customer
Linkages 383

demand for contractassurancesfor high quality cattle and hog supplies in the
future.
The packers'willingness to enter into long-termmarketingcontractswith pro-
ducers,or invest in productionfacilities,implies that packerscannotachievetheir
product quality goals relying solely on existing cash markets.This suggests that
informationidentifying quality problems was not effectively reaching produc-
ers, marketincentivesprovided are not sufficientto triggerneeded improvement
in quality,or producers'adoption time is too slow relative to customer needs.
Thus, direct communicationto producers on quality attributesin the form of
a marketingcontractmay be more effective than the spot market information
and premium/discount systems in stimulatingchanges in producers'manage-
ment decisions. Quality assessment technology continues to evolve and will be
importanteven in closely coordinatedsupply chains. However,some consumer-
demandedqualityattributessuch as how the animalwas raised,what it was fed,
or its geneticscannotbe measuredat the plant.These emergingconsumermarket
niches probablywill requireformallinkages to assure the product specifications
are met.
With such a small percentageof hogs traded in the cash market,and such a
largepercentageformula-pricedoff of this small volume, concernsregardingcash
marketliquidity and price accuracyhave arisen.This trend is not as pronounced
in fed cattle markets,where more cash tradingoccurs.However,little tradingof
cattle occurs on many days during the week. If this patterncontinues,concerns
about fed cattle cash marketprice reportsbased on low trade volumes will con-
tinue to escalate.
Thinlytraded or thinly reportedcash marketsare a concern,as long-termcon-
tractlinkages displace short-termcontractsinvolved in cash markettransactions.
But little is known abouthow many transactionsor reportingfirmsare too few to
accuratelyreflectthe market.Yet,in the transitionand, perhapspermanently,both
cash and contractmarkets coexist. Theoretically,the marginalbuyer and seller
determine the cash market price or the contractterms, including price. Tomek
argued that price variabilityincreases as the number of reported transactions
decreases.Buyers and sellers alike are less confident that representativeprices
arebeing discoveredfrom a price reporters'or reportingfirms'samplingprocess.
This underlyinguncertaintymight lead to inaccurateprices paid under formula
pricing contracts,and may contributeto inefficientresourceallocationdecisions.
Policies that are intended to eliminate or slow the growth of marketingcon-
tractsor self-productionwill jeopardizethe mutuallybeneficialcontractrelation-
ships between packersand producers.The developmentof innovativeconsumer
products or merchandisingarrangementswill face greaterrisks or may not be
possible without tighter coordinationthroughoutthe productionand processing
chain. There may be a correspondingimpact on the pork and beef industries'
efficiency,demand, and competitivenessrelative to that of poultry or pork and
beef fromcompetingcountries.Concernsthathave been raisedregardingpossible
negative impacts of "captivesupplies" and "thin markets"need to be weighed
against benefits of these arrangementsas policy makers and industry members
debate policies for the livestock and meat sector.
384 Review of AgriculturalEconomics

Acknowledgments
JournalPaper No. J-18974of the Iowa Agriculturaland Home EconomicsExperimentStation,
Ames, Iowa, ProjectNo. 3358,and supportedby HatchAct and Stateof Iowa funds.
Theauthorswould like to thankotherteammembersinvolvedin reviewingthe surveydesign and
analysisof the results:DermotHayes, TomislavVukina,ClementWard,WaynePurcell,and Phillip
Kaus.This study was supportedfinanciallyby the AmericanMeatInstituteand the Agriculturaland
Home EconomicsExperimentStationsin the authors'universities.

Endnotes
1The pork and beef product marketsinvolved substantialcontractuallinks much earlierthan
livestockprocurement-for example,25%of pork sales and 40%of beef sales by packersin 1978
(Hayengaand Schrader),thoughthe extentand the natureof the arrangementshas changedover the
years.
2Grimesand Meyer reportedslightly lower cash marketreliance(26%)based on a smallerset
of respondents,adding theirestimatesof threenonrespondents'purchasingpractices,and including
some transferpricesystemsfromhog-producingsubsidiariesin theircalculations.In our survey,some
packersalso may have reportedthe transferpricemethodfor hogs producedwithin the companyor
by a3 subsidiary,and reportedthem as self-produced.
A qualitymatrixdescribesa two dimensionalpremiumand discountschedulebased on leanness
and carcassweight in pork and USDAqualityand yield gradesin beef.
4 Fewer
packers(seven)respondedto questionsregardingcurrentand futuremerchandisingmeth-
ods and motivations.
5 Basiscontracts,or fixed
price contractsbased on futuresmarketprices,with deliveriestypically
severalmonthsin the future.
6Risk and profit-sharingmarketingcontractsare relativelynew in cattle feeding. They include
splittingprofitsor losses relativeto an agreedupon cost of productionbetween the buyer and seller
on a particulargroup of cattleand joint ventureswhere the packertakes partialownershipof cattle
in the feedlot and shares cattle finishingand slaughter-processingprofits or losses with the cattle
producer.
7 Some packersdid not breakthat out in theirresponses.

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