Meat Industry’s Assessment of Integration

July 6, 2000

The livestock and meat industry’s increasing use of production contract, marketing agreement or ownership linkages between beef and pork producers and meat packers has provoked controversy and legislation to abolish many of these market linkages, says the American Meat Institute. In a study of the trends within the industry, an AMI report finds that vertical integration "is not extensive in agriculture."

In fact, less than 8% of farm production is from vertically integrated businesses; poultry, eggs, turkey, and some crops such as sugar beets and cane, potatoes, fresh market vegetables and some fruits and nuts have the greatest shares of production involved in vertically integrated operations. Farmer cooperatives handle or process 30% of farm output.

Contracting "is common" among all types of farms, accounting for 35% of total production. More than two-thirds of contract volume were marketing contracts, one-third was production contracts; more than 11% of all farms were involved in contracts with large family farms having the most involvement.

The study says the reasons given for vertical integration and contracts are that vertical integration reduces quantity and/or quality risk, generates efficiencies in moving product through the system and captures the profits from both levels of the production and marketing process. Integration "assures raw materials or customers and may help avoid market power that might exist in supply or customer markets."

Marketing contracts typically offer farmers more independence, more financial risk and less capital than production contracts and less independence, less financial risk and easier access to capital than cash market arrangements. "Contracts convey clear signals and incentives to producers and may result in faster response to changing consumer demands," according to this study.

There are some disadvantages to vertical integration and contracts such as the requirement for a large amount of capital. "Payoffs from acquiring suppliers or customers may not be great," the study says. "Customer or raw material market foreclosures for competitors are potential concerns when the share of the markets involved is high."

The pork sector has changed its size structure and vertical linkages "dramatically" in the last 15 years, the study notes. About 18% of the industry volume is represented by vertically integrated suppliers. Packers building plants outside typical production regions had to build hog production or encourage expanded production through contract arrangements. Production contracts have been offered primarily by large-scale producers, not packers, according to the study.

Pork packer marketing contract volume now totals more than 50% of industry volume. Long-term arrangements with packers were found to be essential for financial security. "The financial crisis in pork production in 1998-99 probably stimulated more pork producers to seek contracts to stabilize their financial situation," the study says.

About one-fourth of slaughter cattle comes from long-term contracts and marketing agreements, and 5% of slaughter cattle are fed by beef packers. The impacts of packer-fed and contract cattle are controversial, says the report.

"Packers are accused of undue favoritism for contract suppliers or manipulating cash market prices to their advantage," the study notes. "Several studies found lower cash market prices occurred when contract cattle deliveries were high. Although precise reasons for these negative relationships have not been determined, they are probably partly attributable to cattle quality differences and contract cattle feeders, not packers, adjusting contract deliveries to benefit from short-term price changes."

The broiler industry, which is a significant competitor for pork and beef, rapidly gaining market share over the last 30 years, is entirely vertically coordinated through ownership or contract. The table egg industry also is highly vertically integrated, the study says.

To access the complete study, go to the Internet address: http://www.meatami.org/indstructure_6700.pdf