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Pork Quality and the Role of Market Organization
Steve W. Martinez and Kelly Zering
Agricultural Economic Report No. (AER-835), November
2004
In the U.S. pork industry, contracting between pork packers
and producers ballooned in the 1990s. These arrangements accounted
for approximately 69 percent of hogs sold in 2004, compared
with less than 2 percent in 1980 and 11 percent in 1993. Marketing
contracts offered by pork processing companies typically specify
the quantity of slaughter hogs to be purchased on specified
dates and places. These contracts give hog producers a secure
outlet for their hogs and specific pricing terms.
What Is the Issue?
The rapid increase in marketing contracts in the pork industry
has concerned policymakers because as marketing contracts replace
hog sales on the spot market, spot prices are based on fewer
sales. Consequently, these "thin" markets—ones
with fewer sales—may become highly volatile, subject to
manipulation, and less representative of a competitive market
equilibrium. Smaller independent producers complain that packers
prefer to contract only with larger producers and information
about premiums paid are not made publicly available.
On the other hand, survey evidence suggests that long-term
marketing agreements play an important role in solving pork
quality problems. Policies that restrict changes in the organization
of pork markets could leave producers and consumers worse off
if such changes are actually efficient responses to market conditions.
Pork Quality and the Role of Market Organization examines the
relationship between changing organizational arrangements and
pork quality.
What Did the Project Find?
Several events in the 1990s combined to induce packers to emphasize
pork quality:
• Spurred by advances in measurement technology, renewed
emphasis on leanness moved to the forefront as packers adopted
pricing programs based on measures of the carcass. These carcass
pricing programs created strong incentives for producers to
provide leaner hogs in response to consumer health concerns.
• As renewed emphasis was placed on producing lean, well-muscled
hogs, a relatively high incidence of “pale, soft, exudative”
(PSE) pork became apparent. When breeding hogs for leanness,
producers found negative attributes increased in some of the
new, leaner hogs. The PSE pork from those hogs was of light
color, soft texture, and had a high degree of drip loss (fluid
lost from fresh, uncooked pork). Economic losses associated
with PSE pork include reduced yield during processing and cooking,
drip loss in retail display trays, reduced shelf life, increased
quality variation, and reduced consumer appeal. Because of the
potential link between leanness and PSE, packers had an increased
incentive to persuade pork producers to reduce the incidence
of PSE pork.
• A spate of meat safety recalls by food companies and
new regulatory initiatives that shifted responsibility for safety
from the government to meat packers increased incentives for
ensuring the safety of the pork supply.
• Trade agreements, among other factors, that expanded
U.S. export opportunities also increased the importance of addressing
pork quality issues, depending on the preferences of the importing
country.
Carcass pricing programs can raise transaction costs
incurred by producers and packers associated with pricing hogs. As more hogs are purchased by packers based on carcass evaluation
instead of as live hogs, producers must spend more time and
money to evaluate alternative packer bids. These increased costs
are the result of more varied carcass pricing programs and measuring
instruments and different methods of calculating price. Price
premiums and discounts based on more narrowly defined carcass
weight and leanness ranges also would likely increase packer
costs.
Marketing contracts can reduce costs of pricing hogs. As pricing carcasses became more common than pricing live hogs,
marketing contracts between packers and producers quickly supplanted
much of the spot market trade. The long-term nature of marketing
contracts can limit the number of times that producers must
evaluate alternative packer pricing programs. Minimum volume
requirements allow packers to obtain a larger number of uniform
hogs from a single source, so that measuring a few provides
more reliable information about the quality of the rest.
Marketing contracts reduce measuring costs and provide
quality control. By specifying production input requirements
in contracts, packers maintain strong incentives for the easily
measured leanness attribute, while controlling other quality
attributes that are more difficult to measure. These other quality
attributes include pork safety and PSE pork. Given the strong
links among hog production inputs, PSE pork, and safety attributes,
specifying input requirements in contracts and monitoring production
activities combine to reduce output-measuring costsand improve
pork quality.
Marketing contracts reduce costs of adapting to uncertainty. In an uncertain environment where packer demand and input requirements
are subject to change, production input clauses that define
packer expectations and plans for collaboration with producers
facilitate adaptation to these changes. Coupled with production
monitoring provisions, this can support effective coordination
and timely responses to changing input requirements.
For specialized investments in genetics and brand name
capital, organizational arrangements will be designed to protect
such investments. To the extent that carcass pricing
programs fail to meet the quality needs of the packer, packers
may choose to expand their branding programs by investing in
hogs from a specific genetic source. Vertical integration offers
one means of protecting investments in brand name capital and
specific genetics from opportunistic behavior by the other party.
Other organizational arrangements, such as marketing contracts
with added safeguard provisions, production contracts, and joint
ventures may provide advantages over spot markets and vertical
integration by blending elements of both.
How Was the Project Conducted?
Primary sources of information included pork quality and safety
summits sponsored by the National Pork Producers Council in
cooperation with the National Pork Board, and published surveys
of large packers related to contract use. To provide more recent
insights into hog marketing contracts, 15 contracts submitted
by producers to the Iowa Attorney General's Office were examined.
These contracts were offered from 1996 to 2001 by six leading
packers (Farmland, Hormel, IBP, John Morrell, Swift, Excel),
which accounted for 61 percent of hog slaughter in 2002. The
theoretical framework used combines different aspects of the
industrial organization literature.
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