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Summary of Report

Vertical Coordination and Consumer Welfare:
The Case of the Pork Industry

AER-753, August 1997

Contact: Steve Martinez, 202-694-5378.

Net benefits to consumers are not a certainty, but the "industrialization" of the U.S. pork industry could lead to lower prices and larger supplies of higher quality pork products because of lower onfarm production costs, more efficient processing, and greater control over hog quality characteristics.

This report outlines recent changes in the U.S. pork industry and discusses potential gains to consumers from increased coordination of the production and packing stages of the industry. It also reviews previous studies of vertical coordination.

The U.S. food production and marketing system of 40 years ago delivered generic farm products to the marketplace, where consumers bought them and took them home for further preparation. But spending for food consumed at home has declined to about half of total food spending. And a wider range of differentiated food products is produced and marketed by fewer and larger operations.

Changes throughout the food system are clearly reflected in most areas of the pork industry. These include the breeding stock sector, the hog production sector, the marketing system for finished hogs, the packing/processing sector, and retail markets for pork products.

Industrialization in agriculture refers to the use of modern methods of manufacturing, production, and distribution. Application of these methods has been accompanied by changes in vertical coordination. Types of vertical coordination include contracting with producers for a particular type of product, and integration.

As nonprice factors--such as quality--have become increasingly important, contracting and integration have increased. Contracting and vertical integration between producers and packers can help to ensure that processing plants operate closer to optimum capacity with few disruptions in the supply of hogs.

Changes in vertical coordination in the hog sector can result in lower production costs, lower retail prices, and improved quality of food products. But increased contracting and integration also result in concerns about market power. USDA's recent charge of price discrimination against IBP, the world's largest pork and beef packer, is the first time the Department has challenged contracts between packers and producers.

Contracting and vertical integration, plus consolidation, can create barriers to entry and reduce the amount and accuracy of publicly available market information, which may distort smaller, independent producers production and marketing decisions. Policymakers are interested in monitoring the effects of contracting and vertical integration on prices, price variability, margins, and food quality. Information regarding the effects of alternative methods of vertical coordination, including sales on the open market, can influence legislative decisions that play a role in the types of coordinating arrangements that develop.

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