MONOPSONY
The recent Alabama court decision, awarding $1.2 billion dollars to damaged producers, raised fundamental questions to the future of our industry. Is every producer entitled to the same price for the same type animal? Can buyers and sellers choose who they do business with and under what terms? In a little known or studied area of antitrust, comes the Packers and Stockyards Act of 1921. The Act was created to protect the farmers from the market power of the dominant meat packers of that era -- Cudahy, Wilson, Swift [no relation to the current Swift] and Armour. The Act prohibited actions on the part of the meat packers to manipulate prices.
The problem with interpreting the Act, 80 years later, is the industry has changed and any reading of the arcane law is destined to result in mixed readings depending on your own perspective and business objectives. One person’s exercise of a contractual right to buy and sell property [cattle] out in the future might be another person’s example of market price management.
The ability of any business to manage the cost of supplies in the manufacturing and production chain, is at the heart of improving efficiency and competition. The big car companies are constantly tweaking the supplier network to assure they are provided the best parts and the best available price in order to maintain a competitive position in the world’s marketplace. Walmart has built a business model based on demanding price sensitive supplier contracts.
Should one company so dominate an industry as to prevent competition among suppliers, the company would have a monopsony instead of a monopoly, the improper control of prices to the consumer. The antitrust challenge would require proof the company prevented competition for best price and/or obstructed free entry by new suppliers. These are difficult areas of the law and certainly above the pay grade of most juries.
Populism has always had strong roots in the agrarian sector of society. Farmers have blamed their ills on the big companies since the first time there were farmers. Some of this antagonism is well deserved and history is full of examples of large companies preying on the good faith of small farmers to gain advantage and often using unsavory methods to that end. Large companies once held the repository of market information and were able to move quickly on breaking news long before rural America woke up. That day is long gone.
Today information flows to all at the speed of the optic fiber and the most remote farm has the same information as the largest corporation. Most ag businesses recognize the importance of arrangements protecting part of your supply needs for your business. Any good farmer wants to buy part of his seed, part of his fertilizer and price part of the final crop as a management tool and hedge against being all wrong on the market.
Producers have more options to both discover price and forward price than ever before in the livestock industry. They may price on the futures board or forward contract to the beef packers and set their basis [the difference between the futures board and the cash price] or they may price off established benchmarks in the open market. Many firms offer customized pricing options allowing exotic products such as a floor and a cap on the price. Options are sold on both live and feeder cattle as well as corn allowing producers to buy insurance against price declines. Today all prices are reported by the government and this allows a transparency never before realized in such a disparate market.
It would be interesting to take the Alabama case to its natural conclusion and allow stocker operations to also insist no feedyards can control captive supply. This would prevent feedyards from pasturing cattle and forward contracting. Naturally all agreements whereby feedyards have established supply arrangements would be cancelled. It also would control the price each feedyard paid to each stocker operator to assure all prices paid to all stocker operators were the same regardless of the number, geography or reliability of the transaction.
THE BIRTH OF THE FORMULA
Supplier contracts between producers and beef packers under which producers dedicate their entire supply to a single packer, represent approximately one third of the supply. These contracts are merit based -- meaning suppliers are paid according to the carcass performance of the individual pens of cattle. The base price is determined a wide variety of methods but generally based on open market trade prices. The producer then earns premiums and discounts based upon actual yield, yield grade and quality grade with discounts for carcass defects. Formula producers often compete for those premiums against cattle bought by the packer in the open market.
The Alabama case argued these arrangements prejudiced prices paid to open market sellers by allowing packers to have a available kill supply and to wait out the open market sellers causing them to drop their prices in order to attain a kill slot. This argument ignores the reality of the marketplace. In times of excess supply of cattle, open market sellers are harmed because they do, in fact, have to drop the price to win a slaughter slot. However, in times of shortage, the formula sellers are obligated to sell at prevailing prices, allowing open market sellers to hold out for higher prices.
Should the Alabama case be upheld on appeal, the entire industry will suffer. Price discovery is dependent upon allowing buyers and sellers the maximum amount of options. Price discovery should encourage innovation. Never before have more options been available and to restrict these options will be a step backwards in the development of new marketing efforts.
A ban on formula arrangements will destroy much of the consistency created when a packer is able to rely on a steady supply of the same type cattle week after week. This model is the foundation on which many of the newly emerging branded beef products are built.
To prohibit any two parties from contracting to buy or sell according to mutually agreeable terms is an affront to the free right to dispose of property. This action would deny marketing choices to a large segment of the industry. Market efficiency is delivered by more selling options not less. The industry benefits when producers and beef packers are continually exploring new marketing arrangements in order to provide beef products more closely tailored to the marketplace.
Few people have considered the chaos that will result when big brother, government regulators, begin monitoring and determining who can buy and sell with each other.
v Captive supply. A monumental task will be defining “captive supply”. A producer might own cattle up to the day of slaughter but the cattle are covered by a negotiated basis with a packer. A producer could pay the packer a tolling fee to process beef for the producer and it is unclear if that would be captive supply. When does a forward contract become captive supply? How will regulations control feedyards with only one plant in the area? Can a packer finance cattle for a producer if the requirement calls for the packer to process the beef?
v Geography. Will a packer be allowed to trade week after week with a feedyard for the entire supply of cattle because the feedyard is next door to the plant? Will it be restraint of trade because the packer pays the feedyard a premium because of the location? Or will the feedyard be compelled to sell to another packer miles away in order to show they are not part of a captive supply?
v Forward pricing contracts. Will cattle owners and feedyards be prohibited from forward contracts with beef packers?
v Price parity. Will packers be forced to pay the same price from all producers for the same type cattle? Who will decide if the cattle are the same?
v Branded products. Will a new regulation end supplier arrangements serving as the base for branded products? Will cattle produced using carefully orchestrated genetics, feeding regimes and management practices be forced to take a well defined product and sell it to multiple packers on the open market, eliminating the possibility of segregating and branding the product?
v Relationships. Trading cattle involves thousands of individual trades negotiated every day and often the trades are verbal lacking any written documentation. People discover a lot about each other during the course of these trades. Some people are very reliable in delivery of the terms of trade and others very unreliable. Is this value going to be lost and discounted in a new trading model? Can the government compel people to trade with each other?
v Retailers. Can retailers negotiate with a beef packer to receive only cattle from a specified source? How can the packer deliver without captive supply?
There are many business models to be tested in the future. Producers and processors both need a framework allowing the maximum choices and opportunity to fail or succeed based on the merits of the model. One certainty is that any emerging market model will likely be far cry from those in mind when Congress passed the Packers and Stockyards Act of 1921.