Changing pork business affects pork prices and quality

Food Review, May-August, 1997 by Steve Martinez, Kevin Smith, Kelly Zering

* Contractual arrangements give buyers less control over production than integration, but greater control than market exchange. When firms enter into contracts they make commitments, such as delivery times and product quality, before production has been completed. Long-term contracts, usually 4 to 7 years, are typically used by large packers and large hog producers. These contracts specify that an independent hog producer deliver to the packer a certain quality and quantity of hogs on or near a specific date. Packers that obtain hogs through long-term contracts can specify genetic strains of hogs to be delivered. Although less common, packers may own the hogs and establish contracts with producers to feed and house the hogs.

Vertical integration and Contracting Increases Quality...

In the hog industry, long-term contracts and vertical integration are replacing production for the open market. For example, Smithfield Foods emphasizes the importance of long-term contracts and vertical integration for obtaining consistent supplies of lean, high-quality hogs. The company touts its National Pig Development (NPD) program as an excellent demonstration of the effects of a highly coordinated operation. Through a partnership with Carroll's Foods, a major North Carolina hog producer, Smithfield Foods has long-term contracts with Carroll's Foods and its affiliates to raise hogs. This arrangement, referred to as Smithfield-Carroll's, acquired from the National Pig Development Company, a British firm, the exclusive franchise rights to develop and market the NPD breed of hog in the United States. This breed is said to provide the leanest hog in U.S. commercial production and one of the leanest meats of any kind. Nutritional studies by the Sarah W. Stedman Center for Nutritional Studies at Duke University Medical Center in 1996 indicated that NPD pork was 34 percent to 61 percent leaner than non-NPD pork, depending on the cut.

... And Reduces Costs

The cost of producing pork includes the cost of raising hogs and the cost of marketing services to convert hogs into retail pork products (table 1). Marketing services include the slaughtering and processing of hogs, and the wholesaling and retailing of pork.

Table 1
Marketing Costs Account for 68 Percent of Retail Pork Prices

Item                              Value, cost, price
                                  Cents per pound

Farm value                               62.9
Marketing costs:                        135.1
Slaughtering and processing              32.5
Intercity transportation                  3.5
Warehousing and store delivery            9.1
Cutting and merchandising                90.0
Retail price                            198.0

Source: Howard Elitzak, Food Cost Review, 1995, AER-729. USDA's Economic Research Service, April 1996.

Changes in vertical coordination can affect pork production costs in a number of ways. First, by contracting or integrating, packers may obtain a large, stable flow of hogs into the packing plant. This reduces average costs by eliminating variations in the flow of hogs into the packing plant and reducing the under- or overutilization of plant facilities.