Luther Tweeten is an agricultural economist at The Ohio State University. He is a co-author of "Vertical Coordination of Agriculture in Farming Dependent Areas" for the Council for Agricultural Science and Technology.
Q What's the difference between vertical coordination and vertical integration?
A Vertical coordination is a means used to synchronize links in the food chain, such as input supply, production, processing, wholesaling and retailing. Vertical integration occurs when a single firm operates in two or more links of the food chain. About 9 percent of today's agricultural production is vertically integrated.
Historically, coordination through the food chain was carried out by individual firms. Lately we've seen increasing coordination administered in three ways. The first is integrated ownership, which involves ownership in two or more stages of the food chain. For instance, a firm may be involved in pork production and feed manufacturing. Also, the increasing number of production and marketing contracts enters in here.
Q How are these business structures changing the face of the pork industry?
A The most obvious is we're seeing fewer and larger operations. This would have occurred regardless of vertical coordination or integration. Technology and affluence has made it possible.
We are seeing increased regional clustering of producers and processors. This will continue.
There's also an increasing value in getting the right product of the right quality at the right time and place at the right cost. This is an outgrowth of consumers who are affluent and can afford to be selective. Vertical alignments can accommodate this effectively. They also can increase the market's efficiency.
Q What has driven these changes?
A Again, the two major factors are technology and affluence. It's important to use technology whether it's for animal breeding, facilities or in organizing your business. You can maximize technology adoption if you do it through central coordination.
A lot of vertical coordination is an attempt to cut transaction costs. In the past, marketing was done by price, but now the market isn't responsive enough. The retail market is becoming a priority, and the product benefits there will be passed on to producers through conventional methods or through contract arrangements.
Risk is another driver. Given the economies of size that grow out of technology, many independent producers can't get the capital that allows them to build the size of operation to improve efficiencies. Contracting has provided a way to limit risk, and improved chances of getting credit. But there is the fear that a contractor eventually will cut bonuses and increase penalties. I have reviewed the literature, and haven't found much evidence of this.
Q Are these changes positive or negative?
A Consumers are the big winners; the results for producers are mixed. It's the same old story with technology and the food chain. Technology has reduced costs for producers and the savings are passed on to the consumer. It is good for consumers when agriculture produces low-cost food, but it also means fewer and larger farms.
It's especially threatening to many mid-size farms. The reason is that most smaller farms have enough off-farm income to support the operation. Meanwhile, large farms can operate efficiently and can cope with changes that are occurring, such as management, efficiencies and economies of size.
The move toward large farms is only one reason why rural communities have lost businesses and people. These changes would have occurred whether large or small farms dominated.
Q What opportunities or benefits does vertical coordination present independent pork producers?
A It forces independents to be more competitive, to focus on becoming a low-cost operator and produce the kind of hogs packers want. You have to pay attention to genetics, rations and all of the other traits that packers want today. You may have to embrace marketing contracts in order to compete. You won't be able to produce hogs and hope a market is there.
Q Are vertical coordination and integration growing trends in agriculture?
A Yes. It's the direction we're moving and I don't see us moving away from these arrangements because of the nature of the driving forces – technology and affluence.
Q How can producers adapt to these changes?
A In some cases, independent producers might want to develop cooperative marketing or production arrangements. Regardless of the direction a producer takes, he or she will need to be low-cost producer who meets the market's demands.