Sign on the dotted line. That’s not as simple as it sounds, especially when it involves your livelihood. There are many things to consider before you sign, or draw up, a production contract.
For many, contract pork production can offer a viable and stable business opportunity, provided you have all of the facts.
“Contract production is an awfully important part of the pork industry now,” says Glenn Grimes, University of Missouri agricultural economist. “It provides capital, labor and a place to go with the effluent.” (See sidebar for more specifics on the status of contract production.)
The big issue right now is that facility costs (concrete, steel, lumber) have risen dramatically in the last couple of years. “Those costs went from $160 to $180 per finishing-pig space to $220 to $230, which is a 20 percent to 40 percent increase,” says Brian Buhr, University of Minnesota agricultural economist. “Most companies pay a per-pig-space rate of $33 to $36 for finishing and an additional $3 to $6 for wean-to-finish space.”
One trend in contract production is to move from traditional finishing facilities to wean-to-finish systems that involve double stocking of weaned pigs. With that change comes higher construction and investment costs, and contract rates also become part of the mix. That’s where a contract checklist can come in handy. (See sidebar for an example of a production contract checklist.)
With increased costs, you have to find more carefully manage your assets, says Buhr.
Let’s look at one scenario: A producer may extend the length of a facility’s mortgage payment. Instead of doing a seven- to 10-year loan, it’s extended to 12 years. This option allows for lower monthly payments, but in the end you would pay a higher interest amount and a higher total cost for the building. You need to look at the total expected payoff over time from the contract to determine your profit margin.
“Anything that changes costs per pig space, investment costs and interest rates — all that affects the ultimate contract payoff,” says Buhr. “Because of this, producers that built buildings seven to 10 years ago are much better off than those that are building now.” Interest rates are still low, but they are likely to rise. Land costs also continue to increase, as do building materials.
A big issue that’s surfacing now is the rapid expansion of finishing space that occurred before 2000. Many of those barns are now seven to 15 years old and need some level of repair. If you’ve maintained your facilities well, then you’re in a better position than growers facing major building repairs or new equipment purchases, such as fans, heaters or feeders.
Any way you look at it, facilities are a long-term investment and many people are a little uneasy about building something new.
Another issue that’s surfacing is the potential of future animal-welfare requirements and how that may influence stocking density. The European Union is discussing this trend, and it may not be too far off the radar screen here. No question, stocking density could affect your long- term cash flow, especially if you have to provide more space per pig.
Not only would it raise your per-pig costs, it also would change pig flows. That’s an adjustment that would require changes throughout the production
system, including farrowing.
Contractors have already instituted a tiered payment system that’s influenced by type and age of the facility, says Buhr. Contractors already pay different per-pig-space rates on traditional finishing barns compared to wean-to-finish barns. They also take into account improved technology and how the facilities perform. This in part relates back to the facility’s age and maintenance history.
Also in the future, Buhr says growers will be given more specific production standards, such as precise targets for average daily gain, days to market, mortality rates and the like. This is to better manage pig flow and control the quality of the end product, thus giving the contractor more control over the pigs.
With all of these variables, it’s up to the grower to decide the best way to manage his/her investment. “I don’t think you’ll see contractors picking up the tab to pay higher pig-space rates,” says Buhr. Growers have to find ways to pull more money out of the system.
Contracting is like other businesses — the contractor wants to pay the lowest rate he can, and the grower wants the best payment he can get.
“It’s amazing the way the market works,” Buhr continues. “You don’t see a wide variation in per-pig-space rates in the Midwest; they’re all pretty comparable. Of course it does differ by facility, type, age and condition of the buildings.”
That’s where the negotiation process and the “market effect” comes in. There’s always an average price range for a region that surfaces.
In the end, contract production is and will continue to be a viable business option in the U.S. pork industry. So, regardless of which side of the contract you’re on, it’s up to you to make it as profitable as possible.
Who’s Contracting Now?
Contract production is a viable segment of today’s pork industry. Here’s a snapshot of how this part of the industry continues to grow.
According to the 2004 Pork Industry Structure Study, producers involved in contract production in 1997 finished 45 percent of all the U.S. hogs. In 2003, that number increased to 64 percent. As for farrowing, the numbers shifted from 40 percent to 68 percent during that same time frame.
Looking at it from a share of U.S. domestic pork production, 40 million hogs were finished through contract arrangements in 2003. That compares with about 9 million in 1987.
Asked what they plan to do once their current contract expires, roughly 90 percent of growers surveyed said they would continue raising hogs on contract.
Here’s the breakout:
Continue with the same company = 80 percent
Contract with a different company = 9 percent
Become independent = 9 percent
Stop producing hogs = 2 percent
Other = 5 percent
The response to whether growers want to “become independent” has also ranked low in past surveys. “For a number of growers, when they start contracting, they plan to get the building paid off and go independent,” says Glenn Grimes, agricultural economist. “By the time they get to that point, they have usually changed their minds — they like the steady paycheck.”
Looking ahead, Grimes says there aren’t many new contracts surfacing, rather the industry is still restructuring. More independent producers are actually moving into different business arrangements, which involve rising hogs on contract for larger production firms.
The Pork Industry Structure Study is sponsored by Pork magazine, and conducted by Iowa State University and University of Missouri agricultural economists. For more information on the study, go to http://www.porkmag.com/news_editorial.asp?pgID=740&ed_id=2763