Packer margins have been squeezing tighter compared to a year ago, which leaves you with more of the consumer dollar.

About 35 percent of this year’s live-hog-price gains over last year is due to narrower marketing margins, says Glenn Grimes, University of Missouri agricultural economist. Of that 35 percent, packers have seen 75 percent of the cuts.

Packer and retail margins had widened over the last couple of years, while live hog prices suffered. “Pork margins have been wider during the last two or three hog cycles than they were all during the 1980s,” says Grimes.

Packer margins are affected by several factors, with the most significant being high fixed costs.

The volume of pigs slaughtered controls 70 percent to 75 percent of a packing plant’s cost structure, says Marvin Hayenga, Iowa State agricultural economist. Labor costs represent about half of the remaining 20 percent.

The packaging industry’s structural changes that occurred in the 1980s are still having a major effect on packer margins today. During this time, packer margins narrowed, giving producers better profitability. Now that nearly all large plants run a standard double-shift, packers lack the flexibility they once had of increasing or decreasing slaughter capacity as needed, says Grimes.

“One major reason we had a price situation like in the fall of 1998 û where we scheduled hogs by space rather than price - is because the packing industry lacked flexibility,” says Grimes.
Due to structural changes in the packing industry, packer margins have contributed to more inelastic live hog demand.

Because packer margins are private information, no one can tell exactly what they have been, but Hayenga says the typical relationship has been inverse to live hog prices. For example, when live hog prices are high that generally means competition is more fierce for the smaller hog supply, giving the packer less units to spread their fixed costs over, resulting in tighter margins.

The packing industry is not immune to the consolidation that has taken American agriculture by storm. In the past, many small plants dotted the landscape, but that has given way to today’s mega-packing plants. As recently as 1997, the United States had the capacity to kill 418,470 hogs per day. Now, that several plants have closed, including Thorn Apple Valley and Farmland’s Dubuque plant, daily slaughter capacity is 379,000 hogs.

However, Grimes says you can’t point to packing industry consolidation as a significant factor in widening packer margins. “The reason margins are wider has more to do with high hog slaughter numbers in relation to limited slaughter capacity,” says Grimes.

When capacity is challenged and weekend kills are necessary, that means packers have to pay workers extra. This hurts packer margins and helps explain why live hog prices drop so drastically when capacity is challenged.

Consolidation in other industry sectors has affected packer margins, though.

“Retail consolidation has squeezed margins, because the Wal-Marts of the world are extremely tough negotiators,” says Hayenga. “Larger scale pork producers have more negotiating power as well.”

Today, more packers are starting to add value to pork through further processing. In reality this will only shift, not change the distribution of margins among companies. It shouldn’t have any major impact on the market.

At the same time, the movement to further processed pork has been valuable to packers. “Processing is usually a higher margin business and that’s why a lot of companies like Oscar Mayer got out of slaughtering hogs and into processing exclusively,” says Hayenga.

The outlook is for packer margins to remain wide. “I think two things will determine the future of U.S. packer margins: the economies of the primary U.S. export markets, and the continued development of long-term relationships between the packer
and both the producer and the customer,” says Hayenga.

It’s possible that hog numbers will again challenge the limits of slaughter capacity in the fourth quarter of 2001. Even if that is not the case, with another abundant corn crop this year, conditions will be right for hog expansion and slaughter capacity will certainly be pressed by fourth quarter of 2002.

“Productivity has grown more than 5 percent over the past year. If there is only a 3 percent increase annually, we could produce 105 million hogs by 2002 without expanding from current sow herd numbers,” says Grimes. As of July, Grimes’ data showed signs that producers could be building up the sow herd.

Grimes points to the hog/corn ratio, which is around 27:1, the highest level since 1987, as one fact to support eentual herd expansion. Corn prices near $1 per bushel will be tempting to many producers, Grimes says. Of course, the last two years of record losses have made many producers, and lenders, gun-shy about expansion.

With or without expansion, wider packer margins are one more factor that adds to your market risk.

“It’s going to be difficult for the producer to find any kind of stability in the hog market, unless he can add value, like the packers are doing,” says Grimes. “Right now Farmland is the only successful example of a cooperative getting into processing. But through voluntary contracting and coordination efforts you can improve your situation.”