Some agricultural observers believe business alliances between packers and producers will damage the pork industry and hurt consumers. However, a Purdue University study concludes that contract-market and vertical-integration structures that are replacing traditional spot markets can be good for pork producers and packers, and give consumers consistent, high-quality products.

Profit margins and production volumes do vary depending on market conditions and the alignment with producers and packers, but in most cases the relationship can be beneficial to both, says Allan Gray, one of four Purdue agricultural economists who conducted the study.

The findings are detailed in the paper "Evaluation of Alternative Coordination Systems Between Producers and Packers in the Pork Value Chain."

Using market prices and other data from 1998 to 2000 as a basis, the economists simulated spot-market, contract-market and vertical-integration production systems for a fictitious Midwest packing company. The company, modeled after an actual packer, processes 74,000 hogs a week.

"We found that packer or producer profits didn't increase greatly by increasing vertical coordination," notes Gray. "But there was a dramatic difference in the quality of the product."

That contrasts to the spot market, where producers decide when and where to market their hogs. The packer takes whatever hogs the producer is selling. Under this scenario, says Gray, "you get a wide variation in sizes, shapes and forms of hogs being sold."

In a contract system, the packer uses information on ham, belly, loin and other pork product prices, and transfers that information back to the producer. The packer then tells the producer, "These are the kinds, sizes and forms of hogs that we need."

In vertical integration, the packer owns the live hogs from the feeder stage through slaughter and determines when hogs are marketed. Critics claim vertical integration encourages consolidation and could lead to a handful of companies in control.

The Purdue study did not attempt to disprove that allegation, nor defend vertical integration, says Gray.

"Many people believe that packers are the smoking gun– that the packer is a monopoly and is forcing people to move to vertical integration," says Gray. "So, in our study, we built a model that doesn't allow that to happen. Our numerical model specified that the packer has no market power. With our model we were able to ask, if the market-power issue is not there, do all the parties involved still benefit from a coordinated production system?"

In both production efficiency and profitability, the answer was yes for producers and packers. The study showed that vertical integration maintained a more consistent flow of hogs through the production chain than did spot markets. Both the contract and vertical-integration systems were better than spot markets at controlling light-weight pig marketings, which increased the yield of usable pounds of lean pork.

The study showed that producers could sell hogs at higher prices in the spot market vs. contract or vertical-integration systems, but only when prices were strong. Conversely, producers were less vulnerable to price volatility when marketing hogs via contract or vertical integration.

"Producers in a vertically coordinated system do not always get as high a return," says Gray. The Purdue model showed a return of about $20 to $25 a head in the vertically coordinated system, but it's nearly guaranteed, which minimizes risk. A producer selling on the open market may average $28 to $30 a head over time, but will face wide swings from negative to positive numbers per head in any given period.

"Some producers are fine with risk, and would rather average a higher return," notes Gray. "But, many producers would prefer to be in a system with little risk."

Between the two coordinated marketing systems, the study found producers fared better under the contract system, and packers did better under vertical integration. Producer margins averaged $41.20 per hog in a contract system, compared to $20 in vertical integration. Packer margins averaged $21.76 per hog in vertical integration, compared to $4.78 under contract.

Consumers also win when pork producers align themselves with packing companies. Through industry coordination "we're getting more uniform products," says Gray. "If a more uniform set of products is coming through the system, producers and packers both are better able to sell those products."

Other Purdue agricultural economists who contributed to the study include Michael Poray, Michael Boehlje and Paul Preckel.

You can access "Evaluation of Alternative Coordination Systems Between Producers and Packers in the Pork Value Chain" at http://www.agecon.purdue.edu/staff/gray/Research/research.htm