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Articles from 1998 In September

Assuring Market Access

At a time of day when many people are counting sheep, Tom Congleton counts uniform market hogs as they make their way onto a semi trailer. Congleton, a retired vocational agriculture teacher from Springfield, KY, supervises the 5 a.m. load-out of 600 hogs/week on behalf of a group of independent Kentucky pork producers who are happy to still have somewhere to sell their hogs.

The 14 members of the marketing co-op range in size from 40 to 600 sows. Most of the co-op members are full-time farmers. Congleton coordinates the marketing for the group. He also accepts bids from feed companies, purchases feed, prepares a monthly newsletter, plans educational meetings and handles some equipment procurement for the group.

Each producer member of the marketing co-op delivers hogs to a central point every Monday morning for loading and hauling to the packing plant.

The group has a one-year, verbal agreement with a packer in Louisville. Congleton says the group's consistency and dependability are important to the packer, "The packer knows our hogs will be there for the early kill every Monday morning, regardless of weather or anything else that might come up."

All but one member of the co-op are using the same genetics, another plus during packer negotiations.

Members have netted premiums over the cash market in the past. However, since four area packing plants have closed within the past four years, Congleton says the biggest advantage group members gain from working together is simply having access to a packer. According to Congleton, group members received an average selling price of 55 cents/lb. the past two years. Separate checks are issued to the individual producers.

This marketing alliance has more experience than most in the pork industry. After getting a start mainly as an information-sharing group, they shipped their first collective load of hogs on April 1, 1991. "The group has shipped hogs as a group every week since," Congleton says. Members pay 2% of the value of the pig to cover the expenses such as stockyard rental and Congleton's time.

The group produces hogs now that average 6.5% leaner than those first hogs marketed. Hogs are marketed between 235-237 lb., and average 52.5% lean.

"The quality of the pigs and genetics improved much quicker for me as a result of being part of the group versus if I had been on my own," says Philip Lyvers, Loretto, KY. "Our group members now have the kinds of hogs the packer likes."

Packer Closings Barry and Sandra Blanford, Loretto, KY, have been members of the marketing co-op since it started. They decided it was important to start working with the group when three packers in their area closed.

Sandra used to do the marketing, calling packers for bids. "Tom Congleton does all that now, and all we have to do is load them and get them there," she says.

The Blanfords buy all of their inputs through the group. Group members can buy building materials and equipment at a savings. And, most members buy all of their feed as a part of the group.

Congleton gets bids from feed dealers, buying in tractor-trailer lots. Feed is delivered to a building on the Lyvers farm. Group members must pick up their allotment the day of delivery.

Congleton says this method encourages group members to plan ahead so they don't run out of feed. "That's what working together helps us do," Barry Blanford says.

The group's feeding programs are formulated by nutritionists Gary Parker and Richard Coffey at the University of Kentucky. They make farm visits and speak to the group too. Members of the group are not required to use the same feeding program, but most members take advantage of the opportunity.

Most of the pigs that are sold via the marketing group are the result of artificial insemination.

Group members, Philip Lyvers and Barry and Sandra Blanford collect their own boars. They supply semen for almost all of the rest of the group. Group members pay around $5/dose for semen.

Information Sharing Education is stressed as part of the marketing group. The group concentrates on improving financial and production records. Congleton mails out a monthly newsletter, which includes information from every group member's kill sheets. Sandra says the competition among the members to improve their production and marketing figures is a fun part of the group membership.

Lyvers finds the group's information sharing to be a big advantage. His decision to switch to a wean-to-finish enterprise was driven by their information exchange. He just completed construction on five wean-to-finish barns.

Barry Blanford says working together is the biggest advantage he gets from the group. "If you don't keep up with the changes in themarketplace, you will be in trouble," Barry says. "As a group, we can send pigs farther and have access to more packers than we do as individuals."

Lyvers has been in the hog business in Kentucky since 1970. The Blanfords have raised hogs since the late 1960s. Both Lyvers and the Blanfords believe in the future of the pork industry. Lyvers' son and daughter recently came home to the farm, and the Blanfords also have children interested in raising pigs.

"People who are doing a good job are still making money in the pork industry," Lyvers says. He encourages people to get involved with other producers to form marketing groups.

Tom Congleton likes working with people who want to do a good job and want to stay competitive. He says every member of the group would fall into that category.

"I plan to be able to survive in the hog business with the best of them," Barry says.

Gaining Market Clout

Pork producers around the Villisca area in southwest Iowa have always had four packer buying stations within 10 miles of town. Marketing was nothing beyond a few phone calls.

But several producers in the area knew such a luxury was short lived. And it was. Buying stations in the area have closed leaving them few options.

In the meantime, producers like John Kernen and Jim Herzberg of Villisca cover their marketing risks in a group organized through Moorman's, Inc. The two producers first met with other producers in late 1996 to talk about marketing together. Sandy Smith, Moorman's sales representative for the area, was on hand to help organize the group.

These three, plus five other producers, started the group now known as Southwest Iowa Swine Enhancement. The first hogs were sold in October 1997.

Today, the group includes 25 producers who sell a total of 3,000-4,000 hogs/month. Marketing larger numbers gives the group more clout with packers and it's reflected in the prices the group receives. They average about $3-5/cwt., including group and quality premiums, above the previous day's plant-direct, top price.

Kernen and Herzberg are happy to receive the higher prices, especially in today's low hog market. Kernen sells about 7,000 hogs/year from a farrow-to-finish operation. While he produces enough hogs to have pursued a contract directly with a packer, he didn't want to be tied to just one packer.

Herzberg just expanded his herd to 125 sows. "Being able to market at a decent price is a big benefit of this system," he says.

It's producers like Herzberg and Kernen who Moorman's wanted to help when they offered marketing services, Smith explains. Three years ago, Moorman's created an alliance with Hackney and Associates, Omaha, NE, to negotiate packer buying agreements for Moorman's customers. Group marketing helps the independent producers "act like a large producer" when they talk to a packer, she explains.

Hackney and Associates is run by Walt Hackney, who for several years now, has negotiated packer agreements for many producer groups in the Midwest. He is paid on a per cwt. basis.

How It Works Producers in the Southwest Iowa Swine Enhancement group have several obligations they must meet as part of this group. They must complete Pork Quality Assurance level III. Hackney requires this. He says it is an advantage when negotiating with the packer to have all producers at this level.

Each producer commits to selling a certain number of hogs through the group. Then they are obligated to meet this commitment. Hackney recommends producers sell 50-60% of their annual production this way.

Smith schedules the marketings. Producers must notify her by Friday how many hogs they plan to sell the next week. She then contacts Hackney by Friday noon with the number of hogs going to market. Hackney's office, in turn, notifies the packer.

The group collects hogs at two different locations in their area. Both are loading areas only.

Hackney negotiated a formula for the group's hog price. The formula is based on the previous day's Iowa-Southern Minnesota plant-direct top price plus a negotiated premium. Producers receive quality premiums above that price. The packer agreement lasts one year and then is renegotiated.

Kill sheets from all the producers in the group go to Hackney's office. They compile the sheets into one report giving average kill information for the month for each member. Numbers of hogs slaughtered by each producer is not indicated. The information is coded by farm numbers, assuring confidentiality.

Each producer also receives their own kill sheet detailing the cutout information on each hog.

This information tends to push the producers to improve. "Overall as a group, they've improved lean by about 1%. The group average is 51.5%," Smith says. "And they have cut their sort loss. That has been the biggest advantage. Most producers have almost no sort loss now."

Kernen adds, "I think it helps guys when they see somebody else under a 10-cent sort loss and they are at $1/cwt. sort loss. I'd never been able to compare figures with other producers. So this lets you know where you stand."

Herzberg agrees information sharing pays off. Comparing his kill sheet information to other producers in the group made him realize he sold his hogs too light. "I was marketing them at 245 lb.," he says. "I had the genetics to go heavier. Now I'm pushing them to 250-255 lb. and getting 51.1-52% lean and a 0.8-in. backfat."

Joining the group also pushed Herzberg to qualify for PQA III. He says he just didn't take the time before to do it. Now the group schedules PQA III meetings for the members to attend.

The group holds monthly meetings, which Jeff Ramold of Hackney and Associates attends to discuss the kill sheet data. The meetings are also used to cover other issues important to their business like the environment and rations.

Kernen and Herzberg have different feelings about relinquishing the job of marketing hogs. Kernen is glad he doesn't have to do his own hog marketing. "One thing I hated was going back and forthover price from one packer to another," he says.

Herzberg, on the other hand, enjoyed visiting with the different buying station managers. "It's a little different putting your trust in somebody else's hands," he admits.

Smith says giving up control over marketing is probably the most difficult thing for producers to accept when joining the group. "If you've had your hands around everything, it is tough to give that up," she explains. "But like one of our members said, 'I think we have to give up something to remain independent.'"

In July when hog prices skidded well below $40/cwt., John Kernen and Jim Herzberg were selling a portion of their hogs for $43.25/cwt. And he wasn't accumulating debt under a packer's window contract either.

Instead, the two Villisca, IA, and three other area producers received this guaranteed price on 25-50% of their hog production. They signed a 6-month contract with a packer last winter guaranteeing the price.

The contracts these producers entered represent one of several creative tools producers now use to cover marketing risk. These producers used Walt Hackney who operates Hackney and Associates, Omaha, NE, to negotiate the contract.

In a separate deal, Hackney also markets hogs for Kernen and the producers as part of the Southwest Iowa Swine Enhancement marketing group. (See story above.)

The contract Hackney negotiated was for a guaranteed fixed price for a certain period of time, regardless of cash price. This is quite different than the price formula negotiated for the marketing group.

The impetus for the fixed price contract started last winter. "We did this because we felt hog prices were going down," Kernen explains. "We were protecting ourselves."

Working with Hackney, the producers set a narrow price window they wanted to lock in with a packer. They wanted the contract to run six months, starting in March. When setting the window price, the producers considered their own cost of production and an average of the futures hog market for the time period they wanted covered.

"We gave them a window to work with because the price was really going up and down," Kernen says.

The negotiations between Hackney and the packer took place in late December and early January. Based on the futures hog prices then, the price looked like the packer was making a good deal.

Usually the packer will then cover his exposure in the agreement with a hedge on the futures market. The advantage of this situation is the producers have no margin calls. They also know from one delivery to the next what they will receive for their hogs in the contract.

For the Villisca-area producers, the contract paid off big. "Now we are way ahead (with $43.25/cwt.)," Kernen says. "There has been a lot of $34-35/cwt. hogs during this time frame. In March, April and May, we averaged $7-8/cwt. over the actual market."

Today, the group is looking for another opportunity to negotiate another contract with the packer. However, the futures prices and cash market are so low, they are unable to lock in anything above $38-39/cwt.

In addition, packers aren't as aggressive about negotiating when prices are low.

Marketing Group Thrives

Dave Schwerin, Wood Lake, MN, is a team player. He was just looking for a way to be more profitable 10 years ago when he and three other pork producers started offering packers regular semi-loads of hogs in exchange for better prices.

The idea of pooling hogs to gain a better marketing position was fairly new to independent pork producers in 1988. After a decade of unprecedented pork industry ups, downs and changes, the group has not only continued to market together, but has grown and prospered.

"We decided one way to be successful was to make everyone around us more successful too," Schwerin says. "It is a lot easier for us to be successful as a group."

The group presently totals 30, with herd sizes ranging from 80 to 800 sows. Schwerin coordinates the group's marketing efforts, runs a trucking company tohaul the group's hogs, and operates his own 350-sow, farrow-to-finish operation.

Joining The Group "We've been learning for 10 years," Schwerin relates. "The big advantage to being at it this long, is that we've taken out a lot of the problem areas by default. The group's success still comes back to good cutting hogs and people who are willing to work together."

Hog quality remained the highest priority. "There were lots of opportunities for our group to be twice the present size, if we had sacrificed hog quality or cutability," Schwerin says.

In order to market with the group, producers' hogs must cut 51% lean or better. The required lean percentage is set during negotiations with the packer. The group has never had a problem meeting the quality standards, according to Schwerin.

The group also strives for consistency. "If you graph your kill sheet figures, we want the majority of the hogs in the 51-54% lean area. We don't want hogs scattered all over the board to make an average of 51% lean," Schwerin explains

Producers must be National Pork Producers Council Pork Quality Assurance Level III (PQA) certified.

Schwerin has served as the marketing group's coordinator since its formation. In the group's early days, he hauled the group's hogs to market.

"When we started out, it was hard to get trucking for one load of hogs every other week, or part of a load," he remembers. "The truck has to be at the packer when the packer wants hogs." Once again, Schwerin identified a need, and did something about it. He started a trucking business in 1991.

Trucker Holds Contract The trucking company, D&D Schwerin Inc., has helped the marketing group in several ways. The trucking company holds the master, written contract with the packer. This makes it easier for the packer to deal with one entity, versus holding separate contracts with each producer. The trucking company subcontracts with producers. The arrangement also places the greatest risk with the trucking company, instead of on each individual farm.

Schwerin is paid on a "per hundredweight" basis to run the organization, research and negotiate packer contracts. But the final decision on the packer and contract is made by the entire group.

The group members suddenly found themselves in an awkward situation in 1997 when the Dakota Pork packing plant in Huron, SD, closed almost overnight. The group received a fax on a Friday, saying the plant would not be taking any more hogs. Without warning, not only was their contract voided, they had no market for the next week.

It usually takes 4-6 months to gather the data and negotiate with packers for a new contract - but the group needed a place for the pigs immediately. Fortunately, they were able to divert hogs to Smithfield's John Morrell plant in Sioux Falls, SD. An outside consultant was hired to speed up the contract negotiation process, and a new contract was obtained within 30 days after Dakota Pork closed. "That was only possible because we hired a member of the packing industry as a consultant to work on getting another contract set up," Schwerin says.

The new, three-year contract is with John Morrell in Sioux Falls.

The group has a window contract, which includes a floor price and ceiling price paid to the producers. The price paid is set on a formula based on the cash market.

Schwerin sees the contract as a "team effort." He explains: "The pork industry has got to get it out of their heads that the packer is the bad guy. The packer is a business, just like we're a business. We've got to work together so we both can be profitable.

"We have to keep in mind that if the packer has to guarantee us price levels, then the packers are better off raising their own hogs. Our objective is to get people to sell on a weekly basis and to keep hogs on a weight matrix the packer wants to follow," Schwerin says.

The contract guarantees the packer a certain number of head will be delivered per year. John Morrell has the right to specify delivery days, but they can't demand more than a certain percentage of the year's hogs on a specific day. "John Morrell has asked for hogs when their numbers are short, but that is usually not a problem for us," Schwerin says.

Aside from the convenience of having the trucking company hold the marketing contract, Schwerin says having their own trucks makes it easier for both the producers and the packers.

"We can put loads together to meet our own schedule instead of trying to fit our schedule with that of a trucking company," he says. The trucking company only hauls hogs from group member herds.

Every Friday by 10 a.m., group members let Schwerin know how many pigs they plan to sell the next week. Schwerin then relays those numbers to John Morrell. Group members can send full loads, or smaller loads if necessary.

Producers choose the day they want to ship their pigs. Schwerin coordinates the loads and the trucking. Group members are all located within a 40-mile radius of Schwerin. They pay the trucking costs based on local competitive rates.

Trucker Involvement The truck drivers' responsibilities are not as simple as getting the pigs on and off the truck. The truck driver records how the pigs loaded and unloaded, and notes the weather and road conditions with every load. Every time the truck stops, the reason is recorded.

"We have documentation that follows the pigs all the way from the producers barn to the packing plant, if necessary," Schwerin relates.

The trucker is a key information link between the producers and the packer. Producers are contacted the same day the hogs are delivered. The trucker reports how things went at the packing plant and verifies the head counts and weights recorded on the packer's scale ticket.

If there was a problem, then the producers or Schwerin can get back to the packer right away. "This works better than waiting three days to get back to the producer with the kill sheet, and trying to solve problems after the fact," Schwerin says. "If we address problems right away, we have a better opportunity to resolve them."

Staying Competitive Schwerin believes pork producers and packers should work together to succeed.

"Once we have set our market price and established our contract, then our job is to make the packer as profitable as we can," he says. "If the packer is profitable and has done well with our hogs, it is easier to negotiate another good contract. Teamwork between the packer and producer is important. We have the luxury of a number of packers in the Midwest at this time. We need to give the packers the weight range and quality they need to stay profitable.

"It's my feeling we can compete," he continues. "You can run your farrowing operation as well as any really large producer. The cost per lb. of gain can be as good as a large producer can get. The only glitch in the system is the largest producers can sell volume. I have to say, if I were a packer, I would want what the consumer demands. The consumer demands consistency.

"Livestock production is not different than any other business in the world. Get together as a group of producers and you can offer the packer the volume and quality they need. In our case, we know we can offer quality. But what is seen as quality today may not be quality tomorrow. You have to keep talking with the packers and keep asking the right questions. Everyone within our group stays on top of what's happening in the industry. We keep watching the consumers."

Contract Consequences

No doubt about it. Marketing hogs has changed drastically in the last few years. And nothing has highlighted this change more than the current drop in hog prices.

When the hog market dipped to $35/cwt., one producer received $42/cwt. through a packer contract. His contract guaranteed a payment of $5 above a formula price based on cost of production.

A group of producers in a southwest Iowa were getting $3-5/cwt. above cash prices, including group and quality premiums. And producers in a Kentucky group found a place to market their hogs, due in part to their group negotiations. (See stories starting on page 12.)

Now economists wonder how many producers actually receive the cash market price. It appears more producers regularly earn above the cash market than those receiving the cash price.

"We believe 57% of the hogs are sold on some kind of pre-arrangement," reports economist Glenn Grimes. That means the majority of U.S. hogs are sold on prices generally higher than the cash market price.

And few of the arrangements appear to be as lucrative or controversial as the packer contract. Producers on these contracts continue to receive prices well above breakeven. But those producers are also accruing debts, some reportedly into the six figures.

The amount of debt owed packers has created concern and rumors about packer viability and plant closings.

Contract Offerings Halt Grimes, through surveys conducted by the university, believes about 8.5% of the U.S. hogs are sold in written packer contracts with ledger accounts. These contracts involve a price window or a price based on cost of corn and soybean meal.

Last winter, producers scrambled for these packer contracts in anticipation of a poor hog market or short slaughter space. But today, virtually no packers are offering the contracts.

"It would be like shooting yourself in the foot," quips Mike Brumm, University of Nebraska swine extension specialist. The packers don't need to guarantee supply when an estimated 100 million hogs will enter slaughter plants this year.

The packer contracts guaranteeing profitable prices will make the hog glut easier for some producers.

"The packer contracts are performing for those who have them," reports Brian Buhr, agricultural economist, University of Minnesota. "If you look at some of the (packer contract) matrixes, they are paying out in the $40 range, which is a premium over $35-36 cash prices in the last six weeks." This is without quality premiums.

One producer who wishes to remain anonymous highlights the great run with these contracts. "We're making money big time, but sometime we're going to have to give it back," he reports. His contract is paying $42-43/cwt. in late August.

As this producer notes, the good run brings a big drawback. In most of the contracts, producers share the risk for the downside and the upside with the packer. This means, for example, when prices are $36/cwt. and the producer is guaranteed a floor price of $40/cwt., a ledger account begins. The $4/cwt. difference is noted in the ledger account, which the producer owes the packer. Some contracts call for the downside to be split, meaning only $2/cwt. is kept in the ledger account.

The same is true for prices above a certain price ceiling price of, say $50/cwt. If cash prices are $54/cwt., the producer receives $50/cwt. and $4 is noted in the ledger account. This is money the packer owes the producer. In some contracts, this amount is split and $2/cwt. is noted in the account.

The ledger accounts must be settled at the end of the contract period, which can run from 3-7 or more years. Some packer contracts require interest payments on the ledger accounts. They will also pay interest on money they owe the producer, usually prime rates plus 1%.

Hefty Ledger Accounts The down market is creating some hefty ledger accounts owed by the producer. One producer says his contract went from a positive $75,000 accumulated over two years to a negative $100,000. This swing occurred in seven months. The producer says this account is not included on his balance sheet and no cash changes hands. If he is in a negative position at the end of his contract period, he has the option to renew it for five years.

These packer contracts vary greatly, even contracts with the same packer. Many contracts do require that the ledger accounts be paid. Producers should clearly understand just exactly how the ledger account works because it could work against them.

"It may not be showing up on (balance sheets), but it is an accounts payable," says Steve Meyer, National Pork Producers Council economist. "It is another line of operating capital. You can get your current working capital ratios just as out of line there as you can borrowing from a bank.

"I don't know how producers are handling this," he adds. "That is the point - some people are not aware of how it should be handled."

Several contacts for this story also wondered if all bankers are aware of the accruing debt as well as the security positions for both packers and bankers. Some contracts state the packer holds first interest in the hogs, ahead of a lender.

Packer Risk Packers also face risk with contracts.

"On a down market with the packer contract, the pain of that falls back on the packer," Meyer says. "This is the reason the producers signed them in the first place."

While packer troubles due to contracts are not substantiated, rumors continue to swirl. And it is easy to see why.

"The question now is, if hog prices stay low and a packer has 60% of production in long-term contracts, for example, they are paying out a fair share of money over market price," suggests Minnesota's Buhr. "That affects their margins on wholesale price. The packer could face some working capital problems if it involves a large enough share of production."

Buhr says he has not heard of any problems with the packer contracts, though.

Helping keep the contracts in line are low grain prices. On the cost-of-production contracts, the payout to producers would be even higher if corn and soybean meal were higher priced, Buhr adds. This would make those ledger accounts even larger.

"I'm still amazed how lucky people have been with these contracts," he says. "Corn prices are very low in comparison to the five-year averages. There's no reason why we couldn't have $2.50 or $2.75 corn coupled with low hog prices."

The low feed prices have given all producers breathing space. Breakeven on finishing a 40-lb. feeder pig today runs in the upper-$30/cwt. range, Buhr says.

At these costs, some producers are still making money, especially those in the pre-arranged marketing agreements.

But it will be a wait-and-see situation for the overall success of the packer contracts. If producers and packers fair well through a long run of down prices, then there's no doubt, these contracts will be here to stay.