Alternative marketing agreements (AMAs) have replaced the cash market for fed cattle because they cut costs for feeders and packers, increase efficiencies and improve the overall quality of beef. This does come at a cost to the depth of cash market price discovery. But what are the dollars and cents and how much does it affect the industry’s bottom lines? Naturally, the impacts are different for feeders, for packers, for cow-calf and stocker operators; they also vary by region of the country and size of operation.
Stephen Koontz, agricultural economics professor at Colorado State University, puts the bottom-line answers up front in a recent white paper that could be used as a foundation for industry policy decisions. Koontz’ white paper comes on the heels of his pre-publication document we reported on last week.
To come up with real world figures, Koontz drew on the USDA-GIPSA RTI Livestock and Meat Marketing study (LMMS), mandatory price reporting (MPR) data, and interviews with packers and cattlemen both for the RTI study and recent interviews to continually follow trends and costs. The LMMS study involved four teams, 30 researchers, 3 years, six volumes of information and peer review. The knowledge gained from all that research can be used to synthesize dollar costs of the impact of the 30/14 idea and the 50/14 proposed bill now being discussed in the country.
In rough numbers, 70% of cattle nationally are formula marketed, 10% forward contracted (plus 30 days out), 20% negotiated cash and 2% negotiated grid. But these figures vary greatly across the five USDA AMS Livestock MPR regions. The very fact that the use of the cash market and AMAs varies greatly by region of the country certainly explains differences of opinions about what works best for different operations.
Koontz’ research shows that mandating either 30% or 50% cash transactions provides almost no benefit and considerable cost to the beef industry through lost efficiencies and product quality. That is because AMAs confer considerable benefits and almost no costs. AMAs have solid economic foundations as the white paper points out. And those economics hold for cattle, hogs and lambs, all through the meat production chain.
Costs vs. benefits
And the way the chain works out, the costs of mandating a floor to the cash market are ultimately borne by the cow-calf producer and the consumer, the first and last folks in the chain.
How much? Koontz estimates a cost of $2.5 billion in the first year under the 50/14 proposal and a cumulative cost of $16 billion over a decade, most of which would be borne by the cow-calf segment. The 30/14 proposal cost would be roughly half those numbers.
While there would be impacts on the upper Midwestern feeders and packers, Southern Plains feeders and packers and the producers who sell calves into that region would feel major harm. The “distribution of impact could be called egregious,” Koontz said.
The main “cost” of AMA use to the beef production chain is the potential for packers to exercise market power. The benefits of AMA use to the beef industry is operating efficiency for both feedyards and packing plants and higher quality beef for consumers. The question is how the market power vs. efficiency factor boils down in ultimate net dollars.
The second cost to the beef industry is potential detrimental effects on price discovery. Koontz points out that the LMMS study did not address that issue, but he draws on his recent and ongoing research for those conclusions. The key consideration is that the quality of price discovery does not change fundamental supply and demand and does not change costs and benefits as indicated in the LMMS, he said.
MPR information includes loads of data on transactions, including breed type, grades, weights of everything, carcass destination, purchase method and sources. Statistical analysis involved pricing factors like boxed beef, futures, regional cash prices and showlist numbers. Showlist numbers were imputed from the cash slaughter over the succeeding 14 days. The percentage of AMA cattle harvested of total plant purchases or capacity provides a measure of market power, the paper noted.
To us, some of these results log facts and others seem to put flesh on hunches that have been without data backup. The paper notes that economic fundamentals and animal quality explain transaction prices the most.
Higher boxed beef, futures and prior week cash prices contribute to higher transaction prices. Quality premiums are higher. Larger numbers of cattle in a transition garners a premium. Showlist size affects the price. The momentum of prices tends to carry forward, whether higher or lower.
Many market factors
The analyses confirm that many factors affect cattle prices, not just AMA volume. For the time period examined, October 2003 – March 2005, the average price was $138 per cwt carcass weight. Further, the analysis showed that when AMA volumes were higher relative to plant capacity, fed cattle prices were lower but the difference is minimal.
A 1% increase in AMA cattle was associated with a 4-cent-per-cwt decrease in transaction price or 10% more AMA volume showed a 40-cent decrease in price. If all AMAs were eliminated—the average utilization was 17% during that time period—prices could rise 68 cents per cwt, or $6.12 for a 900-pound. carcass. These are weighted averages for all plants.
The researchers asked both feeders and packers what impact AMA restrictions would have on their business. The answers ranged from shutting down to no impact, depending on the actual definitions involved.
But for some, the impact on risk-bearing and capacity utilization would be substantial. Known marketing arrangements allowed feeders to secure both outside investors and better lending terms. Without AMAs, feeders would feed fewer cattle and have to borrow more money against the cattle. Capacity utilization would drop. Maintaining rates of return, more debt and/or more risk and higher borrowing costs would all put downward pressure on feeder cattle bids.
Packers indicated they would have to adjust and added costs would negatively impact fed cattle bids. A key concern was lower quality due to degradation of sourcing to a commodity market. Both feeders and packers were concerned about meeting the needs for branded programs. Unless new strategies were devised, cattlemen would miss out on these premiums.
Lower capacity in the feeding sector due to less capital available, lower quality, higher costs from lower efficiency and higher overhead would lead to a smaller beef industry, some feeders predicted. AMAs can lead to labor efficiency of 1,500 head per person instead of the industry average of 1,000 head. Some feedlots report a 20-percentage point increase in capacity utilization with AMAs, spreading overhead costs over more head.
Cost savings ranged from 17% to 22%, figuring 30 cents per day yardage (not including feed) and 150 days on feed. Total feedlot cost of $45 per head meant cost savings of $7.65 to $9.90 per head. Much of that is labor cost savings, reported in the $1.25 to $10 per head range. Quality premium loss estimates are bigger, ranging from $15 to $17 per head.
Packers would see higher costs, but their primary concerns centered around quality and the loss of customers for higher quality products.
Next, the researchers examined packing plant financials. Not surprisingly, average total cost (ATC) is a function of volume, along with other factors. Larger plants had a lower ATC and the more volume, the lower the ATC, with a fairly steep downward curve, with the range $143 per head down to $122.
Plants at the lower end of the curve were 5-8% more efficient than the middle and 12-15% more efficient than high-end ATC plants. Concentration in the packing industry has happened because the larger plants operate at a lower cost per head. But they require large volumes to operate efficiently and securing regular supplies is crucial.
During this time period, average slaughter costs were $139 per head and AMAs were saving packers $1.22 per head. More importantly, plants with higher AMA volumes had higher total plant slaughter and processing volumes. Without AMA volumes, total volumes would drop by 8% and costs would increase 2.6%. The variability without AMAs would add another 1.2% in costs. Total slaughter and processing costs are 4.7% lower using AMAs, or $6.50 per head. At the time of this data collection, packers were losing $2.40 per head.
The researchers constructed a graphic model using the data they had assembled that would account for all the various inputs, outputs and results that are a part of the beef production chain. The model illustrates that the industry revenue from the consumer—the only source of money for the industry—is really the start of the equation.
That revenue works its way down through retailers and HRI to packers and purveyors and then to cattle production sectors. Everyone taking some profit along the way is referred to as marketing costs. Everyone in the chain responds to incentives. Consumers buy more or less beef according to price, cow-calf producers produce more or less depending on calf prices and everyone in between does likewise.
There is another factor affecting consumer purchases besides price. Demand for beef has definitely gotten stronger over recent decades, supporting consumers’ inclination to buy beef at higher prices. If AMAs have contributed to beef quality and consistency, limiting them would be expected to affect demand.
Indeed it would. Koontz points out that interviews, surveys, analysis of packer P & L statements and market modeling all indicate limiting AMAs would adversely affect demand.
Without the quality incentive, consumers react to higher prices by buying less beef and shifting to other cheaper proteins. A policy reducing AMA use, which would result in lower-quality beef, would cost consumers nearly $370 million in the short run and $2.5 billion in the long run.
In that scenario, changes in costs, revenue and especially lower pounds from fewer cattle mean retailers and the wholesale complex, including packers, see a cost total of $200 million the first year and $3 billion in the long run.
Feeders and cow-calf and stocker operators would take the biggest hit, with feeders seeing costs of $558 million and $3.9 billion in the long run. The policy would cost stocker and cow-calf segments $1 billion in the short run and $5 billion in the long run.
All told, the beef industry would see total costs of $1.9 billion in the short run and $12 billion in the long run (2004 dollars).
It turns out, packer market power from AMAs amounted to much less impact than importance of efficiency savings to the production chain, the report showed.
“Limiting AMAs loses produces a lot of efficiency downstream and gains producers little,” it said.
That bottom line may not be what everyone expected, Koontz said.
“But it is consistent with large amounts of agricultural economics marketing research, the culmination of which was the 2007 LMMS.”
Regions are not the same
The LMMS looked at all the data from a national perspective. But Koontz has used information from current market conditions to shake out regional differences in effects of an AMA restriction policy.
Nationally, fed cattle are marketed 70% through AMAs, 10% forward contracts and 20% cash. But in the Southern Plains, particularly Texas-Oklahoma-New Mexico, the split is 90% AMAs, 5% forward contracts and 5% cash. In the upper Midwest, the splits are more variable, with 10-30% formula, 10-30% forward contracts and 40-60% cash.
Restricting AMAs and forcibly requiring cash would mean a seismic change for the Southern Plains, having to go from 5% cash to 30% or 50%.
A market fact that politicians almost certainly didn’t consider is the significant variation in use of the cash market week to week or month to month, regardless of region. The mandates require a minimum every day. The Nebraska and Iowa region would be the least affected, Texas-Oklahoma-New Mexico and Colorado the most affected, Kansas falls somewhere in the middle.
The white paper concludes that limiting the use of AMAs to 50% would cost the packers at least an estimated $10 per head and at least $25 per head for feeders. For the total beef production chain, the cost would range from $35-65 per head.
Total additional costs at the industry level would be about $2.5 billion per year. But because costs being passed down each year would shrink cattle numbers, the 10-year cost would be roughly $16 billion. The costs would be borne primarily by cow-calf operators and the brunt would be borne in the Southern Plains, the white paper concludes.
Steve Dittmer is a longtime beef industry commentator and executive vice president of the Agribusiness Freedom Foundation. The opinions of the author are not necessarily those of beefmagazine.com or Farm Progress.