Vertical Coordination and Contract Farming
Rehber
performance payment, and disaster payment. The
performance payment is based on a fixed base price per
pound of live meat produced and the variable bonus
payment is based on the grower’s relative performance.
The bonus payment is determined as a percentage of
differences between average settlement costs of all
growers that belong to the integrator’s particular center
whose flocks were harvested in the same period and
producer’s individual settlement costs. Settlement costs
are obtained by adding chick, feed, medication and other
customary flock costs and dividing by the total pounds
of live poultry produced. For below-average settlement
costs (above-average performance) the grower receives a
positive bonus, and for above average settlement costs,
he receives a negative bonus. A grower with settlement
costs substantially above the average cost (typically this
threshold is set at 1.25 cents) will be excluded from the
average, hence, other growers are not rewarded when
one grower performs badly. Similarly, costs that are
substantially below average also are excluded from the
average (Vukina and Foster 1998).
The total payment to the grower can be formulized
as follow.
R = (b + B) q
where, b= Base payment per live pound, B= Bonus
payment per live pound, and q= the number of pounds of
live poultry.
If the producer’s revenue based on performance
payment is smaller than some guarantied amount, the
minimum payment formula will be applied. In the case
of a disaster such as fire, flood or storm, involving a lost
of a part or entire of the flock, the grower will be
compensated based on the disaster payment.
Organization of poultry growers is important. The
recent most significant attempt was the formation of
National Contract Poultry Grower Association.
3.2.2.2. Pork Industry
At the beginning of the twentieth century, most hogs
were slaughtered by the five largest packers. They
generally purchased most of their hogs through
commissions from local markets.
Since the beginning of the 1900s, the number of
farms that rise hogs have been falling and the average
inventory per farm has risen steadily. This trend has
continued during all of the twentieth century. Prior to
1993, most pigs were raised on farms with fewer than
1000 animals in inventory. In 1996, 4,880 U.S. farms
with at least 2,000 pigs in inventory accounted for 51%
of the total U.S. swine inventory (Zering 1998). The
pork sector has two production stages, farrowing and
finishing. Two decades ago, most hog operations were
integrated farrowing-finishing operations. There has
been a trend toward larger, more specified farrowing and
finishing operations in recent years (Ward, 1997).
In recent years, multi-year marketing contracts have
been widely used between the large hog producer-
integrators and large packers. In 1999, 59% of the hogs
in the U.S. were obtained through multi-year contracting
while only 2% were contracted in the 1970s and 1980s
(Martinez 1999). These contracts typically specify that
the producer deliver a certain quantity of hogs to a
certain location at a specified time. In return, the
producer receives a market-based price that is adjusted
for quality premiums. A considerable amount of large
hog producers sell their animals on the open market. A
majority of the contract hog production is horizontally
contracted among producers. The producers having more
assets, managerial skills, and are the risk-taker provide
the hogs and the feed to others who raise them
(Lawrence et al.1997).
Hog production and marketing contracts are
generally written to last five to twelve years and often
require the provision of a notice of termination no
shorter than a specified period, usually about six months.
Provisions often exist to extend the initial terms for an
additional time period subject to mutual agreement. In
addition, it is possible to renegotiate the terms if new
technologies or regulation arise (Hennessy and
Lawrence 1999).
According to a 1994 survey, more than 50% of hogs
acquired by packers were under long-term contracts via
formal, written contracts with a definite term often
ranging from 4 to 7 years. Likewise, large producers
indicated that 63% of the contracts were written rather
than verbal and 59% were for a fixed period (1 to 15
years). The remaining contracts were verbal and
typically continued until canceled (Lawrence et al.1997).
The packers involved in these arrangements required a
minimum value of hogs with either minimum quality
standards or specific genetics.
According to another survey conducted in 1996 with
the 17 swine companies, two firms used tournaments,
nine used fixed performance standards, one used a fixed
payment per pound, one used the bracketed scheme, one
paid a fixed rent per square foot of the house, and three
companies were growing pigs on company-owned farms
(Tsoulouhas and Vukina 1999). Some research results
have shown that, relative to independent production,
contract farming reduces grower income variability.
Relative performance contracts have the potential to
further reduce income variability as opposed to absolute
or standard performance contracts. Martin (1997) argued
that relative performance contracts reduced income
Food Marketing Policy Center Research Report #52
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