Contracting for Consistency: Hog Quality and the Use of Marketing Contracts
Achieving consistency in hog quality has been one of the greatest challenges in the US pork industry. Packers, processors and retailers all ranked lack of uniformity in live hogs, carcasses, and retail cuts with regard to size and backfat as the most important quality issue facing the industry in the mid 1990s (NPPC, Pork Quality Audit, 1994), and quality consistency continues to be a leading industry concern (Martinez and Zering, 2004). The past 15 years have also witnessed dramatic changes in the organization of the US hog industry. In 1993, over 82% of hogs were sold through spot markets while 11% were sold under marketing contracts. By 2005, only 11% of hogs were sold through spot markets, with 67% sold under marketing contracts and over 20% owned by packers through formal integration or production contracts. This change in industry structure has not gone unnoticed by agricultural economists. A large body of literature examines the relations between hog quality and newly developed organization modes, particularly production contracting and vertical integration. A variety of theoretical frameworks and empirical approaches have been employed, whether using surveys (Kliebenstein and Lawrence, 1995), simulation techniques (Poray, 2002), contract document analysis (Martinez and Zering, 2004), and quality outcome analysis (Muth, et al., 2007). However, research focusing on production contracts and formal vertical integration fails to address the dominant institutional form, namely marketing contracts. Likewise, research focusing on market-based incentive mechanisms fails to provide a consistent explanation for the use and design of long-term hog marketing contracts. We propose a theoretical explanation for the use of long-term marketing contracts in the presence of buyer-specific quality attributes in an otherwise commoditized industry. This theoretical framework draws from and builds upon existing theories of contracting and organizational economics. In particular, the paper develops an analytical model that accounts for the use and structure of long-term marketing contracts to increase intertemporal quality consistency in hog procurement. The paper links the packer’s decision to move from spot-market transactions to long-term marketing contracts to the packer’s downstream product differentiation strategy. We provide empirical evidence to support the model and its explanatory power relative to existing theories.
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- Lawrence, John D. & Kliebenstein, James, 1995. "Contracting and Vertical Coordination in the United States Pork Industry," Staff General Research Papers 5050, Iowa State University, Department of Economics.
- Yanguo Wang & Edward C. Jaenicke, 2006. "Simulating the Impacts of Contract Supplies in a Spot Market-Contract Market Equilibrium Setting," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 88(4), pages 1062-1077.
- Tian Xia & Richard J. Sexton, 2004. "The Competitive Implications of Top-of-the-Market and Related Contract-Pricing Clauses," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 86(1), pages 124-138.
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