Good Contract Swine Grower-Integrator Relations
Livestock Update, February 2000
Allen Harper, Extension Animal Scientist, Swine, Tidewater AREC, Virginia Tech
The use of contract arrangements in the production of hogs is not a new practice. Even as early as the 1970s there were some isolated production or marketing contracts in existence. Such arrangements were limited and the overwhelming majority of hogs were produced and marketed by independent producers on open or "spot" markets. However, during the past 10 to 15 years the pork industry has evolved rapidly. Several factors have contributed to this rapid evolution including packer and large producer consolidation, the need to control pork supply and price volatility, and the need for pork to be of consistent high quality and competitive with other food protein sources. Under these conditions, the use of contractual arrangements in hog production has expanded rapidly.
A recent survey indicated that 40% of the hogs farrowed and 44% of the hogs finished in the U.S. were from producers involved in some form of production contract. A higher percent (57%) of hogs sold were under some type of prearranged marketing contract with a packer (Lawrence, Grimes and Hayenga, 1998). Marketing contracts are agreements by a producer to provide a specified quantity and quality of pigs or market hogs to a buyer at a specified price. Production contracts deal more specifically with the production and management of the hogs. In these arrangements a contractor or integrator provides pigs or breeding stock, feed and other services to a producer or grower who manages the hogs at his or her farm until the animals are ready for market or transfer to other farms. This discussion will focus on the importance of integrator and grower relations in production contract arrangements, but some of the general principles apply to marketing contracts as well.
The Production Contract
Most production contracts include written terms for length of contract, terms for renewal, conditions for termination and specific language defining which party is responsible for certain inputs of production, equipment and facilities and required services in the production of pigs. In hog finishing contracts base payment terms are generally defined as a payment price per pound of weight gain with additional incentive payments based on added weight gain beyond a set end weight, improved feed efficiency (lbs. feed per lb. of weight gain), and reduced mortality rate. Payment terms for contract nursery pig production typically focus on a base payment for weight gain in nursery pigs with a feed efficiency incentive payment. Farrow-to-weaned pig contract payment terms are usually based on a set price for each acceptable quality pig produced plus incentives for each pig produced above some set level of pigs produced per sow in inventory. For example, incentive payments may be based on a bonus payment for each pig produced above 16 pigs produced per sow in inventory per year. This figure can be calculated and paid on a quarterly basis.
Agricultural economists and others who have studied contract production make it clear that a written hog production contract is not an unlimited guarantee (Zering, 1997). And, although production contracts are an effective way for swine growers to minimize hog pricing risk, both parties bear some risk that the other party may not be capable of fully meeting the written terms of the contract. Contingency plans may be included in the written contract to minimize these types of problems. Including defined procedures in the contract to address unexpected problems generally helps reduce surprises or conflicts for both parties. Certainly production contracts are binding legal documents. But even well written contracts should be considered a basic framework for a working relationship in contract production of hogs (Zering, 1997). Ultimately the ability of each party to communicate and work together effectively will determine the long term success or failure of the contract production arrangement. Successful contract production occurs when the venture has consistent mutual benefit for both the grower and the integrator.
The Poultry Experience
For nearly 30 years the poultry industry has been heavily dependent on production contracts. And in many respects it has been an economic marvel to other agricultural industries as poultry production and consumption in the U.S. has climbed steadily since the early 1970s. However, the poultry system has not developed free of problems and challenges. Recent agricultural trade publications have presented cases of grower-integrator dissatisfaction. In some regions of the south, calls for increased legislation and government oversight of the contract grower-integrator relationship have taken place. It is reasonable to suggest that the swine industry should learn from the poultry experience. The goal should be adopting those things that are successful but to avoid, or at least deal more effectively with potential problems.
Mark Jenner, commodity specialist with the American Farm Bureau Federation, has provided detailed analysis of the issues and challenges in U.S. poultry grower-integrator relations (1997, 1998). His reports illustrate the complex nature of these types of problems. In some cases integrators feel that problems arise simply from the fact that inefficient growers become disillusioned and make public complaints that are damaging to the overall system. Even on a "level playing field" not every player will be highly successful and some of those who have sub-par performance may be the most vocal in their dissatisfaction. Related to this is the observation that many poultry growers and their integrators are very satisfied with their contractual arrangement. In these cases both parties feel that mutual benefit exists in their contract arrangement and that growers who are constantly complaining are damaging the overall system.
But the Jenner reports also indicate that some real problems do exist. Evidence of these problems include a large lawsuit settlement by Cargill with Florida poultry growers in 1996, a state legislative effort in Mississippi to increase communication between integrators and growers, and a published survey of Alabama poultry growers that indicated that some poultry growers were quite content with their contracts while others were very discontented. One clear message in the poultry experience is that a strong sense of trust between grower and integrator must be established and maintained for long term success. As suggested by Jenner the potential to cultivate trust is greatest when neither party adversely influences the other party's performance. Some points that can impact this situation are defined in the written contract. But ultimately each party's willingness to communicate openly and consistently act in a way that shows good faith effort to make the contractual arrangement work for both parties will dictate the long term success of the production contract.
The Swine Growers Perspective
As described in an analysis by Lauren Harper and co-workers (1991), contract growers may have large capital investments in specialized swine buildings and equipment. Furthermore, meeting the fixed costs to operate such facilities has a major impact on the profitability and net returns to the grower's investment and management. Under this situation it is easy to understand that growers have economic pressure to achieve optimal throughput with their facilities. Growers also feel economic pressure to have reasonable opportunity to achieve incentive bonus payments for better feed conversion, lower death losses, or more pigs produced per sow in inventory.
Growers recognize that contracts allow them to avoid much of the feed and hog price risks associated with the hog business. But they also recognize that they face other types of business risk. Such risks include increases in interest costs on debt, changes in fuel or utility rates and even legal risks associated with environmental regulations or nuisance complaints against the operation.
Like all agribusiness people, contract growers must be profit motivated. Because they bear financial risk and face economic pressure to optimize net returns, it is reasonable that they have certain expectations in the operation of their contract. These expectations may include, but are not limited to the following.
The Swine Integrators Perspective
Like the grower, the integrator faces financial risks and economic pressures. Risk exposure includes such things as potential increases in grain, soybean meal or other feed ingredient prices, changes in pig marketing prices or schedules, changes in labor and management costs, transportation costs, and other variable cost factors in the operation of company farms. In addition the integrator faces financial risk associated with disease or other factors that decrease pig performance and efficiency, either on company farms or on contract grower farms.
The integrator is under economic pressure to meet the demands of a significant payroll for workers, fieldmen and management. Additionally, most integrators must meet the expenses associated with operating a fleet of trucks, a centralized feed mill and, in many cases, establishment and operation of company farms that may provide pigs or breeding stock to contract grower farms.
Therefore, the integrator must also be motivated by profit. Their objective in establishing a production contract is to achieve an expected level of pig production at a predictable cost. The integrator's intent is to pay the grower for management and services in the production of the pigs and for the transfer of facility maintenance, mortality disposal and manure management responsibilities to the grower. However, their reasonable business expectation is that payment for these services will still leave opportunity for return on investment. Reasonable expectations of the integrator may include but are not limited to the following.
So What Is the Answer?
There is no universal policy on the best approach to maintaining good contract grower and integrator relations in the swine industry. But some general principles do apply.
Avoid or Eliminate False Expectations. Both parties should not expect things that the contract arrangement cannot deliver. The best time to determine what a contract can and cannot provide is before the contract is signed. Proforma statements of potential costs and returns for a contract production farm should be drawn up based on realistic data and experiences. Potential growers should critically evaluate the contract and potential financial returns on investment and management. Integrators should be willing to provide reference contract growers that potential growers can contact for information to make decisions. Likewise potential growers should be willing to provide references and information to the integrator if they request such information. Careful evaluation before the contract is established will determine if the relationship is truly feasible and help prevent false expectations among grower and integrator.
Understand the Other Party's Perspective. As described previously, both the grower and the integrator are driven by economic forces to have certain expectations from the contractual arrangement. Some of these expectations may be addressed within the written contract but some may not. However, each party should make an effort to understand the other's reasons behind their expectations. Doing so will improve trust and cooperative spirit and improve chances of long term success in the contract.
Communicate Openly, Honestly and With a Common Goal. Realistically it serves no useful purpose for a contract grower to complain to his or her hired laborer or neighbor about a farm problem as their fieldman is driving away from the farm. Likewise, fieldmen should not fail to address what they perceive as a problem at the farm only to complain about the situation later among others within the integrated company. Instead, open dialogue conducted in a professional manner should occur regularly between grower and fieldman. In this manner problems may be identified early and viable solutions applied. The question is not if or when problems will occur but rather how quickly they will be identified, communicated and addressed. Effective communication that involves both talking and listening is important to addressing these problems. Ultimately the goal when addressing these problems should be to arrive at a solution that is beneficial to both the grower and the integrator.
In addition to routine communication between the grower and fieldman, some growers have expressed interest in periodic group meetings with the integrator's management personnel. The purpose of such meetings could be to discuss common problems and effective production strategies and to hear first hand the long term plans and goals of the integrator.
Respond to Open Communication with Appropriate Action. Open communication is critical, but responding to dialogue and problem identification with appropriate action is equally important. Failure to take proper action to deal with problems after they have been discussed can lead to the impression that one or both parties are good at rhetoric but weak on their ability to actually solve problems. This weakens trust and cooperative spirit within the contractual arrangement.
Be Willing to Terminate the Contract Relationship If It Absolutely Won't Work. This is a difficult statement to make because contract termination may create serious financial problems, especially for growers with a major capital investment in facilities. However, the reality is that in rare situations a contract arrangement simply does not work and cannot be repaired. When faced with this situation, integrators and growers should strive to minimize losses for the other party when a contract must be terminated (Zering, 1997).
Contract production has become increasingly important in the U.S. swine industry and credible surveys indicate that almost half of all hogs produced in the country are involved in some type of production contract. Production contracts are a means of transferring business risk and defining production responsibilities within an integrated pork production system. In this system a swine integrator provides pigs or breeding stock, feed and other services under a contract to growers who are responsible for housing and managing the pigs during one or more production phases and for collection, utilization and disposal of manure and other waste products. Payment terms for the grower are written into the contract and typically include base payment prices for each pig or pound of pig growth with incentive payment schedules for better feed efficiency and productivity. While many important terms and conditions are written into the contract, it should be recognized that a hog production contract is not a risk-free guarantee for either party.
The poultry industry has relied heavily on production contracts for over 30 years and has been tremendously successful in improving efficiency and increasing consumer market share. And in some respects, the integrated poultry industry can serve as a historical model for the integrated swine industry. But the poultry industry has not developed without problems. One current concern is the apparent deterioration of relations between some contract growers and integrators in some regions of the country. It seems reasonable to suggest that the integrated swine industry could learn from the poultry experience, taking advantage of practices that have worked for growers and integrators but dealing more effectively with issues and problems that have not been as positive.
Swine growers and integrators should strive to avoid or eliminate false expectations from the production contract. They should recognize that the contract arrangement provides certain swine business opportunities, but there are also certain opportunities that it is not designed to deliver. Each party should attempt to appreciate the other party's perspective. Both face specific economic pressures, business risks and have sound reasons to be motivated by profit. Within this framework, growers and integrators should strive to have regular communication that is open, professional and has the common goal of improving conditions for both parties in the contract. Communication and dialogue should be followed-up with prompt action to deal with problems and improve efficiencies. All of these actions will help foster a sense of trust and teamwork between the grower and integrator. Practical experience has demonstrated that long term contract production success occurs when the venture has benefit for the grower and the integrator. And finally, it should be recognized that in some rare cases the contract arrangement does not work and cannot be repaired. In such situations, the parties must be willing to terminate the relationship. In such rare cases the termination process should be done in a manner that, as much as possible, reduces economic hardship on the parties involved.
Harper, L. P., D. Kenyon, and S. Thornsbury. 1991. The financial feasibility of finishing feeder pigs under production contract in Virginia. Virginia Cooperative Extension Publication No. 448-205/REAP R006, Virginia Tech, Blacksburg, VA.
Jenner, M. W. 1997. The challenge and opportunity of resolving grower/integrator relations. Iowa Poultry Symposium Paper, Ames, Iowa, Feb. 25, 1997.
Jenner, M. W. 1998. Improved grower/integrator relations would enhance poultry industry. Feedstuffs 70(11): 1-14 (March 16, 1998 issue).
Lawrence, J., G. Grimes, and M. Hayenga. 1998. Production and marketing characteristics of U.S. pork producers, 1997-1998. Published survey results conducted cooperatively by Iowa State University, the University of Missouri and Vance Publishing Company (Pork Magazine).
Zering, K. 1997. Production contract problems and limitations. Presentation paper given at the Al Leman Swine Conference, Minneapolis, Minnesota (1997).