From the Train the Trainer Handbook:

Introduction
The livestock industry has undergone a period of rapid structural change. Much of this change has been technical and business structure oriented, but a key component has also been livestock market structure changes and the way livestock and meat products are priced and sold. With increased reliance on capital intensive production systems, financial exposure to market risk has never been greater. The relative importance of traditional market price risk management compared to strategic market positioning has changed. Traditionally, a livestock producer was assured that there would be a relatively homogeneous and accessible open market for their product. Increasingly, market concentration and demand for specific meat product attributes has led to a strategic form of market risk exposure characterized by the need to negotiate alliances with purchasers and suppliers. These alliances often take the forms of contracting and often tie in with specified production practices including feeding programs and genetic selection. This paper provides a brief overview of the market risks confronted by today s livestock producers. Emphasis will be given to both traditional price risk management and emerging strategic risks of the changing market structure.

Traditional Market Price Risk Elements

1. Output Price Risk

a. Evidence of changing price risk in livestock seasonal and cyclical components of price risk.

b. Implications of continuous cash marketing for price risk management

Hog, poultry and milk marketing tend to be spread continuously over time resulting in long-run average prices. Still, performance may be enhanced by cutting out the lows. Anticipatory hedging makes predefined strategies difficult to identify.

Cow-calf producers tend to market the calf crop in discrete intervals, placing the year's revenues on a single calf-crop
marketing. Backgrounding strategies emerge as a second best for similar storage strategies of crops.

c. Tools for livestock and meat price risk management

• Futures Contracts and Key Changes
  

• Lean hog contracts
  
• Live cattle contracts
  
• Feeder cattle contracts
  
• Ground beef contracts
  
• Fluid milk futures
  
• Pork bellies

Forward Price Contracts w/ Packers
Fixed price contracts
Basis contracts
Long-term agreements

2. Input Price Risk

a. Implications of changing crop programs on feed-grain prices?

Potential increased variability and changes in levels.

b. Reliance on purchased feed inputs vs. farm raised inputs

Ability to more readily substitute cost effective feed ingredients.
Loss of diversification from crop/livestock operation.

c. Interest rate risk

Higher rates of capitalization may increase exposure.

3. Producer Response to Traditional Price Risk

• Marketing plan incorporated with business plan
  
• Learn to use futures markets tools available
  
• Build and maintain relationship with key purchasers (packers) and input suppliers.
  
• Build negotiation skills, increasingly important w/contractual relationships.

New Market Structure Risk Elements

1. Market Access Issues

a. Captive supplies and price volatility

• Packers increasing levels of long-term delivery commitments
  
• Evidence suggests higher levels of captive supplies in a
• particular market area increases the level of price variability of open market prices in these areas.
  
• Fewer plants and more concentrated plants tend to limit viable delivery points, and may increase marketing costs.

b. Linking production plans with market plans

Demands by packers for particular meat attributes leads to necessity to maintain genetics which capture higher
prices.

2. Thin Market Risks (e.g., feeder pig markets)

a. Implications for price volatility and levels

b. Possible remedies to thin markets

Electronic markets
Contract production and marketing

3. Transfer Price Risk

a. Emergence of intermediate markets (e.g., weaner pigs) for which there is no well established market.

b. Alternative transfer price mechanisms

Cost-plus mechanisms
Identify costs of production and then add negotiated margin
Derivative market mechanism
Identify closely related and viable product market and price intermediate product as a function of the viable
market.

c. Contract limitations on marketing flexibility

Contract principal may fail and leave agent with limited marketing opportunities.

4. Pricing Non-Identifiable Attributes

a. Determining prices for new and different product types.

b. Grading and measurement risk

5. Producer Response to New Market Risks

a. Improved negotiation skills

b. Building networks of expertise and business relationships

c. Incorporation of market risks into business plan

Information Access

1. Monitoring and synthesizing information is key in rapidly changing market environment.

2. Increased reliance on private information sources and networks as government resources shrink Information itself
becomes valuable commodity and risky.

3. Information will become more time sensitive as electronic exchange increases.
-e.g., packers electronically reporting kill sheet data and producers incorporate information into genetics and feeding
programs.

Conclusions

The livestock sector is likely to continue it's rapid evolution. While traditional forms of price risk will remain, new forms of risk presented by market structure changes are likely to emerge. Producers will find that price risk is becoming more closely linked to production risk as demand for specific quality characteristics of meat products continues to influence prices received by producers. This new risk environment will require improved strategic business management and negotiation skills, possible increased out-sourcing of expertise, and reliance on trustworthy business relationships. However, traditional pure price risk management tools will continue to play a critical role in producers total risk management toolbox.