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WRITTEN
TESTIMONY OF PRIVATE
Thank you Chairman DeWine and members of the
Senate Subcommittee on Antitrust, Competition Policy and Consumer Rights
for allowing the Organization for Competitive Markets to submit this testimony
for the record. OCM is a multidisciplinary nonprofit organization that
focuses exclusively on antitrust and competition problems and solutions
in agriculture. Our members consist of farmers, ranchers, academics, policy
makers and agricultural businessmen. Horizontal concentration and vertical integration
in the food and agriculture sector has harmed food producers and consumers,
while the gross margins for retailers and processors increase each year.
Farm gate prices for meat have trended lower during the last 20 years
as consolidation increases. This is due to oligopsony market power on
the buy side of the processors. Yet consumers do not benefit - rather they continue paying more for pork. Consumers do not benefit from low live hog prices, nor do they benefit from the so-called efficiencies claimed by the packers. The claimed efficiencies of the packer and the retailers have either been false and/or overwhelmed by the market power increase, or both. In fact, during the historic live hog price crash of December, 1998, when prices dropped to eight cents per pound, packer and retailer price gouging resulted in record profits and higher pork prices for consumers. There are only two possible explanations for
this trend. First, the packers and retailers are increasingly inefficient
despite the fact that wage rates have fallen during the past 20 years.
Or second, the packers and retailers are increasingly exerting market
power to increase their margins far beyond competitive levels at the expense
of producers and consumers. OCM has concluded that packers and retailers
are exercising undue market power to the detriment of producers and consumers.
Efficient resource allocation in the food system has, thus, suffered greatly. Consider these numbers. The Smithfield acquisition
will take out a major competitor, Farmland Foods. This will not cause
upward price pressure for live hogs, but downward pressure. Assuming a
one dollar per hundred live weight loss in market price, hog farmers will
lose $2.70 per hog on 375,000 270 pound hogs per day, or over one million
dollars per day. This is over $250 million per year loss for producers,
and gain for packers, over one year (assuming 250 packer slaughter days).
A two dollar per hundred weight loss is one-half billion dollars per year
lost to Rural America's farms and main streets. The price spread trends explain why both consumer
groups and producer organizations oppose the Smithfield acquisition of
Farmland Industries' pork division. If Smithfield is allowed to acquire
Farmland Foods pork division, there is no reasonable argument that consumers
or producers will benefit. The creditors committee in the bankruptcy court
in which Farmland Industries has filed is compelling this sale to Smithfield
to maximize debt payoff to the creditors. However, the public interest
is in prevention of the acquisition so that Farmland may re-organize,
in this Chapter 11 bankruptcy, around its profitable pork division. PORK PROCESSING INDUSTRY STRUCTURE AND
CONDUCT Horizontal structure: The top tier of pork
processors include Smithfield Foods (86,300 daily plant capacity), Tyson/IBP
(72,200), Swift & Company (43,000), Cargill/Excel (32,000), Hormel
Food Corp. (27,700), and Farmland Foods (25,500). Smithfield's plants
include three in the East/Southeast U.S. and two plants purchased from
John Morrell & Co. in Sioux Falls, South Dakota and Sioux City, Iowa.
Farmland's plants are in Crete, Nebraska; Denison, Iowa; and Monmouth,
Illinois. Smithfield is number one in pork slaughter capacity and Farmland
is number six. All the top six are active in the Iowa-Southern Minnesota
market, which as we will see below, sets the national price for live hogs
each day. The second tier competitors, which are not named here, are not
relevant to setting national or regional hog prices because they are either
too small, or because they are entirely vertically integrated and are
not active in the open market. In theory, the 13% of the non-vertical hogs
set the price for the open market price reports. In practice, three to
five percent of the hogs traded set the price. These are the hogs actually
negotiated between packers and producers in the Iowa-Southern Minnesota
market, the price setting market. The other non-vertical hogs either are
committed to a packer through an oral formula arrangement, or are merely
forced to take the "Posted Price" that the packer says it will
pay based upon the Iowa-Southern Minnesota market. Conduct: Packers always have an incentive
to push hog prices down to save money. But when 90% of the contract hogs
are pegged to the open market price, the marginal cost of bidding higher
for open market hogs is tremendously magnified. For example, if the market
is approximately $47 per hundred weight for live hogs, and a packer needs
to bid $49 to purchase enough hogs to fill the plant for the day, the
extra two dollars only affects those hogs purchased at that price. However,
with 90% of the contracts pegged to the open market price, if a packer
bids an extra two dollars for the final hogs it needs, that price is reported
by USDA and automatically makes all the contract hogs tens of thousands
of hogs more expensive. Conversely, if the packer can force the market
down below competitive pricing levels, they save millions on hog procurement
costs for the dayís purchases. In today's concentrated packer environment,
we have dominant firms interacting in a very thin market. This scenario
exponentially increases their ability to drive prices lower as compared
to a situation where the dominant firm bought all their hogs from a high-volume
open market. It is no surprise that the past 20 years have seen a steady downward trend in hog prices as packers consolidated horizontally and vertically even while the wholesale meat prices justify far more money for live hogs. If Smithfield is allowed to purchase Farmland Foods, this trend will increase, and not decrease. Producers and consumers will suffer as packers and retailers continue price gouging.
The Smithfield bid for Farmland Foods is driven
by two factors. First, Smithfield continues to desire more market power
through eliminating competitors so as to drive hog prices down. Second,
the creditors committee, in Judge Venter's bankruptcy court in Kansas
City, wants the most money it can get for all Farmland Industries'assets,
including Farmland Foods. These two driving factors are inconsistent with
the public interest. Market power is most harmful for perishable
commodities such as pork. Smithfield's market power grab is a far greater
problem in the live hog market, a perishable commodity, than market power
in a non-perishable market given the same industry concentration levels.
This is because a seller of hogs has to sell within a narrow time window,
otherwise the hogs grow too large, are discounted in price and cost more
in production costs. In economic industrial organization terms, hog farmers
are unable to exercise countervailing market power through withholding
hogs from the market. Rather, hog farmers have to sell even at
"fire sale" prices because they can't hold withhold supply
to force bidders to pay more over time. Whereas a seller of books, for
example, does not have to sell within a narrow window because the books
do not deteriorate and the book seller can exercise countervailing market
power by withholding supplies from the market. Thus, concentration in
the packing industry is a far greater concern than the same concentration
in, for example, the book publishing and sales industry. Shackle space crisis: Shackle spaces are another
term for the plant capacity in pork packing plants. The plant capacity
available for hogs is the actual demand factor in the market consumer
demand is indirectly related to live hog demand. There is a substantial
prospect that Smithfield could opt to close on or two of its older Midwest
plants after the Farmland acquisition. Smithfield has a history of buying
plants, closing them down, and guaranteeing that they are never used to
slaughter hogs in the future. Smithfield purchased a Farmland Foods plant
in Dubuque, Iowa on March 28, 2000. Smithfield made optimistic promises,
on April 11, 2000, to spend $10 million to renovate the plant. On June
8, 2000, Smithfield closed the plant and laid off 1,100 employees. It
later stripped the Dubuque plant and it lays dormant today, unable to
add to live hog demand and cause upward price pressure. It is unreasonable to assume that Smithfield
will stand by its public promises with regard to this sale when it has
broken such promises repeatedly in the past and when it has tremendous
financial incentives to break those promises. It is reasonable to believe
that Smithfield will shutter one or more of the four plants in the Western
Cornbelt market that it will own post-transaction. Bankruptcy Proceedings are Inconsistent with
the Public Interest: Farmland Industries filed for Chapter 11 bankruptcy
in May 2002 to reorganize itself into a smaller, profit making entity.
Fourteen months later, there has been no reorganization plan filed. Rather,
the creditors committee has successfully pushed to have the assets of
Farmland Industries sold off as if this were a Chapter 7 liquidation.
If Farmland is to reorganize, it should do so around its profitable pork
business. Antitrust concerns should eliminate the avenue of selling the
pork division. Farmland Foods President George Richter said,
in a July 15, 2003 press release, "This agreement reflects the strong
value of Farmland Foods. Our employees have done an excellent job over
the past year growing the profitability and value of our pork business.
The sales price [offered by Smithfield], which may be increased through
the auction process, will bring significant value for the benefit of our
creditors." This is a creditor driven transaction. The
creditor interest should take a back seat to the interest in maintaining
the integrity of the open market for income to Rural America. Additionally,
it is unlikely that any will bid higher for the pork division because
the Smithfield bid has the support of the management team (who want to
keep their jobs) and the all-important creditors committee. Farmland has sold its beef, fertilizer, and
grain business. It maintains a petroleum business which is highly
cyclical in nature and its pork business, Farmland Foods. Farmland
Foods is quite profitable, with increasing profits each of the last seven
quarters as compared with the same period one year prior. The pork division,
which is a stand alone ongoing business, reported $9 million in 3rd quarter
operating profits ($36 million annualized) on July 14, 2003. But for Smithfield's bid to obtain dominant
market share at a high price and to scare off other bidders, Farmland
could seek bidders that are not an antitrust concern or reorganize around
the pork division as several experts speculated they could do. CONCLUSION America's farmers and ranchers do not want
to receive their income from the taxpayers through a government farm program.
They want to make money from a fair and open market. However, the government
is presiding over market deterioration that is eliminating the opportunity
to engage in private agriculture. The Super Bowl is a hard core, competitive
game enjoyed by millions, but it requires rules of the game and umpires
to enforce the rules. Fans and advertisers would soon lose interest if
the game was mere anarchy and survival of the fittest in the short term.
Similarly, market require rules and enforcement of the rules. Congress
should not allow such deterioration, even as it proclaims that it wants
development in Rural America. The Smithfield acquisition should be prevented. Thank you for your interest in this issue. Michael C. Stumo The processor/retail interface at the wholesale pork price level is also increasingly vertical with the result being ever thinner open market transactions from which price discovery can occur.
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CCMP is not a membership organization. Funding comes from livestock auction markets and independent feeders on a per-head basis at the point of sale. All contributions are tax deductible under OCMs non-profit status. For more information, contact Steve Cady at 402.792.0041 or visit the web site at www.competitivemarkets.com. The Organization For Competitive Markets is a multidisciplinary, nonprofit group of farmers, ranchers, academics, attorneys, and policy makers dedicated to reclaiming the agricultural marketplace for independent farmers, ranchers and rural communities. |
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Organization For Competitive Markets
P.O. Box 6486 Lincoln, NE 68506 Tel: 662-476-5568 e-mail: ocm@competitivemarkets.com |
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