Last week, I received a lot of emails from producers trying to understand the GIPSA debate. A few were disgruntled that I hadn’t presented both sides in an unbiased manner. Most of what I have written is editorial, however; it is my opinion.

I can understand how some people are a little confused about the GIPSA debate, as the two sides claim the proposed GIPSA rules will have drastically different results. The following hopefully will be helpful in understanding this debate.

The origins of the GIPSA debate: This debate goes back a lot of years to the start of the value-based marketing revolution. In addition to branded programs and grids, we started to see some feedyards struggling with managing their marketings on a timely and consistent basis because of increased show-list sizes.

Economies of scale had given larger feedyards significant production-efficiency advantages, which led to declining margins and larger operations. Managing risk and marketing these larger show lists on a timely basis was occasionally difficult.

In an effort to manage their market risk and make it easier to sell their offerings on a timely basis, these feedyards sought out alternative marketing arrangements (AMAs) like formulas and contracts. These arrangements allowed packers to better manage their risk as well, and to have less exposure to daily and weekly market fluctuations. Thus, it was beneficial to both sides who were participating – lowering risk and marketing costs.

These changes helped solidify the efficiency advantage of the large feeding complexes and changed the structure of the feeding industry. These large complexes reduced costs, increased efficiencies, lowered labor costs and leveraged economies of scale.

Still, those weren’t the biggest changes. These new complexes ran year around and they essentially made the mid-size feedlot business model unviable. These large operations looked at turning their money over 2.5 times a year. As a result of this increased inventory turnover, a profit of just $10/head became an extremely good return on the money.

The result was that generally only extremely small farmer feeders, or large commercial feeding operations, were viable. This change and shift was, of course, painful if you were in that mid-tier category.

At the same time, the overall industry was experiencing a significant loss in demand, which resulted in declining profits and margins. Needless to say, these weren’t good times, and many producers attributed these problems to AMAs. Captive supplies thus became the nemesis in the minds of a lot of cattle feeders and cow-calf producers.

Getting to the debate. The debate over captive supplies is viewed by many as the cause of a lot of our industry problems. Studies on captive supplies have been conducted for more than 30 years, and because there are so many variables to be sorted out, the results haven’t been in complete agreement.

Essentially the most recent USDA study concluded that AMAs have had a net beneficial effect on cattle prices. Yet, many studies show that captive supplies have a limited but negative impact on the cash market.

The latest GIPSA study showed that for every 10% increase in captive supplies, there is a corresponding 0.11% decline in cash prices. How can they be a benefit to overall prices, but slightly negative to cash prices? While these two circumstances would seem to be in contradiction, they actually aren’t.

If one takes 10% of the cattle off the market and it’s better than average quality of the mix moving through alternative channels, then the remainder of the cattle will be worth less. But that doesn’t mean that the net price for the entire mix is reduced.

The important and the trivial. There are a lot of provisions in the new rule that address particular circumstances. The two that have been highlighted within the beef industry are the provisions that limit packer-to-packer sales, and the provision that prevents one buyer from holding two different bids.

Regarding the first, the argument is that packer-to-packer sales would allow packers to manage and lower overall supplies. Of course, this would mean that the packers were colluding. Nobody wants this, but conspiring together is already illegal and would be aggressively punished.

Anecdotally, people who follow the markets will tell you that packers are far more likely to bid the price up if a packer is caught short-bought than they are to try and help the other packer out, but it remains a concern. The example often used is the Washington packing entity that owns a feedyard in Kansas. Would they have to ship their cattle to Washington? The law of unintended consequences comes into full view when one contemplates what impact this might have on complexes like Five Rivers or Cargill Cattle Feeding, which are tied to packing companies.

While the impacts could be dramatic on the calf market, few people see this as a real or likely threat to the current market. And, it’s widely assumed that this provision was merely included for compromise sake when it is modified or removed.

The buyer not being allowed to carry two bids is another red herring, as it simply doesn’t happen frequently enough to have an impact on overall market prices.

However, it certainly has a significant impact on those areas that are on the fringe. The problems are obvious if the two were to agree to conspire and split up the cattle; they could buy them cheaper. Conversely, if you are at a small barn with fairly small cull-cow runs, it might not make sense to have an individual buyer there, and obviously having one buyer instead of two is probably not good, either. We see order buyers carrying bids for multiple buyers all the time at sale barns; most people would argue that at times it is very beneficial, and at times it may be harmful to prices.

There is no easy answer, but we have historically relied on the marketplace to fix imbalances. If the basis is too wide, buyers migrate in and out of markets based on profit expectations. These are complicated issues without obvious solutions, but nobody claims they are primary drivers in creating price-discovery issues.

This argument is all about AMAs. Those who support the rule claim it is these non-cash cattle that provide packers with leverage to lower cash prices, and those who oppose it believe AMAs allow producers to differentiate their product, build demand and manage risk.

Where it gets confusing is that one side argues the rules won’t eliminate these arrangements, while the other argues it’s a rejection of the entire quality movement away from commodity production and is a return to a marketing structure that was a dismal failure in the distant past. How can there be two such divergent views?

It comes down to the fact that one side sees declining demand and a commodity system that leads to less profitability and contraction within the industry. The other side sees a lack of profitability under today’s rules, and concludes that things would be dramatically better if we returned to the rules of the game before value-based marketing.

There’s no debating the economic impact here. Loss of demand has been devastating to our industry, and a commodity system promotes marketing to the lowest possible denominator. Meanwhile, value-based marketing sends price signals to consumer preferences and demands throughout the production system, thereby increasing quality and consistency of our product.

Thus, we have the dilemma – how can anyone be against value creation, product differentiation and demand growth? You can’t, so both sides claim they are in favor of all that. Those who favor the rule say it won’t affect these things; those who oppose say it will have a devastating effect. So who does one believe?

Let me begin by saying that the rhetoric from both sides isn’t important, but actual policy stances are. Barack Obama may claim he’s for deficit reduction and reduced regulatory burdens on business, but his policies would say something quite different.

We see the same thing all the time in the cattle industry. Those who avidly oppose trade, claim they are for fair trade when they have never supported any access to our markets ever.

The solution. Start by reading the concerns of the National Cattlemen’s Beef Association, the National Pork Producers Council and the various state cattlemen groups about the rule. Then, read R-CALF’s position on what GIPSA will do. If you’re really ambitious, call up your land-grant university and read the marketing studies done on captive supplies and demand, then determine for yourself which is the larger problem. Then, read the proposed GIPSA rule for yourself and make your own decision.

As for myself, I believe price discovery will become more of an issue and a major component of that is price transparency as AMAs continue to grow. I think our system has some problems, but market manipulation is minor compared to insufficient differentiation in pricing.

The market works amazingly well; the price swings we endure are testament to that. Demand issues overwhelm market power issues on their impact on our industry. The first is the cause of our troubles and our hope for the future. The second is of minimal impact that merely diverts us from attacking real issues; even worse, it leads to lessened demand.

For perspective, a 30% reduction in AMAs would result in a cash price increase of .33% – that’s point .33% in cash prices. I don’t have a good figure to use on the loss of premiums received and ultimately the loss in demand. But we wouldn’t be talking about tenths of pennies/lb.

The simplistic analogies. Let’s say a farmer has 100 tons of hay (representing the fed market). If he sells it on the cash market, he can receive $100/ton or $10,000 for it. A dairy is willing to pay a premium for 20 tons and will pay $150/ton. But, he can only get $95/ton for the remaining hay. Should he do it?

Or, let’s say that the farmer’s production cost is $70/ton, and he has a $7,000 note at the bank. Should he be allowed to sell 50 tons of it at $80/ton early summer and the remainder in the fall to manage his risk? If there are four ranchers who each need to buy 25 tons, is price affected if all four show up to buy the 25 tons on a given day, or if one buys his a week earlier than the others leaving three ranchers to buy 75 tons?
-- Troy Marshall