Price Discovery Systems Organized Markets Decentralized Individual Negotiations

Price Discovery Systems

Organized Markets

Decentralized Individual Negotiations

Price Discovery is the process of buyers and sellers arriving at prices.

Organized Markets

Farmer’sAuctionsTerminalFutures

Organized Markets

Normally open to the publicbuyers, sellers and the commodity are

often at the same location.

Prices are transparent

In general Organized Markets have been declining in importance.

Example: Livestock Terminal Markets

TERMINAL MARKETS DERIVE NAME BECAUSE THEY ARE LOCATED NEAR

RAIL TERMINALS

Chicago Stockyards 1866

Chicago Stockyard 1880 -- 40 acres

BEGAN THEIR DECLINE IN THE 1930'S

SHIFT TO TRUCK TRANSPORT

DECENTRALIZED PACKERS

ABOUT 80 IN 1937ABOUT 6 TODAY

WITH A TERMINAL MARKET PRODUCERS MUST CONSIGN

THEIR ANIMALS TO A COMMISSION FIRM

COST IS FAIRLY HIGH

BIG LABOR COMPONENT TO COST --

THEY OFTEN LACK CONVENIENCE

MAY NOT RESULT IN BEST PRICE

AUCTION MARKETSBY THE MID 90'S THERE

WERE ONLY ABOUT 1000 – ABOUT 1500 LESS THAN IN

1947

ORGANIZED MARKETSNORMALLY OPERATED BY THIRD

PARTIES

ORGANIZED MARKETSNORMALLY OPERATED BY THIRD

PARTIESTHE OPERATORS OF THE MARKET

RECEIVE A FEE

ORGANIZED MARKETSNORMALLY OPERATED BY THIRD

PARTIESTHE OPERATORS OF THE MARKET

RECEIVE A FEEELECTRONIC MARKETS ARE A TYPE

OF ORGANIZED MARKET.

LESS FORMALIZEDLESS PUBLICLESS STRUCTUREINCREASINGLY IMPORTANT IN

AGRICULTURE

DECENTRALIZED INDIVIDUAL NEGOTIATION

ADVANTAGES OF DIN

CONVENIENCE AND LOWER TRANSACTION COST

– LOWER FEES, SHRINKAGE, TRANSPORTATION

PRODUCERS MAY HAVE MORE CONTROL

CAN BE TRANSACTED ANYWHERE AT ANY TIME

OFFER-ACCEPTANCE PRICING

USUALLY DONE BY LARGE BUYERS OR SELLERS

A RETAILER MAY ASK FOR BIDS FROM PACKERS

FORMULA PRICING

MARKET PARTICIPANT USUALLY ARE CONTINUOUSLY DEALING WITH EACH OTHER

THE PRICE IS BASED UPON SOME FORMULA

USDA REPORTED OR FUTURES PRICE FOR LIVESTOCK

LIVESTOCK PRICING

MOST FORMULAS ARE BASED ON A REPORTED

NEGOTIATED PRICE

Percent of Hogs Sold Through Various Pricing Arrangements

Year 1999 2000 2001 2002

Hog or Meat Formula

44.2 47.2 54.0 44.5

Other Market Formula

13.2 20.8 21.9 11.8

Negotiated 35.8 25.7 17.3 16.7

A MAJOR ISSUE OR CONCERN IN LIVESTOCK PRICING IS THE DECLINE IN NEGOTIATED PRICES

NEGOTIATED PRICES DRIVE THE FORMULA

PRICING

THE PRICE A PRODUCER RECEIVES FOR HIS HOGS WILL BE THE FORMULA PRICE WITH PREMIUMS

OR DISCOUNTS BASED ON YIELD

COORDINATION IN THE MARKETING CHANNELWITHOUT EXCHANGE(PRODUCT DOES NOT ENTER THE MARKET)

CONTRACTUAL EXCHANGE ARRANGEMENTS

VERTICAL INTEGRATION A FIRM OWNING TWO OR MORE

LEVELS OF PRODUCTION OR MARKETING

– A FEED COMPANY THAT FEEDS ITS OWN LIVESTOCK

– A FOOD PROCESSOR THAT RETAILS FOOD

MARKETING PROCUREMENT CONTRACTS

AN AGREEMENT BETWEEN A SELLER AND A BUYER COVERING THE PRODUCT, TIME, NATURE OF DELIVERY, AND PRICE

PRODUCTION CONTRACT

A PRODUCER WILL RAISE ANIMALS THAT ARE OWNED BY A CONTRACTOR.

MOTIVATIONS FOR VERTICAL INTEGRATION

PROFIT– MARKET POWER– EFFICIENCIES