oversight

Beef Industry: Packer Market Concentration and Cattle Prices

Published by the Government Accountability Office on 1990-12-06.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

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                               BEEF INDUSTRY
                               Packer Market
                               Concentration and
                               Cattle Prices


                                                                           142827




                                                       RELEASED
                        IEESTRICTJ3D--Not     to be released outside the
                        General Accounting Office unless specifically
                        approved by the Office of Cangressioml
                        Relations.
      united
        States
GAO   General Accounting Office
      Washington, D.C. 20648

      Resources, Community, and
      Economic Development Division

      B-241861

      December 6,199O

      The Honorable Patrick J. Leahy
      Chairman, Committee on Agriculture, Nutrition,
        and Forestry
      United States Senate

      The Honorable Max S. Baucus
      United States Senate

      By letters dated December 19,1989, and February 2,1990, you
      expressed concern about the impact that recent mergers by beef packers
      might have on cattle producers. Such mergers during the 1980s resulted
      in the four largest packers accounting for about 70 percent of the
      slaughter in the U.S. beef-packing industry. Specifically, you were con-
      cerned that such concentration may have allowed the largest packers to
      pay lower prices for cattle than if this concentration had not existed.

      Structural changes in the overall beef industry during the last decade
      have added to the complexity of evaluating the impact of concentration
      in the beef-packing market on steer and heifer prices. For example,
      while the number of fed cattle marketed remained relatively stable
      during the 198Os, the number of cattle-feeding operations in the top 13
      cattle-feeding states that supply steers and heifers to the packing
      industry declined almost 40 percent. Additionally, beef packers have
      gained more control over the feeding sectors of the industry either
      through direct ownership or special agreements, and this situation could
      have an effect on steer and heifer prices.

      Although many factors affect these prices, you asked us to try to isolate
      how prices are affected by the market’s beef-packer concentration.
      Since the amount of empirical research data relevant to beef-packer con-
      centration in the 1980s is very limited, we also obtained the opinions of
      analysts of the beef industry and other knowledgeable individuals. As
      agreed with your office, this report summarizes existing research and
      expert opinion on structural changes in the beef industry and the impact
      of these changes on the prices that beef packers pay for cattle.


      ‘A common measure of concentration, or market dominance, is the Cfirm concentration ratio which
      equals the aggregate market share of the four largest firms ln an industry. Economic theory suggests
      that the greater is concentration, the more likely it will be that large firms can influence the prices of
      goods they buy or sell. In our opinion, a concentration ratio of 70 percent would likely be considered a
      concentrated market.



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                   B241961




                   Economic theory suggests that, other things being equal, a high level of
Results in Brief   market concentration in the beef-packing industry could result in lower
                   cattle prices than would prevail with less concentration. Some of the
                   empirical evidence we reviewed is consistent with this theoretical expec-
                   tation. However, we refrain from drawing firm conclusions based on the
                   literature we reviewed because (1) the number of relevant studies is
                   small, (2) many of the studies relate to the 1970s and may not be appli-
                   cable to market conditions in the 198Os, and’(3) most have certain meth-
                   odological limitations.

                   Generally, the industry analysts and experts with whom we spoke do
                   not believe that the recent increases in beef-packer concentration have
                   lowered cattle prices in the 1980s. During the same period that concen-
                   tration increased, packers invested in new, larger, and more efficient
                   processing plants. This investment led to the development of excess
                   capacity in the packing industry relative to available cattle supplies.
                   Industry analysts argue that the combined circumstances of excess
                   capacity and decreasing processing costs led packing firms to compete
                   more vigorously with one another in purchasing cattle, and this competi-
                   tion led to upward pressure on prices.

                   Some feedlot operators and cattle producers with whom we spoke are
                   concerned that beef packers may exert greater influence over cattle
                   prices in the future. They believe that this influence would result from
                   the combined effect of increased beef-packer concentration, a trend
                   toward increased vertical integration of the industry, and an increase in
                   cattle supplies relative to processing capacity.


                   The beef industry can be divided into three principal stages according to
Background         the growth phase of the cattle: (1) cow-calf production, (2) cattle
                   feeding, and (3) fed-cattle slaughter, or beef packing. Cow-calf “opera-
                   tors” breed cows for the production and sale of young steers and
                   heifers. Cattle-feeding operators take over the primary feeding of the
                   cattle for several months until they are ready for slaughter. Highly spe-
                   cialized commercial feedlots with capacities of more than a thousand
                   head of cattle per year handle most of the cattle feeding. Feedlot opera-
                   tors may either purchase the cattle they feed or custom feed the cattle
                   for others, such as cow-calf producers or beef-packing firms. Since the
                   1940s and 196Os, commercial cattle feeding rapidly evolved as pro-
                   ducers sought to increase the output of their herds by increasing the
                   weight of the cattle. At the end of the feeding stage, the cattle owners
                   sell the “fed” steers and heifers either directly to a beef-packing firm or


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                        E241861




                        to an agent acting on behalf of the beef-packing firm. Most of the large
                        beef-packing firms both slaughter the fed steers and heifers and fabri-
                        cate the carcasses into boxed beef. Another type of packer purchases
                        the carcasses and fabricates them into boxed beef. The third type of
                        packer only slaughters the steers and heifers and sells the carcasses.

                        The issue of market concentration in the beef-packing industry is not a
                        new one. In the early 1900s five companies dominated the meat-packing
                        industry. Their control over a significant portion of the market led to an
                        investigation by the Federal Trade Commission. The investigative report
                        concluded that the five companies had engaged in anticompetitive prac-
                        tices, which they ultimately agreed to discontinue.

                        The Packers and Stockyards Act of 1921 is intended to maintain effec-
                        tive competition and fair trade practices in the marketing of livestock,
                        meat, and poultry for the protection of livestock and poultry producers.
                        The act also protects consumers against unfair business practices in the
                        marketing of meats and poultry and against restrictions of competition
                        that could unduly affect meat and poultry prices. The Packers and
                        Stockyards Administration within the U.S. Department of Agriculture
                        (USDA)has the responsibility for administering the act’s provisions.

                        Following the antitrust activity of the 192Os, market concentration by
                        the larger beef-packing firms declined over the next 50 years. By 1975
                        the four largest firms slaughtered only 28 percent of the steer and heifer
                        market. However, this situation reversed itself after 1975, culminating
                        in mergers and acquisitions by two of the largest packers between 1986
                        and 1987. USDA reported that in 1988 the top four beef-packing firms
                        slaughtered about 70 percent of steers and heifers, and they fabricated
                        about 79 percent of the boxed beef on the market.


                        Over the last decade, the beef industry has had an increasing concentra-
Structural Changes in   tion of fewer operators or firms at all levels, including the cow-calf,
the Beef Industry       feeder, and packing sectors. Additionally, beef packers have exercised
                        greater “vertical coordination,” in that they have gained more control
                        over the feeding and final packaging sectors of the industry.


ESeef-Packing           In the mid-1980s, mergers and acquisitions allowed a handful of large
Concentration”          beef-packing firms to gain a substantial market share of national steer
                        and heifer slaughter and boxed-beef fabrication. USDA'S Packers and
                        Stockyards Administration measures concentration in the industry with


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                                       E241861




                                       two concentration ratios. One is the percentage of the industry con-
                                       trolled by the four largest packers according to slaughter volume. As of
                                        1980, this ratio for steer and heifer slaughter was 36 percent; however,
                                       by 1988 this figure had nearly doubled, reaching 70 percent. During the
                                       same period of time, the other ratio, which measures four-firm concen-
                                       tration for boxed-beef fabrication, increased from 53 percent to 79 per-
                                       cent. Concentration in the beef industry experienced its most dramatic
                                       increase in 1987, after a late 1986 Supreme Court ruling allowed a previ-
                                       ously blocked acquisition of the third largest beef packer by the second
                                       largest beef-packing firm. As table 1 shows, between 1986 and 1987 the
                                       percentage of the beef-packing industry accounted for by the top four
                                       firms increased by 12 percentage points. While this table shows the
                                       available statistics on national concentration, it is generally agreed that
                                       markets for fed cattle are regional and not national, since cattle are not
                                       often transported more than 250 miles to slaughter plants.

Table 1: Four-Firm Concentration
Percentage for Steer and Heifer                                               Four-firm concentration
Slaughter and Boxed-Beef Production,   Year                         Steer 81heifer slaughter                    Boxed beef
1990-99                                1980                                             35.7                              52.9
                                       1981                                             39.6                              57.1
                                       1982                                             41.4                              59.1
                                       1983                                             46.6                              60.2
                                       1984                                             49.5                              61.7
                                       1985                                             50.2                              61.5
                                       1986                                             55.1                              67.4
                                       1987           ---.___-                          67.1                              79.5
                                       1988                                             69.8                              79.3
                                       198ga                                            70.4                               N/A
                                       aPreliminary estimate.
                                       Source: USDA.


                                       Market concentration in the beef-packing industry has been increasing
                                       over the last decade since the number of beef-packing firms has
                                       decreased every year since 1980. According to a Packers and Stockyards
                                       Administration annual report, between 1980 and 1988 the number of
                                       beef-packing plants slaughtering steers and heifers decreased by 40 per-
                                       cent, or from 626 to 374 plants. Most of the plants exiting the industry
                                       during this period were amongst the smallest in the industry. Simultane-
                                       ously, the larger slaughter plants-500,000     or more head of annual
                                       slaughter-increased    their share of the total commercial steer and
                                       heifer slaughter, while plants in the smaller-size categories decreased
                                       their share every year since 1980.


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                         B-241861




Vertical Coordination    Since the 1970s most large beef packers have vertically coordinated
                         with other sectors of the,beef industry. Previously, the packers sold car-
                         casses to firms that specialized in the final processing and packaging of
                         the beef for sale to wholesalers and retailers. However, the largest
                         packers are now producing boxed beef themselves. In addition, beef
                         packers have increasingly entered into forward contracts-contracts      to
                         purchase cattle at a future date- and special marketing agreements
                         with feeders to ensure a steady supply of fed cattle for slaughter. For
                         example, the largest beef packer has entered into an agreement with the
                         nation’s largest cattle feeder. Under this agreement the packer has
                         agreed to purchase all of the steers and heifers offered to it by the
                         feeder.


Changesin Cow-Calf and   Like the number of beef packers, the number of operators in both the
Feeder Sectors of the    cow-calf and feeder sectors of the industry has also declined over the
                         last decade. During the same period, steer and heifer production and
Industry                 marketing remained relatively stable. Data from the Department of
                         Commerce’s Census of Agriculture show that between 1978 and 1987
                         the number of cow-calf producers dropped by about 18.6 percent, from
                         1,032,952 to 841,778. Small farms with fewer than 60 cows accounted
                         for over 90 percent of this reduction, while the number of farms with
                         500 head or more remained relatively stable.

                         Proportionately, the number of cattle-feeding operations decreased even
                         more than cow-calf operations during the 1980s. Although the number
                         of fed cattle marketed remained relatively stable throughout the 198Os,
                         the number of cattle-feeding operations in the top 13 cattle-feeding
                         states2 declined almost 40 percent, or from 78,071 to 46,883 operations.
                         Smaller farm-feeding operations accounted for almost all of this
                         reduction.


                         Given the high level of market concentration in the beef-packing
EBeef-PackingIndustry    industry, economic theory suggests that, other things being equal, cattle
Concentration’s          prices could be lower than in the absence of such concentration. How-
Impact on Cattle         ever, our review of the empirical studies did not lead us to draw any
                         definitive conclusions about the impact of beef-packer concentration on
Prices                   the prices packers paid for steers and heifers in the 1980s.


                         2USDA compiles statistics on the number of fed cattle placed on feed and marketed for 13 selected
                         states that represent close to 90 percent of all fed cattle marketed in the country.



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                          5241861




                          Generally, the industry representatives with whom we spoke believe
                          that, to date, concentration in the 1980s has not been associated with
                          decreases in cattle prices. However, we believe the potential exists for
                          large packers to exert market power over the prices they pay for steers
                          and heifers. Also, representatives of the cow-calf and feeder sectors that
                          we talked to believe that the horizontal concentration, along with
                          increased vertical coordination, on the part of the large packing compa-
                          nies will enhance market power that could enable the packers to influ-
                          ence cattle prices.


Empirical Study Results   We analyzed ten empirical studies on market concentration in the beef-
                          packing industry. Seven of the studies expressly consider price as it
                          relates to an indicator of market concentration. The other three studies
                          assess market power as reflected by price. As is often the case with
                          empirical work, the studies we reviewed have certain limitations
                          relating to scope, underlying assumptions, and age of the data. Conse-
                          quently, we do not draw any overall conclusions from this body of work
                          regarding whether packer concentration has lowered steer and heifer
                          prices.

                          For our analysis we identified 10 studies most of which pertain to the
                          period of the 1970s. Two of the studies fell out of our results analysis
                          because in one case the results are primarily intended to illustrate a par-
                          ticular methodology, and in the other case the study aggregates all meat
                          packing. Of the remaining eight studies, five suggest that beef-packer
                          concentration has resulted in decreases in the prices packers pay for
                          cattle, and three do not find such a relationship between packers and
                          cattle prices.

                          For several reasons, we chose not to draw conclusions from the above
                          body of work. There are relatively few studies on the subject, and many
                          of the studies may not be applicable because they relate to the 197Os,
                          when industry conditions were much different from those in the 1980s.
                          Further, we have concerns about the methodological limitations of some
                          of these studies. For example, the geographic market is defined at a
                          state level in one case and at a national level in several other cases. Most
                          analysts believe that cattle markets are regional-typically     larger than
                          individual states. Additionally, some of the studies focus on measures of
                          beef-packer concentration, but do not directly address the extent to
                          which beef packers may or may not have influenced cattle prices. For a
                          more detailed perspective on these studies, see appendix I.



                          Page 0                                             GAO/RCEDBl-29   Cattle   Priccx3
                                            5241851




Views of Industry                           Leading analysts of the beef-packing industry, including the Director of
Analysts                                    the Research Institute on Livestock Pricing,3 have stated that concentra-
                                            tion has been accompanied by improved efficiency in slaughter and
                                            meat processing, which has enabled beef packers to pay more for a lim-
                                            ited supply of cattle than, as less efficient packers, they could have paid
                                            prior to achieving this efficiency. Since throughout the 1980s cattle sup-
                                            plies have not been sufficient to keep packers operating at full capacity,
                                            beef packers have competed vigorously for available cattle to keep their
                                            plants operating as close to capacity as possible. When plants operate
                                            below full capacity, it causes their per-unit costs to increase
                                            significantly.

                                            For example, a 1985 statistical cost study demonstrates that larger
                                            plants have lower per-unit costs and that meat packers operating at or
                                            near full capacity have substantially lower costs than those operating at
                                            lower levels of production. As table 2 shows, slaughter costs ranged
                                            from as little as $22.20 per head for a plant slaughtering 325 head per
                                            hour to more than $40.00 per head for the smallest plants.

Table 2: Estimated Average Colt for
Steer and Heifer Slaughter by Plant Size,                                                       Plant size by cattle head*
1955                                                                                    Head per year
                                            -Head per hour                                                       Average cost per head
                                            25                                                    52,000                                     $40.71
                                            85                                                   176,800                                      32.58
                                            145
                                            -~                                                   301,600                                      29.17
                                            205                                                  426.400                                      25.54
                                            265                                                  551,200                                      23.96
                                            325                                                  676,000                                      22.20
                                            aAssumes one E-hour shift per day, 5 days per week, at 100 percent of the hourly capacity-or  260 days
                                            per year.
                                            Source: Claudia J. Sersland, “Cost Analysis of the Steer and Heifer Processing Industry and Implica-
                                            tions on Long-Run Industry Structure,” unpublished Ph.D. dissertation, Oklahoma State University,
                                            1985.


                                            Additionally, the cost of fabricating boxed beef was about $10.00 per
                                            head lower for the larger slaughtering plants than for the smaller plants.

                                            This same study shows, for example, that when a plant moves from
                                            operating at 100 percent of plant capacity to 80 percent of capacity, it
                                            experiences significantly higher per-unit costs for slaughtering and

                                            3The Research Institute on Livestock Pricing was initiated in 1987 to contribute to the body of knowl-
                                            edge on livestock pricing issues. Sponsored initially by the Chicago Mercantile Exchange and the
                                            Department of Agricultural Economics, Virginia Tech, the Institute is conducting research at Virginia
                                            Tech and financing applied research at other Universities.



                                            Page 7                                                               GAO/RCEBBl-28      Cattle   Prices
                   R-241861




                   fabricating boxed beef. Combined slaughtering and fabricating costs
                   would go up $7.93 per head-a 12.2 percent increase from the combined
                   $66.00 cost at full capacity.


                   We discussed the concentration issue with four Montana feedlot opera-
Potential Market   tors as well as representatives from a cattle producer organization.
Power for Beef-    While these individuals have strong concerns about the possible effects
Packing Industry   of concentration on cattle prices, they said that since the mergers of the
                   middle to late 198Os, concentration in the beef-packing industry has not
                   resulted in lower cattle prices. However, they are concerned about the
                   combination of horizontal concentration-mergers       and acquisitions
                   amongst beef packers- and the vertical coordination that has and is
                   taking place. Specifically, they believe that since the large beef packers
                   have captive cattle supplies4 of their own, they will be able to influence
                   cattle price levels.

                   We also discussed the effects of beef-packer concentration with officials
                   from two of the three largest beef-packing firms. They both stated that
                   cattle prices are higher than they would be in the absence of the lower
                   cost structures. Their arguments associating concentration with higher
                   cattle prices mirror those of the industry analysts, who noted that con-
                   centration has enhanced access to greater efficiency, which in turn has
                   enabled beef packers to pay more for a limited supply of cattle. Theory
                   suggests that if beef packers are concentrated, they will have long-term
                   market power that would lead them to pay lower prices to the cattle
                   producers. However, current excess capacity along with lower beef-
                   packer costs may have supported short-term cattle prices at levels
                   higher than could be anticipated because of the concentration alone.
                   Therefore, the current price may be between the high price that would
                   result from the increased efficiency alone and the low price that would
                   result from concentration alone.

                   Future changes in industry and market conditions could increase the
                   likelihood that the beef-packing industry will lower the prices it pays
                   for cattle. For example, if cattle supplies expand by several million
                   head, as they have in the past, without a corresponding increase in con-
                   sumer demand and processing capacity, the few controlling beef packers
                   will have less of an incentive to compete aggressively for available

                   4The term captive supply refers to livestock owned or controlled by a buyer in advance of slaughter.
                   Typically, the three noncash-price forms of vertical coordination, i.e., forward contracting, packer
                   feeding, and exclusive purchasing/marketing agreements, constitute captive supplies.



                   Page 6                                                              GAO/RCRDQl-28      Cattle   Prices
              R-241951




              cattle. Prices may then decrease more than if a greater number of firms
              had purchased the cattle.


              According to economic theory, other things being equal, the high level of
Conclusions   concentration in the beef-packing industry could result in lower cattle
              prices than would occur with less concentration. Nonetheless, our
              review of empirical studies did not lead us to draw any overall conclu-
              sions regarding the impact that market concentration in the beef-
              packing industry has on the prices packers paid for steers and heifers in
              the 1980s. Industry analysts and experts we spoke with said that recent
              packer concentration has not lowered steer and heifer prices in the
              1980s. Some industry analysts believe that cattle prices may be higher
              because the increased efficiencies that accompanied increased concen-
              tration enabled beef packers to pay more for cattle when supplies were
              short relative to beef-packer capacity. Nevertheless, future changes in
              market and industry conditions could result in beef packers enhancing
              their market power.


              We performed our work between February 1990 and September 1990.
              We summarized existing and ongoing empirical studies related to the
              concentration issue. We also summarized the opinions of industry ana-
              lysts, including our consultant who is an expert on the beef-packing
              issue-Dr. Wayne D. Purcell, Professor and Director, Research Institute
              on Livestock Pricing, Agricultural Economics, Virginia Polytechnic Insti-
              tute and State University. At your request, we discussed the concentra-
              tion issue in Montana with four feedlot operators, a cow-calf operator,
              and representatives of the Northern Plains Resource Council. This
              Council is part of a larger organization of resource councils, whose
              activities include calling for enforcement of antitrust laws in the meat
              industry. Additionally, we talked about the issue with representatives
              of two of the largest three beef-packing firms. We have not conducted an
              independent economic analysis of the effects of beef-packing concentra-
              tion on cattle prices.

              As arranged with your office, unless you publicly announce its contents
              earlier, we plan no further distribution of this report until 7 days after
              the date of this letter. At that time we will send copies to the Director,
              Office of Management and Budget; the Secretary of Agriculture; the
              Administrator, Economic Research Service; the Administrator, Packers
              and Stockyards Administration; and other interested parties. If we can



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B241851




be of further assistance, please contact me at (202) 2754138. Major con-
tributors to this report are listed in appendix II.




John W. Harman
Director, Food and
  Agriculture Issues




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Page 11   GAO/RCRD-91-28   Cattle   Prices
Contents


Letter                                                                                              1

Appendix I                                                                                         14
Review of Empirical     Background
                        Summary
                                                                                                   14
                                                                                                   16
Studies                 Structural Studies of Concentration and Cattle Prices                      16
                        New Empirical Industrial Organization Studies                              21
                        Game Theoretic Study                                                       26

Appendix II                                                                                        26
Major Contributors to
This Report
Tables                  Table 1: Four-Firm Concentration Percentage for Steer                       4
                            and Heifer Slaughter and Boxed-Beef Production,
                             1980-89
                        Table 2: Estimated Average Cost for Steer and Heifer                        7
                            Slaughter by Plant Size, 1986




                        Abbreviations

                        GAO       General Accounting Office
                        IO        industrial organization
                        NE10      new empirical industrial organization
                        OIS       ordinary least squares
                        UmA       U.S. Department of Agriculture


                        Page 12                                           GAO/RCED-91-28 Cattle Prlcea
Page 13   GAO/RCEDBl-28   Cattle   Prices
 Ppe

Yi3iGkvv
       of Empirical Studies


               In our review of the ways in which beef packers purchase cattle, we
               surveyed three types of empirical studies: structural, new empirical
               industrial organization (NEIO), and game theoretic empirical studies. We
               selected the studies for review on the basis of their relevance to this
               report, relevance which we determined by surveying the literature and
               seeking expert opinion of academic and industry analysts. We recognize
               that empirical studies alone can suggest only causal relationships.

               We reviewed six “structural” studies, so called because they attempt to
               measure the degree of statistical association between a “structural”
               variable, in this case, an indicator of market concentration of fed-cattle
               purchasers, and a “performance” variable, such as price. Hence, the
               structural type of study could directly address the focus of our request,
               which was to examine whether increased beef-packer concentration has
               resulted in lower fed-cattle prices. A weakness of the structural
               approach is that it is not explicitly connected to market behavior at the
               firm level.

               We also reviewed three NEIO studies because they are explicitly con-
               nected to market behavior at the firm level. Measures of the firm’s
               behavior in these studies include the level of competitiveness and the
               degree of market power exercised by beef packers in the fed-cattle
               market. A limitation of this approach is that the analyst must first
               specify an optimization problem in terms of one particular objective
               function to the exclusion of other objective functions.

               Finally, we examined a game theoretic study. This study also focuses on
               the market behavior of firms. In this approach, the co-operative pricing
               behavior of individual meat packers is the behavioral indicator of
               interest. This study evaluates the effects of market power as reflected in
               the short-run dynamics of the pricing process in fed-cattle procurement.


               All three types of studies have emerged from a derivation of applied
Background     microeconomic theory called industrial organization (IO). An important
               tenet of the IO approach is that when a few firms represent a sizable
               proportion of the market, they can influence the price they charge for
               their output and/or influence the prices of inputs they use in producing
               the output. Concentration can be found both in selling and in purchasing
               markets.

               In the IO tradition, market concentration permits individual firms to
               exercise market power, which is defined as the power to influence price.


               Page 14                                           GAO/RCED-91-28   Cattle   Prices
          Appendix I
          Review of EmpirIcal   Studies




          In IO work, the exercise of market power has been detected empirically
          by examining the statistical relationship between market concentration
          and price and between concentration and profits. At the same time, the
          positive impact of market concentration on profits can reflect greater
          efficiency of large scale operation, not market power. This point is
          addressed in other work that has focused on a possible efficiency con-
          nection in the relationship between concentration and profits.1

          Many industrial organization studies of market power are rooted in the
          microeconomic theory of the firm. Traditional microeconomic theory
          holds that, in a perfectly competitive market, prices are determined
          outside the firm, to such an extent that the firm is termed a “price
          taker” in the market for the output it sells and for the inputs it
          purchases. To conform with the competitive market model, no beef-
          packing firm would be able to influence the price it charges for meat or
          the price it pays for any of the inputs it employs in cattle slaughter and
          beef processing, including the fed-cattle input.

          In microeconomic theory, if a market consists of a few firms that can
          influence prices paid for inputs, the market is called an oligopsony (in
          contrast to an oligopoly in which a few firms can influence prices
          charged for output). In this report, we are interested in whether empir-
          ical evidence indicates that the beef-packing industry exhibited oligop-
          sonistic characteristics in its purchase of fed cattle for its slaughtering
          and processing operations during the 1980s.


          Of the ten studies we reviewed, five suggested that beef-packer concen-
Summary   tration has resulted in decreases in the prices packers pay for cattle-
          three structural, one NEIO, and one game theoretic-and    three structural
          studies did not find such a relationship between packers and cattle
          prices. In reviewing two NEIO studies, we focused on their methodolog-
          ical approach as opposed to results because in one case the results were
          intended to provide an illustration of methodology, and in the second
          case the study results were broader than the beef-packing industry.

          Three of the six structural studies found that indicators of beef-packer
          concentration were related to lower fed-cattle prices. Of the three, one
          study only was based on post-1979 data and an update to this study

          ‘II. Demsetz, “Two Systems of Belief about Monopoly,” Industrial Concentration: The New Learning,
          ed. Harvey J. Goldschmid et al. (Boston: 1974), pp. 184-233; H. Demsetz, “Industry Structure, Market
          Rivalry, and Public Policy,” Journal of Law and Economics Volume 16, No. 1, (1973), pp. 1-9.



          Page 16                                                             GAO/RCED-91-28 Cattle Prices
                        Appendix I
                        Review of Empirical   Studies




                        found that concentration was not statistically related to lower cattle
                        prices in the 1981-1986 period. One NE10 study indicated that beef
                        packers exercised some market power on a national level in their
                        purchases of fed cattle from 1951 through 1983, but preliminary results
                        from a recent NEIO study indicate that the effect on regional markets
                        observed in 1980 was negligible. The game theoretic study suggests evi-
                        dence of increasing cooperative pricing power among beef packers for
                        1980 through 1982 and from 1984 through 1986, but declining exercise
                        of the pricing power.


                        To determine whether prices paid for fed cattle have been lower due to
Structural Studies of   market concentration of beef packers, we surveyed the industrial organ-
Concentration and       ization literature for “structural” studies that address the effect of con-
Cattle Prices           centration in the beef-packing industry on cattle prices.

                        We found no convincing evidence in this literature that, in the 198Os,
                        beef packers paid lower prices for fed cattle in more concentrated cattle-
                        buying markets than in less concentrated cattle markets. We examined
                        six structural studies. All of them tested for lower prices by measuring
                        the degree of statistical association between an indicator of market con-
                        centration of meat-packing firms and fed-cattle prices. In all cases, the
                        authors hypothesized a negative relationship between the degree of
                        market concentration and prices. Four of the six studies are based on
                        data prior to 1980; statistical estimates in the fifth study are derived
                        from relationships over the 1971-1980 period. The sixth study relates to
                        the 1973-1989 period.

                        Three of the studies found a statistically significant negative relation-
                        ship between the degree of market concentration and cattle prices. Of
                        the remaining three studies, two did not find a statistically significant
                        relationship between the two variables of interest, and one found a sta-
                        tistically significant positive relationship.

                        Only one of the structural studies that found a statistically significant
                        negative relationship between an indicator of beef- packer concentration
                        is not based entirely on pre-1980 data. This study found that lower fed-
                        steer prices were associated with higher levels of beef-packer concentra-
                        tion during the 1971-80 period for all 13 regions studied, which covered
                        25 states. However, the principal author of this study told us that an
                        update to this study did not find a statistically significant negative rela-
                        tionship between cattle prices in the 1981-1986 time period.



                        Page 16                                             GAO/RCED-91-28   Cattle   Prices
APW-      I
Review of Empldcal studies




Menkhaus, Dale J. et al. “The Effects of Industry Structure on Price: A
Case in the Beef Industry”. Western Journal of Agricultural Economics,
Vol. 6, No. 2 (1981), pp. 147-163.

In this study, cattle prices in 1972 and 1977 were found to be negatively
and statistically significantly related to meat-packer concentration. Con-
centration was the only variable of five that was significant for both
years studied. Average annual fed-cattle prices in each state studied
were expressed also as a function of meat-packing wages, the cattle sur-
plus/deficit position of the state, beef prices, and average feedlot size.
Twelve states were included in the 1972 analysis and 16 states for 1977;
each state constituted an observation2 The structural variables of
interest were meat-packer concentration and feedlot size. Each market
consisted of one state. Ordinary least squares (0~s) regression analysis
was used to estimate a separate equation for each year.

This paper explicitly incorporates the countervailing power of feedlots
by including a “feedlot size” variable. The sign of this variable was posi-
tive and the variable was statistically significant for 1977. The strong
positive relationship between feedlot size and fed-cattle price in 1977 is
important to note. The statistical significance suggests that empirical
models of beef-packer concentration and cattle prices might be more
appropriately specified if they account explicitly for factors which may,
according to economic theory, offset the olisopsonistic tendencies of beef
packers to force down cattle prices. The authors suggest that the posi-
tive sign may indicate a countervailing power structure between beef
packers and feedlots when operating as a bilateral oligopoly.

Although this study concludes that fed-cattle prices were lower when
meat-packing markets were more concentrated, the study’s results may
have been affected by errors in measuring market boundaries. It is gen-
erally agreed that individual states were too small to accurately reflect
the boundaries of fed-cattle markets and that relevant markets crossed
state lines. Measurement error in a regression model can invalidate the
results. In addition, the 1972 and 1977 results are not comparable since
different states were used in the 1977 analysis than in that of 1972.

Multop, John R. and John W. Helmuth. “Relationship Between Structure
and Performance in the Steer and Heifer Slaughter Industry.” Staff


2The author states that the study results should be interpreted conditionally, in part due to the few
degrees of freedom.



Page 17                                                               GAO/RCED-91-28     Cattle Pricee
Appendix I
Review of Empirical   Studies




Report. Committee on Small Business, U.S. House of Representatives,
Washington, DC.: September 1980.

In a series of price equations, average quarterly steer prices for 1969
through 1978 were positively associated with higher concentration
levels. As noted above, economic theory suggests that in more highly
concentrated markets, beef packers could force steer prices down; such
a relationship would imply that steer prices would be negatively associ-
ated with concentration levels. The interpretation of this study’s finding
that the level of national meat-packer concentration was positively
related to fed-cattle prices is not clear from the literature. The finding
was attributed by the authors to increased feedlot concentration in the
High Plains as well as to other factors. Subsequent researchers, ques-
tioning this interpretation of the results, have stated that the positive
relationship between national packer concentration and steer prices was
coincidental, not causal. The model has been termed “misspecified” for
its failure to include a variable to measure shifts in aggregate supply
and to analyze the relationships between steer prices and packer concen-
tration using national, rather than regional, data.

Ward, Clement E. “Short Period Pricing Models for Fed Cattle and
Impacts of Wholesale Carcass Beef and Live Cattle Futures Market
Prices.” Southern Journal of Agricultural Economics, Vol. 13, No. 1
(1981), pp. 126-132.

This study found that during one month of 1979, in one of the four
equations which included it, the number of bids received per sale lot and
heifer prices were directly related. In three of the twelve equations
which included steer prices, the prices were found to increase as the
number of buyers rose. The author characterized the results as indi-
cating considerable variation in the ability of selected variables across
regions to explain the price discovery process for fed cattle.

This study did not explicitly incorporate a variable to measure concen-
tration. We included the study in our review because it relates to the
theoretical notion that market prices rise as the number of buyers
increases. The study incorporates the number of bids received per sale
lot and the number of different meat packers bidding on each lot to
represent bidder and buyer effect. The author hypothesized that both of
these variables would be positively related to cattle prices. Since high
collinearity between the two variables was anticipated, only one of these
variables was used in a single equation.



Page 18                                          GAO/RCEIMl-28   Cattle   Prlcea
Appendh I
Rewiew of Empirical    Studies




Ward, Clement E. “Relationship Between Fed Cattle, Market Shares, and
Prices Paid by Beef Packers in Localized Markets.” Western Journal of
Agricultural Economics, Vol. 7, No. 1 (1982), pp. 79-86.

This study found that during one month of 1979, larger buyers generally
paid neither lower nor higher prices than the smallest buyer in the local-
ized markets studied. The statistical correlation between buyer market
shares and average prices paid was also nonsignificant.

Cattle prices for steers and heifers were regressed on binary variables
representing different cattle buyers in order to test whether the average
price paid by any of the largest buyers in the market was significantly
different from the price paid by the smallest buyers.

The study has been criticized for the absence of a theoretical founda-
tion, since industrial organization theory does not suggest a relationship
between firm market share and firm prices within a market. On the con-
trary, industrial,organization theory does suggest that under price lead-
ership, market prices may not differ across firms, although all prices
may be below a competitive level.

The author states that the results were contrary to the inverse relation-
ship hypothesized between market share and average price paid in the
industrial organization tradition. He also says that the results suggest
that price differences among beef packers may occur but are dependent
on variables other than market share, such as access to and ability to
use information on demand and supply, plant location and transporta-
tion costs, and slaughtering and processing costs.

Quail, Gwen et al. “The Impact of Packer Buyer Concentration on Live
Cattle Prices.” Working Paper 89. North Central Project 117. University
of Wisconsin-Madison: May 1986.

This study found that lower fed-steer prices were associated with higher
levels of beef-packer concentration during the 1971-80 period for 13
regions covering 25 states.3 For each specification, packer concentration




3A 1990 extension of this study, however, indicates that the negative statistically significant relation-
ship between beef-packer concentration and fed-cattle prices disappeared in the 1981-1986 period.



Page 19                                                                GAO/RCED-91-28      Cattle   Prices
Appendix I
R0vkw of Empirical    studies




was represented by either concentration ratios4 or Herfindahl Indexes6
of regional packer concentration. The model was estimated with pooled
cross-sectional/time-series data and employed 01s or generalized least
squares regression analysis. Concentration ratios were statistically sig-
nificant and negatively related to steer prices in both equations that
incorporated the ratios. Herfindahl Indexes were statistically significant
and negatively related to steer prices in all 13 of the equations that
incorporated the Indexes. However, no correlation coefficients (indi-
cating goodness of fit) were reported for any of the equations.

The concentration-price results of this study should probably not be
directly applied to fed-cattle markets in the 1980s since there is some
evidence that excess slaughter and processing capacity precluded fed-
cattle buyers from forcing prices down during that period.

As in the case of the Multop-Helmuth study, the structural variables of
interest included beef-packer concentration and feedlot size. Feedlot size
was positively and significantly related to steer price in ten of the
eleven equations in which it appeared. The study incorporated addi-
tional structural variables, but none were consistently statistically sig-
nificant in explaining steer price variation. The additional structural
variables represented the size of the largest beef packer, the slaughter
surplus/deficit position, and the relative share instability of the top four
beef-packing firms, all for each year and region.

Two additional independent variables were significant in explaining
steer prices in seven or more of the 15 specifications-market     type and
distance. The variable included to isolate the effect of lower steer prices
at terminal markets (relative to prices determined at direct sales to beef
packers) was negatively related to steer price in eight of the ten equa-
tions that incorporated it. In seven of the fifteen equations that included
a variable to isolate the negative effects on price of the distance from
the midpoint of each region to the east and west coasts, the variable was
statistically significant and negative. The variable representing labor
costs of beef packers, although included in eight specifications, was sta-
tistically significant in one specification only and then displayed a posi-
tive sign.


4Concentration ratios are calculations that represent the market share of the few largest firms-
usually four or eight-in an industry.
6Herfindahl Indexes measure market power by summing the squares of the market shares of the
firms in the industry.



Page 20                                                              GAO/RCED-91-28      cattle    Pricea
                       Appendix I
                       Review of J5mpirka.l Btudiea




                       Hayenga, Marvin and Dan O’Brien. “Competition for Fed Cattle in Colo-
                       rado vs. Other Markets: The Impact of the Decline in Packers and the
                       Ascent of Contracting.” Paper presented at the NCR Conference on
                       Applied Commodity Price Analysis, Forecasting, and Market Risk Man-
                       agement. Chicago, IL: Apr. 23-24, 1990.

                       Preliminary results from this study of competition for fed cattle in Colo-
                       rado suggest that prices have not declined relative to prices in other
                       cattle-feeding states. The study incorporates data for the 1973-89
                       period, when the number of large fed-cattle slaughter firms declined by
                       a greater proportion in Colorado (from eight to two) than in neighboring
                       states.

                       In their April 1990 report, the authors state that if further analysis con-
                       firms initial findings, the relevant geographic market for structural and
                       competitive analysis is much larger than any state. The relevant
                       market’s size, which may be much larger than that of the trade areas of
                       individual firms, may also be due to the indirect competitive effects of
                       “third party” firms, in the dynamic arbitrage process.


                       We also reviewed three empirical studies of the NE10 type, which
New Empirical          focused on the exercise of market power by beef packers but did not
Industrial             incorporate explicitly cattle prices. The studies we evaluated incorpo-
Organization Studies   rated two competitive indicators, conjectural elasticities” and market
                       power indexes.?

                       In the NE10 framework, the exercise of market power by meat packers in
                       the fed-cattle market can be detected by comparing statistical estimates
                       of conjectural elasticities and of market power indexes with values sug-
                       gested by microeconomic theory of the firm. Empirical estimates of con-
                       jectural elasticities and market power indexes are evaluated relative to
                       a zero value, which theory suggests is consistent with a perfectly com-
                       petitive market.

                       ‘A conjectural elasticity is the percentage change in all other firms’ output sales (or input purchases)
                       that one firm expects’in response to a l-percent change in its own output (input use). If the value of
                       the conjectural elasticity is zero, the firm is operating in a perfectly competitive market. If the value
                       is +l, the market consists of a monopoly (monopsony).

                       The formula for the conjectural elasticity is the following:0 = (dQ/dq) (q/Q), where dQ/dq is the
                       firm’s conjecture about other firms’ output (or input) response, and q/Q is the firm, q’s, market share
                       of the entire market, Q.

                       ‘For the studies we reviewed, the degree of oligopsony power was calculated by dividing the comec-
                       tural elasticity by the elasticity of fed-cattle supply.



                       Page 21                                                                GAO/RCED-91-28      Cattle   Prices
Appendix I
Review of Empirical   Studiee




Since conjectural elasticities are hypothesized to be zero, a rejection of
this hypothesis points to the conclusion that firms take into account
other firms’ input purchases. The elasticities are hypothesized to take
on a zero value for empirical testing because in a perfectly competitive
market a firm does not expect other firms to change their input
purchases as a result of the competitive firm’s decision to buy more or
less of an input.

Market power indexes are also hypothesized to be zero because, unless
firms have market power, the input prices they pay will be identical to
the marginal value of the output produced with the input.

The studies of national market behavior find some empirical evidence
that meat packers have exercised market power in purchasing fed cattle
during the 195 1-1983 period but no evidence that performance has been
less competitive in the later years of the analysis. The study of regional
behavior projects that buyer power has small effects. It is generally
accepted that markets for fed cattle are regional, not national, since
cattle are not often transported more than 250 miles to slaughter plants,
and fed cattle are raised in distant U.S. regions.

Schroeter, John R. “Estimating the Degree of Market Power in the Beef-
packing Industry.” The Review of Economics and Statistics, Vol. 70, No.
1 (1988), pp. 158-162.

Schroeter detected small, but statistically significant, buyer power price
distortions in his study which extends prior work to include buyer
market power. Prior to the 19809, the market power of sellers only had
been emphasized in the research literature.

In the Schroeter study, 1951 through 1983 annual national data from
the beef-packing industry were used to estimate a system of equations
by the full information maximum likelihood technique. Conjectural elas-
ticities were modeled as a general function of all the exogenous vari-
ables in the system and market power indexes were calculated by
dividing the conjectural elasticities by the estimated fed-cattle supply
elasticity of +1.69. The fed-cattle input is employed in fixed proportions
relative to the meat output. The labor input is employed in variable pro-
portions. The conjectural elasticities estimated for each year are con-
strained to be identical in the fed-cattle and the beef market.

The results indicate that meat packers had some discretion over prices
paid for fed cattle. According to the underlying microeconomic theory of


Page 22                                            GAO/RCED-91-28   Cattle   Rices
Appendix I
Review of Empirical   Studies




imperfect competition, values greater than zero indicate that the
hypothesis of price-taking behavior should be rejected. In the Schroeter
study, estimated values of the conjectural elasticities were positive and
statistically significantly different from zero at the 95-percent confi-
dence level in 28 of the 33 years. The author concluded that beef
packers had some discretion over prices paid for fed cattle during the
period studied.

The detected levels of beef-packer/buyer price distortion in this study
were significant but smal1.QThe estimated price distortion, which was
small for the entire period, declined to about 1 percent in the later years
of the sample. The author notes that the increase in beef-packer market
concentration since 1977 did not increase the size of the price distortion,
which has been relatively stable since 1970.

Azzam, Azzedine and Emilio Pagoulatos. “Testing Oligopolistic and
Oligopsonistic Behavior: An Application to the US Meat-Packing
Industry.” Forthcoming, Journal of Agricultural Economics.

Azzam and Pagoulatos found that the U.S. meat-packing industry exer-
cised market power in both the output (meat) and input (live animals)
markets during the 1959 through 1982 time period. They defined the
meat-packing industry as consisting of beef, pork, sheep, and lamb
slaughter and processing on a national level. (The authors note that data
on output and input use by kind of meat would be preferable to aggre-
gate data, but disaggregated data of the desired type is not available.)
The level of data aggregation limits the study’s usefulness for this
report. However, the study is important for its similarity to the Apple-
baumQand Schroeter studies.

Like Appelbaum and Schroeter, Azzam and Pagoulatos jointly determine
the conjectural elasticities along with other parameters in the model. In
contrast to Appelbaum and Schroeter, they dropped the assumption of
fixed proportions in fed-cattle slaughter and processing, which per-
mitted them to test for identical behavior in the fed-cattle and beef
markets.



RPrice distortion refers to the gap between observed price paid and the price that would be paid if
beef packers were perfect competitors in their purchase of fed cattle.
‘Elie Applebaum, “The Estimation of the Degree of Monopoly Power,” Journal of Econometrics, Vol.
 19 (1982), pp. 287-299.



Page 23                                                              GAO/RCED-91-28      Cattle   Pricea
Appendix I
Review of Empirical   Studies




The authors characterize the meat-packing industry as displaying the
same level of noncompetitive behavior in both the input and output
markets. The extent of noncompetitive behavior in purchasing live ani-
mals was represented by the value of the estimated conjectural elas-
ticity in the input market.

The authors found that the degree of market power in purchasing live
animals for slaughter was significantly higher than in selling the meat
from these animals. A contributing factor to this result is that the elas-
ticity of live animal supply used in the study was one-third the size of
the absolute value of the elasticity of meat demand (.16 vs. .49). (As in
the Appelbaum and Schroeter studies, the conjectural elasticity was
divided by the elasticity of live animal supply to derive the market
power indicator.)

 This study extends the Schroeter work and tests price-taking behavior
 in the meat and live animal markets without restricting the conjectural
elasticities in the respective markets to be identical. The analysis is
 based on the formulation and estimation of a simultaneous-equation
 model consisting of a production function and four first-order optimality
conditions associated with factor employment. The elasticities of live-
 stock supply and meat demand are exogenous. As noted earlier, the con-
jectural elasticities are estimated jointly with other parameters of the
 model.

The authors selected a production function that enabled them to avoid
imposing any constraints on the production characteristics of the
industry. (The transcendental logarithmic translog form used allowed
them to do this.) In addition to the livestock input, labor, capital, and
nonlivestock material comprise the competitively priced inputs utilized
by the meat-packing industry for purposes of this estimation. The
instrumental variables technique was used to estimate the value of each
regressor as a function of a set of variables considered exogenous to the
meat-packing industry. The iterative nonlinear three-stage least squares
technique was used to estimate the model, which was based on annual
aggregate time series data from 1959 through 1982.

Azzam, Azzedine and John Schroeter. “Implications of Increased
Regional Concentration and Oligopsonistic Coordination in the Beef
Packing Industry.” Draft paper. Apr. 1990.

Preliminary results from this study suggest small price and quantity
effects from an increase in regional meat-packer concentration. The


Page 24                                            GAO/lZCED91-28   Cattle   Pricea
                       Appendix I
                       Review of Empirical   Studies




                       authors emphasize that the results are intended primarily to provide an
                       illustration of the method outlined in the paper. This method can be
                       used to project the price effects of changes in regional concentration
                       anticipated in response to specific merger proposals, but the results
                       would be highly dependent on the values assumed for the underlying
                       conjectural elasticities and olipgopsony price distortions.


                       Koontz, Stephen R. et al. “Oligopsony Power, Meatpacker Conduct, and
Game Theoretic Study   Price Dynamics: A Preliminary Investigation of Live Cattle Markets.”
                       Applied Commodity Price Analysis, Forecasting and Market Risk Man-
                       agement. Proceedings NCR-134 Conference, Chicago: April 20-21, 1989,
                       pp. 318-330.

                       This study focuses on the cooperative pricing behavior of individual
                       meat packers. The focus of this approach is to examine the effects of
                       market power on the short-run dynamics of the pricing process of beef
                       packers in their fed-cattle procurement. Like the NE10 work, this type of
                       study focuses on the behavior of firms, but instead of dealing with
                       aggregate industry behavior and average market prices, it is concerned
                       with the degree of price coordination among firms in a particular
                       market. Prices paid for cattle by each meat packer were indicators of
                       whether the firms’ pricing behavior was cooperative or noncooperative
                       during various time periods.

                       This type of study has the advantage of being based on the
                       microeconomic theory of the oligopsonistic firm, and the results do not
                       appear to refute the theory. Although it does not directly consider
                       whether fed-cattle prices were lower due to market concentration of fed-
                       cattle buyers (the focus of our report), we included this study in our
                       review because it deals with oligopsonistic behavior of meat packers.

                       The results of this study indicate that meat packers priced cooperatively
                       during some time periods and priced noncooperatively during other
                       times. All four markets studied exhibited evidence of noncooperative
                       pricing at least 65 percent of the time. However, switching between the
                       cooperative and noncooperative regimes appeared to increase in later
                       periods. The principal author told us that in his expanded analysis, he
                       has found that the ability of beef packers to force down cattle prices has
                       increased over time, but that the packers have exercised this power less.
                       He said that he attributes the competitive environment in the recent
                       period to excess cattle slaughter and processing capacity in the industry.



                       Page 25                                           GAO/RCED-91-28   Cattle   Prices




                                                       ,
Appendix II

Major Contributors to This Report


                        -
                            Flora H. Milans, Associate Director
Resources,                  Jeffrey E. Heil, Assistant Director
Community, and              Patrick J. Kalk, Assignment Manager
                            Mary C. Kenney, Agricultural Economist
Economic
Development Division,       Ellen M. Rominger, Evaluator

Washington, DC.




(160012)                    Page 26                                  GAO/WED-91-28   Cattle   Prices
         .._--_--_   _____-___




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