Contract Hog Production As An Alternative Farm Enterprise

Livestock Update, April 2005

Allen Harper Extension Animal Scientist Ð Swine, VA Tech Tidewater AREC

The federal tobacco quota system "buy-out" and elimination of the federal peanut price support program are having profound impacts on agriculture in southeast and south central Virginia. Common points of discussion center on alternative farm enterprises as acreage in these important commodities continues to decline. A relevant point in these discussions is the finding by the Virginia Tech Rural Economic Analysis Program (REAP) that contract production of hogs offers modest but relatively steady profit potential as an alternative farm enterprise on Virginia farms (see 2003 research reports at www.reap.vt.edu).

True "spot" market or non-negotiated sales of hogs now account for less than 15% of all U.S. hog sales. Recent National Agricultural Statistics Services data indicates that nearly 40% of the U.S. swine inventory is owned by large producers, but are raised by contract growers under a production contract (NASS, 2004). Unlike marketing contracts, production contracts deal specifically with the production and management of the hogs. In these arrangements a contractor or integrator provides pigs or breeding stock, feed and other services to a producer or grower who manages the hogs at his or her farm facilities until the animals are ready for market or transfer to other farms.

It is not likely that contract hog production will become the primary alternative enterprise for most farms that have lost or reduced income from tobacco or peanuts. But, under the right conditions, contract hog production has the potential to be a viable enterprise for certain farms. Potential incentives include the need for swine production integrators to expand or increase geographic range of production coupled with moderate profit potential for contract growers. Potential constraints include financing initial capital investment in specialized swine facilities and restrictive county land use policy and state environmental regulations.

The Production Contract - Most production contracts include written terms for length of contract, terms for renewal, conditions for termination and specific language defining which party is responsible for certain inputs of production, equipment and facilities and required services in the production of pigs. The most common production contract is for raising finisher hogs from approximately 45 lbs. to market weight (about 250 lbs.). In hog finishing contracts, base payment terms are generally defined as a payment price per pound of weight gain with additional incentive payments based on added weight gain beyond a set end weight and improved feed efficiency (lbs. feed per lb of weight gain). Payment terms for contract nursery pig production (weaned pigs to about 45 lbs.) typically focus on a base payment for weight gain in nursery pigs with a feed efficiency incentive payment. Farrow-to-weaned pig contract payment terms are usually based on a set price for each acceptable quality pig produced plus incentives for each pig produced above some set level of pigs produced per sow in inventory. For example, incentive payments may be based on a bonus payment for each pig produced above 16 pigs produced per sow in inventory per year.

Agricultural economists and others who have studied contract production make it clear that a written hog production contract is not an unlimited guarantee (Zering, 1997). And, although production contracts are an effective way for swine growers to minimize hog pricing and feed cost risk, both parties bear some risk that the other party may not be capable of fully meeting the written terms of the contract. Ideally, contingency plans can be included in the written contract to minimize these types of problems. Including defined procedures in the contract to address unexpected problems generally helps reduce surprises or conflicts for both parties. Certainly production contracts are binding legal documents. But even well written contracts should be considered a basic framework for a working relationship in contract production of hogs (Zering, 1997). Ultimately the ability of each party to communicate and work together effectively will determine the long term success or failure of the contract production arrangement. Successful contract production occurs when the venture has consistent mutual benefit for both the grower and the integrator over an extended period of time.

The Swine Growers Perspective - Contract growers typically have large capital investments in specialized swine buildings and equipment. Meeting the fixed costs to operate such facilities has a major impact on the profitability and net returns to the grower's investment and management. The contract grower must also be responsible for environmental regulations associated with manure management and mortality disposal and the associated costs. Under this situation it is easy to understand that contract growers do incur economic risk and consequently are under pressure to achieve optimal throughput with their facilities. They are also justified in their desire to have reasonable opportunity to achieve incentive bonus payments for better feed conversion, lower death losses, or more pigs produced per sow in inventory.

Growers recognize that contracts allow them to avoid much of the feed and hog price risks associated with the hog business. But, they also recognize that they face other types of business risk. Such risks include increases in interest costs on debt, changes in fuel or utility rates and even legal risks associated with environmental regulations or nuisance complaints against the operation.

Like all agribusiness people, contract growers must be profit motivated. Because they bear financial risk and face economic pressure to optimize net returns, it is reasonable that they have certain expectations in the operation of their contract. These expectations may include, but are not limited to the following.

• That they are given the opportunity to have barns fully stocked to their design criteria.
• That "down time" between pig groups is consistently held to a minimum time.
• That health and general quality of the weanling pigs, feeder pigs or breeding stock placed on the farm is sufficient to allow a reasonable opportunity for performance bonuses when good pig husbandry and management is applied.
• That the quality and consistency of the feed delivered is sufficient to allow the animals to perform near their genetic potential when good pig husbandry and management is applied.
• That communication with the serviceman and other representatives of the integrator is frequent, open, sincere and helpful as they work to achieve optimal performance from their pigs or breeding herd.
• That the contract production arrangement can continue on an extended basis so that debt service or financial returns to management can be successful for the long term.

The Swine Integrators Perspective - Like the grower, the integrator faces financial risks and economic pressures. Risk exposure includes such things as potential increases in grain, soybean meal or other feed ingredient prices, changes in pig marketing prices or schedules, changes in labor and management costs, transportation costs, and other variable cost factors in the operation of company farms. In addition, the integrator faces financial risk associated with disease or other factors that decrease pig performance and efficiency, either on company farms or on contract grower farms.

The integrator is under economic pressure to meet the demands of a significant payroll for workers, fieldmen and management. Additionally, most integrators must meet the expenses associated with operating a fleet of trucks, a centralized feed mill and, in many cases, establishment and operation of company farms that may provide pigs or breeding stock to contract grower farms.

Therefore, the integrator must also be motivated by profit. Their objective in establishing a production contract is to achieve an expected level of pig production in a cost effective manner. The integrator's intent is to pay the grower for management and services in the production of the pigs and for the transfer of facility maintenance, mortality disposal and manure management responsibilities to the grower. However, their reasonable business expectation is that payment for these services will still leave opportunity for return on investment. Reasonable expectations of the integrator may include but are not limited to the following.

• That the grower will provide properly maintained facilities in sanitary condition for housing the pigs on a consistent basis.
• That ventilation, heating and cooling, penning, feeding and watering equipment be maintained and operated to promote efficient pig performance.
• In the case of contract sow farms, that skillful breeding herd management is carried out on a consistent basis for a high level of reproductive performance.
• That the grower will provide regular daily care and management of the contracted pigs and that health or other management problems will be promptly addressed in an effective manner.
• That access roads leading to the barns, feed bins, and hog loading facilities are well maintained and allow for delivery and pick-up of feed and pigs under all weather conditions.
• Growers will communicate openly with fieldmen and other integrator representatives concerning many potential or existing problems with the contract pigs so that viable solutions can be reached.

Summary - Contract production has become increasingly important in the U. S. swine industry. Credible surveys indicate that most hogs produced in the country are under some type of contractual arrangement and nearly 40% are produced under a production contract. Production contracts are a means of transferring business risk and defining production responsibilities within an integrated pork production system. In this system, a swine integrator provides pigs or breeding stock, feed and other services under a contract to growers who are responsible for housing and managing the pigs during one or more production phases and for collection, utilization and disposal of manure and other waste products. Payment terms for the grower are written into the contract and typically include base payment prices for each pig or pound of pig growth with incentive payment schedules for better feed efficiency and productivity. While many important terms and conditions are written into the contract, it should be recognized that a hog production contract is not a risk-free guarantee for either party.

Under the right conditions, contract hog production has potential to be a viable alternative enterprise for some Virginia farms that have lost or reduced income from tobacco or peanut production. Such conditions include adequate financing for capital investment in swine facilities and a location that allows the farm to meet local land use and state regulatory requirements. It is also important that farmers carefully assess the details of contract hog production to determine if this type of enterprise is right for them.

References
NASS. 2004. Quarterly Hogs and Pigs. USDA National Agricultural Statistics Service, Released Dec. 28, 2004, Washington, D.C.

Zering, K. 1997. Production contract problems and limitations. Presentation paper given At the Al Leman Swine Conference, Minneapolis, Minnesota (1997).

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