MARKETING                                         PIH-6


             Producing and Marketing Hogs Under Contract

John D. Lawrence, Iowa State University
Marvin Hayenga, Iowa State University
James Kliebenstein, Iowa State University
V. James Rhodes, University of Missouri

John C. McKissick, University of Georgia
Dale Lattz, University of Illinois
Kevin and Audrey Rohrer, Manheim, Pennsylvania
Clem E. Ward, Oklahoma State University

     There is increasing interest in hog contracting, due in part
to  the  difficulty for many producers to obtain adequate financ-
ing. Contracting also is being used to coordinate pork production
from   genetics   and  nutrition  to  the  retail  meat  counter.
Currently, a small but growing percentage of hogs  are  produced,
fed,  or  marketed under contract. It is estimated that about 14%
to 16% are under production contracts, and a  smaller  percentage
under marketing contracts.

     Forward pricing (marketing) contracts for market  hogs  have
been  available  from  most  major  meat  packers for a number of
years. They are the most commonly used marketing contracts in the

     Production contracts for market hog finishing are relatively
new  but  are  increasing in the Midwest. However, they have been
used for some time in portions of the  Southeast  where  contract
hog  production  is  more  widely accepted. Feeder pig production
contracts are not as popular in the Midwest.

     The following is an overview of the most common contracts in
the pork industry.

Marketing Contracts

     Market Hogs. The forward sale contract is a contract between
a  buyer  (normally  a  meat  packer  or a marketing agent) and a
seller (normally a producer), where the producer agrees to  sell,
at  a  future  date,  a specified number of hogs to a buyer for a
certain price. The buyer normally will  have  taken  an  opposite
position  in  the futures market to offset any price fluctuations
between the signing of the contract and  the  delivery  date.  To
cover  margin  and  commission, the contract price offered by the
packer may be lower than futures adjusted for expected basis.

     Terms typically found in a forward contract include:

o    The quantity to be delivered, with the minimum amount  vary-
     ing  anywhere  from  5,000 lb to 40,000 lb (40,000 lb equals
     one live hog futures contract).

o    The date and location of delivery.  The  delivery  date  may
     normally be changed by mutual agreement. The seller may have
     the option of selecting the delivery date within a specified
     time interval.

o    Acceptable weights  and  grades,  including  provisions  for
     premiums and discounts.

o    A description of the pricing mechanism,  either  fixed  base
     price or formula price. Some contracts now price the hogs on
     a grade and yield basis to reward better producers who would
     otherwise be less inclined to contract.

o    Provisions for non-deliverable hogs  and  unacceptable  car-
     casses.   The  buyer  normally  deducts  from  the  seller's
     receipts for unacceptable hogs and carcasses.

o    Provisions outlining the credit requirements of  the  seller
     and  inspection  of  the  hogs  by  the buyer. The buyer may
     request to inspect the hogs while on the seller's premises.

o    A provision dealing with breach of contract. Typically,  the
     seller  is  liable for all losses incurred by the buyer when
     the seller is in breach of contract.

     The producer retains all production risks,  other  than  the
selling price, under a fixed price forward sale contract.

     A producer uses a forward sale contract to reduce  the  risk
of price fluctuations and to lock in an acceptable selling price.
While the forward sale contract allows the producer to lock in  a
particular selling price, it may cause him to miss out on greater
profits if prices rise. Thus, the decision to  contract  must  be
based  upon  each  producer's  willingness or ability to bear the
risk of price uncertainty. Some producers may be forced  to  con-
tract  due  to a lack of diversification, indebtedness, or at the
request of creditors, while  other  more  financially  stable  or
diversified  producers  may  be in a better position to withstand
the risk of price movements.

     Price risk may be reduced by hedging in the futures  market.
A  marketing contract may be preferred to hedging for the follow-
ing reasons.

o    Marketing contracts can typically  be  written  for  smaller
     sizes than the 40,000 pound Chicago Mercantile Exchange con-

o    A fixed price marketing  contract  locks  in  the  delivered
     price.  A futures contract hedge locks in the futures price,
     but the local price differential (basis) may still vary.

o    A marketing contract does not require an initial  margin  or
     additional  margin  calls  be paid should the price increase
     after the contract is signed.

o    The marketing contract is typically made with a local  mark-
     eting  agent  or packer rather than dealing with the Chicago
     Mercantile Exchange. However, unlike a futures contract, the
     producer  is required to deliver the hogs to fulfill a mark-
     eting contract.

     A floor price contract is a variation of  the  forward  sale
contract,  however  it  is not as widely used as the forward sale
contract. The seller agrees to deliver a specified number of hogs
to a buyer at a future date and the buyer guarantees the seller a
minimum price (the floor price) for his hogs. Usually, the seller
receives  the  higher  of  the  floor  price  or  market price at
delivery minus a discount. The discount compensates the buyer for
the  costs  (options premiums and other variable costs associated
with the contract) of providing  the  guaranteed  minimum  price.
Both  the  forward  fixed price contract and floor price contract
reduce only the risk of hog price fluctuations. The producer must
still bear the other risks associated with hog production.

     Feeder Pigs. Typically, feeder pig marketing  contracts  are
between  a  marketing agency, often a cooperative, and a pig pro-
ducer, where the marketing agency agrees to market the  pigs  for
the producer in exchange for a fee.

     A marketing contract might contain the following provisions:

o    The producer agrees to market all pigs through the marketing

o    The marketing agency prescribes  specific  management  prac-
     tices  to  be  followed by the producer. These may relate to
     the weight at which the pigs are to be marketed,  health  of
     the animals, and immunization against diseases.

o    Many larger marketing agencies will pool  feeder  pigs  into
     homogeneous  groups to increase their marketability and will
     provide technical assistance to the producer.

     Producers are  essentially  hiring  marketing  expertise  to
enhance  their  market prices and minimize the time and effort of
locating buyers for their pigs.

Production Contracts

     To expand more rapidly their  own  production,  many  larger
producers  use contract production as a way to hold down risk and
capital required.

     Investors, feed  dealers,  farmers,  and  others  often  are
interested in producing hogs, but are unwilling or unable to pro-
vide the necessary labor, facilities, and  equipment.  Therefore,
they  search  out  producers who are willing to furnish the labor
and equipment in exchange for a fixed wage or a share of the pro-
fits.   The resulting contracts, between owner and producer, vary
considerably in form and responsibility of each  party  involved.
These  contracting arrangements are attractive to young or finan-
cially strapped producers and would-be producers who do not  have
the  capital  to invest in a herd, and for producers with underu-
tilized facilities.

Feeder Pig Finishing Contracts

     There are three  basic  types  of  hog  finishing  contracts
offered, each with variations on payments and resources provided.

     Option 1: A fixed payment contract guarantees the producer a
fixed  payment per head as well as bonuses and discounts based on
performance. Under a fixed payment contract for  finishing  hogs,
the producer normally provides the building and equipment, labor,
utilities, and the necessary insurance. The  contractor  supplies
the pigs, feed, veterinary services and medication, and transpor-
tation. The contractor usually provides a  prescribed  management
system  and  supervises its conduct. The contractor, as the owner
of the hogs, does the marketing. The producer often  receives  an
incoming payment based on the weight of the feeder pigs when they
come into the producer's facilities. For example, $5 for a 30  lb
pig  and $4 for a 40 lb pig. The remainder of the producer's pay-
ment is made when the hogs are sold. The  method  of  calculating
base  payment  varies  by  contract. Some contracts offer a fixed
dollar per head regardless of the weight gained. Other  contracts
pay  a fixed amount per pound of gain based on pay-weights in and
out of the facility. Others pay a fixed amount per head  per  day
spent in the facility.

     Most contracts contain bonuses for keeping  death  loss  low
and improved feed efficiency, as well as penalties for high death
losses and unmarketable animals. Producers  should  have  control
over  factors  that impact their bonuses and penalties. For exam-
ple, the right of refusal on  obviously  unhealthy  pigs,  or  to
negotiate a more lenient bonus schedule for multiple-source pigs.
Contract payment methods typically range from a low base  payment
with  high  incentive  bonuses to a high base with relatively low

     Option 2: Directed feeding by a cooperative or  feed  dealer
that   contracts   with   a  producer  to  finish-out  hogs.  The
contractor's objective when entering into a directed feeding con-
tract  is  to  increase  feed  sales  and  secure a reliable feed

     The contractor provides the feed and some management  assis-
tance  and typically directs the feeding program. The contracting
firm often will purchase the feeder pigs, in which  case  profits
from  the  sale  of the hogs are shared as discussed below; or it
will help the producer obtain financing to purchase the pigs. The
producer  agrees  to  purchase all feed and related services from
the contractor and is responsible for all  costs  of  production.
The producer receives all proceeds for the sale of the hogs minus
any outstanding balance owed to the contractor.

     Option 3: In a profit sharing  contract,  the  producer  and
contracting  firm divide the profit in proportion to the share of
the inputs provided by each party.

     Typically, the  producer  provides  the  facilities,  labor,
utilities,  and  insurance for his/her portion of the profit. The
contracting firm normally purchases the pigs and  is  responsible
for  all feed, the veterinary services, transportation, and mark-
eting  expenses.  Over  the  duration  of   the   contract,   the
contractor's  costs  are charged to an account. This account bal-
ance is then subtracted from the sale proceeds to  determine  the
profit. The contracting firm often will use its own feed and pro-
vide management assistance. The producer is normally guaranteed a
minimum amount per head as long as death loss is below a set per-
centage. For instance, depending on contract  terms,the  producer
may  receive  $5/head  if death loss is 3% or less and $3/head if
death loss is over 5%. The producer receives this payment regard-
less of whether a profit is made. The contractor's return depends
upon the profit made on  the  sale  of  the  hogs  and  the  gain
received from the markup on feed, pigs, and supplies provided.

     Through contracting, producers  are  able  to  achieve  more
stable  returns, trading the possibility of large profits for the
assurance of a more reliable return.  Many producers  enter  into
contracts  because  they  either  lack the capital or they do not
wish to tie up a large amount of capital in hog production.

Feeder Pig Production Contracts

     Feeder pig production contracts come in several forms.

     Option 1: The producer provides everything but the  breeding
stock  and  bids  what he is willing to produce a feeder pig for,
based on production criteria such  as  pigs  weaned  per  litter,
etc., with discounts and bonuses based on a target level. Most of
the production risk is retained by the producer.

     Option  2:  A  contractor  provides  breeding  stock,  feed,
management  assistance,  and supervision, and pays the feeder pig
producer a flat fee for each pig.  This fee varies  according  to
pig  weight and current production costs. In this example most of
the risk falls on the person providing breeding stock, feed,  and

     Option 3: The  contractor  provides  breeding  stock,  feed,
facilities,  and  veterinary  costs. The producer provides labor,
utilities, maintenance, and manure handling. A fee for  each  pig
produced  and  a  monthly fee for each sow and boar maintained is
paid to the manager. This option fits owners who no  longer  want
to  be  actively  involved in production, but have a good manager
with limited cash willing to take over the operation.

     Option 4: A shared revenue program with revenues divided  in
proportion  to  inputs  provided.  One example would be where the
producer supplying facilities, veterinary care, utilities, labor,
and  insurance  would  receive  a  negotiated percentage of gross
sales in return for his/her share of production  costs  for  each
pig  sold.  The  feed  dealer  would receive a certain percentage
based on his/her share of the total inputs. The remaining percen-
tage  would  go to the breeding stock supplier and the management
firm that supplies computerized records, and consultations. Nego-
tiated percentage shares should be based upon inputs provided and
risks borne by each participant.

Farrow-to-Finish Contracts

     While base-payment plus bonus contracts are offered in  some
regions,  many  farrow-to-finish  contracts  are  on a percentage
basis to reflect the relative inputs supplied by each  person  or

     Option 1: The producer supplies facilities,  labor,  veteri-
nary care, utilities, and insurance for an appropriate percentage
of gross sales based on input costs. The feed  retailer  supplies
feed,  standard  feed  medications,  and receives a predetermined
percentage of returns. The capital  partner  and  breeding  stock
supplier  get  another percentage. The management firm receives a
percentage  for  supplying  computerized  records  services   and
management consultation.

     Option 2: The current hog inventory is purchased outright by
a  limited  partnership  and it will supply sow replacements. The
producer supplies facilities, labor, utilities, veterinary costs,
repairs,  and  manure  disposal.  The feed retailer provides feed
and standard feed medications. A management agency supplies  pro-
duction and marketing guidance. Each of the contract participants
receives a percentage of the proceeds when hogs are marketed. The
remaining percentage is split between the limited partnership and
the general partner for managing the partnership.

     Option 3: The contractor provides breeding stock, feed and a
prescribed  system  of  management. The producer provides facili-
ties, labor, utilities, insurance and  disposal  of  manure.  The
producer  receives  fees  per  head or per pound of hogs marketed
plus possibly additional compensation for farrowing  and  feeding

Breeding Stock Leasing

     The popularity of breeding  stock  leases  has  declined  in
recent years and presently they are seldom used. Many contractors
were dissatisfied with the care of the breeding  herd  and  some-
times  were  unable to collect their payments from producers. One
lease involves a payment-in-kind for the use of  breeding  stock.
This  lease  is particularly attractive to producers with limited
capital but ample feed, facilities and labor to produce hogs. The
producer  pays  all  production costs and pays the breeding stock
owner, for example, one market weight hog per litter.

Characteristics of a Good Contract

     The relationship of producer and  contractor  are  generally
more complex and interdependent for production contracts than for
marketing agreements. Hence,  production  contracts  need  to  be
evaluated  with  special  care. When considering contract produc-
tion, contractors and producers need to evaluate each contract on
its  own  merit.  Each party should look for a contract that best
fits its operation and management capabilities. Both parties must
know  their cost of production to make an informed decision. Sim-
ply signing a contract will not necessarily improve efficiency or
insure  a  profit.  It  is doubtful that producers will receive a
bonus for feed efficiency better than 2.9 if they have been  only
achieving 3.5 on their own, for example.

     Also, carefully scrutinize the examples used to  demonstrate
cash  flow or producer returns. Unless otherwise stated these are
only examples and not guarantees. Producers should  consider  the
impact  on cash flow and debt repayment if payments are less than
projected. Is there a guarantee of contract length if new facili-
ties  or  other major capital expenditures are required to obtain
the contract? Most contracts guarantee a stated number  of  turns
(groups  of  hogs)  or  are in force for a stated length of time.
Few, if any, guarantee the  number  of  hogs  that  will  be  put
through the facility in a set time, say one year. Facilities that
sit idle during an unprofitable period in the hog cycle may  pro-
fit  the  contractor,  but  disrupt the producer's debt repayment

     Before considering the details of  a  contract,  one  should
first consider the reputation and financial stability of the com-
pany or individual with whom the contract  is  to  be  made.  For
instance:  How  long  has  the company been in business? What has
been the company's financial success? How long  has  the  company
offered  contracts? Do other producers in the area have contracts
with the company? Does the company fulfill the terms of its  con-

     Because little can be done after the  fact  to  correct  the
problem,  both  parties  should be encouraged to gather financial
information about the other. This may be best handled on a  docu-
ment  separate  from  the production contract. Problems and risks
can arise for both the owner and  the  feeder  due  to  financial
failure of the other. Remember that:

o    Except for the right to remove the hogs, the hog owner is an
     unsecured  creditor  of  the  feeder.  The  owner has little
     chance in recovering losses resulting from  excessive  death

o    The feeder has a statutory lien on the hogs, but  this  lien
     is subject to all prior liens of record. This means that the
     owner's secured creditors can remove the hogs without paying
     the  grower.  Once  the  hogs are removed, the grower has an
     unsecured claim for his contract damages which  is  probably

o    It is possible for the grower to receive first lien  on  the
     hogs  if the owner and his/her creditors are willing to give
     the grower a lien subordination.

At a minimum:

o    The contract must be in written form and must be  clear  and

o    The contract should clearly define the rights and  responsi-
     bilities of both parties involved.

o    The contract also should contain the  following:  number  of
     pigs  involved,  names of both parties, duration of the con-
     tract, method and timing of payment, and definition  of  who
     shall supply certain inputs.

o    A contract should be thoroughly read and  understood  before
     it  is  signed.   Enlisting  the  advice  of  a lawyer, farm
     management specialist, or business consultant is helpful and
     often essential when evaluating contracts.

o    The contract should contain an arbitration  clause.  Such  a
     clause  removes any disputes from the court system. The con-
     tract also should define how the arbitrators are chosen.

o    Complete records  of  inventories,  deaths,  purchases,  and
     sales should be maintained and open to both parties.

Other possible contract provisions would include:

o    The right of the owner to inspect pigs at any time.

o    Designation of responsibility for purchasing and marketing.

o    A procedure for refusing delivery of unhealthy or poor qual-
     ity pigs.

o    The basis for compensation of feed and non-feed costs.

o    Acceptable weight ranges for incoming feeder pigs and outgo-
     ing market hogs.

o    A procedure to use if failure of payment arises.

o    The means and timing of communication by producer  to  owner
     when a death loss occurs.

o    Who assumes the risk of death loss.

o    The extent of the producer's responsibility for care of  the
     pigs and record keeping.

o    Designation of who will provide insurance and how much  cov-

o    The brand  and  quality  of  feed  and  supplement  that  is
     required  if any, and who is responsible for ration formula-

o    How and when the contract may be terminated by either party.

     The key to feeding or producing hogs under contract is find-
ing  the type of contract that will allow each individual to pro-
fit most from his/her skills, resources, and ability to bear risk
associated with hog production. This strength may be record keep-
ing, producing with a low mortality rate, or an ability to maxim-
ize  herd  feed  efficiency.  Whatever the case, producers should
make certain that the contract will reward them appropriately for
what they do best.

     Once the best contract type has been found, the written con-
tract itself should be carefully read and understood. The respon-
sibilities of both parties should  be  clearly  spelled  out  and
understood   as  should  procedures  for  dealing  with  possible
disputes. While a well written contract is essential to  success-
ful  contract  production, it is also important that both parties
are professional and willing to work out any problems that arise.
A  contract  can never be so complete that every possible problem
is anticipated. Individuals  interested  in  contract  production
should check laws regarding contracting in their state.

REV 12/92 (7M)

Cooperative Extension Work in  Agriculture  and  Home  Economics,
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culture Cooperating. H.A. Wadsworth,  Director,  West  Lafayette,
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