During the recent extreme depression in hog prices, producers focused much of their anger at packers. Retail prices generally remained strong, and margins increased dramatically for entities up-chain from the production sector.

The cost of goods for packers nearly disappeared, while sales of processed goods remained strong. Producers faced one of the lowest shares of the retail dollar ever encountered in history.

In the midst of this producer-packer turmoil, it was easy to miss the really interesting competition occurring in the pork chain - that being the competition among packers.

The competition among packers is fundamentally different than among producers. Because there is still a large number of producers, the individual strategy and actions of one producer do not affect other producers via the total supply, cost or price in the market. This is not the case with packers.

Packers Are Oligopolists Oligopolist is an economic term describing the competition in markets with few buyers and sellers.

Packers compete in an environment in which strategy and pricing by one can dramatically affect the competitive outcome of another. This strategic behavior among packers often has consequences at the producer level.

There is a saying, "When elephants fight, the grass gets trampled."

Producers of pork can gain valuable insights about their future by understanding this packer-to-packer competition since it is a key driver in packer actions, investments, government lobbying and pricing in the pork sector.

Part of the competition among packers is for a consistent supply of high-quality raw materials. As the pork production sector transformed in the last 10 years into a relatively larger, more sophisticated set of players (including the professional family farm), supplies and availability of pigs began to change along several dimensions.

While total production transitionally increased as new cost-lowering technology was adopted, the supply changed. Not only did quality change, so did concentration and geography of supply.

Traditional producers with small herds, once nearly everywhere in the Corn Belt, began to cease production. New investments in production began to spring up in North Carolina, Oklahoma and Colorado. Competition among packers for the new supplies is keen.

Packers face the same imperative that capital-intensive producers face - they need to keep fixed assets working constantly. As the source and quality of pigs shift location, existing packing plants face a potential supply crisis.

Even though the total supply of hogs is transitionally large, packers see the shakeout in the production sector will eventually yield more rational production numbers.

When the smoke clears, which packing chain will have access to a stable and sufficient supply of high-quality pigs?

The need to assure a steady source of pigs to existing plants led packers to offer cost-plus and cash-flow type contracts to producers in order to help them stay in business and to assure their hogs came into the plant. Other contracts emerged, assuring shackle space and some forms of price-risk management.

Packers who offered price-stabilizing contracts paid more for pigs in the last three years than those who did not.

At the same time that packers were (and remain) very concerned about the future supply of quality pigs, producers and their lenders became very concerned about market access.

Contracts Offer Advantage As production increased and became more structurally inflexible, producers needed to assure lenders they had a long-term market before long-term loans could be approved. This has driven producers to marketing contracts as a means to keep capital flowing into the operation. Unfortunately for producers, this need to secure contracts coupled with temporary overproduction, reduced their negotiation position with packers.

Packers are no longer willing to compete head-on in the daily marketplace for the quality and quantity of hogs needed. Contractually tying up the right supply gives them competitive advantage over other packers. This reduces an individual plant's search costs and assures supplies upon which consistent value can be added and potentially branded.

Plants that contract large numbers of pigs from relatively uniform supplies have ceased measuring every pig and simply pay on the basis of the distribution of quality. Quality characteristics can be periodically sampled to understand value differences. These plants enjoy the added advantage that their measurement costs are lowered.

As you consider new contracts or extensions to existing packer contracts, think about the competitiveness of packers among themselves. Supply assurance, search costs and measurement costs are key differences between packing plants and form part of the basis for long-term competitiveness among packer/processor chains. This is a very different basis for competition than what the producers face.

The oligopolistic competition among packers forms part of the explanation of price differences. Mandatory price reporting threatens to force plants to reveal their pricing structure.

Surprising to many producers, packers worry more about their pricing structure being revealed to other packers than to producers. A packer's pricing structure reveals a significant amount of information that their competitors can use.

Understanding packer-to-packer competition will help you choose the right chain in the future and potentially help you negotiate your best possible deal.