Regulation of contracts in poultry production
The US Department of Agriculture is proposing to require chicken processors to provide more information in their contracts with producers.
Earlier this month, the United States Department of Agriculture (USDA) released proposed revisions to its rules under the Packers and Stockyards (P&S) Act of 1921. The proposal would require chicken processors to provide current and potential producers with more information about the financial risks inherent in producing chicken under contract.
The passing of the P&S Act, which applies to meat packers and poultry marketers, followed debates over antitrust and trade regulations that culminated in the passage of the Clayton Act and the Federal Trade Committee Act. Incorporating and expanding on the antitrust language of these laws, the P&S Act noted restrictions on trade that are characteristic of monopoly power. It also incorporated tortious language regarding trade regulations, unfair or deceptive conduct, unfair discrimination, and undue preference.
Congress has given the Secretary of Agriculture the authority to make rules, ordinances, and regulations to implement the provisions of the P&S Act. Disclosure has been one of the basic elements of law enforcement, aimed at deterring unfair or deceptive behavior, as well as unfair discrimination and undue preference that harm breeders. With its recently proposed revisions, the USDA aims to provide producers with more detailed information about some of the subtle financial risks associated with poultry production contracts to help them make important investment decisions.
The chicken industry has a unique organizational structure. Almost all chickens are raised by contract farmers, with about 25 large processors providing farmers with feed, chicks and veterinary services. Since feed and live chickens are expensive to transport, processors contract with farms located near their feed mills and factories. Markets for growers are therefore quite localized: 90% of contracted growers are located within 60 miles of their processing plant, and most growers report no more than 3 processors in their area.
Producers provide housing, utilities and labor. A single modern chicken coop, capable of holding 60,000 birds at a time, costs around $350,000 to $400,000. A potential producer would therefore need to invest $1.5 million or more, excluding land costs, in an efficient four-house facility. Most of these facilities are debt financed and with a 20% down payment potential producers can borrow well over $1 million on a 15 year mortgage.
Producer compensation is based on a “tournament” system. When the farmer’s chickens are delivered to the processor, the total live weight of the delivered flock is recorded. The processor then calculates the farmer’s “settlement cost” or the processor’s total costs for feed and chicks delivered to the farmer, divided by the total live weight of chicken returned to the processor. The grower’s establishment cost – feed and chick expenses per pound of chicken delivered – is then compared to an “average establishment cost” for all flocks delivered to the plant by all growers during a week.
Chicken contracts set a base wage per pound delivered, with bonuses or deductions based on the producer’s settlement cost, relative to weekly average settlement costs. Producers with relatively low settlement costs receive premiums over the base, while those with relatively high costs receive deductions. In turn, performance varies with flock mortality, with higher mortality implying fewer pounds of live weight delivered for a given placement of chicks. Performance also varies with feed intake, as calm, healthy chicks convert more feed into meat than stressed chicks.
Contracts used in chicken production dramatically change the mix of financial risks farmers face. They transfer the price risks associated with feeder and adult chickens from farmers to processors, since payments to farmers are independent of feed or chicken prices. Common production risks – arising from disease or weather conditions that affect the performance of all producers – are also borne by processors since producers’ compensation is based on their relative, not absolute, production performance. Producers understand these well-known risks.
Contracts, however, introduce new risks that producers may not perceive.
For example, a producer’s large long-term capital investment may tie it to a specific processor through an incomplete short-term contract with few or no alternative contractors. Once herders invest in housing and commit to a processor, they face counterparty risks: the processor may go bankrupt or fail to deliver as many herds in a year as the herder was waiting there.
The processor may also require additional capital investment from producers as a condition of contract renewal.
Finally, the tournament compensation method ensures that producers’ compensation will vary widely around the average compensation estimates provided by processors and extension agents, in part due to circumstances beyond the control of the producer – the performance of other producers. . Even though contracts transfer common price and production risks to processors, the presence of other lesser-known risks ensures that chicken farmers’ incomes vary quite widely from other farm households and all American households.
In the proposed rule, the USDA aims to ensure that producers are better informed about counterparty risks and pay variations in tournaments. Processors would be required to provide each producer with an information document specifying the minimum number of flocks to be placed in the producer’s facility in a year, as well as the minimum stocking density of those flocks. The document should also note all bankruptcies declared by the processor during the previous six years and any litigation between the processor and any of its producers during the same period. Processors would additionally be required to provide producers with detailed financial information in the form of tables showing distributions of producer compensation over the previous year, measured by revenue per square foot of housing. The distributions would include means as well as quintile values, sorted by production complex and housing types.
The USDA is seeking comments on producers’ financial risks, their sources, the impact of contract design on those risks, and the effectiveness of the proposed regulations. It uses a series of specific questions to get informed feedback on the proposed rule and seeks to use this dialogue to craft a final rule.