Marketing agreements with a base price tied to a cash market price drives prices down. This is a very basic Econ 101 showing captive supply causes lower prices, and not merely coincidental. Consider this simple arithmetic using an IBP (now Tyson) cattle buyer statement to OCM Vice President and cattle feeder Randy Stevenson in 2002:

“… an IBP cattle buyer … looked at high quality cattle we had on our show list for sale. The market was about $66/cwt in the cash market, based on live weight. (He) was very complimentary of our cattle’s quality. He said his hands were tied and he could not offer more for the cattle, despite their above average quality. (He) said ‘In the old days I would have been able to offer $67.50 for these cattle, but now paying more would screw up 20,000 formula cattle.’ It was completely clear to me that (the buyer) was telling me paying a higher price for out cattle would influence prices for cattle bought on a formula contract basis, off the cash market, before the transaction involving our cattle occurred. We lost money in this deal because IBP would not allow its buyer to engage in competitive bidding.”

Suppose that the base price for the 20,000 formula contract cattle was the “top-of-the-market” price. We know such contracts exist. Also suppose that another packer – maybe a very small but competitive packer – had already established the weekly top-of-the-market price at $66.00. If the Tyson buyer pays Randy an additional $1.50/cwt ($18/head) for his pen of 1,000 high quality cattle, then the “additional cost” is the extra $18,000 for Randy’s cattle, plus an extra $360,000 on the 20,000 head of formula cattle. Paying Randy an extra buck fifty on 1,000 head would have cost Tyson an extra $378,000. Offering $67.50 for Randy’s 1,000 high quality cattle in a market with captive supply is the equivalent of offering $117.00/cwt in a cash market without captive supply – both increase Tyson’s cattle costs $378,000.

Captive supply contracts provide packers committed cattle so they are not as hungry to increase bids to fill out their plant capacity, and also create extreme incentives to underbid, costing Randy $18,000 in this illustration and gaining Tyson $378,000. In the jargon of economics, marginal cost of slaughter cattle is higher to the buyer because of the marketing agreements tied to cash price, thus causing cash price to be lower than it would without such captive arrangements. Buyers get it. Independent sellers get it. Why some pundits don’t “get it” remains a mystery. CRT

Cause and Effect - Problem with Base Price Tied to Cash Price: “In the old days I would have been able to offer you $67.50 for these cattle (on a $66 market), but now paying more would screw up 20,000 formula cattle.” Statement made by an IBP cattle buyer to Randy Stevenson, Sept. 17, 2002

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Illustration of the Problem: Base Price Tied to Cash Price

• Suppose that the base price for the 20,000 head of formula cattle was the top-of-the-market price
• Suppose that the top-of-the-market price had already been established at $66 by another packer
• If the buyer pays Randy an additional $1.50/cwt for his pen of 100 high quality cattle
  - Then the “additional cost” is NOT just the extra $1,800 for Randy’s cattle
  - But an extra $360,000 for the 20,000 head of formula cattle
  - Paying Randy an extra $1.50 on only 100 head would have cost IBP an extra $361,800

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Illustration of the Problem: Base Price Tied to Cash Price

• If IBP had paid Randy $67.50/cwt in a cash market without captive cattle, the total cost to
  IBP would have been $81,000.
• But because of the captive cattle, the cost to IBP for Randy’s cattle (at $67.50) would have
  been $361,800.
  - Cost of Randy’s cattle to IBP would have been $301.50/cwt, not $67.50/cwt
• Effect: Softens bids, causes lower cash prices