ORGANIZATION FOR COMPETITIVE MARKETS

P.O. Box 6486

Lincoln, NE 68506

Web site: www.competitivemarkets.com

Date: January 22, 2002 For Immediate Release

Contact: Fred Stokes: 662.476.5568

Michael C. Stumo: 860.379.6199

Respected Ag Economist Found Problems with Captive Supplies

OCM said today that a report by a respected agricultural economist that has never received funding from the meat packing industry found problems with captive supplies in the cattle industry. This report contrasts with opinions set forth in a document released earlier this week by some ag economists, most of whom have received funding from the meat packing industry, claiming that captive supplies are not a problem for the market.

Dr. Richard Sexton, of the University of California – Davis, reviewed a USDA study on captive supplies in the Texas Panhandle. Dr. Sexton is a former editor of the American Journal of Agricultural Economics and is a fellow of the American Agricultural Economics Association. In a letter to USDA dated September 28, 2000, Dr. Sexton expressed concern about “the role of captive supplies in further reducing the competitiveness of the bidding process in the cattle markets.” (Full text of letter in USDA hearing record is set forth below).

“In my opinion,” Sexton stated, “consolidations in the beef packing sector that have occurred over the past 20 years have shifted the balance of power in the cattle procurement market in favor of packers, at the expense of producers.”

Sexton made very strong recommendations to USDA to address his concerns about competitiveness. “Given the evolution of market structure in this industry, both with respect to increasing packer concentration and increased use of mechanisms of vertical control (i.e., captive supplies), I believe that USDA is correct to be considering rules intended to enhance the competitiveness of these markets. In particular, I urge consideration of rules that address the structural deficiencies of the bidding process, as I have outlined them.”

The Organization for Competitive Markets is a multidisciplinary, nonprofit group of farmers, ranchers, academics, attorneys, and policy makers dedicated to reclaiming the agricultural marketplace for independent farmers, ranchers and rural communities.

*** full text of Sexton letter in USDA hearing record, September, 2000, follows ***

Richard J. Sexton

Department of Agricultural and Resource Economics

University of California Davis

Davis, CA 95616

September 28, 2000

Ms. Shannon Hamm

U.S. Department of Agriculture

1400 Independence Ave. NW, Stop 3601

Washington, DC 20250-3601

Dear Ms. Hamm:

I am a professor in the Department of Agricultural and Resource Economics at the University of California, Davis. I participated as a peer reviewer of the GIPSA study on cattle procurement practices in the Texas Panhandle Region. In the light of my general background as an agricultural economist interested and experienced in industrial organization issues and my specific work pertaining to the Panhandle study, I would like to comment on the USDA’s prospective rulemaking regarding captive supplies in the livestock sector.

In my opinion, consolidations in the beef packing sector that have occurred over the past 20 years have shifted the balance of power in the cattle procurement market in favor of packers, at the expense of producers. Data accumulated for the Panhandle study indicated that typically no more than two or three packers were available to bid on any given lot of cattle. This represents an oligopsonistic market structure, wherein economic theory suggests that typically the price for live cattle would be bid down from the level that would prevail if the market were perfectly competitive. Moreover, as I noted in my review of the Panhandle study, the bidding practices that prevailed in that region were likely to further skew the transactions in the packers’ favor. These conclusions followed from the application of the economic theory pertaining to auctions. In particular, when the same small set of bidders interact repeatedly across different feedlots and over time, the opportunities to develop bidding conventions that minimize competition are great. Particularly troublesome aspects of bidding in the Panhandle region were the following:

· The convention of bidding only whole dollar amounts per cwt. I estimated in my commentary on the Panhandle study that this practice cost producers approximately $25 million in lost revenues during the roughly 15 month period of data collection for the Panhandle study.

· Use of a queuing mechanism to distribute cattle to buyers, wherein the first bidder has priority in the case of tie bids. A related problem is that the first bidder in line is given an opportunity to revise his bid in the event that someone bids higher. Thus, the key feature in securing the cattle is not to make a high bid but, rather, to secure the first bid. It need not be the buyer's "best" bid because he knows he will be able to revise it in the event that a higher bid is received. It is probably easy for buyers to agree to queuing conventions among themselves. These mechanisms, rather than competitive bidding, then serve effectively to allocate the cattle among the packers.

· The role of captive supplies in further reducing the competitiveness of the bidding process. Packers who have procured a substantial percentage of their slaughter requirements for a given period through captive supplies can afford to bid conservatively in terms of procuring their remaining needs. Application of basic auction theory indicates that, when bidders are few, eliminating a bidder from the auction or reducing the bidder’s incentive to bid aggressively will likely reduce the price received by the seller. These predictions from theory have been borne out in several experimental studies of auction markets.

Given the evolution of market structure in this industry, both with respect to increasing packer concentration and increased use of mechanisms of vertical control (i.e., captive supplies), I believe that USDA is correct to be considering rules intended to enhance the competitiveness of these markets. In particular, I urge consideration of rules that address the structural deficiencies of the bidding process, as I have outlined them. In addition, the role of captive supplies in attenuating packers’ incentives to bid aggressively in the cash market deserves your attention. Several empirical studies have documented the inverse relationship between cash prices and the incidence of captive supply arrangements. Finally, I caution USDA to exercise care before implementing mandatory price reporting rules. Mandatory price reporting is a well-known technique in the auction literature to enforce bidder collusion. In particular, secret or “under the table” bids are often necessary to destabilize bidder cartels. This type of bidding is not possible under mandatory price reporting.

Sincerely,

Richard J. Sexton

Professor