AgDM newsletter article, January 1997

Pricing pigs

By Harry Tucker, Extension Farm Management Specialist, 319.754.7556, htucker@iastate.edu

Traditionally, auction markets have served as a means of setting feeder pig prices. These markets served as an unbiased method of dividing income between feeder pig producer and finishers.

As the pork industry moves to 2 and 3 site production, new questions arise about pricing pigs. Have auction market receipts declined to the point where they do not represent the true value of the pigs? Can the auction market account for today’s focus on quality? In addition, many producers want to establish an equitable way of pricing pigs over five to seven years.

Transfer pricing

What is needed is an internal method of transfer pricing pigs between the various stages of the production process. For example, producer involved in a production network need an equitable way of pricing pigs between the various production phases of the network. Also, when a production stage is contracted, an equitable method of pricing these services is needed.

Cost of production

In response to this need, I use a procedure that achieves the same results as transfer pricing. It is a method of allocating gross income (sale of the finished pig) over the stages of production I proportion to the cost of production at each stage.

The production process is divided into three segments: farrowing, nursery, and finishing. As shown in Table 1, farrowing makes up 28 percent of the total cost of production, so the farrowing portion receive 28 percent of the sale value. The finisher receives 56 percent. The challenge of this approach comes in equitable valuing inputs such as facilities, labor, management, raised breeding stock, and risk.

Assumptions

Typical cost of production figures for each segment are listed in Table 1. This is meant to be an example and does not fit any specific production facility. Labor is included at $9 per hour, corn at $2.45 per bu., building costs are spread over 14 years, and 22 pigs per sow per litter are assumed. Other conditions such as death loss and how to handle replacements must be addressed.

I made the condition that the cost of producing a 250 lb. pig must not be more than $100 ($40 per cwt.). Although this does not represent most production systems today, I am convinced that pigs must be produced for $100 or less to be competitive in the future.

Table 1. Cost of pork production (per head).

Farrow

Nursery

Finish

Total

Days

0-15

15-60

60-mkt.

Costs

Breeding
$2.38
0
0
$2.38

Feed

8.82

$10.09

$41.83

60.74

Vet. & medical

1.76

.44

.21

2.41

Repair & Main.

.77

.28

.48

1.53

Utilities

1.43

.74

.51

2.68

Labor (tax & benefits)

5.34

.79

1.29

7.42

Fixed cost--building

5.55

3.08

8.34

16.97

Manure handling

1.95

.58

3.34

5.87

Total cost
$28.00
$16.00
$56.00
$100.00

Cost per cwt. (250 lb.)

11.20

6.40

22.40

40.00

Percent of cost

28%

16%

56%

100%

Allocating profits (losses)

This method also allocates profits (losses) based on input costs among the production segments. This is especially relevant for producers in a production network. For the network to work, all producers must share profits and losses.

For example, assume my responsibility is to farrow. In the finished pig sells for $124, my share of the income is $34.72. This includes $28 to cover my costs plus $6.72 of profits (28% x (124-100)= $6.72). The nursery and finisher would receive 16 percent and 56 percent of the profits respectively.

Evaluate prices

The table can be used to help evaluate fixed transfer prices. For example, if asked if a profit can be consistently generated if 45 lb. feeder pigs are sold for $40, the answer is probably not. When the cost of farrowing $28) is added to the cost of the nursery $16), the total cost s $44. This is higher than the $40 sale price.

Long-term arrangement

This is a “one-time” process-not a group by group process. The arrangement should be set up to last at lest three years. The allocation of income may be distorted for shorter arrangements. For example, high corn prices put the finisher at a disadvantage because finishing requires a disproportionately large amount of corn. Conversely, low corn prices put the finisher at an advantage. Likewise, a narrowing between cull sow price and replacement gilt price may give the farrowing segment a temporary advantage. By making a long-term arrangement, these short-term distortions tend to even out over time.

More information on transfer pricing is available from the Decision File Feeder Pig Pricing FormulasAlso, the National Pork Producer Council is preparing a book on this topic. It should be available next spring.

 

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