Purdue News

November 20, 1998 Pork producers need to renegotiate contracts WEST LAFAYETTE, Ind. -- Because hog prices recently have dropped to dramatic lows -- below $20 per hundredweight -- many hog producers are operating under contracts that are causing big losses, according to Purdue University agricultural economist Michael Boehlje (pronounced BOHL-gee). "When some of these fixed-price contracts were initiated, market prices were much higher," Boehlje said. "Over the long run, such arrangements may still be profitable, on average, but the fixed nature of the pricing on these contracts means that the contractor or the purchaser is taking all of the risk." Chris Hurt, fellow Purdue economist and specialist for the Purdue Cooperative Extension Service, said most of today's farmers have not seen hog prices this low in their lives. "Financial conditions for producers are the poorest since the Great Depression of the 1930s. With hog prices at $16 per hundredweight and production costs near $36, losses per hog are mounting," Hurt said. "Moderately sized farms with 300 sows could be losing up to $1,000 each day." Boehlje said producers who are operating under contract should try to renegotiate rather than wind up in court for reneging. "Some form of negotiation or mediation is preferable, of course, to the costly and polarizing approach of litigation," he said. Boehlje said that the fundamental flaw in many of contracts is the inequity of risk-bearing between the parties when the unexpected, such as drastically low prices, occurs. "Many of the contracts that are experiencing difficulty are ones that shift much or all of the uncertainty to one party," Boehlje said. "There are numerous unexpected events that might adversely affect contract performance, including pig mortality, disease problems that interrupt the pig flow, or the death of a key employee or the owner of one of the businesses." Boehlje acknowledges that it is almost impossible to write contracts that anticipate and provide provisions for a myriad of potential unexpected events. Consequently, he said, the solution needs to be more general and should include three fundamental principles: Up-front agreement that the risk and cost of unexpected events be equitably shared. Periodic review of the arrangement so that the sharing of risk and rewards remains equitable. Provision for binding arbitration or some other form of resolution when conflicts develop and the parties can't reach agreement by themselves. Boehlje also said the means by which parties determine equitable sharing of risk and returns is key in renegotiating contracts and avoiding litigation. "One basic approach," he said, "is to determine the value of the resources used to produce the product involved, then to determine the portion of those resources contributed by each of the contracting parties. These percentages should then be used to allocate the amount of revenue each party receives when the hogs are sold, and how much loss each party should bear when the unexpected occurs." CONTACTS: Boehlje, (765) 494-4222; e-mail: boehlje@agecon.purdue.edu; Hurt, (765) 494-4273; e-mail: hurt@agecon.purdue.edu Compiled by Chris Sigurdson, (765) 494-8415; E-mail, sig@ecn.purdue.edu Purdue News Service: (765) 494-2096; e-mail, purduenews@purdue.edu To the Purdue News and Photos Page