Abstract 

The poultry, egg, and pork industries have taken significant steps to improve the control of

production either through contracting and/or vertical integration. These improved controls

were motivated by the emergence of new specialized large-scale production technologies

that placed a premium on quality control and the efficient use of information. The heightened speed of production, the perishable nature of products, and significant measuring and

sorting costs all increased the difficulty of obtaining accurate economic information and

thereby increased the cost of exchange throughout the marketing system. Contracts and

vertical coordination provided an efficient means of organizing markets by reducing these

transaction costs. 

Keywords: Vertical coordination, vertical integration, contracts, transaction cost economics, technology, measuring and sorting costs, poultry, pork.

Acknowledgments

I would like to thank Carolyn Dimitri, Jill Hobbs, and Kelly Zering for their extensive

comments. Carolyn provided invaluable comments regarding the organization and content

of the report. I also thank Jim MacDonald, Alden Manchester, and Annette Clauson for

their helpful comments, John Weber for editorial assistance, and Cynthia Ray for graphic

design assistance. 

Note: Use of brand or firm names in this publication does not imply endorsement by the

U.S. Department of Agriculture.

United States

Department

of Agriculture

www.ers.usda.gov

Electronic Report from the Economic Research Service

Vertical Coordination of

Marketing Systems: 

Lessons From the Poultry, Egg, 

and Pork Industries

Steve W. Martinez

April 2002

Agricultural

Economic

Report 

No. 807
Contents

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Evolution of Vertical Coordination in the Poultry, Egg, and Pork Industries . . . . . . . . . . . . 2

Vertical Coordination in the Poultry and Egg Industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Vertical Coordination in the Pork Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Incentives for Contracting and Vertical Integration: A Transaction Cost Approach . . . . . . . 6

Asset Specificity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Measurement Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

The Viability of Spot-Market Transactions in the Poultry, Egg, and Pork Industries . . . . . 10

Physical Specificities and Small-Number Conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Site and Temporal Specificities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Measurement Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Marketing Contracts, Production Contracts, or Vertical Integration? . . . . . . . . . . . . . . . . . 18

Uncertainty and Vertical Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Vertical Integration in the Turkey and Egg Industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Marketing Contracts in the Pork Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Beyond Transaction Costs:

Benefit Effects From Contracting and Vertical Integration . . . . . . . . . . . . . . . . . . . . . . . . 23

Production Efficiency Gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Quality and Uniformity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Potential for Further Research on Incorporating Benefit Effects . . . . . . . . . . . . . . . . . . . . . 27

Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Selected References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

Appendix A: Vertical Stages of the Poultry and Egg Industries . . . . . . . . . . . . . . . . . . . . . . 37

Appendix B: Geographic Region Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

Appendix C: Location of Broiler, Turkey, Egg, and Pork Production, 1997 . . . . . . . . . . . . . 39

Appendix D: Demand Index Calculations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

ii  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA
Economic Research Service/USDA Vertical Coordination or Marketing Systems /AER-807  iii

Summary

The U.S. poultry, egg, and pork industries each have experienced increases in contracting and vertical integration. Changes occurred decades ago in the poultry and egg

industries and have occurred more recently in the pork industry. Production contracting grew quickly in the broiler industry, and nearly all broilers now are produced

under production contracts between processors and growers. While production contracts also became more prevalent in the turkey and egg industries, vertical integration

also became more common. In the pork industry, marketing contracts became more

popular, although packer ownership of hogs also has risen in more recent years. 

In each of the industries, spot markets apparently became a less efficient means of

coordinating production and processing. This effect may be explained by higher transaction costs from a variety of sources. First, several developments in each of the industries led to higher costs associated with safeguarding investments. Each of the industries underwent periods in which they adopted new specialized technologies and experienced associated scale economies. These developments led to investments with few

alternative uses and few alternative users, or relationship-specific investments, particularly in regions of expanding production. Such investments leave trading partners vulnerable to opportunistic behavior by other parties seeking a more favorable position in

the relationship.

Other factors also created value in continuing relationships between specific trading

partners. For example, in the poultry and egg industries, farms and processing units

located close to each other. Short distances between trading partners resulted in more

relationship-specific transactions—trading partners separated by longer distances

would result in higher transportation costs. Also, poultry and eggs are perishable products that require timely delivery from the farm to the processing plant. This factor

makes producers highly vulnerable to tactics used by processors to delay acceptance

of products to obtain a more favorable deal, as it may be difficult for producers to find

alternative processors before the products perish. 

Contracting and vertical integration provided a means for reducing transaction costs

associated with relationship-specific transactions, especially in regions of expanding

production. Contracts could provide some safeguards to protect against opportunistic

behavior, and vertical integration eliminated the exchange relationship altogether.

Contracts and vertical integration also may facilitate reductions in product measuring

and sorting costs, leaving more gains from trade to be distributed among producers

and consumers. For product attributes that are difficult to measure, gaining additional

control over related production inputs may reduce measuring costs by reducing the

need to measure quality. Similarly, by controlling inputs that result in more uniform

product attributes, measuring and sorting costs may be reduced because there is no

need to measure every product. Controlling production inputs facilitates branding programs that transfer measuring and sorting costs from consumers to the food supply

system. The poultry industry has been especially successful with branding programs,

and the pork industry is increasing its use of branding strategies. 
iv  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

Relationship-specific transactions and uncertain market conditions also may explain

differences in methods of vertical coordination found in the poultry, egg, and pork

markets. As transactions become more relationship-specific, vertical integration will

become more prevalent. Greater uncertainty related to consumer preferences, production, or income make it more important for firms to find ways to adapt. Consequently,

vertical integration and contracts that give the contractor more control over the producer or that respond automatically to changing conditions will become more common.

In addition to reducing transaction costs, contracts and vertical integration may influence production decisions that result in more efficient resource allocations. This effect

is demonstrated by substantial gains in production efficiency in each of the three

industries and development of high-quality, consistent consumer products. Considering

both reductions in transaction costs and benefit effects would provide a more complete

framework for analyzing the organization of agricultural markets.
Introduction

Vertical coordination of the broiler, turkey, and egg

industries changed significantly decades ago. In the

broiler industry, production contracts between feed

companies/contractors and growers accounted for over

85 percent of production in 1955, as fewer growers

operated independently. These contracts later evolved,

giving more control to the contractors. In the 1960s,

relationships between the production and processing

stages also changed, as feed companies became more

directly involved in both broiler production and processing. In the 1970s, many feed companies exited the

broiler business, leaving processors as the major contractors with growers. Since the 1950s, the prevalence

of production contracts in the broiler industry has

been stable. 

In the turkey and egg industries, contracting developed

at a slower rate than in the broiler industry, but vertical

integration was more common. In vertically integrated

operations, a single firm conducts production and processing. Initially, feed dealers entered production contracts with egg and turkey producers. In 1955, 21 percent of turkeys were produced under production contracts, and 4 percent were produced in vertically integrated operations. By 1977, production contracts

accounted for 52 percent of production, and vertical

integration had increased to 28 percent of production.

In 1955, only 2 percent of table eggs were produced

under production contracts or vertically integrated

operations. By 1977, production contracts and vertically integrated operations accounted for 44 and 37 percent of table egg production, respectively. Over this

period, production contracts in the egg and turkey

industries evolved to transfer more price and production risk from growers to contractors, and processors

assumed the role of contractor. Today, production contracts, together with vertical integration, account for

over 90 percent of production in each of the three

industries. 

Coordinating arrangements in the turkey and egg

industries have received less scrutiny than arrangements in the broiler industry, perhaps due to the smaller size and level of growth of the turkey and egg

industries. In 1999, broilers represented 68 percent of

the estimated farm value of U.S. poultry and egg sales,

compared with 19 percent for eggs and 13 percent for

turkeys (USDA[c]). However, despite these differences, a comparison of the structural changes in each

of the three industries may provide useful insights into

other agricultural industries that are undergoing

changes in vertical coordination. 

More recently, the U.S. pork industry also has undergone significant changes in vertical coordination, as

contracting has surged. From 1993 to 2001, hogs sold

through contractual arrangements increased in share of

total hogs sold from 10 to 72 percent. Consequently,

sales and purchases through the traditional spot, or

open, markets have dwindled to 28 percent. 

This report examines possible motives for changes in

vertical coordination of the poultry, egg, and pork

industries. In the broiler industry, production contracts

and vertical integration facilitated rapid growth of the

industry through gains in production efficiency and

response to consumer preferences for convenient,

nutritious products (Martinez, 1999). To what extent

is the broiler industry unique in its motives for contracting and vertical integration? What are the common characteristics of the poultry, egg, and pork

industries that explain such a large degree of contracting and vertical integration? Why are there differences

in the use of contracting and vertical integration in the

otherwise similar poultry and egg industries? What

insights do such comparisons bring to industries that

are currently undergoing dramatic structural changes,

such as the pork industry? This report attempts to

answer these questions by extending concepts from

transaction cost economics. 

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  1
Evolution of Vertical

Coordination in the Poultry,

Egg, and Pork Industries

Vertical coordination refers to the synchronization of

successive stages of production and marketing, with

respect to quantity, quality, and timing of product

flows. Methods of vertical coordination include open

production (also referred to as open, or spot, market),

contract production, and vertical integration. In open

production, a firm does not commit to selling its output before completing production. Cash (or spot)

prices coordinate resource transfer across the stages of

production. Contract production is the production of

goods and services for future delivery. Before completing production, a producer commits to deliver a particular good to a particular buyer. Contract production

involves more interaction between buyers and sellers

than open production. Production contracts vary in

control allocated and risk transferred across stages. In

market-specific production contracts, the contractor

and producer may negotiate delivery schedule, pricing

method, and product characteristics. The contractor

usually provides a market for the goods but engages in

few of the producer’s decisions.1 In resource-providing

contracts, the contractor provides a market for the

goods, engages in many of the producer’s decisions,

and retains ownership of important production inputs.

While this classification scheme is not unique, it provides a general framework for contract terminology

(Martinez and Reed).2

In vertical integration, a single firm controls two or

more successive stages of vertical coordination. In vertically integrated firms, management directives dictate

the transfer of resources across stages. 

Movement along the continuum of vertical coordination from open-market production to vertical integration represents the degree to which control of production has shifted to the contractor or integrator as more

functions are transferred from the producer (fig. 1).

While market-specific production contracts, often

referred to as marketing contracts, provide contractors

with more control than open-market coordination, the

control transferred across stages is usually minimal. 

Vertical Coordination in the Poultry 

and Egg Industries

In the mid-1900s, poultry and egg firms specialized in

certain activities, and spot markets were the dominant

means of vertical coordination (app. A). Feed was produced in commercial feed mills. Poultry and eggs were

sold to slaughter plants and egg-handling facilities that

performed many of the marketing functions. By the

mid-1950s, however, vertical coordination of these

activities through contracts and vertical integration had

become increasingly common.

Broilers3

Production contracts, whereby the contractor and

grower (or a smaller producer) each provide significant

inputs into the production process, have been the dominant means of coordinating broiler production since

the mid-1950s (fig. 2).4 Initially, feed companies contracted with broiler growers, spurred by a potentially

large and stable market for their feed. As broiler production grew in the South, production contracts

evolved to give the contractor more control over production and shift more price and production risk from

growers to contractors.

In the 1960s, feed-company contractors became

involved in broiler processing by acquiring or constructing processing plants. Contractors, such as

2  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

1The contractor in an exchange relationship is the firm that controls several stages of production and marketing through contracts. In this report, the term “integrator” is reserved for a firm

that controls several stages through vertical integration. 

2In their ground-breaking 1963 study, Mighell and Jones also

include production-management contracts in their categorization

of production contracts. These contracts are similar to marketspecific contracts but give contractors more direct involvement in

production decisions. 

3See Martinez (1999) for more details regarding developments in

broiler contracting and vertical integration. 

4Continuous time series data sets that document methods of vertical coordination are generally not available. National surveys and

individual State studies provide some indications of these developments at particular points in time.

Figure 1

Methods of vertical coordination along the 

spectrum of control

Control offered to contractor or integrator Least Most

Vertical

integration

Source: Mighell and Jones.

Open

production

Market-specific 

contract

(or marketing contract) 

Resource-providing 

contract

(or production contract)
Ralston-Purina, Allied Mills, Central Soya, Cargill,

and ConAgra, controlled broiler production capacity

from feed mills to processing and marketing. 

In the early 1970s, broiler price swings caused many

feed companies to reduce their investments in the

poultry business (Strausberg). Processors, such as

Tyson Foods and Hudson Foods, then took over the

role of contractor. Today, nearly all broiler production

and processing is coordinated through production contracts between growers and processors. Contract terms

typically specify that the processors will provide the

baby chicks, feed, and management and veterinary services. The growers provide the labor and chicken

houses and receive a payment per pound of live broilers produced, based on a grower’s performance relative

to other growers. 

Turkeys

Before 1950, turkey growers operated independently,

obtaining financing from traditional sources (local

banks, production credit associations) to pay for feed,

poults, and supplies (Roy, 1972). However, in the

1950s, the industry experienced financial setbacks, and

these traditional sources became more reluctant to

finance turkey growing. Consequently, hatcheries provided poult financing, and feed companies provided

both feed and poult financing as a means to expand

feed production. These financial arrangements eventually evolved into production contracts that shifted risk

from grower to contractor.5 By 1961, feed companies

accounted for 65 percent of total turkey production

under contract (Gallimore). To coordinate production

and processing, many feed companies also owned

hatcheries and acquired processing facilities. As the

turkey industry developed throughout the 1960s,

processors became increasingly involved in turkey production decisions (Manchester). Processors began raising their own turkeys or contracting to better schedule

production and ensure supplies.6 By 1977, as fewer

outlets existed for independent growers, the share of

turkeys sold on the U.S. spot market fell to only 10

percent of turkeys produced.

Today, production contracts account for about 56 percent of turkey production and vertical integration

accounts for about 32 percent. Production contracts in

the turkey industry are similar to resource-providing

production contracts in the broiler industry: the grower

provides the buildings, equipment, and labor, and the

processor provides poults, feed, veterinary services,

and managerial assistance. Most growers receive a fee

per bird or per pound that may include performance

incentives for feed conversion and reduced turkey mortality rates (Lasley, Henson, and Jones). Vertically integrated operations, in which the processor owns all production facilities and hires labor to care for the birds,

are more prevalent in the turkey industry than in the

broiler industry. 

Eggs

In the egg industry, significant increases in contracting

by feed companies and processors began in the late

1950s. As in the broiler industry, contracts in the egg

industry evolved to give the contractor more control

over production and reduce growers’ price and production risks. Grower returns became less dependent on

market prices, as flat-fee payments (for example, per

bird, per dozen eggs) or payments related to producEconomic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  3

1955 65 75 77 94 1955 65 75 77 94 1955 65 75 77 94

0

20

40

60

80

100

Production contracts

Marketing contracts

Vertical integration

Figure 2

Poultry and eggs produced under contracts and

vertical integration

Percent

Broilers Turkeys Eggs

Note: According to Roy (1963), independent broiler production accounted for 

95 percent of total production in 1950.

Sources: Rogers (1979); Manchester. 

5Similar to the broiler industry, turkey production contracts

evolved from financing arrangements, in which the contractor

sometimes participated in the management decisions, to risk-sharing arrangements (Gallimore and Vertrees). 

6According to Gallimore and Irvin, unlike the broiler industry,

processors, rather than feed companies, were “the major coordinators in the turkey industry.”
tion efficiency became more common (Rogers,

Conlogue, and Irvin). Today, production contracts

account for more than a third of eggs produced. In a

typical production-contract arrangement, the contractor

provides layers, feed, and other supplies, and the

grower provides labor and facilities. All eggs produced

under the contract belong to the contractor, and the

grower is paid a fee based on the number of eggs produced, with performance incentives. 

In the mid-1970s, large owner-integrated operations in

the egg industry expanded rapidly. Most vertically integrated operations resulted from forward integration by

producers into processing (Rogers, 1976). Integrators

produce, pack, and market eggs in their own facilities

and may also mix feed, operate hatcheries, and raise

pullets (Rogers, 1979). Compared with vertical integration in the broiler and turkey industries, vertical integration in the egg industry is more commonly used to

coordinate production and processing and accounts for

60 percent of eggs currently produced.7

Vertical Coordination in the 

Pork Industry

Since the early 1990s, the pork industry has experienced

significant changes in vertical coordination (fig. 3).

Marketing contracts between large producers and

processors have become increasingly common. Contract

terms typically specify that the producer will deliver a

certain quantity of hogs to the processor at a certain

time. The producer may receive a formula-based price,

typically a spot-market price (for example, the

Iowa/Southern Minnesota market quote), with premiums or discounts based on size and quality of the hogs. 

Production contracts also are becoming more common

in the pork industry (fig. 4). Under the terms of these

contracts, the contractor, typically a large producer or

processor, provides management services, feeder pigs,

veterinary services, and other inputs. The grower provides land, facilities, and labor to feed the hogs to

market weight.8 The grower receives a fixed payment,

with premiums for efficient production. As in the poultry industry, processors in the pork industry may own

feeder pigs and establish production contracts with

4  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

Figure 3

Share of hogs delivered to processors via contracts

and vertical integration

Percent

Sources: Hayenga et al., 1996; Marion; University of Missouri and National 

Pork Producers Council; and Kelley.

01

2000

99

93

80

1970

0 20 40 60 80 100

Contract

Vertical integration

Open market

Figure 4

Share of hogs produced through production 

contracts

Percent

Note: Shares for 1996 through 2000 are as of December 1 each year.

Sources: Plain and USDA[a].

1991

94

96

97

98

99

2000

0 20 40 60 80 100

7As in the turkey industry, cooperatives were an important force in

the egg industry, performing such functions as assembling, packing, and distribution (Rogers, 1971; 1976). Cooperatives used marketing contracts with producer-members to address quality control

and secure egg supplies. As production contracts and larger vertically integrated operations became more dominant in the industry,

marketing contracts declined. Today, marketing contracts account

for less than 3 percent of eggs produced. 

8 While finishing contracts are the most common arrangement,

production contracts may also be used for nursing or farrowing.
growers to feed the hogs to market weight. Packerowned hogs increased from 6.4 percent of U.S. hog

production in 1994 to 24 percent in 2000, reflecting

Smithfield Foods’ (the Nation’s largest hog producer

and processor) recent purchases of two leading hog

producers (Messenger, April 2000). Most of these hogs

are priced using formula-based marketing contracts

with the production unit (Grimes and Meyer).9

Hog producers and processors may enter into both production and marketing contracts. For example,

Prestage Farms, the Nation’s fourth-largest hog producer, produces its hogs under production contracts

with growers. Prestage then sells the hogs to

Smithfield Foods, using marketing contracts at marketindexed prices. 

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  5

9Grimes and Meyer categorize these contracts as formula-based

marketing contracts. In our classification scheme, these contracts

are best described as production contracts because the processor

owns significant production inputs.
6  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

Incentives for Contracting 

and Vertical Integration:

A Transaction Cost Approach 

To explain alternative forms of vertical coordination in

the poultry, egg, and pork industries, one must rely on

the existence of market failures (Milgrom and

Roberts). In the traditional neoclassical paradigm,

coordination through spot markets can reconcile the

individual objectives of many consumers, direct many

valuable and limited resources to production, and

motivate firms to produce the right products. The

resulting allocation of goods is efficient given the following assumptions:

• Each producer knows prices and production technology and maximizes profits. 

• Consumers know prices and preferences and maximize utility given income.

• Prices adjust to equate supply and demand for each

good. 

Under these assumptions, prices allocate resources to

their most valued use, and consumers prefer no other

allocations given available resources and technology.

In reality, however, firms have concerns about their

ability to buy and sell the quantities they want at given

prices. Buyers and sellers may not know the exact

specifications of goods that they demand or supply.

Buyers face costs associated with searching for adequate suppliers offering the most favorable prices, and

sellers face costs associated with communicating the

availability of products with specific attributes. 

This report applies the transaction cost economics

(TCE) paradigm, which relies on the existence of

transaction costs.10 Transaction costs are costs associated with reaching and enforcing agreements and have

been equated to “the costs of running the economic

system” (Masten, 1996; Williamson, 1996).

Transaction costs include those costs associated with

planning, adapting, and monitoring economic activities. While these functions are not directly productive,

they are required to coordinate the activities of buyers

and sellers. 

TCE analysis suggests that the main purpose and

effect of contracts and vertical integration is to reduce

transaction costs. Transaction costs associated with

spot-market coordination include buyer costs of

searching for suppliers offering preferred quality features at favorable prices and seller costs of determining

prices and buyer preferences. Buyers and sellers can

reduce some of these costs by entering into a contract

arrangement before production is completed, but they

can still encounter other types of costs. Ex ante (prior

to reaching an agreement) contracting costs are costs

associated with drafting, negotiating, and safeguarding

agreements. Ex post (following an agreement) costs

are costs associated with enforcing agreements and

may require measuring damages or injury to a contract

party, enacting penalties, and compensating an injured

party (North). Vertical integration may reduce costs of

contracting and spot-market trading but may also

introduce new types of transaction costs, including

costs related to communicating information within a

firm (Putterman and Kroszner). Firms choose a

method of vertical coordination based on a comparison

of the net effect on transaction costs.

Asset Specificity

Transaction costs and the choice of vertical coordination method depend on characteristics of the transaction. The TCE paradigm places an emphasis on the

degree of asset specificity in an exchange relationship,

or the degree to which assets are specifically designed

or located for a particular use or user. Once specific

assets are locked into a relationship, they can be redeployed only at a great loss in productive value, which

results in sizable quasi-rents.11 Because relationshipspecific assets have much lower value in other uses by

other users, they reduce the number of potential trading partners. Hence, the investing party will be subject

to holdup, or exploitative, self-interested actions (also

referred to as opportunistic behavior) by the other

party to appropriate the quasi-rents and generate

above-normal returns. 

A decline in the number of buyers and sellers also can

lead to small-number bargaining problems (Frank and

Henderson). Coupled with specialized assets, small10Other explanations for alternative methods of vertical coordination include (i) to increase profits in noncompetitive markets

(Royer), (ii) to price discriminate and create barriers to entry

(Stigler), (iii) to shift price and production risk to firms that can

manage risk more efficiently (Knoeber and Thurman; Martin,

1997), (iv) to ensure input supplies (Carlton), and (v) to sustain a

strategic competitive advantage (Westgren).

11The difference between the value of an asset in its best use and

in its next-best use is referred to as “quasi-rent.”
number bargaining increases the potential for opportunistic behavior because alternative exchanges cannot

be easily arranged. Asset specificity and small-number

conditions, however, create value in enduring

exchange relationships. 

Types of asset specificity include physical, site, and

temporal. Physical specificity is derived from the physical features of an asset. For example, special-purpose

equipment and specialized investments required for

scale economies are physical specificities (Williamson,

1979). The buyer of the finished product can appropriate quasi-rents that are generated from these investments by offering a price lower than the originally

agreed-upon price. As long as the offer price exceeds

the value of the asset in its next-best use, the producer

has few options but to accept the offer. Site specificity

occurs when buyers and sellers locate facilities close to

each other to reduce transportation costs. Because

relocation costs are high, site specificities lock parties

into an exchange relationship for the useful life of the

asset. For example, a producer may be deciding

whether to locate a farm operation close to a processor.

The quasi-rents generated are the difference between

the negotiated price and the price available from the

next-closest processor, less transportation costs. Once

again, the buyer can appropriate these rents by offering

a lower price than originally agreed. Temporal specificity refers to the timing of delivery and its effect on

product value. For example, temporal specificities may

arise because a producer of a perishable product has

difficulties finding alternative processors on short

notice. The buyer may appropriate the quasi-rents by

threatening to delay acceptance of the product.

Temporal specificities are less severe in “thick” markets where large numbers of buyers and sellers

enhance competition (Pirrong). 

A party that invests in specific assets will choose alternatives to spot-market coordination that provide safeguards against opportunistic behavior and reduce

resource expenditures on haggling and bargaining over

price. In a contract relationship, one party may agree

on investments to be made and quantities to be delivered. The other party may agree on prices to pay based

on various contingencies that arise over time. Private

actions for breach of contract and public laws protecting contract parties help enforce contracts and protect

contract parties. As assets become more specialized, the

investing party will expend more resources to specify

more contract contingencies because there are greater

benefits from “holding up” the asset owner. In addition,

parties may not always honor contracts, and these

actions may result in costs associated with investigating

contract violations and court litigation. Consequently,

vertical integration, which eliminates the exchange

relationship, becomes more prevalent as asset specificity and the potential benefits to reneging on contracts

increase (Klein, Crawford, and Alchian) (see box on

relationship between asset specificity, transaction costs,

and methods of vertical coordination). 

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  7

Methods of vertical coordination are chosen to minimize transaction costs. In the figure, k is the level of

asset specificity, M(k) is transaction costs associated

with spot-market coordination, C(k) is costs associated with contracting, and V(k) is costs associated

with vertical integration. Each method of vertical

coordination is expressed as a function of asset

specificity. For low levels of asset specificity (k<k1),

transaction costs of spot-market coordination are

minimal. As asset specificity increases to intermediate levels (k1<k<k2), contract arrangements minimize transaction costs. For transactions characterized by high levels of asset specificity (k>k2), vertical integration becomes the cost-minimizing method

of vertical coordination.

Transaction 

costs

0 k1 k2 Asset

specificity

M(k) C(k)

V(k)

Relationship between asset specificity, transaction costs, and methods of vertical coordination

Source: Williamson, 1991. 
Uncertainty

In addition to varying by asset specificity, transactions

may vary by degree of uncertainty, which arises from

three basic sources (Williamson, 1996; 1985;

Koopmans). First, uncertainties arise due to technological changes, unpredictable changes in consumer preferences, and random acts of nature. Second, uncertainties may arise from lack of timely communication or

the inability to determine simultaneous decisions and

plans made by others, such as investment decisions

and purchasing plans of consumers. Third, uncertainties may arise due to strategic behavior regarding

nondisclosure, disguise, or distortions of information

(also referred to as “behavioral uncertainty”). 

Greater uncertainty, coupled with asset specificity,

increases the importance of organizing relationshipspecific transactions in ways that avoid costly haggling

by adapting to market conditions. Bounded rationality,

which makes it impossible, or very costly, to specify

all possible contingencies or appropriate adaptations in

advance, makes it necessary for parties to adapt or

“work things out” (Williamson, 1985).12 That is,

bounded rationality makes it costly to write a complete

contract. Therefore, contracting parties are susceptible

to opportunistic behavior as contracts are renegotiated

in response to changing market conditions. Monitoring

of performance and verification of breach of contract

also become more difficult as uncertainty increases. In

cases where the degree of asset specificity is low,

uncertainty is expected to have no effect on vertical

coordination because little value is placed in an ongoing relationship. The need to adapt to market conditions is lessened because alternative exchanges can be

quickly arranged in light of unexpected events. 

Given investments in specific assets, parties may

respond to increasing uncertainty in two ways. First,

parties may engage in contracts that may become more

relational in nature. That is, instead of laying out specific details, contracts will specify the process through

which future terms of trade will be determined.

Contract terms will be specified that provide incentives

for rent-increasing adaptations to changing market

conditions, while limiting opportunism and the need

for costly arbitration (Masten, 1996). For example,

instead of negotiating a specific contract price, parties

may agree to adjust the contract price based on a market-determined index. This arrangement reduces incentives to gain advantage by obtaining special information on future prices. In addition, if a negotiated contract price differs substantially from the market price,

the disadvantaged party may be reluctant to continue

the agreement. The party may then engage in subtle,

costly behavior, such as requiring strict adherence to

the rules, purposefully delaying deliveries, or interpreting the contract literally.13 Market-based contract

prices, which narrow the gap between contract price

and market price, reduce these types of inefficient

behavior. 

Contracting parties may also respond to increasing

uncertainty by progressing from marketing contracts to

vertical integration in the spectrum of control (fig. 1)

(Frank and Henderson). When the level of uncertainty

becomes particularly high, ceteris paribus, vertical

integration is expected to become more prevalent.14

While contracting relies on the ability to anticipate

potential problems, vertical integration requires no

contract revisions and serves to facilitate adaptation to

changing circumstances as they unfold (Masten, 1996).

Vertically integrated firms can more readily adapt to

changing conditions because opportunistic behavior is

less likely within such a firm, disputes can be settled

by top management, convergent expectations can facilitate planning, and access to relevant information can

reduce haggling (Dietrich).

Measurement Costs

Transaction costs can also result from information

asymmetry among trading partners regarding product

value and producer effort. Some important attributes of

a traded good may not be directly observable to the

buyer, seller, or both. Consequently, parties may benefit by engaging in costly searching and sorting to

obtain information about the attribute of the good. For

example, a producer may sell low- and high-quality

products at the same price, and the purchaser may

expend resources to search for undervalued goods and

reject those that are overpriced. Contracts that include

compensation for efficient producer performance may

require parties to measure appropriate indicators of

production efficiency. Social waste occurs when mea8  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

12Bounded rationality refers to limits on people’s knowledge,

foresight, skill, time, and ability to articulate knowledge in a way

that can be understood by others. 

13According to Goldberg and Erickson, literal interpretation is

often referred to as “working to the rules.”

14 The term “ceteris paribus” is used in economics to indicate that

all variables except those specified are assumed not to change.
surement by buyers to determine the true value of a

good simply redistributes wealth from sellers to buyers

(Leffler, Rucker, and Munn). Expanding time and

effort in haggling and delaying agreements to influence the terms of exchange is also inefficient

(Milgrom and Roberts). 

Vertical coordination arrangements can reduce transaction costs related to inefficient measuring and sorting,

and leave more gains from exchange to be distributed

among contracting parties. If measuring output quality

were cost free, spot-market production would provide

effective price incentives for performance. On the

other hand, if measuring output quality were costly,

parties would be encouraged to shirk, cheat, and

engage in other types of opportunistic behavior. To

limit such behavior, markets may be reorganized so

that accurate measurements require less effort and cost

(Milgrom and Roberts). For example, in contracts in

which output is difficult to measure and inputs serve as

an adequate proxy for output value, buyers may enter

into contract arrangements that enable them to monitor

production inputs.

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  9
The Viability of Spot-Market

Transactions in the Poultry,

Egg, and Pork Industries

This report examines the role of contracting or vertical

integration in reducing transaction costs in the poultry,

egg, and pork industries and relates transaction characteristics to vertical coordination methods over periods

of significant change in vertical coordination. Asset

specificity and measurement costs are examined as

possible sources of transaction costs that reduce the

efficiency of spot-market trading.15

Physical Specificities and 

Small-Number Conditions

Firms that specialize in certain types of output or differentiated products, or those with highly technical

production processes, may require investments in specialized assets.16 Investments in assets that have few

alternative uses, coupled with fewer outlets or input

suppliers, determine the relationship-specific nature of

the transaction. In the broiler, turkey, egg, and hog

markets, investments in relationship-specific assets

suggest a role for contracts and vertical integration,

particularly in geographic regions undergoing industry

expansion. 

Broilers and turkeys

Following World War II, the poultry industry experienced rapid changes in technology, which induced

more specialized production facilities, processing

plants, and breeding stock designed for the production

of chickens for meat or for eggs. In the broiler industry, most growers invested heavily in chicken housing.

As noted by Breimyer, “As a broiler house cannot be

converted readily to uses other than poultry, the financial obligation imposes a tight restraint on a grower’s

freedom of action.” Similarly, the U.S. Department of

Agriculture, Packers and Stockyards Administration

found that “limited alternative uses for existing investments in broiler enterprises and limited off-farm

employment, principally in the South, have kept many

farmers in broiler production in spite of excess capacity and generally low returns.”

Investments in specialized broiler production and processing assets affected the relationship-specific nature

of transactions by limiting alternative uses and users

of such investments. While broiler houses may be specific in a production sense (that is, specialized to

broiler production), they may not represent relationship-specific investments unless there also are few

buyers.17 Scale economies associated with specialized

technology adoption resulted in fewer and larger

firms, especially in expanding regions of the South.18

According to Reimund, Martin, and Moore, technological innovations could be adapted more readily in

areas with relatively little output because existing capital investments and production methods had less

influence in these areas. 

The extent of technology adoption and associated scale

economies in the South is indicated by changes in the

size and number of U.S. broiler firms as the share of

production in the South increased (fig. 5) (app. B). In

1964, 201 processing firms operated 320 plants that

slaughtered 6.7 billion pounds of broilers. By 1984,

134 firms operated 238 plants that slaughtered 17.8

billion pounds. Larger plants became more prevalent in

the South as broiler slaughter capacity became more

concentrated in this region. In 1984, pounds slaughtered per plant in the South averaged 99 million

pounds, compared with the U.S. average of 73 million

pounds. On the production side, from 1959 to 1982,

the number of farms selling broilers fell from 42,185

to 30,100. Over the same period, the share of U.S.

broiler sales by large broiler farms (100,000 or more

birds) increased from 29 to 89 percent (Lasley et al.). 

Similarly, in the turkey industry, investments in specialized assets had a significant effect, especially in the

South. As confinement and semi-confinement production operations replaced range rearing, increasingly

specialized production stages created demand for

10  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

15Efficiency of alternative organizational arrangements is typically related to observable characteristics of the transaction because

transaction costs are difficult to measure directly (Joskow).

Hence, transaction-cost economics requires detailed information

on organizational form and attributes of transactions (Williamson

and Masten). 

16Proxies for physical asset specificity used in the empirical literature include fixed assets to shipments, fixed assets to number of

employees, advertising (representing intangible assets, such as

brand name and reputation) to shipments, expenditures on

research, ratio of research and development expenditures to sales,

and the difference between acquisition price and salvage value

(Mahoney; Frank and Henderson; MacDonald; Shelanski and

Klein; Sporleder; Caves and Bradburd).

17I thank Jill Hobbs for emphasizing this point.

18In addition to the relationship-specific nature of these investments, larger operations are associated with larger quasi-rents

and, hence, greater benefits from holdup by the other party

(Pirrong).
feeds, equipment, and other products and services

designed for each stage (Rogers, 1979; Small). By the

mid-1980s, large and specialized turkey processing

plants replaced plants that slaughtered both broilers

and turkeys during the broiler slack season, a common

practice in the 1960s (Gallimore and Irvin; Lasley,

Henson, and Jones). Regional variations in the adoption of new, specialized production technology were

reflected by the rapid decline in number and growth in

size of turkey production and processing operations

(figs. 6, 7, and 8). 

Table eggs

In the table egg industry, specialized production

replaced the general farm flock due to improvements

in breeding, feeding, disease control, management, and

marketing. For example, as in the broiler industry, pullet growing in the table egg industry was dominated by

specialized, large-scale operations using mass-production techniques (Roy, 1972). Technological innovations

in the 1950s and 1960s, including automated egg

washers, blood spot detectors, and automated egg cartoners, encouraged large-scale production and mechanized handling and distribution of a large number of 

eggs.19 Large-scale enterprises could implement new,

highly mechanized technology more advantageously

than smaller operations, which encouraged further

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  11

19Modern “in-line” operations that mechanically gather, clean,

grade, and package the eggs require large capital investments for

environmentally controlled housing and computer technology to

control egg flow, quality control, and packaging. Typically, eggs

on commercial egg-laying farms are never touched until they are

handled by the food service operator or consumer (United Egg

Producers).

Figure 5

Geographic patterns of poultry and egg production

Total U.S. production

Source: Lasley.

Broilers Turkeys Eggs

1950 70 80 1950 70 80 1950 70 80

0

20

40

60

80

100

South

West

North Central

Northeast

Figure 6

Decrease in number of turkey farms (1959-78) and

processing plants (1962-81)

Percent

Source: Lasley, Henson, and Jones.

Northeast East

North

Central

West

North

Central

South

Atlantic

South

Central

West United

States

-120

-100

-80

-60

-40

-20

0

Farms Processing plants

Figure 7

Increase in average number of turkeys per farm,

1959-78

Percent (thousands)

Source: Lasley, Henson, and Jones.

Northeast East

North

Central

West

North

Central

South

Atlantic

South

Central

West 0

2

4

6

8

10

12

14
growth in specialized egg production units (National

Commission on Food Marketing; Strausberg). 

Regional changes in the size and number of egg operations reflect corresponding differences in the rate of

specialized technology adoption. Emerging table egg

production areas of the South and West experienced

significant increases in the size of flocks (fig. 9).

While the number of farms selling eggs fell 72 percent

from 1959 to 1978, the rate of decline was highest in

States where total output expanded (Lasley; Rogers,

Conlogue, and Irvin). Average egg-packing volume

also was above average in plants in the South and in

areas of the West and below average in the North

Central, where plants were less efficient (Rogers,

Conlogue, and Irvin). 

Hogs

The pork industry has been moving toward more specialized hog production and processing operations for

over 60 years, but the trend appeared to accelerate in

the 1990s (Hurt). Modern facilities are equipped with

state-of-the-art technology dedicated only to pork production (Brewer, Kliebenstein, and Hayenga). These

new technologies are more commonly used in the larger hog-production operations (see box on hog production technologies). 

Expanding hog-production regions (for example, the

South Atlantic region, led by North Carolina, and the 

South Central region, led by Oklahoma) used the

newer, specialized technologies nearly a decade before

the traditional hog-production areas of the North

Central region (Brewer, Kliebenstein and Hayenga;

Hurt; Hurt, Boehlje, and Hale) (fig. 10). The North

Central region, which had its last major capitalization

in the late 1970s and early 1980s, was characterized by

smaller, more diversified farming operations and older

hog-production technology (Foster, Hurt, and Hale).

Much of the newer technologies could not be fully

implemented by these operations given their existing

physical and human capital. 

Regional differences in the adoption of the newer technologies, and associated scale economies, are reflected

by differences in the size of operations. In 1997, units

marketing 7,500 or more hogs and pigs accounted for

nearly all production in North Carolina and Oklahoma,

compared with less than 40 percent of production in

Iowa and Illinois (Martinez, 2000). Lower production

costs for large operations resulted from the application

of specialized technology, large capital expenditures,

bulk purchasing, and other strategies to achieve

economies of scale (Brewer, Kliebenstein, and

Hayenga). 

Small-number conditions also were apparent in regions

of hog-industry expansion. A limited number of

processors accounted for a large share of slaughter

capacity in the expanding-production regions, South

Atlantic and South Central, compared with the North 

12  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

Figure 8

Increase in average number of turkeys per plant,

1962-81

Percent (thousands)

Source: Lasley, Henson, and Jones.

Northeast East

North

Central

West

North

Central

South

Atlantic

South

Central

West 0

0.5

1.0

1.5

2.0

2.5

Figure 9

Increase in average number of eggs sold per farm,

1954-68

Percent (thousands)

Source: Rogers, Conlogue, and Irvin.

Northeast East

North

Central

West

North

Central

South

Atlantic

South

Central

West 0

0.5

1.0

1.5

2.0

2.5

3.0

3.5
Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  13

Large-Scale Hog Production Technologies

Since the 1980s, and especially since 1989, U.S. hog production has been shifting to highly specialized, largescale farms. Large-scale hog production technology differs from small-scale production technology in several

ways. Newer buildings, three-site production, and the use of all-in/all-out and isoweaning, split-sex/phase feeding, and artificial insemination typically characterize large-scale operations. 

In the 1970s and 1980s, farrow-to-finish operations with fewer than 1,000 hogs and pigs were the most common method of producing hogs. In these small-scale operations, hogs are raised from birth to market. In larger scale, commercial hog operations, specialization occurs in the three phases of production: farrowing, nursing, and finishing. Many hogs are produced on three sites (that is, one for each phase of production) while having one owner. The facilities at each site may be owned by the owner of the hogs or by another producer who

raises the hogs under a production contract. From 1978 to 1995, farrow-to-finish operations fell from 78 percent of all U.S. hog farms to 35 percent. 

Disease transmission throughout the various production stages, which reduces growth rates, lean tissue deposition, and feed conversion efficiency, is more difficult to control in larger operations. Mixing groups or ages

of hogs compromises the animals’ health because pathogens can enter through breeding stock, feeder pigs, and

other sources. Larger operations use high tech methods, such as all-in/all-out production and isoweaning, to

prevent the spread of disease. With all-in/all-out production, all animals are replaced at the same time, and

buildings are cleaned and disinfected before another group of animals arrives. With isoweaning, weaning

piglets (that is, young pigs separating from the sow) are placed in isolated accommodations to eliminate infectious agents. Precautionary measures ensure that each group of isoweaned pigs is not contaminated by pigs of

other ages. In traditional farrow-to-finish operations, younger pigs are placed in direct contact with older pigs.

Because nutrient requirements vary as pigs age, and male and female pigs develop differently after reaching a

certain weight, different levels of nutrients are required in a pig’s diet to optimize lean growth. To obtain the

most efficient feed conversion, market hogs may be separated by sex by the time they reach 70 pounds and fed

different diets (split-sex feeding). Changing a hog’s diet several times in a hog’s life also improves feed efficiency (phase feeding). Splitting the tube that distributes feed to the hogs and using additional feeding equipment (for example, feed bins and sort boxes) enables hogs to be fed different diets at different locations in the

building. Furthermore, the types of feeds flowing through the feed distribution tubes can be switched. While

many smaller operations use these techniques, they are more commonly used in large operations. 

Attempts to improve leanness and other traits in hogs require changes in the hogs’ genetic makeup. With artificial insemination (AI), the genetic makeup of hogs can be quickly controlled and changed, and new genetics

can be easily sampled. An AI program also can be tailored to the needs and goals of each farm. The use of artificial insemination increased from less than 1 percent of U.S. sows in the early 1990s to approximately 40 percent in 1998.

Sources: Brewer, Kliebenstein, and Hayenga; Marbery; Cline et al.; Singleton and Schinckel; Harris and

Harris; Hayenga et al.; Schrader; Hodson; Martinez, Smith, and Zering.
Central region (fig. 11). This scenario leaves producers

with fewer alternative outlets and, hence, makes them

more vulnerable to opportunistic behavior by existing

processors. The number of alternative hog suppliers to 

packing plants also was especially limited in the

expanding regions (fig. 12).20 Traditionally, hog-packing plants were concentrated in the North Central

region because of the abundant supply of hogs within a

reasonable distance of the region’s packing plants

(Zering, 1995). More packing capacity generated more

hog production, which generated more packing capacity, and so on. In 1992, this pattern of regional concentration growth was broken when Smithfield Foods

opened the world’s largest pork-packing plant in Tar

Heel, North Carolina.21 Smithfield’s plant was twice as

large as any plant in the North Central region (Hurt,

Boehlje, and Hale). The plant also was built to

Japanese and European standards, featuring optical

probes to measure backfat and loin eye depth and

magnetic resonance imaging to measure fat content in

hams (Miller, May 2000). The opening of this facility

occurred at a time when the North Carolina/Virginia

region already had excess processing capacity, a limited share of U.S. hog inventory, and few other hogs and

processors within reasonable trucking distance. 

14  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

Figure 10

Share of hog inventory accounted for by regions

Percent of total hogs

Note: Inventories as of December 1.

Source: Compiled by ERS/USDA from USDA[a].

1987 1990 1995 1999

0

20

40

60

80

100

North Central

South Atlantic

South Central

Other

Figure 11

Hog-packing capacity by firm and region, 1999

Percent of regional total

Note: Excel is a subsidiary of Cargill, and Swift is a subsidiary of ConAgra. 

Source: Compiled by ERS/USDA from Pork Facts, National Pork Producers Council, 2000.

Smithfield

Foods

IBP Excel FarmlandHormel Swift Other Lundy's GreenwoodOther Seaboard Sara

Lee

Swift Other

0

10

20

30

40

50

60

70

80

90

Smithfield

North Central South Atlantic South Central

20From 1981 to 2000, the number of U.S. hog farms fell from

579,000 to 86,000 (USDA[a]).

21Later, in 1995, Seaboard opened a large state-of-the-art processing plant in Guymon, Oklahoma.
Changing methods of vertical coordination

in regions of industry expansion22

In light of investments made in new specialized assets

and small-number conditions in expanding poultry,

egg, and hog markets, transaction-cost considerations

suggest that the spot market was an inefficient means

of vertical coordination in regions of industry expansion. At the same time, contracting in the broiler and

turkey industries became more prevalent in the South.

Similarly, table egg contracting increased in the South

as well (table 1). In the late 1950s, egg production

contracts existed mostly in the Southern States, where

contracting and large-scale flocks were common

because of the region’s sizeable broiler industry. By

the mid-1960s, egg production contracts had spread to

the West, where contract systems and large, vertically

integrated egg complexes that require huge investments developed together. 

In the pork industry, expanding production in nontraditional regions also was accompanied by marketing

contracts and packer-owned hogs produced under production contracts. A 1994 survey of large hog producers found that large producers in the North Central

region marketed 26 percent of hogs through the spot

market and 63 percent using marketing contracts. In

areas outside the North Central region, the difference

was greater; 14 percent of hogs were sold through spot

markets, and 81 percent were sold through marketing

contracts. For example, Smithfield Foods, which has

most of its slaughter plant capacity in the South

Atlantic region, obtains 50 percent of its slaughter

requirements from company-owned hogs, and an additional 14 percent are obtained from marketing contracts (Smithfield Foods, 10K, filed July 28, 2000).

Seaboard Farms has most of its slaughter capacity in

the South Central region and owns about 75 percent of

the hogs that it slaughters (Marbery). On the other

hand, in 1999, IBP, which has slaughter plants in the

North Central region and is the Nation’s second-largest

pork processor, did not own sows (Freese). The company’s main supply of hogs is purchased daily by IBP

buyers, a few days before processing (IBP, 10K, filed

March 23, 2000).23

Investments in specialized genetics for producing pork

with unique quality attributes also have increased. For

example, in the early 1990s, Smithfield Foods introduced Lean Generation Pork in response to diet and

health concerns related to fat content of foods. Lean

Generation Pork is produced from National Pig

Development (NPD) hogs, the leanest hogs in U.S.

large-scale production. In this case, specialized genetics represents a relationship-specific asset, regardless

of small-number conditions, because it is tied to a specific brand. Smithfield obtained uniform genetics for

the pork through a partnership with a leading hog producer, Carroll Foods, involving long-term marketing

agreements and joint ownership of hog-production

operations.

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  15

Figure 12

Number of U.S. hog and pig operations, 

December 1, 1999

Operations (thousands)

Source: Compiled by ERS/USDA from USDA[a].

North Central South Atlantic South Central

0

10

20

30

40

50

60

70

22In this section, information on regional differences in methods

of vertical coordination is obtained from Roy (1963; 1972);

Gallimore; Rogers, Conlogue, and Irvin.; Rogers (1979); and

Lawrence et al.

23 In each of the next 5 years, IBP is committed to purchasing

about 21 percent of its annual hog production capacity, using

marketing contracts with payments based on market-derived

prices (IBP, 8-K, filed November 7, 2000). 

Table 1—Table egg production and contracting in

the South

State Change in Production under

production, 1959-65 contract, 1964

Percent

Alabama 71 45

Georgia 72 33

Arkansas 159 50

Source: Gallimore and Vertrees.
Site and Temporal Specificities24

Limited procurement distances also created relationship-specific transactions in the poultry and egg industries. Parties can move chickens only about 30 miles

and still remain profitable because live birds lose

weight if transported over lengthy distances.

Consequently, as advances in distribution technology

made it more efficient to transport processed poultry

products, site specificities were created when large

processing plants moved closer to the flocks.

Production density was more critical than optimal processing plant size in determining the competitive position of processors. As processors sought high-production density to reduce the span of their broiler supply

sources, many contract growers had essentially no

alternative trading partners. Vertically integrated operations, in which the integrator owns both the production

and processing facilities, were more common with

larger-than-average broiler houses located closer to the

processing plants.

Timing factors create temporal specificities in the poultry, egg, and pork markets.25 Poultry and eggs are considered to be perishable products. Poultry requires a

withdrawal period, whereby growers withdraw feed

before the birds are processed to limit intestinal contents and protect against fecal contamination of poultry

carcasses. Processing delays can result in deterioration

of the birds’ intestines, which increases susceptibility to

rupture and contamination. Furthermore, the pressure

required to remove the crop in older birds can rupture

the crop, spill its contents, and lead to salmonella contamination, which suggests that poultry must be sent to

the processor within a narrow age range.26 In addition,

large investments by poultry processing plants in the

late 1950s, in response to mandatory inspection

requirements, increased the importance of timely bird

supplies. Table eggs undergo weight loss and albumen

deterioration immediately after lay, so eggs must reach

the supermarkets within a few days of leaving the laying house to ensure a fresh and safe product. 

In the pork industry, timely delivery of hogs to the

processing plant affects processing costs. Modern pork

processing plants are designed to operate efficiently at

a particular utilization level, and operating costs rise

rapidly at other levels of production. 

Measurement Costs

While consumers gain by understanding the value of a

good, measuring the good at the point of sale may be

costly to the consumer. Some meat attributes, such as

taste and product safety, are costly to verify before the

meat is consumed. In addition, consumers incur a cost

sorting through heterogeneous packages of equal price

to affect the distribution of gains but do not alter the

overall quality of the products. As household leisure

time becomes more valuable, such sorting becomes

even more costly.

Many product attributes that can influence consumers’

eating experiences depend on the characteristics of

animals supplied for processing. These characteristics

may be difficult to measure when the animals are sold,

but production inputs, such as genetics, feed and nutrition, and management practices, may affect certain

product attributes. For example, the pale, soft, exudative (PSE) condition in hogs, which is associated with

tough, dry, and lean pork, is difficult to measure when

hogs are sold but is highly heritable (K.E. Smith).

Measuring pathogen content also may be difficult.

Furthermore, it is costly to measure and sort animals

of varying size, shapes, and quality within and across

flocks and herds. 

Contracts and vertical integration, together with branding of retail meat products, can reduce total measurement costs within the food system. Branded products

tend to reduce consumer concerns about purchasing a

deficient product. Such a product could tarnish the

brand name and saddle the producer with potentially

critical losses. For this reason, the quality of branded

products is expected to be less variable. Quality assurances inherent in branded products are especially

important for those product attributes that are difficult

for the consumer to measure at the point of purchase.

Instead of consumers incurring the cost of attribute

measurement at the time of purchase, processors can

measure product characteristics more cheaply further

upstream, or earlier in the process.27 For those quality

16  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

24This section is based on information contained in Henry,

Chappell, and Seagraves; Rogers (1976); Marion and Arthur; Roy

(1972); Pork ’99 Staff; Byrd; Martinez (1999); Van Leusen and

Ceton; and United Egg Producers. 

25Rapid structural changes in the production of poultry, eggs,

and pork that resulted in thin markets, particularly in regions of

industry expansion, may have increased the severity of temporal

specificities.

26The crop stores undigested feed and is removed at processing.

27“Upstream” refers to stages of the marketing system closest to

the beginning of the production process. “Downstream” refers to

those stages closest to the consumer. Value is added as product

moves downstream through successive stages to consumers.
attributes of a live animal or carcass that are costly to

measure, processors can reduce measurement costs by

controlling farm inputs through contracts or vertical

integration.28 Substituting measurement by consumers

with earlier, less costly measurement further upstream

reduces total measurement costs in the food system,

leaving more gains to be distributed among buyers and

sellers.29 As sellers bear some of the cost of buyer presale measurement, sellers would also benefit (Barzel).

Branding has been an integral part of the poultry

industry for over 20 years. For example, Tyson Foods,

the Nation’s leading broiler producer, maintains a

strong national brand. Tyson’s broiler contracts specify

that growers use only company-supplied birds, which

come from genetic stock supplied by Tyson’s breeding

stock company, Cobb-Vantress. Tyson invests in breeding stock research and development to produce birds

with the most desirable natural characteristics. In the

turkey industry, Jennie-O Foods, the world’s leading

turkey processor, emphasizes branded, packaged consumer items, such as the company’s rotisserie turkey.

The company owns turkey production facilities and

supplements output from these operations with grower

contracts that specify the breed to be used, in addition

to weight and pricing formula (Hormel Foods, 10-K,

January 23, 1998). 

Leading egg companies also emphasize branding. CalMaine Foods, the Nation’s largest egg company, produces branded egg products for health-conscious consumers under the Egg·Land’s Best and Farmhouse

labels. Egg·Land’s Best eggs (with “EB” stamped on

each egg) come from hens that are fed all-natural, vegetarian diets, with no animal by-products, and contain

less saturated fats than regular eggs. Farmhouse eggs

are produced from free-range hens that feed on natural

grains. Attributes of these branded products, which

depend on special feeds and production practices,

would be difficult to measure by consumers and

processors in a spot market. 

As in the poultry industry, contracts and vertical integration in the pork industry may lower measurement

costs and facilitate branding programs for fresh pork

(chops, tenderloins, ribs, and roasts). Companies that

have recently introduced branded fresh pork products

include Hormel Foods and Seaboard. Hormel obtains

50 percent of its hog supplies from 5- to 10-year marketing contracts (Egerstrom). These contracts specify

that producers use Hormel-approved facilities and

genetics that can produce lean, uniform-sorted hogs.

Seaboard controls genetics and nutrition for its Prairie

Fresh label through integrated, environmentally controlled operations. The Pig Improvement Co. provides

the genetic base for producing uniform products with

fewer PSE-related meat attributes, resulting in less

moisture loss and juicier meat after cooking (Marbery,

June 5, 2000). 

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  17

28Furthermore, tournament production contracts used in the broiler industry also reduce measurement costs by basing grower payments on a grower’s performance relative to other growers (a

tournament). This feature reduces measurement costs because relative performance is cheaper to measure than absolute performance associated with weight and other factors, such as feed efficiency and mortality rates (Knoeber).

29The opposite is true for consumer warranties. According to

Barzel, warranty contracts on finished products, such as household appliances and other durables, reduce measuring costs

because it is cheaper for consumers to determine output quality as

the product is used than for manufacturers to test every product.
Marketing Contracts,

Production Contracts, or

Vertical Integration?

While characteristics of poultry, egg, and pork market

transactions and associated transaction costs suggest

that spot-market trading will be inefficient, the significance of alternative vertical coordination arrangements

varies across industries. Vertical integration of the production and processing stages is more prevalent in the

turkey and egg industries, while marketing contracts

are more common in the pork industry. Reasons for

these differences are explored in the following section. 

Uncertainty and Vertical 

Acquisitions

In markets with significant asset specificity, increasing

levels of uncertainty are expected to lead to methods

of coordination that transfer more control over functions to the integrator. During periods of extensive

changes in structure and vertical coordination in the

poultry and egg industries, uncertainty originated from

a variety of sources.30 Disease and heavy mortality

rates were found among birds (Black). Significant

technological advances were made within a short period of time (technological uncertainty) (Tobin and

Arthur; Martinez, 1999).31 Poor coordination of sales

between producers and buyers led to wide market

swings. Sharp industry losses in 1959 and 1961, characterized by overproduction and depressed live-bird

prices, led many hatching-egg producers, hatcheries,

and feed companies to exit the broiler and turkey

industries. Extensive changes in competitive conditions, mergers, and acquisitions at all stages in the

1960s (National Commission on Food Marketing) and

rapid inflation fueled by OPEC (Organization of the

Petroleum Exporting Countries) in the early 1970s created further uncertainties.

In the late 1950s and early 1960s, uncertainty in the

broiler industry led management centers to become

involved in stages further downstream in the vertical

chain (Tobin and Arthur). At the time, rapidly increasing broiler sales complicated coordination of vertical

stages. Advances in technology at all stages led to

excess production and depressed prices. Greater

demand for research and new product development

increased demand for capital through periods of erratic

price movement. Retailers who offered chicken breasts

and thighs at one price and drumsticks at another complicated inventory control (Strausberg). Lack of communication with buyers of dressed broilers and

overemphasis on broiler shortages and surplus led to

the demise of open markets further upstream. Feed

companies began to deal directly with wholesalers or

retailers by acquiring or merging with processors and

by building their own processing facilities. Consequently, production-related decisionmaking was

enhanced by the retailers’ superior knowledge of consumer preferences and buying habits.

In the pork industry, sources of uncertainty include

government regulations (for example, environmental

regulations, family farm ordinances) and hog prices

(table 2). In recent years, hog prices have become

more sensitive to changes in hog production (fig. 13).

Hog demand has become more inelastic, which has led

18  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

30Proxies for technological uncertainty in the empirical literature

include years to technological obsolescence, frequency of changes

in product specification, and probability of technological

improvements (Mahoney).

31In the United States, shell egg production accounts for over 70

percent of total table egg production. 

Table 2—Types of uncertainty faced by selected pork companies

Firm Type

Hormel Hog prices and availability, government regulations, consumer acceptance of products, 

and interest rate debt.

Smithfield Foods Availability and prices of live hogs and raw materials, product pricing, competitive environment

and market conditions, and failure or inability to comply with government regulations, including

environmental and health regulations.

Seaboard Farms Hog and raw material prices, third-party hogs, and pork prices.

Farmland Industries Federal, State, and local environmental laws and regulations, disease, genetic changes, 

market prices for hogs, strength of competition, and regulatory delays that affect growth 

strategies, joint ventures, and operational alliances. Note: Includes uncertainty that may cause

a company’s actual results to differ substantially from forward-looking statements.

Sources: Smithfield Foods, Form 10Q, March 14, 2000; Hormel, Form 10-K405, January 28, 2000; Farmland Industries, Form 10-Q, January 14, 2000 and Form 

S-1, January 19, 2000; and Seaboard Farms, Form 10-Q, April 28, 2000. Filings with the Securities and Exchange Commission.
to more volatile prices and revenues. The demand elasticity for a factor of production will be smaller in

absolute value as its share of total production cost

becomes smaller (Thurman). Hence, an increase in the

proportion of pork that is consumed in furtherprocessed form is expected to result in a smaller (in

absolute value) own-price demand elasticity. As pork

is bundled with other goods and services, the percentage of the pork price accounted for by marketing services increased 14 percentage points between 1990

and 2000, from 55 to 69 percent, compared with only

a 5-percentage point increase from 1980 to 1990.

Another source of uncertainty in the pork industry is the

competitive environment in which firms operate.

Processors compete in an environment in which strategy

and pricing by one company can dramatically affect the

competitive outcome of another firm, which also has

consequences for the company’s suppliers (Di Pietre). 

As in the poultry industry in the 1960s, vertical acquisitions and coordination of production and processing

through production contracts, led by Smithfield Foods,

has become more common in the pork industry.

Following 50-year lows in hog prices in fall 1998,

Smithfield purchased two leading hog producers with

which it had marketing contracts. In 2000, Premium

Standard Farms (PSF), the 2nd-largest hog producer

and 13th-largest hog slaughter firm, acquired Lundy

Packing, a hog slaughter firm based in North Carolina,

which more than doubled PSF’s processing capacity.

Vertical Integration in the Turkey 

and Egg Industries

While uncertainty in the poultry, egg, and pork markets has been associated with increases in production

contracts and vertical integration, vertical integration is

much more prevalent in the turkey and egg industries.

One possible contributing factor to the prevalence of

vertical integration is that uncertainty is more significant in the turkey and egg industries. In turkey production, both disease susceptibility and longer growing

periods increase uncertainty (National Commission on

Food Marketing; Gallimore; Strausberg; Roy, 1972).

With longer growing periods, more time elapses

between a change in buyers’ plans and corresponding

changes in production, so it takes longer to react to

price changes resulting from demand shocks.

Consequently, efficient transfer of information

between parties becomes more important, which,

ceteris paribus, increases the likelihood of vertical

integration (Caves and Bradburd). Turkeys are marketed at 4-7 months of age, compared with 5-6 weeks for

broilers, so adjustments in broiler production can be

made more quickly. The table egg production cycle is

also longer than the broiler cycle (Strausberg). 

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  19

Figure 13

Hog price and production changes over selected periods

Percent change

Source: Compiled by ERS/USDA from Meyer.

Expansion phases Liquidation phases

1978-79 1982-83 1987-88 1991-92 1993-94 1997-98 1974-75 1981-82 1985-86 1989-90 1992-93 1995-96

-50

-40

-30

-20

-10

0

10

20

30

40

Production Price
Income uncertainty from shell egg sales may be especially significant to vertical integration.32 Differences

in procurement methods of two of the top three U.S.

egg producers support this statement. Cal-Maine Foods

produces 78 percent of its eggs in vertically integrated

facilities, in which feed is manufactured, chicks are

hatched, pullets are grown, and eggs are produced,

packed, and distributed (Cal-Maine Foods, Form 10-K,

filed with Securities and Exchange Commission

August 21, 2000). Cal-Maine procures the remaining

eggs through production contracts with growers who

own their own egg-production facilities. On the other

hand, Michael Foods procures only 35-40 percent of

its eggs from company-owned hens and purchases the

remainder through marketing contracts and the open

market (Michael Foods, Form 10-K, filed with

Securities and Exchange Commission March 31,

1999). Cal-Maine sells nearly all of its eggs in the

shell egg form, whereas Michael Foods sells 94 percent as further-processed eggs, such as reduced-cholesterol products, liquid eggs, and precooked omelets.

Greater uncertainty in shell egg sales makes vertical

integration by Cal-Maine a more efficient means of

coordination. Income from shell egg sales is sensitive

to the highly variable market-based wholesale price of

shell eggs (Urner Barry Price Quotation).33 The production of value-added products can help limit uncertainty related to price changes in commodity shell

eggs. Gross margins from sales of value-added egg

products are generally less sensitive to commodity

price fluctuations.34

Changing consumer tastes and preferences for table

eggs provided an important source of demand uncertainty. Beginning in the 1950s, faster paced lifestyles

led consumers to favor lighter breakfasts and less fresh

egg consumption. In the 1970s and 1980s, health concerns raised by nutritional studies linking cholesterol

and fat to heart disease contributed further to the

downward trend in egg consumption (Brown and

Schrader). 

The inefficiency of tournament contracts, commonly

used in broiler production, could also contribute to

more vertical integration in the turkey and egg industries. In tournament contracts, grower payments adjust

automatically to production influences common to all

growers because payments are based on relative performance of growers, which is not affected (Knoeber).

Hence, these contracts do not require costly renegotiation of contract terms in response to shared production

influences, such as rapid advances in production technology. However, tournaments require a large number

of contestants (growers) to effectively reduce riskbearing costs.35 Tournament contracts perform more

efficiently in the broiler industry than in the turkey and

egg industries because there are more broiler growers

relative to processors (Knoeber). The design of tournament contracts for turkey and egg production was less

feasible.

Transaction costs associated with significant site specificities in the egg industry also suggest that vertical

integration is a more efficient means of organizing

transactions than other methods of vertical coordination. Technological breakthroughs in the 1960s led to

high-speed, in-line grading, in which eggs are conveyed directly from laying cages to grading and packing machines. Soon after 1961, on-farm egg processing became the norm (Jasper). These packing and processing operations may be considered an extreme form

of site specificity because they are located at the same

site as the farms. 

Temporal specificities in markets associated with shell

egg production also may be significant to vertical integration. For example, Cal-Maine produces mostly shell

eggs, which are highly perishable as indicated by the

company’s low shell egg inventory, consisting of 4 days

of production (Cal-Maine Foods, Form 10-K, filed with

Securities and Exchange Commission August 21,

2000). On the other hand, Michael Foods produces

mostly egg products. Furthermore, over periods of

important changes in vertical coordination, reductions

in the number of alternative egg producers with which

to bargain were more severe than in the broiler indus20  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

32 In the United States, shell egg production accounts for over 70

percent of total table egg production. 

33Variance of prices makes it easier for firms to cheat by raising

their price (Klein, Crawford, and Alchian). Evidence from the

petrochemical industry suggests that input price uncertainty in the

1970s led to more vertical integration into input stages (Fan).

34Michael Foods recently sold shell egg production facilities to

reduce exposure to the commodity egg market and to focus on

production of value-added products (Smith, 2000).

35In the transaction cost economics literature, the risk-shifting

role of coordinating methods is ignored. This has been justified

based on several factors, including (i) the ability of owners to

diversify their business to limit the effects of risk, (ii) the inability

to directly observe risk preferences, and (iii) the lack of attention

to other explanations for business arrangements by focusing on

risk aversion (Masten, 1996). 
try. From 1959 to 1978, the number of egg farms fell

72 percent, compared with an 18-percent reduction in

the number of broiler farms over the same period

(Lasley). This finding suggests that thin markets

increased the severity of temporal specificities.36

Less dense production areas in the egg industry, compared with the poultry and pork industries, suggest that

vertical integration may be especially prevalent in egg

markets. Geographically concentrated regions may

provide a check on opportunism associated with specific assets, which suggests that motives for vertical

integration would be more pronounced in geographically dispersed industries, as firms vertically integrate

to protect against opportunism. The egg industry is

more widely dispersed than the poultry and pork

industries (app. C). News of opportunistic behavior

also may spread more rapidly in concentrated regions,

which would reduce the likelihood of holdup and

lessen the need for vertical integration (Enright). For

example, in the pre-1960s U.S. tuna industry, small

boats and frequent deliveries to port served to constrain processor opportunism because of the potential

for losing the trust of current and potential trading

partners (Masten, 1996). That is, the high density of

trading partners that could observe and communicate

instances of opportunism put the processors’ reputation

at stake.

Marketing Contracts in the 

Pork Industry

While processor-owned hogs are becoming more common in the pork industry, marketing contracts remain

the prevalent method of vertical coordination in the

pork industry, particularly in comparison with the poultry and egg industries. The prevalence of asset specificities in the poultry and egg industries possibly leads

to more vertical integration, which reduces the likelihood of holdup. In hog markets, temporal specificities

have less influence on vertical coordination because

there is greater flexibility in the age at which hogs can

be slaughtered (Pork’ 99 Staff). Site specificities also

have less influence because hogs have a higher dressing

percentage and more value, which enables them to be

transported longer distances (Pork’ 99 Staff). 

Greater uncertainty, coupled with investments in relationship-specific assets, typically results in fewer marketing contracts and greater reliance on production

contracts and vertical integration. However, marketing

contracts that are relational in nature provide a compelling incentive for reliance on these contracts in the

pork industry. With formula-priced contracts, which

are the most popular type of hog marketing contract,

payments adjust automatically to changes in market

conditions because contract payments are typically

linked to a spot-market price.37 This feature limits

opportunities for producer or processor holdup because

it is not necessary for parties to continually renegotiate

the base price.38 In addition, following significant

changes in vertical coordination in the poultry and egg

industries, advances in information technology may

have reduced some sources of uncertainty for the pork

industry in the 1990s. These advances would lessen

the need for production contracts and vertical integration, which offer more control to the contractor and

integrator.39

Another factor that may influence the pork industry’s

reliance on marketing contracts is that processors contract with fewer and larger hog producers using a uniform set of inputs. By establishing marketing contracts

with large hog producers, coordination occurs across

fewer firms, which can substitute, albeit imperfectly,

for greater control offered to processors through production contracts and vertical integration. Marketing

contracts also may give the processor some control

over hog quality and uniformity by stipulating inputs

to be used by the producer. A survey of 19 of the

largest hog processors found that half of the packers

with marketing contracts required a minimum volume

to be supplied, and either the minimum quality of hog

to be supplied or their genetics (Hayenga et al., 1996).

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  21

37 These contracts provide no shifting of price risk because the

contract price varies directly with the spot-market price. 

38Spot-market prices are often adjusted based on quality premiums and discounts, which may provide an area of contention.

However, changes in private grading programs occur less often

than changes in spot prices. 

39In their empirical analyses using transaction cost economics,

Levy and Frank and Henderson construct a measure of unanticipated demand uncertainty. Their analysis is accomplished by calculating the variance of the residuals from a regression of logged

food industry, or firm, sales on a time trend. Similarly, in this

report, annual logged pork, broiler, turkey, and egg expenditures

were regressed on a time trend to construct a measure of demand

uncertainty. Poultry and egg uncertainty was calculated over two

periods of extensive changes in vertical coordination, 1955-64

and 1965-74. To compare, recent demand uncertainty in the pork

industry was calculated for the period 1990-99. Statistically, the

variance of residuals for poultry and eggs was significantly larger

in the 1965-74 period than the variance for pork. However, in the

1955-64 period, only broiler demand uncertainty exceeded recent

pork uncertainty. 

36 The decline in the number of turkey farms also was quite

severe, falling 92 percent from 1959 to 1978.
Processors that contract for large numbers of hogs

from uniform supplies have stopped measuring every

hog, basing payments instead on periodic samples and

the distribution of quality (Di Pietre). In 1999,

Smithfield Foods had marketing contracts with 3 of the

top 10 hog producers (Murphy Farms, Maxwell Foods

(also known as Goldsboro Hog Farm), and Prestage

Farms), accounting for 29 percent of slaughter. These

producers, in turn, established production contracts

with growers, which provided substantial control over

production. After acquiring two large hog producers,

Murphy Farms and Carroll Foods, Smithfield currently

has production contracts with 1,200 growers, representing about 70 percent of hog production in North

Carolina (Marbery, December 18, 2000). On the other

hand, Tyson Foods has contracts with 7,402 broiler

growers (Tyson Foods).

22  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA
Beyond Transaction Costs:

Benefit Effects From

Contracting and Vertical

Integration

While contracts and vertical integration can minimize

transaction costs, these arrangements also may facilitate

new, more efficient resource allocations (Dietrich;

Milgrom and Roberts; Klein, Crawford, and Alchian;

Demsetz; Langlois). “Benefit effects” resulting from

more efficient resource allocations increase, rather than

merely redistribute, gains from exchange. For example,

if a firm overcomes supplier quality deficiencies, benefits extend to production, by price and/or productivity

changes. In the poultry, egg, and pork industries, benefit effects from resource allocations include improved

production efficiency and changing product characteristics that lower costs and increase demand. 

Production Efficiency Gains

Lower production and processing costs associated with

changes in vertical coordination can be derived from a

number of sources. First, contracting or vertical integration can induce firms to make optimal investments

in relationship-specific assets. The threat of opportunism in the spot market may discourage parties from

investing in highly productive specific assets (for

example, genetics, modern in-line egg facilities and

equipment). Without contracts or vertical integration to

safeguard against opportunism, the producer and

processor each may invest in more flexible, less efficient technology that could be used for a wider range

of customers.40 On the other hand, investments in

more specific assets and increased management control may alter the production function to increase productivity at higher volumes. Second, contract arrangements and vertical integration also may encourage

buyers and sellers to locate closer to each other, thereby lowering transportation costs. Other potential

sources of cost savings include improved scheduling of

perishable product deliveries and faster responses to

changing market conditions. 

Important technological innovations in poultry and egg

production resulted in significant gains in production

efficiency, as measured by feed requirements, length of

production period, and output per bird (table 3).

Efficiency gains, over periods of extensive changes in

vertical coordination, were passed on to consumers in

the form of large supplies of lower priced meat and egg

supplies (fig. 14). The broiler industry was the last of

the poultry and egg industries to develop, as technological innovations helped to fuel rapid growth of the industry (Martinez, 1999). Commercial broiler production

was practically nonexistent in 1930, and until 1948,

most of the chickens sold were old, tough, egg-type

chickens that were primarily by-products of the egg

industry. Production of chickens bred for meat rather

than egg laying increased from 100 million pounds in

1934, when the numbers were first compiled, to 3 billion pounds in 1953. Another 20-year period, 1960-80,

saw broiler production nearly triple, compared with only

a 35-percent increase in nonbroiler chicken production.

Over the same period, less sizeable, but substantial

increases in the turkey industry occurred as production

doubled, and despite falling demand for table eggs, egg

production rose by 13 percent. 

Studies have verified that broiler contracting had lower

production costs than independent broiler production

and influenced the industry’s growth and efficiency

(Roy, 1963, 1972; Marion and Arthur; Tobin and

Arthur). Important sources of cost reductions in the

broiler industry from 1955 to 1962 included economies

of scale at all stages, closer proximity of birds to proEconomic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  23

40According to Masten (1998), the effects of contract protection

on the willingness of transactors to make beneficial relationshipspecific investments are just beginning to be analyzed.

Table 3—Efficiency gains in the poultry and egg sectors

Broilers Turkeys Eggs

Year Age to Feed per Market Age to Feed per Market Eggs per Feed per

market pound of weight market pound of weight hen per dozen

(wks) gain (lbs) (lbs) (wks) gain (lbs) (lbs) year eggs (lbs)

1925 15.0 4.0 2.8 34 5.5 13.0 112 8.0

1950 12.0 3.3 3.1 24 4.5 18.6 174 5.8

1975 7.5 2.1 3.8 19 3.1 18.4 232 4.2

1990 6.5 1.9 4.5 16 2.6 21.1 250 4.0

Source: University of Arkansas.
cessing plants, and closer forms of vertical coordination.

Increases in broiler contracting in the South provided

the impetus for the region’s expanding production,

while other regions had lower levels of contracting and

lagged in production volume. Low production costs

made it feasible for processors to ship broilers to all

parts of the United States and overseas as well. 

The turkey industry also benefited from cost reductions (Roy, 1963, 1972; Gallimore and Irvin). A highly

coordinated turkey production and marketing system

in the South, along with mild weather and low transportation rates, helped enable the region to overcome

disadvantages in feed costs. In the 1960s and 1970s,

vertically integrated firms usually had better management control and lower costs. 

In the 1960s, close proximity of large table egg flocks

to egg-packing plants lowered procurement costs and

increased the optimal size of the packing plants, resulted in sizable scale economies (Rogers, Conlogue, and

Irvin). Without the industry’s arrangements to protect

against opportunism, however, eggs obtained from

small and dispersed flocks would limit plant size. That

is, it would be infeasible for processors to expand the

procurement area to support a larger specialized plant.

At a particular distance, procurement costs would

exceed gains from scale economies. The cost of eggs

from vertically integrated table egg firms is significantly lower and less variable than the cost of eggs

from spatially separate production units associated

with spot-markets and contract operations (George

Morris Centre Food Industry Research Center; Roy,

1963; Michael Foods, Form 10-K, filed with Securities

and Exchange Commission March 31, 1999).

More recently, contracting in the pork industry has

been associated with continuing gains in production

efficiency. Larger litter size, more litters per sow, and

heavier market weights have resulted in 30 percent

more pork per breeding animal in 1999 than in 1990.

In 1999, a 4-percent smaller breeding herd than in

1998 produced 7 percent more pork. Larger hog operations that produce hogs under contractual arrangements tend to have higher production efficiency and

lower costs (Kliebenstein and Lawrence; USDA,

Animal and Plant Health Inspection Service). In areas

of expanding production, productivity gains of hog

production have helped to offset feed cost advantages

enjoyed by the Midwest. 

Quality and Uniformity

The broiler industry has successfully adapted breeds

and processed products to meet consumer preferences.

Consumer preferences are shaped by a number of factors, including demographics (for example, workforce

composition, household size, ethnic diversity) and

information linking diet and health.41 Consequently,

consumers increasingly demand a wide variety of

branded products that can be prepared quickly or consumed away from home (Kinsey). The TV dinner was

the first major prepared poultry product to win consumer acceptance and provided considerable benefits

to working mothers of the 1950s and 1960s

(Strausberg). As broiler integrators became increasingly dissatisfied with low, highly variable prices for

“commodity” chickens, they focused on the development of value-added chicken products (Strausberg).42

In the 1980s, branded fresh chicken and furtherprocessed products became increasingly popular with

consumers. For example, Tyson Foods introduced a

rolled tortilla with a chicken-based filling for the

Nation’s rapidly growing Hispanic market. By 1990,

the company expanded its product line to include precooked fried chicken. 

24  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

Figure 14

Relationship between retail prices and share of U.S.

output under closely coordinated production

Percent change in price, 1957-64 to 1973-80

Source: Compiled by ERS/USDA from Lasley; Marion.

0

0.5

1.0

1.5

2.0

2.5

3.0

0 10 20 30 40 50 60 70 80 90 100

Percent of output produced under vertical

integration and contracts, 1980

Pork

Beef

Lamb

Turkeys

Eggs

Broilers

41According to marketing specialists, value influences market

share, where value is defined as perceived benefits from consumption divided by price (Ritchie et al.).

42The deflated price of chicken paid by retailers fell 25 percent

from 1974 to 1980.
How do contracts and vertical integration facilitate

response to changing consumer demands? As valueadded food processing increases and specifications for

the raw materials become more stringent, material

inspection must become more rigorous as well. In the

spot market, prohibitive testing costs and sampling and

measuring errors can cause underinvestments in farmlevel quality control (Hennessy). The situation is especially relevant when processors place a significant premium on quality and consistency of inputs (see box on

marinating and breading of chicken products) or when

quality is difficult to identify in the raw product, as

with food safety. Under these circumstances, there are

incentives for processors to substitute costly measuring

with vertical integration or production contracts.

Hence, contracts and vertical integration could facilitate resource allocations that improve the quality and

uniformity of chicken supplies by removing the need

to test for quality (Hennessy). At the same time, transaction costs associated with measuring product attributes are reduced. 

The benefits of further-processed, branded products

are suggested by increases in broiler demand, as measured by the broiler demand index, corresponding to

expanded value-added products in the 1980s (fig. 15).

Demand indices represent percentage changes in 

demand relative to 1979. Each index is calculated by

comparing actual changes in per capita broiler consumption to changes that result from variations in the

retail chicken price (app. D). A broiler index approximating 200 in 1999 suggests that broiler demand nearly doubled since 1979. 

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  25

Marinating and Breading of Chicken Products

Automation enables poultry processors to quickly and efficiently meet the high-volume demands of foodservice

outlets and supermarkets for further-processed, branded products. As demonstrated by the processes in which

chicken is marinated and breaded, those demands place a premium on uniform size and shape of poultry. Most

marinated products, which are the fastest growing and highest volume value-added products, are injected with

marinade on the processing line. A tray loader automatically accumulates and deposits cut-up chickens on a conveyor belt. While workers are required to spread and turn the cut-up chicken for injecting with marinade, no

manual sorting is required. 

In the early 1980s, most processors began to manufacture breaded products (most of which are first marinated)

in response to the popularity of breaded chicken in the fast food industry. The development of in-line bread and

batter machines enabled the production of breaded chicken on a commercial scale. A conveyor belt pulls cut-up

chicken parts through a bed of breading to cover the underside of the chicken parts. Breading is also sifted from

above to cover the tops of the chicken parts. Modifications to the machines include rollers, flips (to turn the product over), and blowers (to remove excess breading). The amount of breading material applied to the parts

depends on a number of factors, including size and shape of the raw products. 

Fast food companies, such as Kentucky Fried Chicken, prefer broilers that are small and uniform for portion and

cost control purposes. Breaded chicken parts of uniform weight and size facilitate even frying.

Sources: Benton; Smith (October 1999); Marion and Arthur; Horowitz and Miller. 

Figure 15

Poultry, egg, and pork demand relative to 1979

Index (1979=100)

Source: Compiled by ERS/USDA.

Pork

Turkey

Eggs

1979 81 83 85 87 89 91 93 95 97 99

0

20

40

60

80

100

120

140

160

180

200

Chicken
Because the demand index provides no information on

the cause of the demand shift (price of competing

meats, income, tastes, and preferences), a regression

equation is used to explain per capita chicken consumption. A simple linear demand equation is estimated using data from 1970 to 1982:

PCC = 32.8 - .18 x CHICKEN + .05 x BEEF 

+ 1.5 x INCOME, R2 = .96,

where PCC is per capita consumption, CHICKEN is

the retail price of chicken, BEEF is the retail price of

beef (chicken substitute), and INCOME is per capita

disposable income. Forecasts of per capita chicken

consumption are obtained by substituting actual values

of the independent variables, from 1983 to 1999, into

the regression equation. These forecasts are consistently below actual per capita consumption, which suggests that factors other than prices and income have

accounted for persistent increases in per capita consumption after 1982 (fig. 16). The industry’s response

to changing consumer tastes and preferences, along

with consumer perceptions regarding the healthfulness

of chicken versus red meat, has apparently influenced

the growth in broiler demand.

In the turkey industry, increased production of cut-up

and further-processed turkeys led to tighter control

over input specifications to provide more uniform

birds of specific weight (Rogers, 1979).43 Demand for

the turkey roll (one of the first processed items) and

other processed products developed slowly, as consumers were slow to change their eating habits.

However, 90 percent of turkeys are now processed

beyond the ready-to-cook form, compared with 17 percent in 1963 and 33 percent in 1970 (Gallimore and

Irvin; Gardner and Hyatt). Consequently, the availability of value-added products has extended turkey consumption from Thanksgiving and Christmas to other

times of the year (fig. 17).44

Growth in table egg contracting and vertical integration was influenced by mass merchandisers’ demand

for egg quality and uniformity. A growing demand for

higher quality eggs by egg-breaking plants reflected

efforts by food manufacturers to improve the quality of

their products (Roy, 1963). Modern, vertically integrated facilities produce a high percentage of grade A

eggs, which sell at higher prices (Cal-Maine Foods,

Form 10-K, filed with Securities and Exchange

Commission August 21, 2000).45

In the pork industry, contracts and vertical integration

can facilitate production of case-ready products by

reducing measuring costs and protecting against

opportunistic behavior associated with specialized

investments in genetics. Case-ready pork is packaged,

priced, and labeled by the processor for store display.

Uniformity in size and weight of hogs is required for

size control in the production of standardized caseready products.

26  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

Figure 16

Actual versus forecasted per capita broiler 

consumption

Retail pounds

Source: Compiled by ERS/USDA.

Regression 

equation forecast

Actual

1983 85 87 89 91 93 95 97 99

40

45

50

55

60

65

70

75

80

43 In the early 1960s, some smaller firms had well-known brand

names and indicated a preference for expanding through buying

or leasing farms, instead of contracting, because integration could

help maintain quality associated with these brand names

(Gallimore).

44Evidence suggests that an increase in turkey demand in the mid1980s (fig. 15) was likely due to new product development and

consumer preferences for white meat (Cheney et al.). 

45While egg demand has fallen since the 1950s because of convenience and health-related factors (Brown and Schrader), more

recent developments have apparently stabilized the decline in egg

demand (fig. 15). In the 1990s, per capita egg consumption

increased 9 percent, compared with a 13-percent decline in the

1980s, as the percentage sold in egg-product form continued to

increase. For example, more liquid egg products are now sold at

grocery stores as a cholesterol-free and safer alternative to shell

eggs. In addition, recent research indicates that the correlation

between egg consumption and cholesterol levels is not as strong

as once thought.
Allocating resources to the production of case-ready

meat offers several benefits. Case-ready meat promotes

the development and expansion of branded products

(M. Miller) and reduces retailer labor costs related to

meat handling and cutting. Case-ready pork also facilitates reductions in the frequency of “out-of-stocks,”

which refers to products that are sought by consumers

but are not on the display shelves (Messenger). Pork

out-of-stocks are particularly problematic because

retail meat cases typically have fewer pork cuts on display than beef cuts or chicken parts. A National Pork

Producers Council study in 1998 showed that pork

averaged 29.0 percent out-of-stocks during peak shopping hours, compared with 16.0 percent for beef and

7.5 percent for chicken (Messenger). The low rate for

chicken is attributed to the higher number of caseready products. Ready-to-stock meats reduce the frequency of out-of-stocks that are due to labor shortages

and inexperienced workers in the meat department. 

Large supplies of uniform, precooked, furtherprocessed products also are required to meet the needs

of the foodservice sector. According to the National

Pork Producers Council, pork use by the foodservice

sector, including bacon-topped sandwiches, rib dinners, and ham, grew 17 percent from 1996 to 1999

(Smith, February 18, 2000). This increase was more

than double the growth in volume experienced by the

foodservice sector as a whole. Since 1995, the number

of new pork items on menus has more than doubled

(National Pork Producers Council, February 2000).

Currently, pork receives more menu mentions than any

other meat, except for chicken.46

Potential for Further Research on

Incorporating Benefit Effects

According to Williamson (1999), most, but not all,

predictions from TCE have been found to hold when

production costs (which are affected by resource allocations) also are considered. However, Williamson

acknowledges that transaction and production costs

should be considered together. One implication of considering benefit effects is that transaction costs may

not change with different methods of vertical coordination, or may increase to exploit potential benefits. The

shift from farrow-to-finish hog production operations

to highly specialized, large-scale operations illustrates

this point. Production stages in traditional farrow-tofinish operations are vertically integrated. A single

producer located at a single site conducts all stages of

production, from farrowing to finishing. Producers that

specialize in distinct phases of production at separate

locations are “disintegra-ting.”47 The larger producers

tend to own the farrowing operations because labor is

more specialized and investment decisions are more

critical (Martin, 1999). Grower-owned facilities under

production contracts with the larger producers are then

used to finish or nurse the pigs. While coordinating

through production contracts (for example, drafting

and monitoring agreements) carries costs, these costs

are apparently outweighed by benefits from vertical

disintegration. Benefits are derived from scale

economies, specialization of capital resources, disease

control, specialized labor and management, and

manure dispersion. Large producers that specialize in

certain phases of production can spread capital over

more production units, hogs, and management services

and still maintain significant control over production.

Employees specialize in specific functions, focusing

on breeding, feeding, health maintenance, and other

areas. 

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  27

Figure 17

Per capita turkey consumption by quarter

Percent of total consumption

Source: ERS, USDA.

1960s 1970s 1980s 1990s

0

20

40

60

80

100

4th 3rd 2nd 1st

46An apparent decline in the demand for pork since the 1970s

appears to have stabilized in more recent years (Martinez, 1999).

Based on the pork demand index (fig. 15), demand for pork has

increased 11 percent since 1995. In 1999, per capita pork consumption reached its highest level since 1981. 

47According to Langlois, firm disintegration due to costs of vertical integration has received relatively little attention.
To account for “neoclassical” production costs (productivity) in the TCE framework, Williamson (1979;

1985) establishes a framework whereby firms choose

open market production or vertical integration to minimize the sum of transaction costs and production

costs. According to Dietrich, however, transaction

costs and production costs cannot be summed in such

an ad hoc fashion. Transaction costs depend on

humans’ limited cognitive abilities (bounded rationality), while neoclassical production costs do not. 

Dietrich asserts that TCE is an inherently static

approach. If attributes of a transaction do not remain

invariant when contracts replace open-market production, then the transaction costs involved (for example,

monitoring activity) cannot be defined. In other words,

when comparing the effects of alternative methods of

vertical coordination on transaction costs, the underlying characteristics of the transaction must not change.

This condition is equivalent to assuming that benefits

from resource allocations must not change (for example, productivity improvements, ability to control economic processes). These benefits are based on how

resources are used rather than simply efficient allocations with given technology and product characteristics. To avoid considering benefit effects, one must

assume a general organizational equilibrium (that is,

equality of conditions before and after a contract

agreement or other change in vertical coordination), so

that there is no incentive to adjust coordinating

arrangements. Such an assumption requires an ex ante

understanding of relevant issues or conditions or an

understanding that does not require changing based on

actual events.

Because methods of vertical coordination may be

influenced by benefit effects, Dietrich further suggests

placing transaction cost economics in a “dynamic” setting, where change unfolds rather than being specified

ex ante (Dietrich).48 In this case, the general organizational equilibrium loses its significance, and vertical

coordination need not rely solely on reducing transaction costs. 

To introduce a dynamic element into the analysis of

vertical coordination, concepts from resource-based

theory (RBT), pioneered by Penrose, may be useful

(Mahoney and Pandian). RBT views the firm as a

unique pool of productive resources and attempts to

model the sources of sustainable competitive advantage. A reallocation of resources, which include physical capital, human capital, and organizational capital,

creates benefits that may be viewed as a way for a firm

to achieve a sustained competitive advantage.49

Translating TCE into the RBT framework would view

the firm as both a pool of productive resources and an

administrative organization (Mahoney and Pandian).

28  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

48In his 1999 article, Oliver Williamson, a pioneer in the area of

transaction cost economics, concurs that transaction cost economics could benefit from a more dynamic approach. However, he

also suggests that such an endeavor will not be easy and will

require working “through the mechanisms of economic organization in a slow, molecular, definitive way” (p. 1101). 

49Organizational capital includes decisionmaking processes, coordinating systems, training, and routines (Westgren).
Conclusions

Transaction costs affect decisions to contract or vertically integrate in the poultry, egg, and pork industries.

Spot-market trading is less feasible in markets characterized by (i) new and specialized technology in thin

markets with few producers and processors, (ii) close

proximity of producers and processors, and (iii) important scheduling and timing factors related to raw product deliveries. These situations expose investors to hazards related to unscrupulous behavior by other parties.

Furthermore, measuring quality attributes of raw product inputs is more costly if the attributes are difficult to

observe or if a significant premium is placed on quality and consistency of inputs. These conditions provide

incentives for contracts and vertical integration. 

Relationship-specific investments, and market uncertainty from a number of sources, including (i) technological

advances, (ii) price and quantity instability, and (iii) lack

of communication between parties at different vertical

stages of the production process, can influence the type

of contract or the decision to vertically integrate.

Uncertainty, coupled with relationship-specific assets,

creates incentives for contracts that adjust automatically

to changing market conditions. As the degree of uncertainty increases, contracts should be used that provide

the contractor with greater control over production.

When uncertainty or relationship-specific investments

are especially severe, processing and production should

be coordinated through vertical integration. Contracting

practices and vertical integration in the poultry, egg, and

pork industries support these assertions. 

What are the implications for assessing rapid changes

in coordinating arrangements currently underway in

agricultural industries, such as the pork industry?

Policymakers can indirectly influence pressures to

enter production contracts and vertically integrate

based on how policies are shaped, enacted, and

enforced. Laws and regulations can affect firm strategies and the competitive environment in which firms

operate. Uncertainties and inconsistencies related to

enactment and enforcement of antitrust and environmental policies make it increasingly important that

firms find ways to adapt to changing policy situations.

Firms can adapt through vertical integration or contracts designed to reduce haggling and provide greater

control over the vertical stages in production. 

In the pork industry, most marketing contracts

between “independent” producers and processors are

directly related to a spot price, such as the

Iowa/Southern Minnesota quote, which facilitates

adaptations to the changing market. However, spot

prices may become less reliable indicators of market

conditions as less trading occurs on spot markets,

which may lead to conflicts between producers and

processors. Further-more, the ability of large buyers

and sellers to manipulate spot prices is enhanced

because spot prices will be based on fewer trades.

Unless alternative base prices are found, producers

and processors will seek greater control through production contracts or vertical integration. Prices from a

thriving spot market, perhaps a wholesale price, that

can serve as a base price in a marketing contract

would enable producers to survive as separate entrepreneurial entities. This arrangement suggests a role

for public programs that collect and distribute market

information to ensure a vibrant spot market. 

In addition to reducing transaction costs, contracts and

vertical integration are also associated with gains in

production efficiency and more value-added product

offerings of consistent quality. These arrangements

could facilitate important investments in cost-reducing

technology and value-added production that may have

been otherwise delayed. The effect of combined production efficiencies and tailored product offerings on

demand and consumption are likely to vary across

industries. However, continual progress in responding

to consumer tastes and preferences can facilitate an

industry’s competitiveness at home and abroad through

cost savings and sustained demand. Policies designed

to restrict business arrangements may, in fact, inhibit

industry growth and hasten the exit of firms as fewer

firms are able to compete. 

Benefits derived from contracts and vertical integration

also have implications for the framework used to evaluate these arrangements. Further research might extend

the TCE paradigm to incorporate both transaction-cost

economizing principles and benefits derived from new

resource allocations. While empirical studies generally

have supported the TCE theory (Williamson, 1999;

Shelanski and Klein), such a combined framework

may provide greater explanatory power regarding various types of vertical coordination in a variety of different industries.

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  29
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36  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA
Appendix A:

Vertical Stages of the Poultry and Egg Industries

The poultry production and marketing process consists of several stages. Company-owned feed mills are used to

manufacture feed for the various stages. Breeder farms specialize in producing the generations of male and female

strains. Breeder flocks are raised to produce male and female pullets that are sent to breeder houses. Eggs are produced and sent to hatcheries. Chicks from the hatcheries are moved to the growing stage, where they are raised to

slaughter size. After processing, products are sent to distribution centers and then transported to customers. 

In the table egg industry, egg-type chicks are hatched and grown to produce laying hens. These hens produce the

eggs that are cleaned, graded, and packed for the fresh shell egg market. Table eggs are then transported to retail

distribution centers. Eggs may also be further processed into value-added products, such as liquid eggs, and reach

the consumer through retail or institutional outlets. 

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  37

Feed mill

Breeders

Laying flocks

Hatcheries

Growers

Processors

Retailers

Feed mill

Breeders (Egg-type)

Laying (Eggs for hatching)

Hatcheries (Egg-type chicks)

Pullet growers

Table egg laying flock

Shell egg assembly, grading,

cartoning

Egg product

processing

Consumers

Retailers

Turkey and Broilers Eggs
Appendix B: 

Geographic Region Definitions

38  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA

Region States

Northeast Maine, New Hampshire, New York, Rhode Island, Connecticut,

Pennsylvania,Vermont, Massachusetts, New Jersey

North Central

East North Central Illinois, Indiana, Ohio, Wisconsin, Michigan

West North Central Iowa, Minnesota, Missouri, Kansas, Nebraska, South Dakota,

North Dakota

South

South Atlantic North Carolina, South Carolina, Georgia, Virginia, Florida, West Virginia,

Maryland, Delaware

South Central Alabama, Mississippi, Oklahoma, Texas, Tennessee, Kentucky,

Louisiana, Arkansas

West Washington, California, Utah, Oregon, Montana, Idaho, Nevada, Colorado,

New Mexico, Arizona, Wyoming
Appendix C:

Location of Broiler, Turkey, Egg, and Pork Production, 1997

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  39
40  Vertical Coordination of Marketing Systems /AER-807 Economic Research Service/USDA
Appendix D:

Demand Index Calculations

Demand indices are calculated using annual per capita consumption (1979-99), annual deflated retail prices (1979-

99), and a demand elasticity (app. table 1) in the following steps (Purcell):

1. To obtain an estimate of the annual percentage change in retail price associated with the corresponding change

in per capita consumption, the annual percentage change in per capita consumption is divided by the demand

elasticity. 

2. The “demand constant price” is calculated by adjusting the deflated retail price by the percentage change in

price from step 1.

3. The percent difference between the actual deflated retail price and demand constant price is calculated.

4. Demand indices are then calculated by first setting the 1979 index equal to 100. The 1979 index is adjusted by

adding the percentage difference calculated in step 3 for each year. 

Economic Research Service/USDA Vertical Coordination of Marketing Systems /AER-807  41

Appendix table 1—Retail demand elasticities

Broilers Turkeys Egg Pork

-.5308 -.6797 -.1452 -.7297

Source: Huang, K.S. 1985. U.S. Demand for Food: A Complete System of Price and Income Effects, Technical Bulletin 1714, U.S. Department of Agriculture, 

Economic Research Service. 

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