Mr. Chairman and members of the Committee, I appreciate the opportunity to appear at this hearing to present trends in the structure of the grain and livestock industries. I will first discuss what is meant by "structure" and why it is an issue. Then I will examine recent trends in grain merchandising and issues related to concentration. I will follow that with a discussion of the trends in the livestock industry, emphasizing the structure of livestock production, meat processing and livestock contracting and other marketing arrangements. In the last section, I will focus on some of the general issues raised concerning concentration, including its potential effects and some of the actions the Department of Agriculture (USDA) has taken in response.

What is Structural Change in U.S. Agriculture, and Why is it an Issue?

Structural change in agriculture usually refers to changes in the number and size distribution of farms and agribusiness firms, changes in the distribution of key production characteristics across farms and firms (such as what and where things are produced), and the changing business arrangements farms and firms make with one another. Structural change is studied because of concerns over economic and social effects of certain structures, particularly consolidation of farms and firms. Consolidation of farms into very large production units is sometimes called "industrialization." For example, as U.S. farms have consolidated, the number has declined from nearly 7 million in the 1930's to 2.2 million in 1998, and the share or production accounted for by the larger farms increased, raising concerns over the level of economic opportunity for small farms. Similarly, as meat packing became more concentrated with few firms dominating the market, concerns have been raised over the degree of competition in some markets.

There are many causes of consolidation in U.S. agriculture. A dominant cause is economies of scale from technical change, which increases labor productivity and reduces production costs over larger volumes of production. Farms produce larger volumes with the same or less labor at lower per unit production costs. Consolidation may also be encouraged by pecuniary economies related to size, such as volume-based price reductions on production inputs which can lower per unit production costs or premium prices on large volumes of specific outputs which increases per unit returns. Other factors that can generate consolidation include the exit of operators to retirement or more attractive income opportunities in off-farm occupations; knowledge and skills of entrepreneurs and what is needed to stay competitive; and government programs, including farm programs, tax provisions, research programs and credit programs.

Another aspect of structural change of interest in this hearing is increased "coordination" in the farm-to-consumer chain, which usually refers to contractual arrangements, alliances or vertical integration. A major force today that will increasingly affect grain and livestock coordination is the benefit derived from meeting changes in consumer demand. Consumers increasingly demand higher quality products offering nutritional benefits, convenience and taste, rather than simply homogenous commodities purchased for home meal preparation. Contracting and vertical integration bring farm production closer to the consumer, helping to ensure production meets specific consumer needs without interruptions.

Increased consolidation and coordination is accompanied by potential benefits and costs. Benefits include higher quality products available at lower consumer prices and more efficient use of production resources enabling resources to move to production of other products thus increasing national living standards. Costs include issues related to environmental quality, economic viability of small farm and firm operations, and effects on rural communities dependent on agriculture. If consolidation results in concentration, potential costs include the exercise of market power in unduly discriminatory or predatory ways.

Finally, when assessing the costs of consolidation or coordination, economists usually consider several factors. Consolidation does not necessarily mean concentration. For example, while farms have become larger, and some very large, there are still sufficient operations to ensure competition in the supply of farm production. However, if high concentration does occur, the potential for adverse effects on competition depends importantly on the level of barriers to entry of new firms, the ability of consumers to switch to substitute products, and the speed with which competitors react to one another's price changes.

Trends in Grain Production, Merchandising and Processing

Grains and oilseeds are produced by a large number of predominantly, family-operated farms. According to the 1992 Census of Agriculture, the most recent available for today's hearing (USDA will release the 1997 Census on February 1), 503,935 farms reported growing corn for grain; 292,464 farms reported growing wheat for grain; and 381,000 farms reported growing soybeans in 1992. While these numbers have declined over time and a larger share of production is accounted for by an increasingly smaller number of producers, production remains largely unconcentrated. Because of this, producers are generally price takers, that is, their individual decisions of how much to produce or market will not affect the market price; they have no negotiating power.

As grain leaves the farm gate, however, the number of firms involved with marketing and processing grains is far smaller. Assessing the impact of this concentration on producers is difficult for a number of reasons. First, focusing on concentration in one segment of the industry may mask the alternative marketing opportunities facing the farmer in other segments. For example, some producers may be able to market their grain to a variety of outlets including elevators, feed lots, or industrial users such as ethanol plants, while others may face very limited opportunities beyond the local elevator. Second, since many companies are privately owned, data on grain merchandising are not generally available, so it is difficult to assess the degree of concentration in many segments of the industry.

Concentration among grain and oilseed exporters. Preliminary data on grain inspected by USDA for export suggest the degree of concentration in U.S. grain and oilseed exports. Table 1 shows the share of export inspections accounted for by the four largest exporters as reported by the Federal Grain Inspection Service (FGIS) for their five main reporting areas over the period 1985 to 1998. In 1998, market shares of the four largest firms for the United States ranged from 47 percent for wheat to almost 70 percent for corn. While the share of total U.S. wheat exports held by the four top firms has remained relatively constant over time, the U.S. corn export market has become more concentrated. The export share for soybeans of the four top firms declined over the period. The changes in aggregate U.S. market share may mask changes at a particular port and the fact that the four top companies for some markets may have changed from period to period. In general, those reporting areas where export volumes are large and growing (e.g., New Orleans) tend to be less concentrated than reporting areas with smaller and declining volumes. For example, volume exported through the Atlantic Coast reporting area declined by about two-thirds over 1985 to 1998. The number of firms fell to four or less over the same period. Over the same period, the volume of soybeans exported through the Great Lakes reporting area increased by over 123 percent and the share of inspected exports for the four largest firms fell from 100 percent in 1990 to 71 percent in 1998.

The FGIS inspection data may understate or overstate the level of concentration because intra-company exports are frequently shipped without being federally inspected. The data also do not account for marketing arrangements between companies that may allow one company to ship through another company's exporting facility.

Control of grain warehouses and elevators. Control of storage capacity has implications in four areas-export facilities, control of delivery points for Chicago, Minneapolis and Kansas City futures markets contracts, inland or country elevators, and control of overseas grain handling facilities. While storage capacity is generally not limited to only a few firms at the national or state level, local markets may be serviced by only one or two facilities, potentially limiting farmers' storage and marketing choices and thus their net returns.

Data from Federally-approved warehouses show the relative unconcentrated market for storage space at the state level (table 2). At the national level, the four largest firms accounted for almost 27 percent of total elevator capacity. While there is much variation across states, in general, concentration tends to be lowest in those states with the largest off-farm storage capacities. The relatively high concentration ratios for Mississippi, Louisiana and Arkansas reflect the fact that the measure of total off-farm storage capacity does not include data for rice. The data do not reflect throughput and hence concentration levels could be higher if the amount of grain handled by the larger firms is proportionately greater than their share of total elevator capacity.

An analysis of delivery points for the Chicago Board of Trade's wheat, corn and soybeans futures market contracts shows that the top four companies account for more than 85 percent of the bin space available for delivery. Again, concentration may be higher (or lower) at given inland locations. Economists also point to the relatively low cost of entry for delivery of grain to barges on the Illinois River.

Grain and oilseed processing industries. The degree of concentration among grain and oilseed processing firms is largely related to the degree of processing (table 3). The top four cereal manufacturers accounted for about 85 percent of the sales in 1992. Flour and other grain milling were less concentrated; the top four firms accounted for about 56 percent of the market in 1992. Most industries have exhibited trends towards greater concentration over the period 1967-1992, with some exceptions (e.g., prepared flour mixes).

Cargill-Continental merger. On November 10, 1998, Cargill announced plans to acquire Continental Grain Company's grain trading business. In identical letters sent to Attorney General Reno and Federal Trade Commission Chairman Pitofsky, dated December 4, 1998, Secretary Glickman urged the Department of Justice to review Cargill's plans to determine whether the acquisition would notably increase concentration in agriculture and its allied industries. USDA is concerned that the acquisition might reduce competition in local and regional markets where Cargill and Continental currently compete with each other. To the extent producers have no other buyers available within their feasible delivery range, the reduction in competition would lead to a single buyer, potentially causing harm to producers.

Livestock Structural Trends

The trend toward fewer and larger farms during the last three decades has been pronounced in the livestock sector (tables 5-8).

Cattle. The number of farm operations with cattle totaled 1.168 million during 1997, down 2 percent from 1996 and 4 percent below 1995. Beef cow operations in 1997 were down 2 percent from 1996 and 3 percent below 1995. The pace of concentration for cow-calf operations has remained well below that of other livestock sectors, as production has remained spread throughout much of the country. The top 10 percent of counties had 34 percent of the total beef cow inventory in 1992, and 32 percent in 1969.

On the other hand, fed cattle has become one of the more concentrated livestock sectors, although the location of the industry has remained relatively stable in recent decades. There were about 110,000 feedlots in 1997, but the largest 2 percent market 85 percent of the fed cattle marketed. Some fed cattle production moved from the Corn Belt into larger feedlots of the Plains, but these areas were already highly concentrated in cattle feeding. Nearly all U.S. counties experiencing significant change since the 1970's are in the major producing areas of the Central and Southern Plains. Outside this area, structural change is significant in only a few counties, mainly in the Western states.

Cattle slaughter is highly concentrated (table 4). The four largest steer and heifer slaughter firms accounted for 80 percent of commercial slaughter in 1997. Although the four-firm concentration ratio is high, it has not increased since 1993. The rapid increase in concentration took place in the 1980's and early 1990's with the four-firm ratio growing from 36 percent in 1980 to 81 percent in 1993. Another indicator of the structural change in the slaughter industry is the decline in the number of Federally inspected cattle slaughter plants. From 1976 to 1996, the number of Federally inspected plants fell by more than half, from 1,665 to 812. At the same time there was a substantial decline in non-Federal plants because of closings or shifting to Federal inspection.

One measure of concentration used by the Department of Justice and Federal Trade Commission in evaluating mergers is the Herfindahl-Hirschman Index (HHI), according to which the industry in 1996 was highly concentrated. Because of the high concentration in cattle slaughter, close attention has been paid to the methods packers use to procure slaughter cattle. Firms may purchase cattle on the spot market or they may procure their cattle from their owned inventories of cattle, forward contracts, or other marketing agreements. Transactions outside the spot or cash market have become an important element in cattle producers' marketing strategies and in slaughter firms' procurement plans. Arrangements include trades using forward contracts, with either a fixed basis or price, and trades through marketing agreements with price established through a negotiated formula, which typically includes a base price with premiums or discounts for quality differences. Data from the Grain Inspection Packers and Stockyards Administration for the four largest firms slaughtering steers and heifers, show that in 1997, 3.8 percent of supplies were acquired from packer-fed cattle and 16.0 percent from forward contracts or marketing agreements. These figures have varied by only a few percentage points since 1988 with no evidence of an upward trend in the use of these procurement arrangements.

Hogs. Over the last three decades, the structure of hog production has trended toward fewer and larger operations, mirroring the general trend in the structure of American agriculture (figures). In 1967, there were 1.047 million hog operations. This figure fell to 667,000 in 1980 and to 114,000 in 1998, declining by over one-third every five years. Our most recent data show that between 1997 and 1998 the number of operations fell by 8,000 or 6.4 percent.

Large operations account for the majority or inventory. Operations with more than 1,000 hogs accounted for only 5.9 percent of the operations in 1998 but 63.5 percent of total inventory. In just the past 6 years, the percent of total inventory accounted for by these operations has grown from 28 percent to 63.5 percent. In 1998, there were 1,915 operations with over 5,000 head in inventory, accounting for 42 percent of total U.S. inventory.

Over 62,000 small operations have less than 100 head and still account for 62 percent of all operations. However, these small producers account for only 2 percent of the U.S. hog inventory. These small hog operations market too few hogs to generate sufficient net revenue even in times of strong prices to provide an adequate livelihood for their owners. Therefore, small operations are usually operated in conjunction with other farm enterprises, such as grain production and with off-farm employment.

Hog production continues to be concentrated in the north central states. Iowa, Illinois, Minnesota, Indiana, Missouri, and Nebraska are major producers. Hog production has spread to other areas, notably North Carolina now the second largest hog producer, Oklahoma, and Colorado. Growth in these and a few other states has been characterized by a relatively few but very large operations.

U.S. hog production has been becoming more efficient in general with larger operations tending to have higher litter rates and more litters per year than smaller operations. For example, operations with more than 5,000 hogs in 1998 had 24 percent more pigs per litter than operations with less than 100 head. Feed conversion to useable meat has been improving and the quality of hogs marketed has improved. Producers are using improved genetic stock to produce more standardized hogs with carcass characteristics desired by meat packers and consumers. It is this ability to produce and deliver large lots of desirable quality hogs which explains in large part the trend seen in increased marketing and production contracting.

Broadly defined, technology seems to be responsible for the geographic spread of hog production and the trend toward larger operations. Large confined operations appear to be more efficient and their location seems to be driven by low-cost land, labor, and construction costs. Some analysts also postulate that location of some new hog production investment has been influenced by environmental considerations.

In the meat packing sector, the four largest hog slaughter firms accounted for 54 percent of total commercial hog slaughter in 1997, up from 40 percent in 1990 and 34 percent in 1980. The eight largest firms accounted for 73 percent of total slaughter in 1996 (estimates are not available for 1997), up from 58 percent in 1990 and 51 percent in 1980. The HHI for hog slaughter in 1996 indicated a relatively unconcentrated industry.

On a regional basis, there are fewer packers in the Southeast (NC, SC, VA), Southwest (TX, OK, NM), and West (CA, UT). The four largest firms in these regions slaughtered more than 90 percent of the total federally-inspected hog slaughter in the region in 1997. However, a large share of the hogs produced in these regions is produced by packers or through contracts with growers. The number of federally inspected hog slaughter plants fell from 1,322 in 1976 to 770 in 1996. USDA's 1996 study, Concentration in the Red Meat Packing Industry, found no correlation between regional concentration and price; rather geographic hog pricing patterns were consistent with a single national market for slaughter hogs.

A large and growing proportion of hogs is produced and marketed under some form of contractual arrangement. The volume of hogs traded on the spot market has declined. Production contracts often specify production practices and genetics that help assure that hogs will conform to a packer's product requirements. Contract producers provide packers a steady supply of uniform quality hogs, which leads to efficiencies in plant utilization. Contract arrangements have enabled producers to enter or expand in the hog industry and to reduce some price risks for hogs and feed.

Contact terms vary. A few pay on the basis of cost of production but most pay on a formula with hogs prices based on the spot or futures market prices at time of delivery. Many hogs are sold through long-term contractual arrangements that provide price risk sharing if market prices fall outside a specified range. Producers who enter into these contracts give up some opportunity for high prices for protection against very low prices. Packers in turn provide the enhanced price when prices fall to protect themselves against very high prices and assure a steady supply of hogs when the market tightens.

With some marketing contracts, called ledger contracts, some or all of the difference between the market price and the guaranteed price is recorded as a loan. Producers incur a debt obligation to the packer when the guaranteed minimum price is above actual market prices. Packers incur a debt obligation to the producer when the guaranteed maximum price is below actual market prices.

While there is consensus that the share of hogs sold through spot markets has declined in recent years, estimates of the current size of the spot market vary from a low of 10 percent of trades to 50 percent. USDA data indicate larger producers market a larger proportion of their hogs under marketing contracts than smaller producers.

Sheep. The number of sheep operations in the United States has fallen from 113,640 in 1987 to 72,680 in 1997. The corresponding drop in sheep inventories was 28 percent, indicating the average operation is now larger. Sheep operations are widely dispersed across the States but the number of operations and inventories are largest by far in Texas. California, New Mexico, and the Mountain States account for the largest concentration of sheep production.

The largest four sheep slaughter firms accounted for 70 percent of total commercial sheep slaughter in 1997. This is down from 75 percent in 1987 but well above 56 percent in 1980. The HHI value for sheep slaughter in 1996 indicated moderate concentration. The number of federally inspected sheep slaughter plants grew from 789 in 1975 to a peak of 1,034 in 1984, but has since trended downward reaching 593 in 1996.

Issues Generated by Structural Change

The decline in the numbers of operations in many livestock enterprises and the rise in concentration in some processing activities has given rise to a number of issues including the future of small farms, environmental concerns, the transparency of markets and the efficiency of pricing, including the potential for the exercise of market power.

Small Farms. As farm production units get larger in size and first buyers of farm products become fewer in number, concern has been raised about the survivability of small farms. Secretary Glickman, sensitive to this issue, and in response to the Civil Rights Action Team Report, created the National Commission on Small Farms, to examine the issue and make recommendations. The January 1998 report of the commission indicates that there is no simple remedy to assure sustainability of small farms and that multiple barriers to their economic success need to be addressed, including targeted research, education, outreach, and friendlier farm program design. USDA knows that producers realizing available economies of scale help improve the competitiveness of U.S. agriculture and contribute to higher U.S. standards of living. With that in mind, USDA has taken actions to help improve the competitive position of small farms to enable them to realize greater returns on a smaller asset base and thus give them an increased economic opportunity to survive alongside the larger farms.

Environmental concerns. A major concern with large animal feeding operations has been the handling of livestock waste. Spills due to weather events or poor construction of facilities or inappropriate application on land to utilize the nutrients can lead to contamination of ground or surface water from nutrients, pathogens or other pollutants. Odor, which can be more intense from large operations, is also a problem for nearby residents. These concerns have led to efforts in some areas to impose state and local restrictions on size and form of ownership of livestock operations. Antagonisms generated by these concerns have probably been a factor in the change in location of hog and feedlot operations to less densely populated areas where restrictions may be fewer and the economic activity of the operation more welcome. Livestock waste concerns are also being addressed by the Federal government's national strategy on animal feeding operations which combines voluntary and regulatory programs to minimize water pollution from feeding facilities and the land application of manure. USDA's Environmental Quality Incentive Program specifically prohibits assistance to large animal operations.

Transparency and efficiency of markets. In farm product markets where the concentration ratio is high, buying firms may have the ability to obtain a farm price that may differ from the price that might otherwise prevail. One feature of markets that has received attention, particularly in cattle buying, has been the procurement of cattle by packers through forward contracts and marketing agreements and cattle that are packer-owned or fed. These methods of procurement, often collectively referred to as captive supplies, accounted for about 20 percent of steer and heifer procurement in 1997, according to Grain Inspection Packers and Stockyards Administration data, about the same as in 1988.

A producer concern about captive supplies is that as more animals are procured through captive supply arrangements, the thinner cash or spot markets may make it more difficult for a producer to find a spot buyer, an issue of access to competitive markets. Some small, independent producers worry that they may not have access to contracts and be left with a thin, potentially less competitive and more volatile spot market. Some cattle producers have alleged that the spot price may be influenced by the supply of cattle being delivered under contract, which may be under the control of the packer. On the other hand, captive supply arrangements are voluntary agreements common to other industries to manage risk on the part of both the buyer and the seller. These methods ensure a market for the seller and provide the buyer more control over delivery of animals to use packing capacity to maximize production efficiency.

The concern over the potential effects on competition in concentrated markets led Secretary Glickman to appoint a USDA Advisory Committee on Agricultural Concentration. In response to the Committee's report and USDA's ongoing concerns to ensure competition prevails in livestock slaughter markets, USDA has taken a series of actions to help ensure more transparent markets.

For example, since 1996, we have expanded coverage of boxed beef sale commitments; initiated a weekly report of premiums and discounts being offered by packers; started reporting beef grading results on a regional basis; started reporting the number of hogs produced under contract; started reporting weekly the number of cattle produced under contract for future delivery and reporting the basis difference from a futures price, if part of the contract; started reporting daily live cattle, hog and sheep crossings from Canada and Mexico; expanded the Missouri hog price reporting project to other states; started a new weekly report on meat imports; and announced intention to propose a rule to require mandatory reporting of export sales of meat by volume and destination. Last year, Secretary Glickman indicated his desire to have discretionary authority to require that livestock price information be reported to USDA. In addition, the Economic Research Service has expanded its reporting of commodity-specific market supply and demand outlook and situation reports from six times a year to twelve times.

To deal with issues related to the potential exercise of market power, USDA has restructured the Grain Inspection Packers and Stockyards Administration to strengthen enforcement against anticompetitive practices and improve the ability of the agency to enforce other provisions of the Packers and Stockyards Act. The agency has added economic, statistical and legal expertise to its field staffs and recently completed an assessment of hog procurement practices. In addition, Secretary Glickman recently called upon the Department of Justice to closely examine the proposed acquisition of Continental's grain business by Cargill.

That completes my testimony. I will be happy to respond to questions.