Variation

     I had an opportunity to spend some time at VION, one of the largest food companies in the EU and one of the largest slaughterhouses for pigs due to recent expansions by merger and acquisiton.  They provide a website for their producers which gives a tremendous amount of very valuable information regarding their performance.  From the website the producer can download their individual animal kill stats as well as benchmark against the plant average and top performing farms.  In addition, they are provided information about lung health for instance and can also benchmark that against the plant.

     Let's take another crack at this optimal selling weight idea.  In general, for a single pig (to get the theory down), you want to add weight as long as the next lb added returns a profit.  That is, the cost of adding that pound is less than the return it receives.  Somewhere in late finishing, a pig will start receiving less and less for each pound added.  This is because feed efficiency is deteriorating and the packer matrix will at some point discount the lb because the pig is too heavy.  Even though all lbs are discounted when the sort matrix indicates a penalty, as long as the last pound was at a profit, it should be added.

     Since we have no studies which tell us this, I leave the question to you:  Is contract production of swine a low variance production method?  Which is to say, given the emerging strategies to control variation in production, will contract production systems be successful in implementing them?

     It is typical now for contract producers to be paid by the pig space instead of on performance.  This trend began a little over 10 years ago and was largely brought about for a couple of important reasons.  The typical payment schemes prior to this had paid on lbs of gain and occasionally a death loss premium and a sort loss bonus (where the grower was actually selecting the animals for harvest).  Some contracts also had a feed efficiency bonus which tried to give the grower a good incentive to adjust feeders.

Normally, lenders allow contract producers with a dependable, modern production system to put up only 15-20% of the new cost of the building as inital equity. This is because the cash flow from the unit is dependable and uniform. Because such a small amount of initial equity is required, returns on equity (ROE), the primary measure of financial outcome tend to be very high for the grower.

As mentioned previously, the payment is calculated to reimburse the grower for all costs including principal and interest on the note at a relatively small initial equity. Returns on equity (ROE) can run in the 40-70% range depending on the length of the contract and the terms of the note. Usually, this return does not calculate or factor in the cost reduction in fertilizer which accrues to those who can use the manure nutrients to offset fertilzer needs on a cash crop such as corn. When these returns are included, net of application cost, the total returns to a contract wean to finish or finishing building become some of the best that can be achieved in agriculture.

     The principal motivation for contract swine production by those who employ it has been to allow the growth of the operation.  The owner of the animals typically invests in the sow farm, animals, feed mill and related capital items and lets contracts for the facilities post-weaning.  By inviting investment in the very capital intensive production process by others, added scale can be achieved.

     I'm not sure anyone has ever thought that contract production was a low cost method of production but it allows additional scale to be achieved which offsets some of the added cost associated with it.

So let’s play around a bit with this variation stuff and see how the future cost of production might look for hogs if we forecast it by first forecasting corn and soybean meal prices and then putting those forecasts into a cost of production model to generate a forecast for future carcass prices.

This hog cost forecast was generated assuming that corn would average about $3.50/bushel and that soybean meal would be about $250/ton on average.  Under those circumstances and some stuff I will share in a minute, the average hog cost of production for a 270lb animal would be about $62.50/cwt on a carcass basis.  However, by using the variances and the correlation between the input prices in the forecast model, we can create a forecast not only of the average price but the range over which it is likely to wander and the probability it will reach any one price in the range.

     Variation in a group or population is usually described with reference to one or more basic statistical functions.  The mean or average of a group or distribution is the most common statistic used.  It is calculated simply by adding all of the observations and dividing by the number of observations.  The mean is sometimes referred to as the expected value since it is a measure of central tendenancy and in one single oberservation, represents all of the different observations in the population.  All of the observations, when taken together, will be closer to the mean than any other single number.

    Reducing variation requires first an understanding of the source(s) of variation, the likelihood of mitigation strategies to successfully reduce the variation and the cost/benefit trade-off in source mitigation. As we have discussed, the typical farm record systems and the procedures which are considered practical to perform, work against developing the necessary data and anaylysis to gain a clear understanding of the return for variance reduction.

    However, one of the most powerful aspects of variance reduction strategies is that if they are successful, they favorably affect both revenue and cost simultaneously. This results in a double bang for the buck when considering the potential financial outcomes of variance reduction investments.

Causes of variation in pig production are many and not well understood. One of the key issues arises from the spread in pig weights which begins through a kind of competitive process among the pigs beginning well before birth. Competition in the uterus and during lactation results in a sometimes widely spread distribution of potential in pigs by the time they reach weaning. Some common management procedures are implemented beginning at birth to attempt to reduce variation but their outcome is often marginal, while others, such as processing and castration introduce new challenges to subsets of pigs. Pigs of different weights require different environmental temperatures, feed types and other conditions, yet as variation increases, "average" conditions are provided which probably miss the ideal environment for all but a very small number of pigs.

Understanding variation in a pig production process is a data thing. In order to manage something or improve it, it must be measured. Measuring variation has not been a high priority in the first phase (if you will) of the modern pork industry, at least at the production level. Most record systems and the available technology to-date have focused on measuring and recording group averages. Kill sheets traditionally have provided more information about variation but until relatively recently, most producers have not had access to individual pig outcomes even from the packer (which is the only place in the vast majority of operations, where individual pigs are weighed and evaluated for quality). Typical kill sheets group pigs in ranges without giving individual animal weights and lean percents.