Executive Summary

Pricing hogs using a percentage of the pork cutout value is intuitively attractive. Producers get paid directly and consistently based on the value of pork cuts. Packers receive a consistent share of the cutout value to add to the drop value they capture to provide a gross margin from which to pay all other costs. Using a percentage of the cutout provides an incentive for packers to always maximize the carcass value?the higher the cutout, the more the packer makes. However, using a constant percentage of the cutout value to price hogs, which is how most, if not all, pork-price formulas are currently constructed, provides packers less incentive to work extra shifts to handle the normal fourth quarter and January surge in market hog slaughter numbers. This issue will only continue to grow if a larger and larger share of swine or pork market formulas use a flat percentage of the cutout to price hogs. This article identifies a solution to allow the cutout value percentage used in formulas to vary during the year. The varying percentage peaks in the summer and bottoms in the late-fall and early-winter. This would help ensure packers receive higher gross margins during the fourth quarter and January to compensate for higher costs. Producers and packers could utilize historical long-run patterns in negotiations when establishing formula percentages.