Measuring the Importance of Transaction Costs in Cattle Marketing Jill E. Hobbs Transaction cost economics recognizes that transactions do not occur in a frictionless ‘onomic environment. Information, negotiation, and monitoring costs arise in any ransaction and can influence the vertical coordination outcome This paper Jemonstrates a method for measuring the influence of transaction costs on slaughter scattle markeu 12 The paper focuses on the factors affecting the choice between ‘veweight (live-ring auction) and deadweight (drect-to-packer) sales. Using Tobit ited dependent variable analysis, data trom a survey of UK farmers are used to estimate the relative importance of various transaction costs and farm characteristic variables for the choice of marketing channel. Wey words ‘oordination. Beef producers often have a number of mar- keting channels available when selling slaugh- ter cattle. Typically, these include live-ring and electronic auctions, direct deadweight sales to meat packers, and sales through cooperative marketing groups. Farmers can choose to sell ail, a proportion, or none of their cattle through any one of these outlets. The factors affecting the selection of marketing channel(s) have nev- er been satisfactorily addressed. One explana- twon for a cattle producer's choice of marketing channel(s) may be the transaction costs that al- ternative outlets impose on the seller. This pa- per uses transaction cost economics (TCE) (Coase, Williamson) to explain the use of live- cing auctions and direct sales to meat packers by cattle producers in the United Kingdom. Empirical measurements of the importance of transaction costs in the selection of marketing channels are obtained. Transaction Costs and Problems of Measurement ‘Transaction cost economics, unlike traditional neoclassical economic theory, recognizes that ‘he author 1s with the Faculty of Management, University of Calgary ed Mount Royal College. The research for this paper was eared out ‘re the author was withthe University of Aberdcen and SAC Ab. ‘deen, Scotland The author would hke to thank J D_Gasford, DV Gordon, WA ene and an anonymous reviewer for helpfl suggestions cattle marketing. Tobit analysis, Transaction costs. vertical commercial activity does not occur in a fric~ tionless economic environment (Williamson). Instead, it posits that there are costs to carrying out any exchange. These are transaction costs; they can be divided into three main classifi- cations: information, negotiation, and monitor- ing or enforcement costs. Information costs arise ex ante to an exchange and include the costs of obtaining price and product informa- tion and the costs of identifying suitable trading partners. Negotiation costs are the costs of physically carrying out the transaction and may include commission costs, the costs of physi- cally negotiating the terms of an exchange, and the costs of formally drawing up contracts. Monitoring or enforcement costs occur ex post to a transaction and are the costs of ensuring that the terms of the transaction, e.g., quality standards or payment arrangements, are ad- hered to by other parties to the transaction ‘The key insight provided by TCE is that, ceteris paribus, vertical coordination! between different stages of a production, processing, and distribution chain will be carried out in the According to Mighell and Jones, verea coordination includes al the ways of harmonizing the successive vere steps af production and marketing) The market-price sem, tie integration, conractng, eonperatan singly or combina 2 seme ofthe alternative mcane of coordination (p 1) ths paper. the broad definition of vertical coordination, hich 1 suds market peice, is used father thar a nareower defintion which tncludes only qonmarkst transactions Amer. J. Agr. Econ 79 (November 1997): 1083-1095 Copyright 1997 American Agriculural Economies Association Copyright © 2001 All Rights Reserved1084 November 1997 most transaction-cost-efficient manner (Coase, Williamson). Vertical coordination can be viewed as a continuum. At one extreme lie spot markets, such as auction markets, where goods are exchanged between multiple buyers and sellers in the current time period. At the other end of the spectrum lies full vertical integration, where products move between the various stages of the production-processing-distribu- tion chain as a result of within-firm managerial orders rather than at the direction of market prices. In between these two extremes lie a myriad of alternative ways of coordinating eco- nomic activity. These include informal (Le., noncontractual) buyer/seller transactions, stra- tegic alliances, formal written contracts, joint ventures, and franchise arrangements (Hobbs 1996a). One of the determinants of vertical co- ordination is the nature and level of transaction costs. Hence, a cattle producer's selection of marketing channel(s) may be affected by the transaction costs that are imposed on the seller.” ‘A number of studies have provided sound logical reasoning for, and anecdotal evidence of, the importance of transaction costs (Bar- kema and Drabenstott, Sporleder). Others have highlighted the contribution that an institutional approach such as TCE could make to our un- derstanding of agricultural markets (Paarlberg). However, there have been only a limited num- ber of attempts by agricultural economists to verify empirically the insights that TC provide (Frank and Henderson).’ One criticism of TCE is that its theoretical development has not been accompanied by suc- cessful measurement of transaction costs. Em- pirical analyses of the effects of transaction costs on vertical coordination are limited. This is perhaps not surprising because, unlike phys- ical production costs, transaction costs are often not easy to separate from other managerial costs. The complex nature of economic insti- tutions means that the costs of their operation are not easy to quantify. The data one might use to measure transaction costs are not rou- tinely collected by governments nor by the standard accountancy practices of firms. For this reason, attempting to obtain accounting- based financial measurements of transaction costs has not proven a useful avenue of inquiry. = can © The transaction costs incurred by buyers also affect which vertcat «coordination mechanism prevails (Hobbs 1996b) This pape, however focuses onthe tratsacton cosy faced by sellers “Barley. Peterson. and Bronen, man analy of the pce dite. envals between video cate suction mafkets and regional markets ‘alculate final prices not of a set of transaction costs although they fd not make expliet use of the TCE theoeeical framework Copyright © 2001 All Rights Reserved Amer. J. Agr. Econ Instead, analyses that measure the importance of individual transaction costs in determining vertical coordination outcomes may be a more fruitful approach. Slaughter Cattle Marketing in the United Kingdom Approximately 50% of slaughter cattle in the UK are sold through the traditional live-ring auction system, with the remainder largely sold directly to packers by individual producers.‘ If transaction costs are important in influencing a farmer's choice of marketing channel, changes in transaction costs will alter the proportion of cattle sold through auctions or directly to pack- ers. Previous research has investigated the im- portance of factors such as price differentials, the socio economic characteristics of produc ers, and the distance from the sales point in explaining livestock marketing decisions (Bai- ley, Brorsen, and Thomsen; Cowell and Todd; Koontz and Ward; McLean-Bullen). It is not claimed that transaction costs alone explain a farmer's choice of marketing channel. Many of these factors traditionally considered by agti cultural economists remain important. Transaction Costs The hypothesis that a producer's choice be- tween live-ring auctions (liveweight sales) and direct-to-packer (deadweight) sales is influ- enced by transaction cost and producer/farm characteristic variables is tested using data col- lected from a survey of 100 cattle producers across northeast Scotland in 1993.’ This meth- od of collecting information about transaction costs had not been attempted before, so no guidelines existed; the questionnaire was de- signed to obtain information on a wide range of potential transaction cost variables. In this way, a check was provided on variables that potentially could be important transaction costs but were not expected a priori to be important in the particular institutional environment of the UK beef marketing system. ‘The dependent variable in the analysis is the y 86 of slaughter cate ace sold though electonic mg schemes accounted for only about ales tn 1988 IMAFF). The proportion of fate sold through live-nng auctions has declined since the 1950s, When auctions accounted for HOM of slaughter cutle sales “Farther details ofthe survey and a copy of the questionnaire are available trom the author on requestHobbs proportion of a farmer's cattle sold through live-ring auctions. Fifty-six percent of respon- dents sold all of their cattle directly to a packer ‘over the period in question. Ten percent sold 111 of their cattle through a live-ring auction. ‘Thirty-four percent of producers used a mixture of auction sales and direct-to-packer sales. The independent variables are transaction st and producer and farm characteristic vari- ables. Table 1 describes the transaction cost variables that potentially could be included in ‘his analysis. The questions used to obtain mea- surements of these variables are summarized in he third column. These are the transaction costs that might be expected to influence the choice of cattle marketing channels. The final cnoice of transaction cost variables for inclu- sion in a model depends on the particular cir- cumstances of the marketing environment un- der investigation. Given the marketing envi- ronment in which UK farmers operate, several of these variables were expected to be unim- portant. The variables and reasons for their in- lusion or exclusion in the estimated model are uiscussed below. They are divided into the three categories of information costs, negotia- on costs. and monitoring costs. A complete description of the statistical properties of the data can be found in Hobbs (1995). Information Costs Before making a decision about how to market a product and to whom to sell it, beef producers must determine the price that they expect to receive. Sellers incur price discovery (or price information) costs (PINFOLW for auctions and PINFODW for direct sales in table 1). The costs of obtaining price information depend on the extent to which there is readily available in- formation on market prices. In the UK cattle market, sources of price information are well developed. Price discovery costs would prob- ably be more important in the less-developed marketing channels of the economies in tran- sition in Central and Eastern Europe, e.g., than they are in the UK. The survey data confirmed that the variables PINFOLW and PINFODW tid not vary greatly across respondents. Hence. these variables were not included in the final del. A second information cost that can arise is price uncertainty (PRICEUNC). This differs from the price discovery costs discussed above and tends to arise only under auction sales. Al- though producers can determine general price Transaction Costs im Cattle Marketung 1085 trends prior to an auction sale, they cannot know the actual price that cattle will fetch be- fore the auction takes place. This creates some uncertainty for the producer. When cattle are sold directly to a packer, the producer has been offered a price per grade before the cattle leave the farm.’ Price uncertainty is heightened if the producer is unsure of the number of buyers likely to be present at the auction sale (ADEQ- BUY). If the number is too few, there is a risk that prices will not be set competitively. Since prive uncertainty is affected by the number of, buyers present, the variable PRICEUNC was included in the model in preference to the ne- gotiation cost ADEQBUY to avoid problems of multicollinearity. Farmers selling cattle directly to packers may incur product information costs if different buy- ers require cattle with different quality speci- fications (PRODINFO). Producers must decide which packer to sell to, given their type of cat- tle, and may also have to adapt their production methods to meet these buyer requirements. This variable was not included in the final model. Pretesting revealed it to be statistically insig- nificant, with a sign contrary to theoretical ex- pectations, This may reflect the importance placed by farmers on the procurement staff from packing companies who provide farmers with information on prices and on the type of cattle required. The variable RATEPROC (see below) measures this transaction cost more ef- fectively Negotiation Costs The costs of transporting cattle to the market- place are often considered in traditional anal- yses of marketing costs. However, they can also be transaction costs if they are specific to that marketing channel. To use an auction, cattle first must be transported to the auction and sub- sequently to the premises of the buyer; there is, an additional transportation cost relative to di- rect delivery from farm to packer. This cost consists of the opportunity cost of the pro- ducer’s time and effort in organizing transpor- tation to the auction market (ORGLW) plus the monetary value of the transportation cost (LWTRAN). For comparison, data on trans- portation costs for direct-to-packer sales were * the tarmer cannot know how the calle will grade Grade uncee tainty 16a separate transaction cost and is discussed below Copyright © 2001 All Rights Reserved