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Court battle between titans Smithfield and Maxwell Foods lifts veil on corporate hog industry

[1]
Maxwell Foods alleges Smithfield intentionally lied, low-balling the price of pigs to drive Maxwell out of business

For 22 years, a cabal of the nation’s largest hog producers held an annual private get-together — a high-powered gathering that court documents describe as “The Circle.”

The Circle — Smithfield, Carroll’s, Murphy Family Farms, Prestage and Maxwell Foods — began meeting in 1994 to discuss prices, trends and other issues facing the industry as it was headed toward a near-monopoly. By late 1999, Smithfield had bought Carroll’s and Murphy Family Farms, transforming The Circle into an inverted pyramid: Smithfield at the top, consolidating nearly all industry power, and Prestage and Maxwell teetering at the bottom, trying to compete.

The cutthroat nature of the corporate hog business has been detailed in a recent lawsuit filed by Maxwell against Smithfield in Wayne County Superior Court. Maxwell alleges that Smithfield not only breached a contract by refusing to buy a certain number of its hogs, but also intentionally lied about the agreed-upon price.

Smithfield allegedly paid other hog producers more,  even though its contract with Maxwell stipulates all members of The Circle are to be paid at the same rate. The purpose of the dual pricing system, Maxwell alleges, was to cement Smithfield’s dominance of the hog industry — to “drive [Maxwell] out of hog production altogether to benefit Smithfield-owned competitors of Maxwell.”

Keira Lombardo, executive vice president, corporate affairs and compliance for Smithfield Foods issued a statement to National Hog Farmer [2] that read in part: “It is regrettable that one of our longstanding hog farming partners, Goldsboro Milling, the parent company of Maxwell Foods, who has been a valuable part of our supply chain for many years, is taking legal action against us for what is fundamentally a commodity market issue of low livestock prices, from which we have also suffered. The allegations by Maxwell Foods are not true, and we will respond to the lawsuit accordingly.”

Beyond the individual allegations, Maxwell’s complaint reveals how left unchecked, one powerful company — Smithfield — can tilt the so-called free market in its favor: Beginning with the mechanisms by which whole hog prices are set, it affects purchasing agreements with other swine producers and their ability to earn a profit. Smithfield owns and operates hundreds of its own farms. And in contracts with individually-owned farms, Smithfield controls every aspect of the operations — feed, medication, lagoon and sprayfield waste systems and trucking. The only aspects of the farm it doesn’t own or control are the labor, the buildings and the land.

While Prestage and Maxwell have similar contracts with their growers, the companies still must pass through Smithfield to slaughter their pigs. Smithfield owns the only three major packing plants in the East: in Clinton and Tarheel, NC; and Smithfield, Va. (Prestage recently began trucking some of its hogs from North Carolina to Iowa, where it owns a slaughterhouse, an 18-hour trip of 900 miles.)

Ultimately, Maxwell could not compete; the company recently announced it would go out of business by the mid-2021, leaving its 150 contract growers in limbo.

“It’s inevitable,” said Lee Miller, a lecturer [3] at the Duke University School of Law, who teaches courses in agricultural law. (He is not involved in the lawsuit.) “This is just another example of how monopoly power gets exercised but is invisible to the consumer.”

Maxwell’s predicament could be viewed as karmic

S ince 1994, Maxwell has been contractually required to sell as many as 155,000 hogs to Smithfield each month. At the time, Smithfield also purchased hogs from other members of The Circle, and according to the contract included in the recent lawsuit, Maxwell was supposed to be paid the same. That price was based on the daily average set by an auction in the Iowa-Southern Minnesota market; nearly two-thirds of all hogs in the U.S. were sold that way.

But the economics changed, especially after Smithfield bought Murphy Family Farms and Carroll’s, the second- and third-largest hog producers. Industry consolidation “undermined the stability and reliability” of the auction method, court documents read, and with market control so concentrated, “it is very easy for the processors to exert undue influence over the entire [auction] market.”

Soon a new economic model emerged. Throughout the 2000s, hog producers began contracting with individual growers for the majority of their swine. By 2016, auctions had become nearly obsolete, with only 5% of hogs sold that way; today the figure is 2%.

Instead, most swine were bought and sold under a new mechanism — called “cut-out pricing” — to better reflect the true price of various cuts of a hog. A provision in the contract between Smithfield and producers in The Circle stated that if the auction price was no longer economically viable, the contract would be amended to reflect a substitute rate.

But Smithfield, which was purchased by the Chinese company, WH Group, in 2013, continued paying its producers the substandard auction price, the lawsuit reads. In 2016, Maxwell began to feel the economic hit, and asked to renegotiate the pricing structure with Smithfield. Smithfield allegedly refused to adjust the price.

Coincidentally, that was the same year that Smithfield stopped holding meetings of The Circle. “Producers were unhappy with prices they were receiving from Smithfield” — the auction price — according to the lawsuit. And Smithfield “curtailed the production and sale information it provided to Maxwell.”

For the next four years, Maxwell thought it was being paid the same rate as the other producers, even if everyone was getting low-balled. It routinely asked Smithfield to renegotiate the price, and allegedly Smithfield always rejected the request. Finally, this year Maxwell reached a financial breaking point. During a meeting with Smithfield management in February, Maxwell again asked to amend the contract for cut-out pricing.

Smithfield allegedly ignored follow-up phone calls from Maxwell until March 19, when it said there would be no change in the pricing. “Maxwell reiterated that their refusal to provide better pricing meant that Maxwell could no longer continue its operations,” the lawsuit reads.

Meanwhile, Smithfield reduced the number of hogs it bought from Maxwell by half. That stuck Maxwell with pigs it couldn’t sell, at least not easily. Consolidation has resulted, according to the complaint, in “Smithfield being by far, the dominant pork processor in the Southeast, and the only one with the capacity to handle Maxwell’s production. Smithfield represents approximately 25% of the total pork processing market nationwide which in turn has left Maxwell with no bargaining strength in its dealings with Smithfield.”

Then Maxwell learned this summer that while Smithfield was rebuffing its requests to renegotiate, “Smithfield hid from Maxwell the fact that Smithfield was already providing pricing to one or more other producers” higher than what it was paying Maxwell — allegedly in violation of the contract. As a result, Maxwell claims it “will eventually be forced out of the hog business by Smithfield.”

Now they’re just fighting over scraps.”

I ronically, Maxwell’s predicament could be viewed as karmic. “It’s hard to feel pity for the Maxwells of the world,” said Miller of Duke Law. They were an early player in consolidating several aspects of production under one company — vertical integration, as it’s known. The company started as a feed mill, branched into turkeys  and then diversified into hogs. Meanwhile, they further integrated their milling business to grain purchases and storage. “They’re the victims of the market power they used to build their own company,” Miller said. “This is very foreseeable.”

In a “rational view” of anti-trust law, Miller said, Smithfield would not be allowed to operate at its present scope and scale. Yet because consumer prices for pork are steady — the barometer federal regulators use to determine if anti-trust laws apply — Smithfield has avoided that level of scrutiny. “But that ignores the other powers that Smithfield can exercise, its capture of regulatory agencies and the legislature,” Miller said.

As part of separate nuisance suits [4] filed against Smithfield by neighbors of their contract- and owner-operated farms, Thomas Hubbard, professor of management at Northwestern University, provided an expert report explaining how anti-trust laws don’t consider the full impacts of a near-monopoly. In the instance of industrialized hog farming, “there can be ‘externalities’ … at various stages in the supply chain such as the pollution of air, water or soil  that don’t affect consumers or hog producers.” The bulk of the financial benefits rest largely with the company and its shareholders, not the contract growers or the local economies.

Although National Hog Farmer reported on an NC State University study [5] showing the hog industry created 19,000 jobs in North Carolina’s top-producing counties — Duplin, Bladen, Sampson and Wayne — those same counties are among the most state’s economically distressed, according to rankings by the NC Department of Commerce.

Even if Smithfield loses the Maxwell lawsuit, it could turn it to an advantage. Smithfield could buy out Maxwell’s contracts with individual farmers, further consolidating the industry. “These contract farmers will be desperate and out of work,” Miller said. The buyouts would also help Smithfield amass more hogs at these existing operations, allowing the company to grow despite a long-standing moratorium on new or expanded hog farms.

As for Maxwell, it could be awarded money to compensate it for lost income, but it has little other recourse. The company would still likely go out of the hog business, as it previously announced. “The fact they’ve filed this lawsuit says Maxwell has no power whatsoever,” Miller said. “Now they’re just fighting over scraps.”