The Pricing Of Beef Cattle

Slaughter cattle, as indicted in Fig. 1, can be marketed numerous ways. However, slaughter cattle are priced in predominantly three ways: 1) live weight, 2) dressed weight, or 3) by a value-based pricing system. The premium and discount structure of a value-based pricing system is firm-dependent and varies across the industry. These value-based pricing systems are often referred to as a grid pricing system.[4]

The interaction of supply and demand for beef and beef by-products determines the market price for slaughter cattle or what economists refer to as price determination. Price discovery is the process by which buyers and sellers arrive at a transaction price for a given quality and quantity of a product. Price discovery begins with the market price level. The actual transaction price will be dependent on: 1) pricing method, 2) number of buyers and sellers in the market, and 3) the amount of information on the quality of the product being sold. Price determination and price discovery are interrelated economic concepts. Market concentration, captive supply, and incomplete information can all affect the price discovery process. Feedlot and packer market concentration cannot affect market price if competitive market forces are maintained in the beef industry.

Meat packers represent the demand side of the slaughter cattle market and the supply side of the box beef and beef by-product markets. Therefore, a packer's profit is derived from the transformation of live cattle into beef products destined for consumer markets. When a meat packing firm is making a slaughter cattle purchasing decision, the firm begins by establishing a bid price for slaughter cattle. First, the packer estimates sales revenue from the sale of beef and beef by-products. Next, the packer subtracts processing cost and a profit target to determine the price the packer would be willing to pay for slaughter cattle. Beginning with a basic profit equation,

Profit Total Revenue Total Cost

Eq. 1 can be expanded to incorporate relevant variables into the packer's profit equation:

Profit = (Pboxed -beef Qboxed-beef

^ Pbyproduct ^byproduct) (Pcattle Qcattle

+ Costs of slaughter and fabricating) (2)

where P is price and Q is quantity.

Eq. 2 can be rearranged into a general bid price equation:

Bid price per head

((Pboxed-beef Qboxed-beef + Pbyproduct Qbyproduct)

— (Costs of slaughter and fabricating + profit target))/No. of head (3)

Key points associated with the general bid equation:

1. When boxed beef and/or beef by-product prices change, then the fed cattle bid price will change.

2. Bid price will vary across individual packers because cost structure and profit targets vary across firms.

3. Profit targets shrink when fed cattle are in short supply and increase when fed cattle supply is high.

The bid price presented in Eq. 3 is a starting point for the packer. The actual offering price for a particular pen of cattle will be dependent on the marketing method selected by the seller.[5]

cattle are usually sold by lot or pen. This implies that individual animals are sold at an average per-head price.

Direct purchases of slaughter cattle either in the cash market or through one of the contractual methods listed in Fig. 1 can be conducted on a live, dressed-weight, or value-based pricing system. GIPSA reported that in 1991 48% of slaughter cattle were purchased on a live-weight basis. This implies that 52% were purchased on a carcass basis. However, Ward[6] reported that only 20% of direct purchases are made on individual carcass quality merit basis. Therefore, approximately 32% of slaughter cattle are purchased on a dressed-weight basis. Ward's findings indicate that approximately 80% of slaughter cattle are purchased at an average price per head.

The issue of average pricing of slaughter cattle has been named as a major contributor to the beef industry's continuing problem of inconsistent product quality and excess fat production.[7] Recent research on the economic consequences of average pricing of slaughter cattle suggests that average pricing introduces carcass quality estimation error into the pricing mechanism for slaughter cattle.[4] Average pricing favors producers who sell below-average quality cattle and penalizes producers who sell above-average quality cattle. Average pricing therefore interferes with the transmission of consumer preferences for specific type of beef product to producers because producers are receiving the same price for above and below average animals when sold by the pen at an average price.

The beef industry's solution to the average pricing problem has been a movement toward marketing slaughter cattle on a value-based marketing pricing system. Value-based pricing systems today are commonly referred to as grid pricing systems. A typical grid will apply premiums and discounts based on the following carcass quality characteristics: 1) quality grade, 2) yield grade, and 3) hot carcass weight. A grid pricing system begins with the packer establishing the market value for yield grade 3, quality grade choice carcass weighing between 550 and 950 pounds. This industry standard for carcass quality is then used to establish the grid system's base price. Carcasses failing to meet any of the minimum yield, quality, or weight specifications of the grid are discounted. Carcasses that exceed the minimum yield and quality specifications are given a premium.

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