Kansas Economist Sees Trend
Toward Grid Sales On Cattle

By David Bowser

MANHATTAN, Kan. — A Kansas economist who tracks price discovery trends thinks the future will see more and more cattle sold using a grid pricing system.

"I think we're going to continue to see more expansion of that because we've just got too many incentives in the industry to get away from the average-based pricing system," says Dr. Ted. C. Schroeder of the Kansas State University Department of Economics.

Schroeder says that within the last week or so the three largest packers have indicated they are all willing to bid on a base price, heretofore a completely foreign concept for two of them.

"That is evidence to me that the packers are serious," Schroeder says. "They do want to have incentives to go into a value-based pricing system, not just to throw it out as a formula and say, 'Here, do it or leave it.' I think they're saying, 'Look, we're going to try to work with you on bidding and negotiating a base as a part of what it's going to take to get you in.'

"I think a lot of the packers really desire to have a longer run marketing agreement type relation that's going to be on a value-based system. The reason I think so is that volumes drive packer efficiency, but more and more the packers are finding that there is a lot of opportunity in terms of value with having a contractual relationship on the selling side."

Packers are seeking relationships with particular food service institutes that have stringent product specifications. They want to develop relationships with export opportunity that also have specific needs and specifications.

"There is just more and more information being demanded by the buyer of the meat that it has a quality attribute associated with it," Schroeder says. "It may even have to do with the way it was produced."

That's consistent with what's happening throughout the food chain, he says.

"I do see that as a growth area," Schroeder says. "I think it's one that will continue to expand. I don't know what ultimately is the target there for the percentage of cattle that will move through that, but I do think it's quite a bit larger than it is today."

In research studies over the last few years, Schroeder says that on the average, selling dressed beef generally brings the highest return. Selling live cattle brings the lowest. Various grid systems fell somewhere in between, but generally closer to the returns offered by dressed beef.

But those studies, Schroeder says, were based on pen averages. Selling dressed beef is still basing the price system on average carcass value. More recent studies, he says, indicate that cattle individually marketed on a grid system can provide a much higher return.

In Schroeder's earlier research, he reached the conclusion that the key was knowing what kind of cattle were being produced and how best to market them for the highest return.

His most recent studies affirm that knowing the cattle is indeed the key to better returns.

"It's interesting, because some of the conclusions are consistent, but what I've found is as you dig deeper you find a lot more really happening with individual carcass value," he says. "I've looked further and even still with some grids and some cattle, it looks like dressed pricing offers, on average, similar to slightly higher opportunities, but I don't want to suggest that means much, because of what I've found as I look at cattle on an individual carcass level basis."

He took about 11,000 head of cattle and got individual carcass level grid prices as well as what they would have sold for dressed and live.

"What I found was in that data set, if you took those cattle and instead of selling them on the grid, you had sold the whole bunch dressed — dressed is again average-based pricing — the packer would have paid somewhere in the neighborhood of on average $30 too much for some of those cattle or up to $30 too little for others," he says.

"If you retarget, reshuffle and sort those cattle and send them to the optimal location, send some dressed and some to the grids, you get substantial revenue enhancements by doing that."

Schroeder says he's less concerned about selling everything grid or selling everything dressed.

What he found in his most recent studies reaffirms his initial finding that the cattle feeder and producer has to know the cattle and what they are capable of.

"It even more strongly affirms it now," he says, "with the further research that we've been able to get through. It really shines through when you put it on an individual carcass basis."

That is why Schroeder thinks the opportunities are there, he says.

"They're huge from managing simple things. Just weights alone add significant amounts of money," he insists.

He uses a computer simulation based on an actual lot of about 180 steers to show producers how much value they add by managing single attributes in a typical pen of cattle.

"I take a pen of cattle that was actually sold on a grid," he says. "It had nine percent heavyweights. The first thing you do is move the heavyweights away and you increase the value of the pen of about 180 steers by about $1500. It had a few Yield Grade 4s and Yield Grade 5s. If you remove those, you added another $600 or $700."

The pen also had a few Selects and Standards.

"If you managed those a little better," Schroeder says, "it very quickly gets up to $5000 for that pen, just one pen, in terms of value in managing some attributes. Some of them are very easy to manage. The weight issue, my goodness, we ought to be able to get to that one."

He says yield grade could be better managed, as could quality grade, even though it would be more difficult.

"My point is there are huge value opportunities in individual carcass-based management, whether it be sorting, selling at different times, even selling some on a live basis and others at a targeted grid," Schroeder says. "The amount of money that's being left lying on the table is why I think the opportunity is going to increase.

"I think they're going to take more advantage of those different marketing options. They have to. If they don't, they're really just giving up some huge returns.

"I know there are costs associated with managing all that and collecting all that information, but to me the returns are really there."

Beginning almost three years ago, Schroeder and J. Minert from KSU joined with C.E. Ward and Darrel S. Peel of Oklahoma State University's Department of Agricultural Economics to survey attitudes of cattle feeders and packers concerning price discovery issues.

"We spent with many of these folks anywhere from three hours to a full day," Schroeder says.

It was a fairly intensive interchange of issues and ideas, he says. The survey wasn't about something they could quantify in numbers. It was gathering the essence of issues and ideas.

They talked with feeding operations that included some of the 25 largest as well as some smaller operations throughout the Midwest. The bulk of the feedyards they visited were in Texas, Oklahoma, Colorado, Nebraska and Kansas.

"The particular study we did was not a scientific random sample," he concedes.

While there are some regional differences within that set, many of the differences in opinions seemed to be related more to the size of the operation than with the geographic region.

"We wanted a little geographic dispersion of folks, but we probably spent a little more time on size dispersion," Schroeder says.

There were some geographic differences.

"Some of the differences we were exploring had to do with the perceptions of selling grade and yield, for example," Schroeder says. "You certainly had a lot more comfort in that up north than you had down in the southern regions."

There were some issues in the north regarding quality grade versus the south, and some concerns about the northern quality grade specifications because the perception there, he says, is they're a little more stringent.

There was a tendency for the yards in the south to be a little more volume-driven and low-cost oriented, he says. The ones in the north seemed a little more quality-oriented. A lot of that is reflective of the size of the yards and the kinds of cattle they typically feed.

"There was a little bit of difference in management philosophy, I think, across those two regions," he says. "Primarily because of those two reasons."

Another issue that was geographically divergent was basis risk issue after the June 1995, change in the futures contracts.

"The folks in Nebraska were really fairly complacent about the basis issue," Schroeder says. "They felt there really wasn't any big to-do about the change in the contract."

They felt that the change didn't adversely impact them while the feeders down south and in the Colorado area voiced some concerns about their perception of increased basis risks and increased problems with trying to deliver on that specification.

"I think what they've just recently changed in the live cattle contract, making the discounts and premiums on quality vary over time, is a market step improving some of the problems they were having," Schroeder says. "They were concerned mainly about those fixed discounts and premiums, that if you tried to make delivery in an area where you had some cattle that were off contract spec quality, you were just going to get nailed. I suspect part of it is that Nebraska has had fewer of those kinds of cattle, so they weren't hitting those discounts quite as hard."

Despite the differences, Schroeder was particularly fascinated by the similarities.

"I think what was more important from our perspective was where there were similar attributes and concerns," Schroeder says.

One of the overriding themes of the groups the team interviewed was the need to improve the price discovery process.

The two primary aspects of that, he says, are general market information and movement toward a value-based pricing system.

"We need general market information so we know what the supply and demand scenario is on a given day and we know what prices are being traded at and how many quantities are traded," Schroeder says, "just some of the market dynamics on a day to day and week to week basis, particularly as we have large amounts of cattle moving through non-cash means."

A general concern across all regions was getting more information into the discovery process.

Another concern that was at least as significant was the need to get closer to some kind of value-based pricing system where the feedlot or cattle owner in particular is rewarded for quality or discouraged for lack of quality, Schroeder says.

Those two were the most strongly held and probably the most broad-based opinions, he says.

"There were some people who disagreed with the quality value-based pricing thing, but by and large that was a very strongly held belief jointly with the price discovery one," Schroeder says. "Those were two that we've heard a lot about in a lot of regions."

While the issues were not surprising, Schroeder says he did find it interesting that some of the producers who are noted for being commodity-driven and numbers-driven with low-cost feedlot goals voiced the same concerns and the need to get closer to value-based pricing.

The packers he interviewed indicated that they would be willing to pay more for higher quality beef. But, Schroeder notes, they are also willing to discount for lower quality beef.

"I think it's both sides," he says. "Since we completed that survey, there have been pretty significant strides in further development of grid pricing systems. I think those are consistent with that theme."

There has also been continued development of alliances that are trying to target specific quality attributes.

"We were sort of at that point in time, on the fringe of what I think is going to be a pretty significant move in the next few years," Schroeder says.

There is some indication that northern producers are more amenable to alliances or group marketing than southern producers, but Schroeder says he would have a hard time saying it was a geographic trend.

"Certainly, some up north were exploring that more aggressively," he says, "but I have a feeling that it has to do with size differences as well."

The northern yards were smaller on average. In the south, there was a little more independence, in part, he thinks, because of size.

"I don't know that I would want to go too far in saying there is a difference in their philosophy about alliances or about cooperative type of arrangements based on geography," Schroeder says. "Even in Kansas, we had some yards who were fairly aggressive or progressive about getting involved with some alliances. In Texas, we didn't see as much, but then again the yards down there were doing some of their own value-based marketings and didn't see the need perhaps to collaborate."