grid pricing motivation, mechanics, price discovery, risk...

1

Grid Pricing Motivation, Mechanics,Price Discovery, Risk Transfer, and

Management Implications

Clement WardDepartment of Agricultural Economics

Oklahoma State University

Marketing Basics

Marketing is customer orientedEffective marketing requires understanding customers and customer wantsMarketing should start before production

What Do Beef Consumers Want?

Products that are --Tender and flavorfulConsistentConvenient to prepareHealthy and nutritiousSafeCompetitively priced

Motivation for Grid Pricing

Improve price signals from the retail level to producer levelGuide production and marketing decisionsMove toward value-based marketingReward producers for the quality of beef producedEnable buyers to match price and quality

2

Pricing Methods

Distinct trend away from live weight pricing to grid pricingFormula pricing tied to the cash market (price quote or plant average) will remain most commonBut increasing interest in negotiated base prices, or formula prices tied to the boxed beef market or futures market

Percent of Weighted Average Marketings by Pricing Method

0

10

20

30

40

50

60

70

1996 2001 2006

Perc

ent

Live Weight Carcass Weight Grid

Alternative Base Prices in Grids(Percent of weighted average marketings)

05

10152025303540

1996 2001 2006

Perc

ent

Tied to Cash Market Tied to Boxed BeefTied to Futures Market Negotiated

Motives for Using Grid Pricing

Most important -Access to carcass premiumsAccess to carcass dataObtain higher base prices

3

Highest-Rated Motives for Grid Pricing(9=Strongly agree)

0123456789

Obtain carcasspremiums

Access carcass data Obtain higher baseprices

Scal

e

Rating

Alliances By Beginning Dates

0

5

10

15

20

1976-80 1981-85 1986-90 1991-95 1996-00 2001-

Num

ber

Alliances

Cumulative Alliance Volumeby Beginning Dates

0.0

1.0

2.0

3.0

4.0

5.0

1976-80 1981-85 1986-90 1991-95 1996-00

Mill

ion

Hea

d

Alliance Volume

Type of Grids

0

5

10

15

20

25

30

Quality Grade Yield Grade Both

Num

ber

Alliances

4

Sample, Simplified Grid($/carcass cwt.)

Choice YG3 525/950# Base Price ($/cwt.)

Prime-Choice SpreadCAB-Choice SpreadChoice-Select SpreadSelect-Standard SpreadLight CarcassesHeavy CarcassesYG1YG2YG4YG5

?????

+13.00+4.00-7.00

-12.00-10.00-15.00+8.00+3.00

-20.00-30.00

Sample Grid in Matrix or Grid Form($/carcass cwt.)

Quality GradePrimeCABChoiceSelectStandard

Light carcasses (<525) -10.00Heavy carcasses (>950) -15.00

------+8.00------

------+3.00------

+13.00+4.00Base-7.00

-12.00

------

-20.00------

------

-30.00------

Yield Grade1 2 3 4 5

Premium Cells($/carcass cwt.)


21.0012.008.001.00

---

16.007.003.00

------

13.004.00

---------

---------------

---------------


Discount Cells($/carcass cwt.)


Light carcasses (<525) -10.00Heavy carcasses (>950) -15.00

-------------4.00

----------4.00-9.00

---------

-7.00-12.00

-7.00-16.00-20.00-27.00-32.00

-17.00-26.00-30.00-37.00-42.00


5

Sample Carcass Distribution(number of head)


14441

21010

22

31240220

45310

31100


Premium Priced Carcasses(number of head)


1444-

21010

--

312

---

-----

-----


Discounted Carcasses(number of head)


----1

---22

---

220

45310

31100


Grid Pricing Formula

Base pricePlus (minus) each premium (discount) cell times the percent of carcasses in each respective cell of the carcass distribution matrix

6

Grid Pricing Outcome

Base price = $120/cwt.Premiums

50 head for a total of $2.40/cwt.Discounts

45 head for a total of $4.41/cwt.Net grid price, $117.99/cwt.

Grid Pricing Examples

GridCalcCEW

http://agweb.okstate.edu/pearl/agecon/marketing/index.html

Grid Pricing versusFormula Pricing

Grid pricing involves using a premium-discount grid with some method of establishing the base priceFormula pricing typically refers to the method of finding the base price in a premium-discount gridFormula pricing uses another price as a reference price. Two common examples are:

Plant average prices or costsReported cash prices

Price Discovery Implications with Alternative Base Prices

Plant average or reported cash market formula pricesTie base price to a price that packers have an

incentive to keep as low as possibleTie base price to a declining (thinning) reference

market priceTie base price to a price representing a lower

quality of cattle

7

Base Price Alternatives

Negotiated pricesInvolve competition among packersPotentially reflect current market conditions more

accurately


Futures market pricesTie grid prices to another arena for price

discoveryLink cash and futures markets closer together


Wholesale beef prices (boxed beef cutout)Tie grid prices to a price that packers have an

incentive to increaseTie fed cattle prices closer to the retail value of

beef

Price Signals with Grid Pricing

Less emphasis on weightMore emphasis on carcass traits (merit)More variable but more accurate prices (i.e., pricing to value)Highest prices are associated with higher quality grade, better yield grade carcasses, with no weight or other discounts

8

USDA Premium-Discount Report

http://www.ams.usda.gov/mnreports/lm_ct155.txt Livestock Marketing Information Center

-30

-25

-20

-15

-10

-5

0

5

10

11/4/96 11/4/97 11/4/98 11/4/99 11/3/00 11/3/01

Prem

ium

($/c

wt c

arca

ss)

Prime

Certified Programs

Select

Standard

03/05/02

Reported Quality Grade Premiums/DiscountsNovember 1996 – April 2002

Select Discount Pattern

-20

-15

-10

-5

0

5

34 41 48 55 62

Percent Select

($/c

wt.)

Base Discount Weight

Heavy

Light

Livestock Marketing Information Center

-25

-20

-15

-10

-5

0

5

11/4/96 11/4/97 11/4/98 11/4/99 11/3/00 11/3/01

Pre

miu

m ($

/cw

t car

cass

)

YG 2-3YG 1-2

YG 3-4

YG 4-5

YG 5

03/05/02

Reported Yield Grade Premiums/DiscountsNovember 1996 – April 2002

9

Yield Grade 4-5 Discount Pattern

-20

-15

-10

-5

0

5

0 2 4 6 8

Percent Yield Grade 4-5

($/c

wt.)

Base Discount Weight

Light

Heavy


-30

-25

-20

-15

-10

-5

11/4/96 11/4/97 11/4/98 11/4/99 11/3/00 11/3/01

Dis

coun

t ($/

cwt c

arca

ss)

1,000 up lbs.

950-1,000 lbs.

500-550 lbs.

400-500 lbs.

03/05/02

Reported Discounts for Light and Heavy Carcasses November 1996 – April 2002


-40

-35

-30

-25

-20

11/4/96 11/4/97 11/4/98 11/4/99 11/3/00 11/3/01

Dis

coun

t ($/

cwt c

arca

ss)

Hardbone

Dark Cutter

Bullock/Stag

03/05/02

Reported “Out” Carcass DiscountsNovember 1996 – April 2002 Shift in Risk with

Alternative Pricing Methods

Pricing MethodLive weight

RiskPackers: quality and yield grade, dressing percent, outs

10

Shift in Risk withAlternative Pricing Methods

Pricing MethodDressed weight

RiskPackers: quality and yield grade, outsCattle owners: dressing percent

Shift in Risk withAlternative Pricing Methods

Pricing MethodGrid, formula base

RiskCattle owners: quality and yield grade, dressing percent, outs, base price

Risk-Return Tradeoff

As producers assume more risk, the potential return also increasesResearch shows - on average - as producers move from live weight to dressed weight to grid pricing, prices increase However, results depend on cattle quality characteristics

Further Considerations

Price variationManaging feeding and marketing of cattle for grid pricingValue implications for buying feeder cattle and calves

11

Variability with Grid Pricing(one day, four plants)

Average grid price $/head rangeAcross formula base prices 15-22Across seven grids 18-22Across four plants 22-45Across quality groups 11-72

Distribution of Prices(one day, seven grids, in a Northern Plains plant)

05

101520253035

Less than2.00

2.00-3.99 4.00-5.99 6.00-7.99 8.00 or more

Num

ber

of P

ens

Price Range ($/cwt.)

Quality Grade and Yield Grade Trade-off

Standard

Select

Choice

PrimeQuality G

rade

54321

Yield Grade

Target

Feeding Length Effectson Carcass Characteristics

Carcass weight increases at a decreasing rateMeaning a higher pay weightMeaning increased discounts for heavy

carcassesQuality grade increases (from Standard to Prime)

Meaning increased premiums for Prime and upper Choice

Yield grade decreases (from YG1 to YG5)Meaning increased discounts for YG4 and

YG5

12

Value of Managing Cattle AttributesValue of Managing Cattle Attributes

Attribute USDA Grid PercentPrime +$7.00 6.2CAB +$3.00 24.9 Choice +$0.00 46.5Select -$8.50 21.0Standard -$17.00 0.7Outs -$20.00 0.7YG 1 +$2.00 1.5YG 2 +$1.00 33.2YG 3 +$0.00 61.2YG 4 -$14.00 3.6YG 5 -$24.00 0.5 <550 lbs. -$20.00 0>950 lbs. -$20.00 7.3 PRICE $115.42/cwt carcass weight

186 steers on feed 147 days, ADG=3.8, Conversion=6.9, Live wt=1419lbs, 883 lb carcass, Choice, YG-3 price = $118.00/cwt


Attribute USDA Grid Percent PercentPrime +$7.00 6.2 6.2CAB +$3.00 24.9 24.9Choice +$0.00 46.5 46.5Select -$8.50 21.0 21.0Standard -$17.00 0.7 0.7Outs -$20.00 0.7 0.7YG 1 +$2.00 1.5 1.5YG 2 +$1.00 33.2 33.2YG 3 +$0.00 61.2 61.2YG 4 -$14.00 3.6 3.6YG 5 -$24.00 0.5 0.5<550 lbs. -$20.00 0 0>950 lbs. -$20.00 7.3 0.00PRICE $115.42/cwt $116.88/cwt

$2,397 pen revenue186 steers on feed 147 days, ADG=3.8, Conversion=6.9, 883 lb carcass, Choice, YG-3 price = $118.00/cwt




Value of Managing Cattle Attributes Value of Managing Cattle Attributes



Value ofManagingAttributes$3.27/cwtor$28.87/head

13

Value of Informationto Producers (KSU)

By sorting and selling 11,000 cattle by the best pricing method, revenue increased ....

$15/head compared with the next best pricing method$18/head compared with selling all cattle on a

grid$35/head compared with selling all cattle on a live

weight basis

Carcass Value Differences: Using Ultrasound and Sorting at Placement

(ISU)

800810820830840850860870880890900

Small Frame Large Frame Less Backfat More Backfat

$/H

ead

Frame and Backfat Groups

Profit Differences: Using Ultrasound and Sorting at Placement (ISU)

0

10

20

30

40

50

Small Frame Large Frame Less Backfat More Backfat

$/H

ead

Frame and Backfat Groups

Return Differences: Using Ultrasound and Sorting at Final Implant (CSU)

0

5

10

15

20

25

30

Two Three Four Five EachAnimal

$/H

ead

Number of Groups Sorted from a Single Pen

14

Implications from CSU Study

Marginal increase in returns from sorting suggests sorting into three groups at final implant stage

Marginal return ($11/head) exceeded the marginal sorting cost ($5/head)

Returns to sorting were more related to cost of gain than to grid structure

Management Musts

Know the carcass characteristics of cattle marketed via gridUnderstand the base price and its implicationsUnderstand the grid and how the net price is calculatedRecognize that management can significantly affect the grid pricing outcome

Revenue (Price) vs. Profit Goal

Profit is total revenue minus total costsRevenue considers price and weightProfit also considers purchase cost and feeding costs, including potential days on feed tradeoffs between quality and yield grade or other carcass characteristics

Grid Effects on Feeder Cattle Values (Heifers, 750 lbs.)

0

20

40

60

80

100

120

140

Prime, YG1 Choice, Y3 Standard, Y4 Average

Dol

lars

/cw

t.

COG 0.40 COG 0.60

15

Grid Effects on Calf Values(Heifers, 500 lbs.)

0

20

40

60

80

100

120

140

Prime, YG1 Choice, Y3 Standard, Y4 Average

Dol

lars

/cw

t.

COG 0.40 COG 0.60

Summary

Grid pricing offers significant opportunities - but not without additional riskCow-calf producers can be rewarded for quality genetics and feedlots can be rewarded for quality managementProducers must know their cattle, understand the grid, and make appropriate management and marketing adjustments

grid pricing motivation, mechanics, price discovery, risk...

Documents