Fausti, Scott W.

Peterson, Donald

English

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South Dakota State UniversityOpen PRAIRIE: Open Public Research Access InstitutionalRepository and Information ExchangeEconomics Commentator Department of Economics5-23-1997Introduction to Value Based Marketing for FedCattle; Hay Prices Expected to Hold Into EarlySummerScott W. FaustiSouth Dakota State University, scott.fausti@sdstate.eduDonald PetersonSouth Dakota State UniversityFollow this and additional works at: http://openprairie.sdstate.edu/econ_commPart of the Agricultural and Resource Economics Commons, and the Regional EconomicsCommonsThis Newsletter is brought to you for free and open access by the Department of Economics at Open PRAIRIE: Open Public Research AccessInstitutional Repository and Information Exchange. It has been accepted for inclusion in Economics Commentator by an authorized administrator ofOpen PRAIRIE: Open Public Research Access Institutional Repository and Information Exchange. For more information, please contactmichael.biondo@sdstate.edu.Recommended CitationFausti, Scott W. and Peterson, Donald, "Introduction to Value Based Marketing for Fed Cattle; Hay Prices Expected to Hold Into EarlySummer" (1997). Economics Commentator. Paper 344.http://openprairie.sdstate.edu/econ_comm/344ECONOMICSCOMMENTA TORSDSUSOUTH DAKOTA STATE UNIVERSITYINTRODUCTION TO VALUEBASED MARKETINGFOR FED CATTLEhyScott W. FaustiAssociate ProfessorEconomics DepartmentThe issue of improving beefs competitivenessagainstother domestic meat products and foreign importshas been discussed widely by groups associated with thebeef industry. One possible strategy that has beenconsideredseriously is a Value Based Marketing System(VBMS) for finished cattle beyond dressed weight &.grade. This strategy is articulated in the Value BasedMarketing Task Force final report (1990), published bythe National Cattlemen's Beef Association (NCBA).Based on findings in the report, the task force gave astrong recommendation for the development of a newmarketing system(applicationof discountsandpremiumsbeyond dressedweight &. grade). The systemwouldbedesigned to encourage producers to raise leaner cattlethat still will grade USDA low choice or higher. Inturn, leaner cattle will reduce revenue loss due to fat(estimated at $2 billion per year) and increaseconsumptionof leaner beef by fat conscious consumers.The NCBA support for the value based marketingconcept is due to the perceived failure of the currentcash marketing system to transfer information onconsumer preference, through price, to the producer.The NCBA report and recent articles in the animalscience literature clearly implicate current cashmarketing alternatives for fed cattle as a major obstacleto improving beefs competitive position in thedomesticmarket. This view is articulated in the NCBA report(Continued on p. 2)No. 375 May 23, 1997HAY PRICES EXPECTEDTO HOLD INTOEARLY SUMMERbyDonald PetersonExtension Marketing &Management SpecialistHay prices in the upper Midwest should remainstrong into early summer as a result of the smallestcarry-out in the area since 1989, winter kill, and a cold,late spring. Cold weather is retarding pasture and haygrowth, forcing the feeding of hay later into the springthan normal. So far this spring, growing degrees arebehind normal at every reporting station in SouthDakota.Ending Hay Stocks DownU.S. hay stocks of all hay on May 1, 1997 totaled17.4 million tons, down 16% compared to May 1, 1996.This is the lowest ending inventory since 1970. The lowending inventory can be attributed, in part, to a smallerhay harvest in 1996 and to a long and very harsh winter.The smaller hay harvest in 1996 caused the hayinventory in December 1996to be down 3.9% comparedto a year earlier. The long, cold winter forced thefeeding of more hay per day for a longer period of time.In the upper Midwest, the ending hay inventory onMay 1, 1997 totaled 8.537 million tons, down 31.2%from May 1, 1995. This is the smallest endinginventory for the area since May 1989 when it totaled7.911 million tons.The December 1 inventory for 1996 was 51.743million tons, down 4% from December 1995, but up(Continued on p.3)Page 1(Consensus point 7); "Fed cattle should be valued on anindividual carcass basis rather than an average liveprice." Proponents of a new VBMS argue that thecurrent multiple alternative cash marketing system forfed cattle (live; dressed weight; dressed weight & grade)is a barrier to the transmission of consumer preferencesfor a particular type of beef product to the fed cattleproducer. The barrier arises because cattle are sold ona lot basis, and this implies that above-average cattle inthe lot are paid less than their market value and below-average cattle in the lot are paid more than their marketvalue. Thus, it is argued that the price discoverymechanism fails because information to the producer onindividual animal market value is not provided or isdistorted.The Concept of VBMCurrently, the USDA beef grading system is twodimensional: quality grade and yield grade. Carcassquality grades of finished cattle are divided into fourcategories: prime, choice, select, and standard,determined by animal maturity and degree of marbling(percentage fat content). Marbling is the primary factordetermining quality grade: the higher the intramuscularfat content, the higher the quality grade. Carcass yieldgrades of finished cattleare divided intofive categories:Table 2. Prices from AMS Grid Systemyield grade 1 to yield grade 5. Yield grade refers to thepercentage of the carcass suitable for boneless retail cuts.The higher the percentage, the lower the numeric valueassigned as the yield grade.In the cash market for fed cattle, the dressed weight& grade system is the only widely used value basedsystem. Under the current grading system, there are 20possible outcomes for a particular animal's grade (seeTable 1). The dressed weight & grade base price,premiums, and discounts were estimated from datacollected from the USDA Agricultural MarketingService.Yield GradeOualitv Grade 1 2 3 4 5Prime 110 110 110 87.50 87.50Choice 110 110 110 87.50 87.50Select 106 106 106 83.50 83.50Standard 100 100 100 77.50 77.50When cattle are marketed under the dressed weight &grade system, packers set a base price. That base priceis determined by market forces for cattle that meetminimum yield and quality grades. In South Dakota, theYIELD GRADEQUALITYGRADELessthanYG 2.0Equal to orGreater thanYG 2.0GreaterthanYG 2.5GreaterthanYG 3.0GreaterthanYG 3.5Greaterthan 'YG 4.0GreaterthanYG 5.0CARCASSWEIGHTPrime S119 $118 $117 $116 $115 $ 95 $ 90Choice $114 $113 $112 $111 $110 $ 90 $ 85Less than900 lbs.Select $110 $109 $108 $107 $106 $ 86 $ 81Standard $104 $103 $102 $101 $100 $ 80 $ 75Choice $111 $110 $109 $108 $107 $ 87 $ 82Select $107 $106 $105 $104 $103 $ 83 $ 78 900-950Standard $101 $100 $ 99 $ 98 $ 97 $ 77 $ 72lbs.Choice $ 96 $ 95 $ 94 $ 93 $ 92 $ 72 $ 67Greaterthan 950lbs.Select $ 92 $ 91 $ 90 $ 89 $ 88 $ 68 $ 63Standard $ 86 $ 85 $ 84 $ 83 $ 82 $62 $ 57Page 2base price is calculated by adding approximately half thechoice-select price spread to the Nebraska hot carcassweight price.Table 1 reflects the assumption that in the cashmarket for finished cattle, the minimum standard forreceiving the base price is quality grade choice and yieldgrade 3 when animals are sold dressed weight & grade.For all practical purposes, all animals that meet theminimum grade receive the base price and no premiumis given when animals exceed the minimum.' For thoseanimals that fail to meet the minimum, discounts areapplied. For a majority of animals marketed dressedweight & grade, the system is a value based system ofdiscounts only. This particular characteristic of thedressed weight & grade system is considered a seriousdeficiency by many producers.The explicit goal of the VBM initiative is to developa marketing system that incorporates a greater range ofpremiums and discounts than what currently exists underthe dressed weight & grade system. There have beenseveral designs proposed, commonly referred to as gridsystems.^ The grid system discussed here is three-dimensional and was developed by the AgriculturalMarketing Service (AMS 1996) division of the USDA.'The proposed AMS grid system is based on the currentgrid system used in the hog industry. This proposedsystem expands the yield categories from five under thedressed weight & grade system to seven. It also adds anadditional dimension: weight class, divided into threeweight class categories.An example of the AMS grid pricing system ispresented in Table 2. The base price of the AMS gridsystem is set at $110.00 (consistent with Table 1).Premiums and discounts are incorporated according to ananimal's yield, quality, and weight classification. Thereare 70 possible outcomes for a particular animal's gridrating, as shown in Table 2.In comparing Table 1 to Table 2, it is clear that theAMS system differentiates with respect to price to amuch greater degree than the dressed weight & gradesystem. For those producers who produce aboveaverage cattle, marketing their animals on a grid pricingsystem will increase their revenues relative to the othercash marketing alternatives. However, for thoseproducers who produce below average cattle, marketingtheir animals on a grid pricing system will decrease theirrevenues relative to the other cash marketingalternatives.In the next issue of the Economics Commentator, acomparative revenue analysis between the AMS gridpricing system and the dressed weight & grade pricingsystem using SDSU slaughter data will be discussed.Footnotes:' In Table 1, the base price is set at SllO.OO. This base price wasarbitrarily selected for this example. There are exceptions to thisrule of thumb. Some packers will negotiate with producers toincorporate premiums into a formula-based sales agreement.However, it is not common practice.^At the present time, grid pricing arrangements are being offered toslaujghter cattle suppliers by Beef America, Monfort, and Excel Co.The common link between these systems is the addition of premiumsand a disaggregation of the discounts as compared to the dressedweight & grade system. However, there is no industry standard inplace at this time.' Currently, the AMS is publishing grid pricing information on aweekly basis. The AMS reports the price range and the averageprice for packer discounts and premiums. The grid pricing data iscollected from seven packers.(Hay Prices cont'd from p. I)3.1% from December 1994. The difference between theDecember 1996 and May 1997 inventory numbersimplies that 43.206 million tons of hay were consumedin the region. This is the largest use since the winter of1986-87 when 47.533 million tons were fed. (Thatwinter there were 680,000 more head of cattle in theregion.) Comparing hay fed with cattle inventorynumbers on the first of January, 1.06 tons per head werefed this winter. This is the heaviest feeding since 1987when 1.15 tons were fed. This year's use of hay wouldhave been higher but continued drifting snow preventedmany livestock owners from getting feed to animals.Also, large numbers of livestock perished in theblizzards that occurred after the first of the year.Looking at South Dakota numbers, ending stocks onMay 1 totaled 1.570 million tons, down 49% from 1996and the smallest carry-out since 1990 when only 1.287million tons were left. Nevertheless, South Dakota hadthe largest carry-out of any state in the nation. It alsostarted the winter feeding period with more hay~8.530million tons—than any other state. This was down 4.8%from December 1995 but up 14% from December 1994.Early IntentionsThe USDA planting intentions report released inMarch indicated farmers in South Dakota, North Dakota,Nebraska, Iowa and Wisconsin planned to hold hayacreage constant with last year. Minnesota intended toincrease acreage 1%; Missouri, 5%; and Kansas, 10%But, winter kill in the area will reduce the actual amountfrom intentions, at least until the new seeding is inproduction.Page 3WinterKillTherewasseverewinterkillofalfalfainthesoutheasternpartofSouthDakota.Oneestimateputsalfalfawinterkillat30%to40%forsoutheastSouthDakota,southwestMinnesota,northwestIowaandnortheastNebraska.Onlyaboutone-thirdofthealfalfasurvivedthewinterintheGayville-Mecklingarea.Insomeplacesthemortalityratewas80%to90%.MuchofthealfalfalookedgoodattheendofMarch,buttheAprilblizzardandsingledigittemperaturesweremorethantheplantscouldtake.Asaresult,bothnewandoldstandsperished.FarthernorthinSouthDakota,alfalfasurvivedmuchbetter.Heavysnowontopoficelastfallallowedtheicetomeltandavoidsuffocationoftheplants.Thesnowwaslateinmelting,soplantsweredormantwhentheweatherturnedcoldinApril.However,continuedcoolweatherisretardingspringgrowth.Withthegoodmoisture,agoodwarmupintheweathercouldpromoterapidalfalfagrowthandgoodyieldsineastcentralandnortheastSouthDakota.CurrentMarketMovementAsaresultofthewinterkillandslowspring,alfalfapricesattheRockValleyHayAuctionmovedup$5to$10pertoninearlyMayafterlevelingoffinApril.Premiumalfalfaisinthe$130to$190pertonrangeforsmallsquarebalesand$112to$135forlargeroundbales.Goodalfalfaisbetween$110to$135forsmallsquarebalesand$62to$105forlargeroundbales.•a-slfliinioajgaivdatstsoj-s-n•SjOigwj-ssNGrasshaypricesareremainingstrongaswell.Premiumgrassinsmallsquarebalesisinthe$100to150pertonrange,andlargeroundsarebetween$95to$130perton.Thereseemstobeagoodsupplyofgrasshayinlargeroundbaleswithpricesbetween$52and$90perton.ConclusionItlookslikeproducersgrowingforthecashmarketshouldstronglyconsidersellingtheirfirstcuttingfromthefieldassoonasharvested.Thedemandisstrong,andpricesaregoodandshouldremainsointoearlysummer.Abouttheonlynegativeaspectforsellersisthedecliningpriceofmilkwhichwilllimittheamountthatdairyfarmerscanaffordtopay.Ifweatherimproves,holdinglatercuttingsforsalenextfallandwintermaybeconsideredifgoodstorageisavailableandproductionconditionsbecomemorefevorable.ECONOMICSCOMMENTATORECONOMICSDEPARTMENTSouthDakotaStateUniversityPhone;(605)688-4141Box504AFax:(605)688-6386Brookings,SD57007-0895E-Mail:StoverP@ing.sdstate.edu450copiesofthisnewsletterwereproducedatacostoflessthan$100p9;sanb>HaofP3xi03ssuppvLQOLSas'sSupioojflluamuedsQsoraoaooaAJIS^HAimELVISVIOXVQHinOSnsns

Introduction to Value Based Marketing for Fed Cattle; Hay Prices Expected to Hold Into Early Summer

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Introduction to Value Based Marketing for Fed Cattle; Hay Prices Expected to Hold Into Early Summer

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