Fausti, Scott W.

Sondey, John A.

English

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South Dakota State UniversityOpen PRAIRIE: Open Public Research Access InstitutionalRepository and Information ExchangeEconomics Commentator Department of Economics6-10-1997Value Based Marketing for Fed Cattle: Part II GridPricing; Migration, Housing Rural RenewalScott W. FaustiSouth Dakota State University, scott.fausti@sdstate.eduJohn A. SondeySouth 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 Sondey, John A., "Value Based Marketing for Fed Cattle: Part II Grid Pricing; Migration, Housing Rural Renewal"(1997). Economics Commentator. Paper 345.http://openprairie.sdstate.edu/econ_comm/345ECONOMICSCOMMENTATORSDSUSOUTH DAKOTA STATE UNIVERSITYVALljE BASED MARKETINGFOR FED CATTLE:PART n GRID PRICINGbyScott W. FaustiAssociate ProfessorEconomics DepartmentIn the last issue of the Economics Commentator, therational for the developnient of a new VALUE BASEDMARKETING SYSTEM was discussed. In this issuea comparative revenue analysis between the AMS gridpricing system and the dressed weight & grade pricingsystem using SDSU slaughter data will be presented.The explicit goal of value based marketing is toimprove the transfer of information from the consumerto the producer on cattle quality through price. ValueBased marketing supporters argue that this Can beaccomplished if: 1) the practice of pricing fed cattle bylot is ended; and 2) a pricing system is introduced whichrewards superior cattle and discounts inferior cattle.Currently, the only widely used value based pricingsystem for fed cattle is dressed weight & grade.However, for a majority of the 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 (See Table 1).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 77.50(Continued on p.•2)IntroductionNo. 376 June 10, 1997MIGRATION, HOUSINGRURAL RENEWALbyJohn A. SondeyAssociate ProfessorEconomics DepartmentNorthern Plains states enjoy unemployment ratessignificantly below the current national rate of 4.9%.Small state populations plus relatively large farm sectorsensure tight labor markets. With farming increasinglydriven by scale economies, small farmers are forced topursue other occupations. In theory, this exodus shouldexpand the overall available labor pool; but, asunemployed farmers are few in number, statewide effectsare quite small.Concurrent with the growing concentration infarming is an influx of manufacturing firms to theNorthern Plains. From a producer's standpoint, theamenities of the region include relatively low levels ofwages, unionization, and state taxes and regulatoryeffort, and a work force with high levels of educationand work ethic.DualismDualism is a term used by development economiststo explain the side-by-side existence of structuallydifferent sectors. Within a society, the dual relationshipmight consist of a" high tech, high wage, expandingsector and a low wage, contracting rural sector. Thedisparity between the sectors is not temporary, and thewage differential between sectors may not diminish withtime.(Continued on p. 3)Page 1Table 2. Prices for AMS Grid SystemYIELD GRADEQUALITYGRADELessthanYG 2.0Equal to orGreater thanYG 2.0GreaterthanYG 2.5GreaterthanYG 3.0GreaterthanYG 3.5GreaterthanYG 4.0GreaterthanYG 5.0CARCASSWEIGHTPrime $119 $118 $117 $116 $115 $95 $ 90Choice $114 $113 $112 $111 $110 $ 90 $ 85Seiect $110 $109 $108 $107 $106 $ 86 $ 81Less than900 lbs.Standard $104 $103 $102 $101 $100 $ 80 $ 75Choice $111 $110 $109 $108 $107 $ 87 $ 82Seiect $107 $106 $105 $104 $103 $ 83 $78 900-950 lbs.Standard $101 $100 $ 99 $ 98 $ 97 $ 77 $ 72Choice $ 96 $ 95 $ 94 $ 93 $ 92 $ 72 $ 67Seiect $92 $ 91 $ 90 $ 89 $ 88 $ 68 $ 63Greater than950 lbs.Standard $ 86 $ 85 $ 84 $ 83 $ 82 $ 62 $57One solution to the current fed cattle pricing systemis pricing animals on a grid system. A typical gridsystem has a greater range of premiums and discountsthan exists under the dressed weight and grade system.The concept of a grid system has gained considerableattention in the industry and there have been severaldesigns proposed.'The grid system to be discussed here was developedby the Agricultural Marketing Service (AMS 1996)division of the USDA.^ The AMS grid system is three-dimensional. The AMS grid system is based on thecurrent grid system used in the hog industry. Thispricing system expands the yield categories from fiveunder the dressed weight & grade system to seven. Italso adds an additional dimension: weight class, dividedinto three weight class categories.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 producers who produce above averagecattle, marketing their animals on a grid pricing systemwill increase their revenues relative to the other cashmarketing alternatives. However, for producers whoproduce below average cattle, marketing their animals ona grid pricing system will decrease their revenuesrelative to the other cash marketing alternatives.^The Animal and Range Science Department at SouthDakota State University (SDSU) has conducted aRetained Ownership Demonstration Program (ROD?) forbeef over the last six years (Wagner, et al., 1991-95).During the first five years of the project, 1409 steercalves were entered into an accelerated feeding programand raised to slaughter weight. At slaughter weight, theanimals were marketed under the dressed weight &grade marketing system. SDSU's animal scientistscollected detailed carcass data at the time of slaughter.The actual dressed weight & grade price data for the1409 animals reveals that those animals which attaineda quality grade of choice and yield grade of less than 4received the highest price per cwt on market day.Animals which graded select and less than yield graded4 received the next highest price on market day.Discounts were applied to approximately 3% of theanimals that did not meet the above standards.However, no premiums were given despite the fact that65% of the animals yield graded better than 3 and 42%graded choice (the average yield grade was 2.7).The marketing performance of RODP animals underthe AMS grid system is compared with the dressedweight & grade system. This is possible because anarbitrary but equivalent base price for both systems is setat $110.00. The dressed weight& grade system is two-dimensional, so weight class is not a factor. However,for heavy cattle, an across-the-board discount iscommon. Under dressed weight & grade, there are nopremiuihs and the discounts are derived by aggregatingthe AMS grid system discount categories. Animals thatgraded yield grade 4 or lower incurred a $22.50discpunt. Animals that quality graded select or standardwere discounted $4.00 and $10.00, respectively. Forcattle whose hot carcass weight was above 950 pounds,an $18.00 cwt discount was applied.Table 3 contains the summary statistics with respectto revenue per head under the marketing alternatives.Page 2Table 3. Mean, Standard Deviation, and Range ofRevenue per head.Marketing MethodDressed Weigh& GradeAMS-GridSvstemMean SD Max Min766.87 81.54 1006.50 491.84781.74 82.86 1005.70 505.76Marketing under the grid system increased averagerevenue per head by $14.87 and the standard deviationby $1.32 (Table 3). However, the range for revenue isgreater under the dressed weight & grade system by$14.72. However, variability is measured by thestandard deviation and is a better measure of revenuerisk. An increase in the standard deviation indicates thatmarketing under the GRID system entails greaterrevenue risk.The results of this comparative study indicate that aproducer with cattle of similar quality to those used inthe SDSU study would have earned an additional$20,951.83 in revenue on 1409 head under the pricestructure presented above. If the quality of the cattleused in the comparative study would have been belowaverage in quality, then the grid system would haveheavily discounted those animals. In the final analysis,marketing fed cattle under a grid pricing system willprovide superior returns for those producers whoproduce superior cattle.Foomotes:' At the present time, grid pricing arrangements are being offered to slaughtercattle suppliers by Beef America, Monfort, and Excel Co. the common linkbetween these systems is the addition of premiums and a disaggregation of thediscoimts as compared to the dressed weight & grade system. However, thereis no industry standard in place at this time.^The AMS presented its beef grid system at the 1996 nationalconventionofthe NCBA. The AMS grid pricing system is derived by the AMS through aweekly fed cattle premium and discount survey of seven packers. Thepremiums and discounts reported in Table 2 represent an average of thosereported premiums and discounts from the AMS Grid presented at the NLBAconvention.^ In Tables 1&2, the base price is set at $110.00. This base price wasarbitrarily selected for this example. That base price is determined by marketforces for cattle that meet mmimum yield and quality grades. Currently, forSD the base price is calculated by adding half the choice-select price spreadto the Nebraska hot carcass weight price.(Diversification ... cont'd from p.l)In the Northern Plains, there are two different storylines playing out simultaneously. Urban centers see aninflux of relocating or expanding manufacturers, furtherconstricting already tight labor markets. Housing pricesrise and infrastructure is strained by in-migration. Atthe same time, employment possibilities contract andinfrastructure lies idle in mral communities.Recent evidence indicates that some states, includingSouth Dakota and Nebraska, have lost prospective newindustries because of inadequate labor supply wherefirms wished to site. The challenge for states andpotential entrant firms is to entice migration to deepenthe labor pool in or proximate to those areas favored byentering firms. Alternately, with proper policy.Northern Plains states might make less favorable areas,"off the beaten path" more attractive to entrant firms.The Migration DecisionThe work of Sjaastad (1962) views migration as anhuman capital investment decision which entails bothcosts and benefits for the migrant. To the potentialmigrant, benefits or relocation include a higher wageand/or a higher level of amenities (non-wage income)than exists at the point of emigration.Amenities include (but are not restricted to) climate,outdoor recreational facilities, low crime and povertyrates, and proximity of museums, theaters, and othercultural facilities (Clark and Hunter, 1992). A broaderdefinition of regional amenity regards the cost ofhousing, utilities, and transportation as necessaryinclusions in the immigration decision matrix. Brown(1994) proposes that real wage differentials act toequalize amenity differences across regions. Thus, lowwage states, if relatively high in amenity value, are notunattractive to potential immigrants.Amenity GenerationDifferences in amenity inventories can enable statesto differentiate their product (business environment andquality of life) in the eyes of "buyers" (firms and labor).Bending the economic theories of production andexchange, we suggest that a state should specialize inproducing a product (environment) which uses itsabundant resources intensively. For Northern Plainsstates, comparative advantage means intensive use ofland in the "production" mix.Numerous studies have indicated that the availabilityof affordable housing ranks high on the list of amenitiessought by workers. Moreover, housing amenities rankhigher with both executives and workers in high-techindustries than in industry overall, and are an importantfactor in retaining highly trained workers within an area(Gottlieb, 1994).Page 3One specific option would make use of rural land inthe hands of municipal, township, or county authorities—acquired through tax default or purchase of marginalfarmland. There are a number of options inimplementing a home-siting program. The locally(regionally) acquired land could be sold in individudplots to residents and immigrants seeking low costhousing. Low land prices, allowed by the modest costsof acquisition, would make the land parcels appealing tobuyers. State aid would aid in the acquisition of land.Bonds backed by the revenue from land mortgages couldbe sold to finance the development (streets, sewer,utilities) of land. The rural community would have thefinal say in how many land parcels and potentialimmigrants it would welcome.Care would be taken to locate potential housingtracts outside the urban ring and inside a rural localitywith excess capacity for an existing infrastructure. Theinitial series of home-sitings must be within reasonablecommute of a significant labor market. With solidplaiuiing and luck, subsequent sitings can be further inthe "hinterlands" as earlier sitings generate their ownmini-labor markets.vriianj•Q's 'iluiyxugaivda»W«-S*nConclusionsIt is important that Northern Plains states considerimmigration policy as a means of enhancing economicdiversity and states' labor pools. Inducements such ashome-siting assistance in communities with excesscapacity utilizeNorthern Plains states' abundant (cheap)resource and can trigger a positive multiplier effect,aiding rural development.ECONOMICS COMMENTATORECONOMICS DEPARTMENTSouth Dakota State University Phone: (605) 688-4141Box 504A Fax: (605) 688-6386Brookings, SD 57007-0895 E-Mail: StoverP@mg.sdstate.edu450 copies of this newsletter were produced at a cost of less than $100paisanba^ 00^33x103 ssuppyLQOLS as •s3upfOQie Vvw)s*oalusimicdsQ sonnonosH <7,AJJSHHAim ELVIS VIOSVQ HXflOS -nsQS

Value Based Marketing for Fed Cattle: Part II Grid Pricing; Migration, Housing Rural Renewal

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Value Based Marketing for Fed Cattle: Part II Grid Pricing; Migration, Housing Rural Renewal

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