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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.)
Quality GradePrimeCABChoiceSelectStandard
21.0012.008.001.00
---
16.007.003.00
------
13.004.00
---------
---------------
---------------
Yield Grade1 2 3 4 5
Discount Cells($/carcass cwt.)
Quality GradePrimeCABChoiceSelectStandard
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
Yield Grade1 2 3 4 5
5
Sample Carcass Distribution(number of head)
Quality GradePrimeCABChoiceSelectStandard
14441
21010
22
31240220
45310
31100
Yield Grade1 2 3 4 5
Premium Priced Carcasses(number of head)
Quality GradePrimeCABChoiceSelectStandard
1444-
21010
--
312
---
-----
-----
Yield Grade1 2 3 4 5
Discounted Carcasses(number of head)
Quality GradePrimeCABChoiceSelectStandard
----1
---22
---
220
45310
31100
Yield Grade1 2 3 4 5
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, $117.99/cwt.
Grid Pricing Examples
GridCalcCEW
http://agweb.okstate.edu/pearl/agecon/marketing/index.html
Grid Pricing versusFormula Pricing
Grid pricing involves using a premium-discount grid with some method of establishing the base priceFormula pricing typically refers to the method of finding the base price in a premium-discount gridFormula pricing uses another price as a reference price. Two common examples are:
Plant average prices or costsReported cash prices
Price Discovery Implications with Alternative Base Prices
Plant average or reported cash market formula pricesTie base price to a price that packers have an
incentive to keep as low as possibleTie base price to a declining (thinning) reference
market priceTie base price to a price representing a lower
quality of cattle
7
Base Price Alternatives
Negotiated pricesInvolve competition among packersPotentially reflect current market conditions more
accurately
Base Price Alternatives
Futures market pricesTie grid prices to another arena for price
discoveryLink cash and futures markets closer together
Base Price Alternatives
Wholesale beef prices (boxed beef cutout)Tie grid prices to a price that packers have an
incentive to increaseTie fed cattle prices closer to the retail value of
beef
Price Signals with Grid Pricing
Less emphasis on weightMore emphasis on carcass traits (merit)More variable but more accurate prices (i.e., pricing to value)Highest prices are associated with higher quality grade, better yield grade carcasses, with no weight or other discounts
8
USDA Premium-Discount Report
http://www.ams.usda.gov/mnreports/lm_ct155.txt Livestock Marketing Information Center
-30
-25
-20
-15
-10
-5
0
5
10
11/4/96 11/4/97 11/4/98 11/4/99 11/3/00 11/3/01
Prem
ium
($/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
($/c
wt.)
Base Discount Weight
Light
Heavy
Livestock Marketing Information Center
-30
-25
-20
-15
-10
-5
11/4/96 11/4/97 11/4/98 11/4/99 11/3/00 11/3/01
Dis
coun
t ($/
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
Livestock Marketing Information Center
-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
Value of Managing Cattle AttributesValue of Managing Cattle Attributes
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 AttributesValue of Managing Cattle Attributes
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 65.3YG 4 -$14.00 3.6 0.0YG 5 -$24.00 0.5 0.0<550 lbs. -$20.00 0 0>950 lbs. -$20.00 7.3 0.0PRICE $115.42/cwt $117.50/cwt
$3,421 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
Attribute USDA Grid Percent PercentPrime +$7.00 6.2 6.2CAB +$7.00 24.9 24.9Choice +$0.00 46.5 57.9Select -$8.50 21.0 10.0Standard -$17.00 0.7 0.0Outs -$20.00 0.7 0.0YG 1 +$2.00 1.5 1.5YG 2 +$1.00 33.2 33.2YG 3 +$0.00 61.2 65.3YG 4 -$14.00 3.6 0.0YG 5 -$24.00 0.5 0.0<550 lbs. -$20.00 0 0>950 lbs. -$20.00 7.3 0.0PRICE $115.42/cwt $118.69/cwt
$5,381 pen revenue186 steers on feed 147 days, ADG=3.8, Conversion=6.9, 883 lb carcass, Choice, YG-3 price = $118.00/cwt
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