ECON 337: Agricultural Marketing Chad Hart Associate Professor Lee Schulz Assistant Professor

Livestock Marketing Decisions

Where to sell –Type of market –Location When to sell –Weight, grade, costs What to sell –Live or carcass –Value-based

 Important Market Functions  Assembly function – a large number of small farms o Feeder cattle o Cull cows  Sorting function o Various frame, grade, and condition o Various weight classes o Intended use/destination Where to Sell

Terminal markets –Feeder cattle and fed cattle Auction markets –Feeder cattle, cull cows, fed cattle in fringe areas Direct sales (including private treaty) –Breeding stock, fed cattle and hogs, feeder pigs Hybrid markets –Becoming more common for livestock in general

Terminal Markets Also called central markets or public stockyards Facilities are owned by a stockyard company The company charges for the use of the facilities and feed fed while they are in the stockyard Title to the livestock does not pass to the stockyard company Charge for Yardage, feed, insurance, selling fees Seller receives the net amount after the charges are taken out

Terminal Markets Exist for both feeder cattle and slaughter cattle Today there are < 30 Compared to the 80 that existed in the 1920’s and 30’s Most are in western states Terminal markets are located near population centers and packing plants

Auction Markets  Sold by public bidding.  Also called local sale barns and community auctions.  Livestock collected at auction facility and presented to buyers  Popular due to their convenience for buyers and open competition.  Of the most value to the smaller producers.  Requires minimal marketing on part of producer. o Seller pays commission for this service.

Auction Markets Yardage Feed Insurance Brand inspection Health inspection Check-off dollar Charges are based on either a percent of the selling price or a fixed fee Costs are paid by the seller

Direct (Private Treaty) Sales  Livestock producers negotiate sale with downstream customer.  i.e., cow-calf operator to backgrounder, feedlot to packer, seedstook to commercial cow-calf operator  Potential to save on commission.  Price discovery is more challenging and must be negotiated (private treaty).  Terms and pricing method determined ahead of marketing date (direct sales).  Allows for relationships to build.

Hybrid Markets  Becoming more common  Livestock usually videoed at farm  Eliminates transport to auction location and exposure risks  Can be shipped directly to buyer  More uncertainty about weight, quality, etc.  Electronic (internet) markets  Centralized pricing  Decentralized product movement  Examples  Superior Livestock Auction  Showpig.com

When to Sell Classic production function –Optimal selling weight is where marginal cost = marginal revenue –The cost of the next pound = the price of the next pound –Costs increase beyond optimal selling weight Cost per pound decrease then increase with weight –Costs are a function of  Genetic potential, cost of diet, opportunity costs of future production Price per pound increases then decreases –Weight discounts outside optimal range –Fatter carcasses are discounted –Adding extra weight?

Using Marginal Concepts Profit-maximizing level of input can be found by examining marginal changes in costs and revenues. Marginal cost is the additional cost of producing that additional unit of output. Marginal revenue is the change in total revenue from selling one more unit of output.

Marginal Cost (MC) What is often talked about: average cost of gain for the entire feeding period Important for marketing decision: marginal cost as animal approaches market weight The average cost of gain changes slowly, but the marginal cost of gain changes rapidly

Basic Fed Cattle Feed Efficiency (MC) Facts A.Steers are more efficient than heifers, i.e., 6.5 vs B.Holsteins are 8 – 10% less efficient than beef cattle. C.Efficiency tends to decrease with time on feed.

Marginal Cost (stylized example) 700 to 1,200 lbs Average F:G = 6.25 Last 50 lbs Marginal F:G = 8.0 By 1,300 lbs Marginal F:G = 10.0 F:G = 10.0 Ration = $100/ton ($0.05/lb) $0.50/lb of gain F:G = 10.0 Ration = $200/ton ($0.10/lb) $1.00/lb of gain * Selling the last lb for $0.90 made sense with $100/ton rations, but not with $200/ton rations Marginal cost changes with F:G and feed price

Marginal Revenue (MR) Change in income from selling at a later date and it is also a moving target. 1.Additional pounds to sell 2.Carcass merit and value of the livestock change with weight

Marginal revenue –Added weight –More upper Choice, Choice & Prime –Fewer lights –More heavies –More Y4s (Y3.5) –Fewer Y1s + Y2s Marginal costs –Added cost of gain on every animal held Should I Feed a Few More Days?

Other Factors In addition to feed, interest and out-of-pocket yardage cost (cattle) should also be included. For small delays in marketing, i.e., a week, interest is often insignificant If pen space is not needed immediately or a daily yardage is not charged, the out-of-pocket yardage charge may be small.

The Decision Rule MR = MC The decision rule, MR = MC, leads to the profit-maximizing point. When does it make sense for me to ‘stop’ feeding? – When it costs me more to add additional lbs than it generates in additional revenue.

Optimal selling weight for beef cattle (stylized example)

Fed Cattle Pricing Process Feedlots will typically offer various groups for sale Processors will have buyers who look at and bid on slaughter cattle They are estimating quality as best as they can How do you bid in this situation?

What to Sell Fed cattle are typically sold in one of 3 ways 1.Live weight – price agreed upon for slaughter steer live weight (on the hoof) 2.Carcass weight – price is agreed upon, but based on carcass weight 3.Grid Pricing – base price is agreed upon and premiums and discounts are taken at slaughter based on quality and yield grade

What to Sell Live weight One average price for all live pounds Negotiated price before delivery or at auction Weighing conditions important  Mud, shrink (fill, time, stress) Was most common for hogs but not now Still common in large cattle feedlots, less in Iowa Used for feeder cattle, feeder pigs, cull cows Buyer stands quality risk Live weight x price = revenue

What to Sell Carcass weight (in-the-meat) One average price for all carcass pounds Negotiated price before delivery Dressing percent (also called yield)  Important to compare bids  Not important in determining value Seller (feedlot) stands risk of low dressing percentage (e.g., genetics, trimming, and condemnation) Buyer (packer) bears risk of poor quality Price will reflect an estimation of quality by the buyer Common for fed cattle in Midwest Carcass weight x price = revenue

Data Source: USDA-AMS Livestock Marketing Information Center

Dressing Percentage Percent dressed weight of live weight Dressed weight (hanging weight) –After removal of head, hide, etc. –Impacted by weighing conditions, shrink, fat thickness, genetics Typically 60-64% for most cattle Example: 1350 lb steer dresses 841 lbs –841 / 1350 = 62.3% dressing percentage If live slaughter steers prices are $135 per cwt, what is the comparable carcass price? –Assume 62% dress

Price Conversions $135 live price / 0.62 (expected dressing percentage = $ carcass equivalent $225 carcass price X 0.62 (expected dressing percentage) = $ live equivalent

What is shrink? Shrink = weight loss –And typically refers to weight loss during transport and / or prior to sale Cattle will weigh less after being transported to a sale or weighing location –Ie: from farm to stockyards May help to think of this as actual shrink – the weight that is actually lost

What is a “pencil shrink”? “Pencil shrink” – a percentage shrink applied to weight to account for this weight loss For example – cattle purchased and weighed directly “on the farm” vs. cattle hauled, weighed, and sold at stockyards Sometimes buyers may want a “pencil shrink” to adjust weight downward –Typically if cattle are weighed on farm –2% is very common

What to Sell Value-based (grid) marketing Each carcass evaluated and priced individually Premiums and discounts determined ahead of delivery Base price may be negotiated or come from formula Carcasses are graded and values assigned Farmer stands grading risk Different buyers have different systems

Cattle Marketing Method LiveCarcassGrid Price Each Animal No Yes $ Animal Variability None High $ Packer Variability LittleModerateHigh Trucking Costs BuyerSeller

Cattle Marketing Method LiveCarcassGrid Pricing Location Feedlot + Shrink Packing Plant Meat YieldEstimatedCarcass Weight Yield Grade Quality Grade Estimated Actual Base PriceLive Market Dressed Market Varies

Cattle Marketing Method LiveCarcassGrid Large Discounts NoSomeYes Price Set Each Time Yes No Seller’s Knowledge Not Critical Somewhat Critical Very Critical

Grid Pricing Base price + / - premiums and discounts = grid price Carcass weight x grid price = revenue Removes the uncertainty of live weight pricing –Buyers can see under the skin

What is the Purpose of a Grid? To shift quality risk from packer to producer To allow for targeting of certain types of cattle Different types of programs have different grids –Quality based grids, yield based grids –Laura’s lean has a very different grid

Four factors impact premiums 1.Hot carcass weight Usually around 62% of live weight Often discounts for large and small 2. Quality Grade Distribution (USDA Grader) Prime, Choice, Select, Standard Based on marbling, proxy for eating experience 3. Yield Grade Distribution (USDA Grader) 1, 2, 3, 4, 5 Based on lean meat yield 4. Other specs: Product safety & quality assurance Acceptable color Youthfulness What determines price on a grid?

Source:

Quality Grades Prime – most amount of marbling, highest quality Choice Select Standard – least amount of marbling, lowest quality

Which steak would you rather eat? or AB

USDA Select Select (Sl)

USDA Choice Choice+ (Md)Choice0 (Mt)Choice- (Sm)

USDA Prime Prime0 (MdA)Prime- (SlA)

Yield Grades YG 1 – highest expected yield of retail cuts, most desirable YG 2 YG 3 YG 4 YG 5 – lowest expected yield of retail cuts, least desirable

Yield Grade 1 Source:

Yield Grade 4 Source:

Yield Grade 5 Source:

Common Ground for Targets 1. Carcass Weights lbs 2. Quality Grade> Se + or < Ch 0 3. Yield Grade1’s and 2’s

Carcass Merit Grid and Premium Trends

More on grids Choice / select spread Select discount vs. YG 4 discount CAB and other premiums Other discounts –Heavy carcasses, age, etc.

Estimated Steak Brand Premiums Compared to Unbranded Product, January 1, 2004, through March 31, 2009 Schulz, L.L., T.C. Schroeder, and K.L. White “Value of Beef Steak Branding: Hedonic Analysis of Retail Scanner Data.” Agricultural and Resource Economics Review 41(2):

Data Source: USDA-AMS, Compiled & Analysis by LMIC Livestock Marketing Information Center

Ex: Grid Premiums & Discounts  Base: Choice YG lbs  Quality Grade$/cwt  Prime:$12.00  Certified Angus:$6.00  Select-$9.00  Standard-$24.00  “Out” cattle-$30.00 Yield Grade$/cwt 1:$6.00 2:$3.00 3:Par 4:-$ :-$15.00 Carcass weights$/cwt Under 550-$ & up-$24.00

Comparing Bids ($/carcass cwt) Price in appropriate $/cwt AB Base bid price Prime 20% CAB70% Select15% Yield 110% Off weight, >1000 lbs10% Transportation Net farm gate price Bid A is a straight in the meat bid, Bid B is a valued-based bid.

Value-based Hog Marketing Base price –Formula based on another market –Negotiated before delivery Factors impacting premiums/discounts –Carcass weight, leanness Fixed (known dollar amount) Relative premiums (percent adjustment) Not USDA graded –Packer employee measures Fat-O-Meter, ruler, ultra-sound

Purchase TypeDescription Negotiated Cash TradeCarcass-based negotiated cash market trade Swine or Pork Market FormulaFormula based on a USDA – quoted hog or pork price Other Market FormulaFormula typically based off of lean-hog futures price Other Purchase AgreementOther agreements such as feed cost, breed programs, etc. Value-based Hog Marketing

NEGOTIATED OTHER MARKET FORMULA SWINE OR PORK MARKET FORMULA OTHER PURCHASE ARRGMENT HEAD COUNT14,01925,262132,55257,406 CARCASS BASE PRICE AVERAGE NET PRICE AVERAGE CARCASS WT AVERAGE SORT LOSS AVERAGE LEAN PERCENT NATIONAL DAILY DIRECT HOG PRIOR DAY REPORT - SLAUGHTERED SWINE Slaughter Data Barrows and Gilts (Live and Carcass Basis): 339,933

CARCASS WEIGHT DIFFERENTIALS 145# # # # # # # # # NATIONAL DAILY DIRECT HOG PRIOR DAY HOG REPORT Plant Delivered Purchase IOWA/MINNESOTA DAILY DIRECT NEGOTIATED HOG PURCHASE MATRIX LM_HG204, USDA Market News Des Moines, Iowa

Hog Carcass Price by Backfat and Loin Eye Area Hog Carcass Price by Loin Eye Area/Depth (inches) Backfat4.0/1.45.0/1.76.0/2.07.0/2.38.0/ National Daily Direct Prior Day Hog Report, Plant Delivered Purchase Data LM_HG200, USDA Market News Des Moines, Iowa

Value Range*Average* VOLUME TRANSPORTATION DELIVERY TIME BREED PORK QUALITY ASSURANCE NATIONAL WEEKLY DIRECT SWINE NON- CARCASS MERIT PREMIUM FOR WEEK * Prices reported per hundred pounds carcass basis

Comparing Bids Let’s say you raise hogs halfway between two packers (so transportation costs are the same to both packers) Packer A offers you $65.00/cwt live for your hogs Packer B offers you $82.00/cwt carcass for your hogs –Packer B will grade the carcasses, paying premiums for lean carcasses (+$1.25/cwt), but charging a $0.75/cwt sorting discount –You expect a dressing percentage of 75%

Price in appropriate $/cwt AB Bid Price (live)$ Bid Price (carcass)---$82.00 Lean premium Sort discount Dressing percentage Adjusted to live Transportation Net farm gate price$64.65$61.53 Comparing Bids

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