VALUE-BASED PRICING:
AN ALTERNATIVE PRICING METHOD FOR RETAINED OWNERSHIP CATTLE
P.J. Rathwell, Extension Ag. Economist

Retained ownership is becoming a viable marketing alternative in today's cattle industry. Producers can maintain ownership from the cow-calf level to the feedlot. When the animal is sold to a packer it is typically sold on a per head basis. The animal's individuality is lost. He is only as good as the average of the pen. Grid pricing values the individual's carcass. The quality of the producer's herd is identified and rewarded.

The opportunities to profit from better matching fed cattle prices to value have encouraged packers, alliances and producers to begin using carcass-based pricing. In fact, the basic tenet of the alliance is developed around the identification of animal traits that meet their market's requirements and rewarding the producer for producing these animals. The price the producer receives for each animal produced is based upon the underlying value of the individual carcass and by-products.

The cattle industry is now offering several value-based fed cattle pricing systems, including formula pricing, price grids and alliances. Is there one "best" pricing method? How are live weight, dressed weight and grid or formula prices related? Let's look at these pricing methods and focus on how each one might benefit the producer.

The starting point of the analysis is to evaluate each pricing method. Benefits will vary between producers due to: 1) the quality and dressing percentage of the cattle produced; 2) the Choice to Select market price spread; 3) production and feeding cost associated with targeting cattle to fit a particular grid or packer; 4) the producer's knowledge of the price/quality distribution of his cattle and his ability to sort his cattle to meet the criteria of a particular grid or formula.

Cattle are typically priced in one of three ways: 1) live; 2) dressed weight; or 3) carcass grade or yield pricing. Let's look at each one of these methods.

Live Cattle Pricing

Live cattle pricing is generally a negotiation between the packer and feedlot. Each participant to the sale estimates the expected value of the cattle when the animal is processed (usually with a 4% pencil shrink). The packer's offer is frequently based upon the Choice carcass price with premiums or discounts for quality and yield grade differences. This evaluation is generally for the total pen of cattle at the feedlot and not on an individual basis. This adjusted carcass price is converted to a live animal price by multiplying it by the expected dressing percentage. The live price is further adjusted to account for by-product, hide values, slaughter and transportation costs, and the packer's profit margin. Finally, the live price offer is determined.

This method is appealing to some producers since it provides the greatest amount of flexibility in cattle pricing until the sale is executed. However, because meat quality and dressing percentage are difficult to predict accurately on live animals premiums and discounts paid do not generally reflect the true value of the animal. Frequently, high valued cattle are under-valued and low quality cattle are over-valued. While the risk of guessing wrong is on the packer this method of sale gives little producer incentive to invest in better genetics.

Dressed Weight Pricing

Dressed weight pricing is based on the animal's hot carcass weight. The dressed price offered is similar to the live price bid in that the buyer starts with a Choice carcass base and adjusts it for expected quality and yield grade, over and under carcass weight, by-products and hide value, slaughter and transportation costs (seller usually pays transportation on dressed cattle sales) and packer profit.

In principle, the dressed weight price will be comparable to a live price adjusted for dressing percentage for the same pen of cattle. Actually, the dressed price (after transportation costs) may be higher or lower than the live price because there are no errors in estimating dressing percentage.

Grid Pricing

Grid pricing is essentially the same as pricing on a dressed weight basis, except that in addition to dressing percentage, the packer also bases price on the known quality grade of each animal in the pen. Many beef packers and alliances offer cattle producers the opportunity to price cattle on a carcass grid basis. Most packer grids list a base price for a Choice, yield grade 3, 550-750-pound steer carcass. An example of a typical price grid offered by packers is shown in Table 1.

Table 1 Example Grid Premiums and Discounts

Yield Grade

Quality Grade

$1.00

$2.00

$3.00

$4.00

$5.00

Prime		$8.00	$7.00	$6.00	-$9.00	-$14.00
CAB		$3.00	$2.00	$1.00	N/A	N/A
Choice		$2.00	$1.00	Base	-$15.00	-$20.00
Select		-$7.00	-$8.00	-$9.00	-$24.00	-$29.00
Standard		-$16.00	-$17.00	-$18.00	-$33.00	-$38.00

Carcass Weights

Other

550-749	Base		Dark Cutter, etc.	-$25.00
750-950	-$4.00		Bullock/Stags	-$25.00

<550	-$19.00
>950	-$19.00

The price received for each carcass is the base price plus the particular premiums and discounts. For example, if the Choice, yield grade 3, 550-750 carcass price was $105/cwt., a Select, yield grade 4, 800 pound carcass would receive a price of $77/cwt. ($105/cwt. -$24/cwt.- $4/cwt.).

This table illustrates how quickly price discounts increase with yield grades 4 and 5 and with quality grades below Choice. In this example the discount from Choice to Select is a relatively severe $9/cwt. The discount between Choice and Select quality grades depends on the supplies of Choice versus Select carcasses and the demand for each. For example, if Choice supplies are low and demand for Choice carcasses is strong then the spread difference will increase. There are usually large discounts for Standard grade carcasses, dark cutter caresses and carcasses lighter than 550 pounds or heavier than 950 pounds.

It is very important for the producer to understand the grid's construction and the way packers use it in valuing cattle. For many packers' grids, price premiums and discounts are additive. The base price is adjusted in an additive manner for the associated characteristics of the carcass. For some packers, not all premiums and discounts are additive. For example, some packers quote the same price for all Standard grade cattle regardless of yield grade.

The USDA reports a weekly survey summarizing selected packer grid schedules. This report is on the Internet at http://www.ams.usda.gov/mncs/mn_reports/NW_LS195.txt (National Carcass Premiums and Discounts for Slaughter Steers and Heifers). The report is useful for understanding average grid price premiums and discounts being offered by packers and alliances.

Use this report as a guide to understanding grid pricing and not as absolute guide to expected prices. The USDA grid summary report assumes additive premiums and discounts. In addition, this report is not volume-weighted and only includes packer-stated grids, not actual purchases (this will likely change under the recently passed Mandatory Pricing Law). As a result, the report does not represent market average grid prices. This is important to understand when interpreting the USDA price report and comparing it with any particular grid.