Management Topics

Oct 26, 2012

Grid value-based marketing

Value-based marketing of fed cattle is quickly becoming the norm, so genetically designing cattle that pay premiums on such a marketing system should be a consideration for cow/calf producers in order to add value to their calf crop. However, cow/calf producers selling calves should also always keep in perspective that the value of carcass traits is less than growth traits and very much lower than reproductive traits.

In 1995 when I negotiated the first value-based grid with Monfort (now JBS Swift), the idea was revolutionary. Formulas had already been in existence, most notably ones for “hot fat trim,” which serves as a good example of the difference between a formula and a grid. Formula cattle were all processed on one day, and producers were paid on how they performed compared to plant average. The problem was the more high cutability formula cattle were processed, the more the plant average improved, so the lower the potential premiums became. A grid was the answer where the premiums and discounts were fixed in relationship to their value to the packer. For example, a better Yield Grade (YG) will always have the same premium value regardless of plant average.

The first grid was Red Angus’ and was greatly frowned upon by much of the industry because it lumped forward contracted cattle into what feeders deemed captive supply. Captive supply was hated because it took potential good cattle off a feed yard’s show list (those pens of cattle for sale that week), and when that show list was sold, all of them brought the same money regardless of quality. This was great for low quality pens, but if you were retaining ownership on high quality cattle, it was a terrible deal.

I go through this in detail because with value-based marketing, good cattle bring higher prices than poor cattle, allowing feeders to start paying more for top quality feeder cattle and discount low end cattle. This meant a cow/ calf producer would be rewarded for investing in genetics and other practices that gave his/her cattle the potential to hang higher quality (Yield and Grade) carcasses. Therefore, as more and more feed yards embraced value based marketing, price differentiation became more common, leading us to today to being the industry standard.

All grids work basically the same. Base price is either negotiated or comes from that region’s average. It is in the best interest of large feed yards to bid the cattle, since they generally have buyers from all the major packers. For small feed yards which sometimes only have one packer visiting them, going on the average gives them the bargaining power of the large feed yards.

Once the base price is negotiated, premiums and discounts are applied to carcasses. USDA Choice cattle get about 35 percent of the Choice/Select (CH/ SEL) spread above the base price depending on the time of year and region you are in, and USDA Select cattle are discounted approximately 60 to 65 percent of the spread below the base price (National Beef Quality Audit has national average Choice at 61 percent).

For instance, if hot carcass weight is selling for $200 per cwt and the Choice/Select spread was $10, the base Choice price would be bring approximately $203.50 and the Select price would be $194.50. From this basis all other premiums and discounts apply. So to begin with, it is important for cattle to have the genetic potential to grade 60 to 65 percent Choice to avoid losing money on the base price.

As for Choice premium, it varies widely during the year, sometimes going from extremes of near $0 to $20 with an average of under $10. Summer will see a good spread, fall narrowing, leading up to the holiday wide, and after the first of the year becoming narrowest. In spring, when the calves are first being processed, the spread will be wide, only to narrow till the summer. Bottom line, it is sometimes more advantageous to feed cattle to a higher end point at certain times of the year than others. Therefore, during certain times of the year, Choice is very profitable while at others, it is not as valuable.

The YG 3 cattle generally bring about a $1.50 to $3 premium per cwt and YG 1 about $5 premium. Premium Choice (upper 2/3 of Choice) like Certified Angus Beef, is about the blend of the YG 1 and 2 premium, and USDA Prime is generally fixed above Choice at about the average CH/SEL spread in a normal year.

Now for the discounts: YG 4 fixed discount generally comes close to the Prime premium. However, the National Beef Quality Audit had Prime carcass with over 20 percent YG 4s and 5s. Therefore keeping YG 4s to a minimum is important and it is imperative to avoid YG 5s. Although cattle can vary widely, it is my experience that average pens of cattle will grade about 33 percent premium Choice of the percent Choice, i.e. 60 percent Choice cattle will have about 20 percent premium Choice.

Now the kicker. USDA Standards, carcasses too big or small, dark cutters, hard bone (over age), and YG 5s are all considered “outs” and will receive discounts as high $35 cwt.

“Outs”—out cattle—are those that have little value to the packer and receive large discounts.

The bottom line is the optimum target for a pen of cattle is Choice minus YG 2 with no outs. This is generally best, and often accomplished with Angus-based cattle (black or red) with some percentage (< 50 percent) Continental influence. Cattle with the inherent ability to marble are desired because when the CH/SEL spread is narrow, they can be marketed early and still maintain a respectable percent Choice, and when it is wide, they can be fed to higher percentage Choice.

Always remember that it takes two and one quarter times more energy to put fat on than lean, so with high priced grain and with the premiums and discounts being what they are, it is beneficial to feed for an optimum percentage Choice and YG, i.e. CH minus, YG 2 on an average CH/SEL spread. — Dr. Bob Hough

[Dr. Bob Hough has served as the executive vice president of the Red Angus Association of American and more recently as executive vice president of the North American Limousin Foundation from 2009 to early 2011. He is now a consultant, freelance writer and semi-retired.]