No one who buys or sells cattle or beef wants to be “off” the market. Those who sell obviously want to get more for their animals or product than anyone else. Conversely, those who buy don’t want to pay a penny more than anyone else.
The live cattle market was bedeviled for years by the practice of selling “live, on the average.” Those with higher-quality cattle became increasingly frustrated at not getting more for their cattle. More important, there was little incentive for producers or cattle feeders to raise the quality of their cattle.
The result was that beef of widely variable quality found its way into grocery store meat cases and onto restaurant menus. This meant that one in four steaks provided an unsatisfactory eating experience and was partly responsible for a 20-year decline in beef demand from the mid-1970s to the mid-1990s.
Beef industry leaders recognized this had to change. And it did. Changes on many fronts began to whittle away at the issue of consistency. Some of the most important changes began at the production level, with more uniform genetics in the cattle herd (in large part thanks to the American Angus Association) and a change in the way live cattle were sold. Marketing agreements between cattle feeders and packers led to the widespread use of pricing grids that rewarded higher quality and penalized lower quality cattle.
What also evolved was a move way from selling cattle on the cash market to the use of formula pricing (based on the cash market averages of the prior week). Cash negotiated purchases slipped below 50 percent of total purchases for the first time in 2006. Formula purchases that year were 34.3 percent of the total. But they grew steadily in percentage terms most years after that.
By 2018, 61.1 percent of all purchases on a national basis were on formula, versus 57.2 percent in 2017. Negotiated cash purchases held steady at 25.5 percent, versus 25.7 percent in 2017. The big decline came in forward contract purchases, whose percentage slid to 9.6 percent from 13.0 percent. Negotiated grid purchases eased to 3.8 percent from 4.1 percent in 2017. These percentages are unlikely to change in the coming years. Most cattle feeders are comfortable about getting a formula price based on 25 percent of weekly sales.
Two reasons why cattle feeders agreed to more formula purchases were that they guaranteed them shackle space at packing plants within a certain time frame. The other was that they did not have to tie up time-consuming hours each week negotiating with packers. This rationale also caused beef buyers at the retail, foodservice and distributive levels to start buying more beef on formula.
Packers sold 34.9 percent of all beef (cuts, grinds, and trim) on formula in 2002, the year that mandatory price reporting (MPR) offered a weekly and annual breakdown of the way in which beef was purchased. Formula sales declined to 32.0 percent in 2004 but steadily climbed after that. They rose above 50 percent for the first time in 2014 and peaked in 2015 at 52.5 percent of total sales. The percentage in 2018 was 51.2 percent.
Beef buyers embraced formula buying for several reasons. As veteran buyers retired, a new generation took their place that had neither the experience nor the appetite for negotiating with packers every day. More important, they did not want to be seen to be “off the market” and having to tell their boss why they had paid more for a certain cut than everyone else.
In contrast, negotiated sales zero to 21 days (spot market sales) were at 48 percent in 2002, peaked at 54.1 percent in 2004 and were at 28.1 percent in 2018. This was the lowest number since MPR began. What’s fascinating about this is that packers have continued to persuade beef buyers to purchase the majority of their beef on formula, which is based on spot market prices. Yet reduced offerings on the spot market often increase prices more than if more sales were on the spot market. Buyers are aware of this but seem unwilling to revert to buying more beef week to week because of the price risk involved.
Forward sales are the other important component of wholesale beef sales. Negotiated sales 22 days and up represented 16.6 percent of total sales in 2018, the highest percentage since 2002. Forward contract sales represented 4.7 percent of the total. They have ranged from 3.4 percent to 5.9 percent of the total since 2002. Restaurants and grinders use forward contracts to know what their beef costs will be, so they can set their menu prices months in advance. But packers also load contracts with risk premiums, which have limited the percentage of contract sales.
The bottom line is that cattle feeders and beef buyers will continue to use formula pricing to sell the majority of their cattle and buy the majority of their beef, respectively, to ensure they will never be “off the market.” — Steve Kay
(Steve Kay is editor/publisher of Cattle Buyers Weekly, an industry newsletter published at P.O. Box 2533, Petaluma, CA, 94953; 707-765-1725. Kay’s Korner appears exclusively in WLJ.)
