Over the past 30 years, the beef industry has made tremendous strides in value-based marketing. In the mid-1990s, the industry was grappling, mostly in the dark, to start value-based programs. This was because most drivers of profit and loss were closely guarded proprietary secrets by the various industry segments. However, today, the USDA Agricultural Marketing Service provides weekly updates in the “Cattle Contracts Library Summary,” which reports a weekly comprehensive review of these profit and loss drivers, and how they influenced the specifics of value-based programs.
Most people in the beef industry who are younger than 50 years old would find it hard to understand or believe the way the industry sold fed cattle prior to the onset of value-based marketing. Back in the 1990s, and earlier, feedlots would have a “showlist” of all the pens that were finished and ready to market. This may have ranged from some of the best pens of cattle they had in their yard, to some of their lowest quality pens of cattle, and everything in between.
The feeders and packers would then play a game of chicken during the week, knowing the feeders had to free up the pen space where their finished cattle were, and the packers needed “blood on the floor” to keep in business. A lot of it came down to inventory, and which party was in the stronger position. However, when the market was established—which generally was a narrow range from high to low of just a few dollars—the packers and feedlots would largely make their transactions for the week in a few short hours. Additionally, the whole show list generally sold for a single price because in this marketing system, underpaying for the top cattle would make up for overpaying for the poor-quality cattle.
This was all well and good if the feedlot owned the whole inventory. However, often times, many of the cattle would be owned by investors—particularly before President Ronald Reagan changed the tax code in the 1980s—or the ever-growing number of producers who were retaining ownership. If you were in this group of investors or ranchers retaining ownership, there was little incentive to invest in top-quality carcass genetics as there was little to be gained financially the way fed cattle value was determined. The system needed changing.
A system overhaul
This change occurred starting in the mid-1990s through three separate efforts. Some of the very largest cattle feeders signed proprietary agreements with a packer committing all their production to that packer. Very little is known about how these agreements were designed in terms of premiums and discounts, but it was assumed they were receiving a favorable base price because they represented “captive supply” for the packer. The larger the amount a packer had guaranteed coming to them every week through captive supply, it was assumed the harder the bargain they could drive on the cattle they needed to buy on the cash market. Therefore, captive supply was looked on very negatively by most feeders, and the early value-based systems were lumped into being “captive supply,” which slowed their implementation.
Two other efforts were being led by breed associations. The first was by the American Gelbvieh Association under the leadership of Dr. Jim Gibb who was their executive director, and Tim Schiefelbein, who Gibb had hired as the industry’s first commercial marketing director. This was during the time when the industry was still amidst its “war on fat,” and Gelbvieh set up a formula under Monfort’s “hot fat trim” experimental slaughter system, where external fat was removed on the kill floor.
With a formula, the cattle were paid based on the performance of their carcasses compared to the other cattle being harvested in the hot fat trim program. However, the problem with straight formulas is that the better the cattle supplying the program in order to receive a premium, the better the average of the cattle they are competing against for that premium. In this sense, they can be self-defeating to the producer marketing the cattle. Hot fat trim also turned out to be fairly short-lived because carcasses without adequate external fat cover are prone to excessive shrink and cold shortening, which results in less tender beef.
In 1995, the Red Angus Association of America (RAAA) got approval by USDA to enter Angus-branded beef programs based on genotypic criteria, which allowed them to become one of the suppliers of a very large food service company’s Angus branded beef program. Monfort was the packer supplying the brand and negotiated a grid marketing system with RAAA. Unlike Gelbvieh’s formula system, the RAAA had more fixed premiums and discounts. This was initially calculated based on boxed beef cutout values for the various wholesale cuts within the different quality grades and yield grades. The base price was the practical top for the region the cattle were being marketed in, which was adjusted by the Choice-Select spread.
RAAA would go on to work with Excel and other packers, and the system worked extremely well. However, when the base price went from the practical top of the region to the regional average, much of the premiums the cattle would earn were eaten up getting them back to the former practical top base that they were likely to sell at on the cash market. Still today, establishing a fair and representative base price for the cattle entering a value-based marketing system is one of the keys to a feeder’s profitability on a set of cattle. This is becoming more difficult to do as the success of value-based marketing has significantly lowered the amount of cattle sold on the cash market, which is used as the basis for the grids.
Carcass premiums
One of the major problems at the time of these early grids was that there were not enough cattle qualifying for Certified Angus Beef (CAB), also reported as premium Choice, as well as USDA Prime to establish a market for those categories. This left hot carcass weight static premiums set at approximately $2/cwt for premium Choice, which is the upper two-thirds of the Choice grade, and approximately $5/cwt for USDA Prime. Today, that has changed drastically, with CAB jumping from approximately 15% of the carcasses qualifying for the program to around 37%, with qualifying carcasses seasonally bringing approximately a $3-9/cwt carcass weight premium. Prime has especially skyrocketed, with it not being unusual for it to command over a $20/cwt premium over commodity Choice.
In totality, there are a lot more market signals for carcass value, particularly when it comes to carcass quality. However, where quality signals have increased, the opposite has occurred with yield grades. While the USDA Yield Grade 1 and 2 premiums have remained fairly steady at approximately $2.50/cwt to $4.50/cwt, respectively, the tolerance for USDA Yield Grade 4s, and to a lesser extent, Yield Grade 5s, has increased drastically. It is not uncommon for valued-based systems to have a 15% allowance for USDA Yield Grade 4s before discounts kick in. Interestingly, CAB has removed yield grade from its carcass schedule, replacing it with a cap of one inch of backfat, a maximum of a 17-square-inch ribeye area, and a top carcass weight of 1,100 pounds.
Industry progress
In the future of value-based marketing, it is believed the industry will continue to see more interaction between wholesalers and packers, which will help determine value. An interesting example is Walmart having a minority ownership position in the new Sustainable Beef Plant in North Platte, NE. They, like other plants that are coordinating with wholesalers, are expected to have tighter specifications and traceability, generally requiring electronic identification. They want there to be a story behind the product and a tighter connection between the producer and consumer. Taking a more systems approach to the supply chain—one where the consumer can put a face with the product, whether literally or figuratively—is believed will add value to beef.
The beef industry has come a long way in better objectively valuing its product, and there is no sign this will slow down. This will result in more “haves and have nots” as those that do the right things should be rewarded. In the long run, this will help the industry progress forward through increased price differentiation for specification versus non-specification beef. This is a far cry from when packers would buy a feeder’s showlist for the same price despite obvious quality differences of the cattle both within and between pens being purchased. — Dr. Bob Hough, WLJ correspondent
