Grid pricing has advantages, but don't participate without thorough knowledge.
Recently, there has been increased emphasis on improving the quality and consistency of beef. Cattle producers, breed associations, feed suppliers and packers have initiated value-based pricing methods commonly referred to as grid pricing. While these various schemes may differ substantially in the carcass traits they seek to reward or penalize, they all have one common feature: price is established on each individual animal based on carcass merit.
With most grids, price is discovered after animals have been slaughtered. With a few exceptions, most grids are based on dressed weights for fed cattle. Unlike live weight pricing or dressed weight “in the beef” pricing where there is a single average price for the entire sale lot, a price is discovered for each animal with grid pricing.
As a result, higher quality cattle receive higher prices and lower quality cattle receive lower prices. Thus, cattle producers who market desirable types of cattle are rewarded.
Most grids consist of a base price with specified premiums and discounts for carcasses whose quality perform above and below the base or standard quality specifications. An example is shown in Table 1, but does not represent the grid for any specific packer or marketing alliance.
Some grids may provide added premiums for carcasses meeting specifications of Certified Angus Beef or other marketing programs. Likewise, packers may specify discounts for hide damage, injection site blemishes and other “out” or unmarketable carcasses.
To compute a grid-based price, the distribution of carcasses by quality grade (QG) and yield grade (YG) from a sale lot of fed cattle must be known. That distribution also is put into a matrix framework.
A hypothetical distribution of carcasses for a 100-head sale lot of steers is shown in Table 2. The hypothetical pen is a fairly typical pen of cattle — 65% QG Choice and Prime, and 60% YG 1 and 2.
Once the base price is known for the grid in Table 1, the net price for a pen of cattle can be computed by multiplying the percent of carcasses in each matrix cell in Table 2 by each premium and discount cell in Table 1. For example, if the base price is $110/cwt. of dressed weight, then the weighted average price for the pen distribution in Table 2 is $109.68/cwt. See Figure 1. We assumed there were no “out” carcasses. The actual net price for a pen of cattle may vary from the calculated price due to differences in carcass weights.
Some other thoughts:
A higher base price is probably more critical to receiving a higher net price from a grid than are the specific premiums and discounts. The base price affects all cattle in the sale lot, whereas premiums and discounts affect only selected carcasses.
Many grids compute the base price using the previous week's cash price. These formula base prices don't contribute to price discovery and provide packers an incentive to lower cash market bids.
Formula base prices tied to the Chicago Mercantile Exchange Live Cattle Futures or to the wholesale beef market price are preferable to formulas based on fed cattle cash prices. Preferably, base prices can be negotiated weekly in the fed cattle market and contribute to competition and price discovery.
Pricing And Management Issues
Without knowledge of the cattle's carcass quality, marketing on a grid may be disappointing and risky. Grids can provide an incentive to market higher quality cattle, but the penalty for not recognizing and marketing lower quality cattle is large.
Even a few lower quality cattle, priced at large discounts to higher quality cattle, can offset the premiums for higher quality cattle. The bottom line results might be a price that is lower on average than a live weight or dressed weight cash price.
Cattle quality significantly affects the bottom line price results when marketing by a grid. For example, in Table 2 there are 30 head of Prime and Choice, YG 1 and 2 carcasses. Using the grid in Table 1, they add a premium of $1.08/cwt. to the base price.
Table 1. Example grid in a completed matrix format. ($/dressed cwt.) Base price is $110/cwt. Yield Grade Quality Grade 1 2 3 4 5 Prime 11 9 6 -14 -19 Choice 5 3 Base -20 -25 Select -1 -3 -6 -26 -31 Standard -11 -13 -16 -36 -41 Dark Cutters -20 Light Carcasses (< 550 lbs.) -10 Heavy Carcasses (> 950 lbs.) -20 Table 2. Example Distribution of Carcasses by Quality and Yield Grades (100 Head Total). Yield Grade Quality Grade 1 2 3 4 5 Total Prime 0 1 5 3 0 9 Choice 6 23 26 1 0 56 Select 10 19 5 0 0 34 Standard 1 0 0 0 0 1 Total 17 43 36 4 0 100 Fig. 1. Example of grid pricing calculations. Yield Grades 1 2 3 4 Prime $119 × 1 + $116 × 5 + $96 × 3 = $987 Choice $115 × 6 + $113 × 23 + $110 × 26 + $90 × 1 = $6,239 Select $109 × 10 + $107 × 19 + $104 × 5 = $3,643 Standard $99 × 1 = $99 _______ $10,968 $10,968 100 head = $109.68 Net price/cwt.
Also in Table 2, there are four YG 4 and one Standard carcasses. These five discounts reduce the base price by 96¢/cwt., nearly offsettinxg the premiums from 30 higher quality carcasses.
Should pens of cattle be sorted to fit different grids or sorted to sell some cattle on the cash market? Sorting cattle to fit different grids may be economical provided a producer has a good idea how the different groups of sorted cattle will perform in carcass form. Sorting off “out” or lower quality cattle just before marketing them and mixing them with a pen of cattle sold on an average live weight or dressed weight price is a shortsighted approach to marketing.
Profit from sorting may be higher for both pens but, over time, packers will likely bid lower for the cash market cattle. However, sorting cattle earlier may enable the feeder to manage both pens of cattle to meet specifications in more than one grid. This management change may reduce feeding costs, increase returns and enhance short- and long-term profitability.
Producers must realize that if feeding and other management practices are altered, then receiving the highest price doesn't imply the greatest revenue. Nor does the greatest revenue imply the largest profit.
Revenue is price multiplied by weight, and profit is revenue minus costs. To maximize profit on a pen of cattle, the selling weight and feeding costs need to be considered, in addition to the selling price.
Grid pricing methods have become more common in recent years. Grids have the advantage of pricing each animal, thereby improving pricing accuracy. Cattle are paid on actual dressed weights and the price is adjusted for carcass traits. Better quality cattle are rewarded and poorer quality cattle are penalized.
While grid pricing has definite advantages, producers need to know the quality of their cattle and how grids are calculated before knowing whether grid pricing is advantageous for them. Producers also must consider profit (cost and revenue) implications of altering feeding practices to target specific grids.
Dillon Feuz is an associate professor of agricultural economics at the University of Nebraska's Panhandle Research & Extension Center in Scottsbluff. He can be reached at 308/632-1230; e-mail: [email protected]