Reality Gap

Vultures. How else do you explain the fact that feedlots are bleeding record amounts of red ink, yet retailers continue to receive a growing portion of the retail dollar? For perspective, according to Chuck Lambert, chief economist for the National Cattlemen's Beef Association (NCBA), the producer's average share of retail value declined from 62.2% in 1984 to 47% in 2001. That's based on how USDA

Vultures. How else do you explain the fact that feedlots are bleeding record amounts of red ink, yet retailers continue to receive a growing portion of the retail dollar?

For perspective, according to Chuck Lambert, chief economist for the National Cattlemen's Beef Association (NCBA), the producer's average share of retail value declined from 62.2% in 1984 to 47% in 2001. That's based on how USDA calculates the price spreads it reports. During the same period, packers share of the retail dollar increased from 5.1% in 1984 to 9.1% in 2001. Retailers' average share increased from 32.7% in 1984 to 43.5% last year.

Again, short of greed and larceny, what could explain such a seemingly unbalanced scale?

The short answer is this: Because of the way these spreads are calculated, they say more about increased costs in the different segments and necessarily less about profitability.

What the Numbers Don't Say

“The farm-to-retail spread is often cited as an indicator that producers are being taken advantage of,” says Andy Gottschalk, cattle market analyst and owner of HedgersEdge.Com, LLC, an agribusiness research firm. “But more important than what those numbers tell us is what they don't.”

First, Gottschalk explains the USDA retail price series used in calculating the spreads is based on USDA Choice Quality Grade product. Since most of the beef selling at retail isn't Choice, the bulk of retail beef — most of it selling at prices lower than Choice — is not included in the calculation, thus overstating the average retail price paid for beef (Table 1).

Plus, Ted Schroeder, a Kansas State University agricultural economist, points out the USDA price series is not weighted for volume. It's a simple average of prices posted in sampled grocery stores for Choice grade cuts that comprise a carcass. Prices that consumers actually pay for beef are not necessarily consistent with or reflective of these posted prices.

For instance, two different stores may bee selling the same beef cut but one is featuring the product with a special sell. Under the USDA price series, the two prices are simply averaged, despite the lower-priced store maybe selling much larger volume.

As well, the price series does not account for retail featuring or specials — offering specific advertised cuts at a lower price — or for shopper discount cards that apply varying discounts to varying cuts purchased by frequent shoppers. Again, the USDA retail beef price is likely biased upward.

Even without these obvious and known pitfalls, if retailers' share of the consumer dollar paid for beef is increasing, Schroeder says the next question is whether or not the margin is increasing because of cost or profitability.

After all, since the retail price, like the packer price, accounts for costs incurred, prices charged at the meatcase can increase without adding to the profitability of the packer or the retailer.

“One of the biggest factors driving the increased spread at the retail level is the sharp increase in marketing costs over the past few years,” says Gottschalk. “Data from most retailers would indicate a profit margin on beef of 1 percent of gross sales, which is quite consistent with the other meat products they sell.”

So, the fact that the price spread between producers and retailers has increased says nothing about profitability.

“The margin reported is a gross margin and has nothing to do with net margin. As such it is not a good proxy of profitability,” Gottschalk says.

Pitfalls of Predicting Packer Profit

Likewise, the producer-to-wholesale price spread, or packer margin, accounts for costs and gross margin, not net.

“If you alter some sort of process in the plant, such as compliance with new food safety standards or compliance with new price reporting procedures, and those changes increase cost or product loss, the packer margin increases. Profit is in that margin, too, but it is one of many dimensions that must be considered,” says Schroeder.

Incidentally, recent years have yielded an explosion of heat-and-eat convenience beef products. Packers, processors and retailers are doing all the further processing. The same logic that would expect this reality to increase their costs, also says they're entitled to any added profit.

Still, Schroeder says, “Analysis and evidence suggests profits in the beef packing sector are quite small, very thin margins over time.”

But what about those headlines in the business section boasting of the record quarterly earnings of one publicly traded meat company or another?

Table 1. Retail price differences
Year Choice retail beef ($/lb.) All retail beef ($/lb.) Featured retail beef ($/lb.)
1990 2.81 2.62 2.56
1991 2.88 2.71 2.62
1992 2.85 2.66 2.56
1993 2.93 2.71 2.72
1994 2.83 2.65 2.59
1995 2.84 2.59 2.42
1996 2.80 2.52 2.45
1997 2.80 2.54 2.50
1998 2.77 2.53 2.52
1999 2.88 2.61 2.58
2000 3.06 2.75 2.72
2001 3.38 3.01 2.93
2002* 3.32 3.06 2.82
*First quarter
Source: USDA, Cattle-Fax, NCBA

Aside from the fact that beef is only one enterprise beneath the roof of packing conglomerates, Schroeder says, “I don't put much faith in annual accounting profits because there are so many variables that go into the process.”

Perhaps a company applied an asset write-off this time that they didn't last time. Maybe they changed their depreciation schedule. Bottom line, it's tough to get a fix on the true profitability of a single firm from year to year, much less derive some sort of universal profit index across an assortment of firms involved in the same business.

Searching For Clarity

While assessing profitability will likely remain a vexing challenge, economists say USDA is working to make their reported spreads more meaningful.

As an example, Gottschalk says, “USDA is currently examining the use of private data (think in terms of retail barcode sales and the like) that would give us a much better read on actual prices paid at the retail level. Hopefully, some of that can be utilized in the next 12-18 months.”

In the meantime, Schroeder says, “When we see the producer's share of the retail dollar declining, it raises red flags and it should. But, producers also need to make sure they understand the detailed mechanics of it.”

Calculating The Spread

Ted Schroeder, Kansas State University agricultural economist, says the producer-to-wholesale spread or packer margin is basically the value of the meat, hide and offal of an animal sold, minus the price paid for the animal.

Likewise, the producer-to-retail price spread accounts for the simple average of non-featured, non-volume-weighted, USDA Choice grade retail cuts that comprise a carcass, minus what the retailer paid the packer for the boxed beef representing those cuts.

“Unfortunately, both these spreads have been widely misunderstood,” says Schroeder. “A lot of people want to use them as measure of what the different segments are capturing in profitability.”

As you can see in the following example adapted from information provided by Chuck Lambert, chief economist for the National Cattlemen's Beef Association (NCBA), there's no way to derive profitability from the figures.

  • Every 1,000 lbs. of fed cattle live weight yields 630 lbs. of carcass weight and 427 lbs. of salable retail weight, based on the industry average yields used by USDA.

  • Assume a fed steer brings $65/cwt. On 1,000 lbs., that's $650 in gross receipts paid to the feeder.

  • If the USDA Choice lightweight cutout is $1.15/lb., that means the packer will garner $724.90 (630 lbs. carcass weight X $1.15) on the sale of the meat. He'll also receive the by-product value (hide and offal).

    In this case, let's say USDA calculated by-product value at $90/ head. All told, the packer earns gross receipts of $814.50 ($724.90 + $90) on the sale of the harvested steer. Subtract the $650 the packer paid for the steer to begin with, and he has receipts of $164.50. Keep in mind, that's still not net.

    Current estimates peg the cost of harvesting and processing the steer at about $130. So, the net spread in this case is around $34.50.

  • Now, if the average Choice retail price is reported at $3.30/lb., the retailer supposedly rings up gross receipts of $1,409.10 (423 lbs. × $3.30) for that same steer. Subtract the $724.50 the retailer paid for the animal in boxed beef form, and there's $684.60 remaining. In figuring retail price spreads, the value of hide and offal is added back in.

But none of this says anything about profitability. It merely says here are the dollars left after the raw cost of the input (and likely an inflated figure) to further process, package, market, pay overhead and all the rest.