Economic Research Related to the Montana Beef Network: An Interim Report

by Gary W. Brester

Economic research related to the Montana Beef Network can be categorized into four general areas:

Evaluating the value of BQA participation on feeder cattle prices.
Evaluating the feedlot performance of Montana feeder cattle.
Using data from the Montana Beef Network to evaluate the tradeoffs between selling cattle on a value basis versus a live basis.
Developing a model which describes the critical aspects of information regarding animal quality as it pertains to cattle prices.

The Value of BQA Participation

To date, research regarding the potential value of BQA and the Montana Beef Network has centered on two sets of data. The first is the result of a mail survey conducted by Marc King. The survey was sent to 400 BQA members and 400 non-BQA members. Responses were received from 147 members and 69 nonmembers. Econometric regression techniques have been used to analyze the data. The following conclusions can be drawn from the survey:

In 2000, BQA members averaged $98.04/cwt for steer calves; non-members averaged $96.42/cwt – with the differences being statistically significant.
BQA members averaged $93.28/cwt for heifer calves; non-members averaged $91.82/cwt – with the differences being statistically significant.
No statistical differences between BQA members and non-members were found for calf sale weights, sale methods, or number of calves marketed.
BQA members used modified live vaccines relative to killed vaccines much more frequently than non-members.
On average, BQA members vaccinated calves 1.73 times; non-members vaccinated calves 1.35 times – with the difference being statistically significant.
After accounting for calf sale weights (and the number of years out of the last five that ranchers had marketed cattle to the same buyer), it appears that the BQA program added $1.56/cwt to steer calf prices and $1.09/cwt to heifer calf prices.

Feedlot Performance of Montana Feeder Cattle

Data from seventy pens of cattle were obtained from a Colorado branded-beef feedlot program. Statistical procedures were used to evaluate the impact of a variety of factors on morbidity, mortality, average daily gain, carcass weight, and carcass quality. The following summarizes the regression results:

Pens which contained animals from multiple ranches had a 6.7 percentage point increase in morbidity. In addition, pens which contained heavier feeder cattle had significantly lower morbidity.
Pens which contained heavier feeder cattle had significantly lower mortality.
After accounting for gender, pens which had lower morbidity had higher average daily gains. In addition, Montana feeder cattle had significantly higher average daily gains (about 0.2 lbs/day) than feeder cattle from 5 other states.
Increased average daily gains and heavier feeder cattle resulted in larger carcass weights.
After accounting for gender and carcass weights, straight bred British animals had higher percentages grading Choice than British crossed with British animals, and British crossed with Continental animals had lower percentages grading Choice than British crossed with British animals.
Montana feeder cattle were not different from those originating in other states in terms of morbidity or mortality. However, because of higher average daily gains, higher carcass weights, and higher percentage of animals grading Choice, Montana feeder cattle generated $31.47-$35.70/head more than other animals depending upon Choice-Select price spreads and selling method.

Value Based Marketing

Data were provided by the Montana Beef Network. Data were reported for over 13,000 animals during the 1999-2001 period. Of these, approximately 4,700 animals had associated carcass data indicating yield and quality grades. The data indicate that:

61.3% of the animals graded "Choice"; 36.1% graded "Select"; 1.3% graded "Prime"; 1.2% graded "Standard"; and 85% of the yield grades were between 2 and 3.99.
If all animals had been sold on an average grid which existed at the time each animal was slaughtered, gross revenue would have averaged $858.29/head. If each animals were sold on a live basis, gross revenue would have averaged $898.12/head. If animals could have been perfectly sorted so that discounts were not incurred, gross revenue would have averaged $900.83/head. This underscores the importance of knowing the historical performance of animals and selecting grids which optimize that performance.
A web-based decision tool is being developed which will allow producers to enter grid values and anticipated herd quality parameters. Using this information, the decision tool will analyze the relative economic tradeoffs between selling cattle on a grid versus on a live basis.

Estimating the Effects of Factors Influencing Variability of Grid Pricing Revenue

Selling fed cattle based on carcass quality (referred to as grid pricing) has increased in popularity over the past few years. Grid pricing requires that each carcass be evaluated for its own quality merits. Carcasses are valued from a specified base price and receive premiums or discounts based upon individual characteristics. Packers according to their demand for beef meeting certain standards determine base prices, premiums, and discounts. Characteristics such as quality grade, yield grade, and carcass weight are evaluated. This pricing method more closely reflects the wholesale value of the carcass and offers producers incentives to produce high-quality cattle. These market incentives should also help the beef industry to become more consumer driven and better address issues that have lowered beef demand over the past couple of decades. Along with these benefits, however, come substantial changes in the sources and magnitude of producer risk. Previous studies consistently show that revenue risk associated with grid pricing is generally greater than that of average live weight sales.

Managing this multifaceted risk is a complicated procedure. For example, managing cattle to increase the probability of realizing quality grade premiums simultaneously increases the probability of receiving discounts for high yield grades and heavy carcasses. In addition to these competing production factors there are marketing risks associated with base carcass prices, premiums, and discounts that vary over time and across grids. Therefore, to accurately assess the risk/return tradeoff of managing cattle for various grid pricing schemes consideration must be given to the interrelationships among the entire battery of influencing factors.

Little research has analyzed these interrelated risks associated with grid pricing. The general objective of this study is to model the risk surrounding the expected revenue of marketing fed cattle on a grid. The specific objective is twofold. Identifying which factors have the greatest influence on carcass revenue risk is the first component. Factors to be considered include variability in quality grade, yield grade, and carcass weight as well as variability of the carcass premiums and discounts. Second will be to determine how managing the risk of an individual carcass trait affects risk of other traits as well as total carcass revenue risk.

Using USDA Weekly National Carcass Premium and Discount Summary data from October 1996 to present and data from the Montana Beef Network; distributions of possible base prices, premiums and, discounts will be simulated. A distribution of expected carcass revenues will then be generated by pricing the simulated carcasses using these distributions of base prices, premiums, and discounts. Finally, sensitivity analysis will be used to determine the effect of different factors on carcass revenue variability. From this analysis benefits of effectively managing interrelated carcass traits will be determined.

Results will help producers better understand the interrelatedness and multi-faceted nature of revenue risk associated with marketing cattle on a grid. Furthermore, results will be of interest to professionals who consult with producers regarding issues such as the value of producing high-quality cattle to be marketed on a grid and what factors must be controlled to effectively manage the revenue risk associated with this strategy.

The Value of Information Regarding Cattle Quality

Ranchers producing feeder cattle confront significant challenges in marketing their products. In contrast to many crops, feeder cattle vary markedly with respect to quality from ranch to ranch, depending on genetics, quality of range, management practices. Feeder cattle also differ with respect to quality within any given operation, because of differences with respect to breed, mother cows, and other animal specific and ranch specific random effects. This product diversity or heterogeneity would not be so critical if accurate and inexpensive tools were available for measuring animal quality attributes that have value in the market place, such as the potential for producing tender steaks. Lack of this sort of precise information in auction and some other marketing settings leads to what economists call the “Lemons” problem. In the absence of credible quality assurance guarantees, buyers assume that animals are of relatively low, or at best, average quality, given the characteristics they can observe. In this sort of environment, those ranchers who invest in quality improving practices tend to be under-compensated for their products.

This has important consequences. First, buyers who want and are willing to pay for specific quality attributes often cannot find them in traditional marketing venues such as auctions. Second, those buyers then have incentives to seek alternative means of acquiring the quality attributes they want and for which they are willing to pay. Third, the needs of these buyers create potential opportunities at least some ranchers to increase revenues through developing new marketing channels through which they can provide quality assurance.

Beginning in the 1990s, two forces have come into play to increase pressures for the creation of new marketing channels for beef livestock. The first has been sharply rising real household incomes in the United States, Europe, and several Asian countries that has increased demands and premiums for high quality beef products. The second is the advent and widespread adoption of new biological and communications technologies for identifying quality attributes and reducing the costs of sharing such information. In response, in the United States and Europe a wide array of new producer initiatives and marketing arrangements have been initiated. Some have been successful for both ranchers and buyers and are flourishing. Other experiments have either been unsuccessful for ranchers or unsuccessful for buyers and have collapsed.

Success for the rancher requires that the new quality assurance and marketing arrangements increase producer revenues from quality enhancement by more than they raise costs of production. Success for the buyer requires that the improvements in quality obtained are more valuable than any increase in the buyer’s costs of acquiring the improved quality.

An example from Britain is of illustrative importance. Marks and Spencer's is a department store with a reputation for offering high quality products in its retail food outlets. To provide household customers with beef products of guaranteed minimum quality, beginning in the mid 1990 it has attempted to develop direct relationships with beef cattle producers but will only pay a premium for those cattle that meet its quality specifications. While some producers found the premiums to be satisfactory, others found that relatively large proportions of their animals were being rejected, even though they had adopted the herd management practices specified by the retailer. The rejected animals had to be sold in the traditional auction market and did not receive any quality premiums, leading many producers to drop out of the Marks and Spencer's program. As a result, the retailer has had some difficulties in obtaining adequate supplies of beef that meet its quality specifications.