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Beef and Pork Values and Price Spreads Explained

by 5m Editor
21 May 2004, at 12:00am

By U.S.D.A., Economic Research Service - This report examines these price transmission issues and also explains price spread calculations and analyzes the relationship between marketing costs and livestock prices in the long run.

USDA Economic Research Service

Abstract

Livestock and meat prices vary more in the short run than costs of production, processing, and marketing. ERS research shows that month-to-month changes in livestock and meat prices are driven by dynamic adjustment. It takes time for prices to adjust, and they tend to adjust more rapidly when they are increasing than when they are decreasing. When rates depend on direction, price adjustment is called asymmetric. The slow and asymmetric adjustment of prices does not appear to work against livestock producers.

Introduction

This report examines a number of controversies surrounding price spreads for beef and pork. A price spread is the difference between the cost of an item at one stage of the marketing channel and a different stage. ERS collects prices at three different stages of the marketing chain for beef and pork: the farm, the packing plant (wholesale), and at the grocery store (retail). These three sets of prices are used to calculate farm, wholesale, and retail values for beef and pork. These three price levels allow the calculation of three price spreads: farm-wholesale, wholesale-retail, and farm-retail.

High and increasing price spreads often lead to controversy. Livestock producers often blame low livestock prices on high price spreads. Consumers blame high retail prices on high price spreads. Increasing price spreads can both inflate retail prices and deflate farm prices.

Sometimes analysts cite increasing amounts of valueadded as a cause of rising price spreads. Consumers shifting demand toward more value-added products will result in lower percentages of the consumer food dollar being passed on to farmers. A higher demand for value-added products and a lower farm share of the consumer food dollar will not generally lead to decreases in farm prices. Analysts who cite increasing value-added as a factor in pork and beef price spreads misunderstand how these are calculated.

Price spreads fluctuate greatly from one month to the next. These short-term fluctuations are consistent with what economists call “dynamic price adjustment.” It takes time for prices to adjust to changes in economic conditions. With dynamic price adjustment, price spreads can be temporarily higher or lower than they “ought” to be. Price adjustment dynamics will tend to move prices so that price spreads go toward where they ought to be. One of the important factors that determines how farm and retail prices react to dynamic adjustment is a concept that economists call price discovery. In this case, price discovery is about which, if any, of the stages in the marketing system is most important in determining prices. In simple cases, one price reacts first and the others follow. In more complex cases, each price can simultaneously influence and be influenced by the others.

How Values and Spreads Are Calculated

The basic idea behind price spreads is simple. Consumers, for the most part, do not buy food directly from farmers. The price consumers pay for food is almost invariably higher than that received by farmers. The farm-to-retail price spread is the difference between what the consumer pays and what the farmer receives. From the consumer’s point of view, the retail price is the most important. Changes in retail prices affect consumers directly. Producers are directly affected by the farm price. Why would either care about price spreads?

Producers expect two things out of a price-spread reporting system. The first is help with marketing their products. The better their knowledge of what consumers want from meat, the better producers can meet consumer expectations. Retail prices or values are part of the information producers need to understand consumer demand. Price-spread calculations require the collection, calculation, and reporting of retail prices.

Producers also use price spreads to measure the efficiency and equity of the food marketing system. Producers are concerned about getting their fair share. Consumers are also concerned about the efficiency and equity of the food marketing system. All other things the same, consumers would prefer lower prices and producers higher prices. In mathematical terms, the price spread is the retail price minus the farm price. We can rearrange the price-spread equation and make it more useful for farmers or consumers. Consumers can view their price as the farm price plus spread. The consumer equation implies that higher price spreads cause higher retail prices. Farmers can see their price as the retail price minus spread. The farmer equation implies that higher price spreads cause lower farm prices. Price spreads can become lower if farm prices increase and/or retail prices decrease.

Turning the price-spread definition into a farm-price or retail-price equation is a mathematical exercise. In order for this exercise to correspond to something in reality, the price spread has to be something more than just the difference between the farm and retail price. It is. The price spread is the costs and profits of the marketing system that moves the farm product from the farm to the consumer and processes it to its final form. Innovative technologies can lower costs and, consequently, price spreads.

The farm-to-wholesale and wholesale-to-retail spreads divide the total costs and profits between packers and grocery stores. Economic efficiency increases when costs and profits drop. In theory, changes in price spreads can help measure changes in the efficiency of the beef or pork marketing system. Both consumers and farmers can gain if the food marketing system becomes more efficient and price spreads drop. Lower price spreads can reflect both higher farm prices and lower consumer prices.

One of the problems with implementing a price-spread calculation is coming up with a definition for the farm and retail product. At the farm level, hogs and cattle come in a variety of sizes, ages, grades, and other factors that affect their price. Consumers also have a variety of outlets where they can buy meat, and can often buy multiple forms of this meat from the same outlet. The perfect price-spread system would calculate price spreads for all animal types and outlets, and give information on the relative importance of each of the marketing channels. The perfect price-spread system would require large amounts of data, computing resources, and human time, and consequently would be extremely expensive. The perfect price-spread system would also require data the government does not collect. For example, official statistics show only total domestic disappearance of meat, which means we do not know how much meat goes through stores and how much goes through food service, only the total going through both.

ERS provides two different “compromise” measures of meat price spreads. One compromise is to compare the “average” value of all hogs and cattle sold to the “average” value of pork or beef purchased in all forms from all outlets. The Food and Rural Economics Division of ERS calculates price spreads for meats and other foods using this method.1 The major purpose of these price spreads is to calculate the farmer’s share of the consumer food dollar. The consumer costs of meat are based on research that the Bureau of Labor Statistics (BLS) uses to calculate the Consumer Price Index (CPI). The consumer market basket is based on periodic surveys of consumer purchases. Between surveys, price spreads are calculated using the assumption that the items consumers buy do not change.

ERS’s Market and Trade Economics Division, on the other hand, calculates price spreads based on a standard animal, cut up in a standard way at the packing plant, and sold in standard form through the retail store. These price spreads are the basis of this report. Focusing on a standard animal and marketing channel reduces the amount of data that has to be collected compared with that needed to calculate an “average” spread. Spreads based on average costs of beef and pork through all outlets change when the mix of outlets changes and when the margins in each outlet change. Increasing “average” spreads can be the result of increasing costs/profits, shifts to more costly channels, or both. Focusing on a single market channel allows one to attribute changing spreads to changes in economic performance in that channel. Given that one is focusing on a single channel, it would be helpful if that channel handles a relatively large volume of meat. Grocery stores are an important channel for meat sales, which is one reason that ERS calculates its retail value based on grocery-store prices.

Producers also use retail-price information in analyzing the end demand for their livestock. Focusing on a single channel and type of animal makes the retail values more consistent over time and easier to compare. The ERS standard marketing channel is a non-specialized or generic market. Those producers that are looking into market niches could always divert their animals into this “generic” channel. The ERS retail value represents a potential minimum value for more specialized producers.

The quality of animals that producers raise, and the cutting practices at the packing plant and the grocery store, evolve over time. ERS makes occasional changes in its standard animals and standard cuts to better reflect current practices. When the standard animals or cuts are changed, ERS recalculates the previous farm, wholesale, and retail values in an effort to make the historical data consistent with the new practices. The current standard beef animal (farm) price is the five-market, weighted average for a 35-65% Choice Steer as reported by USDA’s Agricultural Marketing Service (AMS). The standard hog (farm) price is the AMS 51-52% base-lean-hog price. Some people have complained that these ERS standard animals are now substandard relative to the bulk of the market. However, the goal of this methodology is to compare price spreads for a consistent animal over time, not to compare price spreads for each period’s most “representative” animal.

Wholesale values for beef and pork cuts are also published by AMS. ERS uses these wholesale values to make the wholesale composite values. The retail beef and pork cuts that ERS uses in the calculation of its retail composite prices are relatively low value-added cuts. All the beef cuts are fresh cuts sold through the meat case. The pork cuts are all fresh except for ham and bacon. Consumers purchase little fresh ham or bellies. (Bacon is cured and smoked pork bellies.) ERS changes in the standard retail value have been small. The current standard retail product has fewer bones and less fat than the standard product of the 1970s. The standard retail product has always been a relatively low-value-added mix of cuts sold through the retail meat case.

Before 1980, ERS collected data directly from cooperating retail stores. The ERS survey started with 20 chains; however, the number declined over time. The cooperators kept track of the prices of their cuts and the volume sold of those cuts, and provided ERS with sales-weighted average prices. Stores commonly change meat prices only weekly. When a store lowers the price of a cut, it will likely sell more of it. The sales-weighted price of an item was usually lower than the price averaged over weeks.

High costs and loss of cooperators led to a change in ERS procedures. Since 1980, ERS has used retail prices reported by the Bureau of Labor Statistics (BLS). BLS data are collected from more outlets than the old ERS data and from a statistical sample of outlets versus self-selected cooperating stores. The selfselected stores ERS used prior to 1980 may have been different from stores in general, and this might have induced some degree of unknown bias in the retail prices. However, BLS collects only prices from stores, not sales volume on the individual cuts. It can not change the weights on its averages to reflect changes in sales volume associated with changes in retail prices.

This omission led to some concern that using BLS retail prices leads ERS to overstate the retail values for beef and pork. The Livestock Mandatory Reporting Act of 1999 required that USDA “compile and publish at least monthly (weekly, if practicable) information on retail prices for representative food products made from beef, pork, chicken, turkey, veal, or lamb.” In response, ERS began to buy commercially available retail-scanner data, which are compiled and published on the web. These data have sales-weighted average prices for beef and pork cuts, which are generally, but not consistently, lower than BLS prices.

Grocery stores are not required to provide scanner data to ERS, so these data come from a self-selected sample of stores. These stores may have either consistently higher or lower prices than the average supermarket. As with the pre-1980 ERS data, the self-selected sample could induce some unknown bias in the reported average prices.

ERS continues to use the BLS data in calculating price spreads, also mandated in 1999’s Livestock Mandatory Reporting Act. Sticking with the BLS data also makes current estimates consistent with those from the 1980s and 1990s.

The retail value used in price spread calculations is the average price per pound of all the cuts an animal produces. In other words, the retail value is the average cost per pound rebuilding the animal with meat parts only from the grocery store. Animals are not entirely meat. The further up the marketing chain an animal goes, the more weight it loses due to the removal of bone and fat trimming, hides, hair, offal, and the like. For example, a 1,000-pound steer produces 417 pounds of retail meat cuts, 110 pounds of edible fat, 38 pounds of variety meats, 80 pounds of hide, 40 pounds of blood, 175 pounds of inedible fats, and 140 pounds of liquids lost during processing (shrinkage).

To make the price comparisons easier, ERS transforms the farm and wholesale prices to a retail-weight equivalent. The live animal value is the cost of the amount of live animal it takes to produce 1 pound of retail meat. The ERS conversion factors are 2.4 pounds of live, Choice steer to produce a pound of “standard” retail beef; and 1.869 pounds of 51-52 % lean hog to produce a pound of “standard” pork. Some bone and fat trimmings are removed in converting wholesale cuts to retail cuts, so wholesale prices also must be adjusted to a retail-weight basis. The ERS standard conversion is 1.14 pounds of wholesale beef per pound of retail beef, and 1.04 pounds of wholesale pork per pound of retail pork.

Table 1 shows January 2003 price spread figures for beef and pork and includes two farm values and a byproduct value. Many animal parts that are not meat (hides/skins, tallow/lard, bone meal, and edible/inedible offal) have value. ERS does not track the value of these byproducts past the packer level. Most of these products are used as intermediate inputs in the production of other goods, and tracking their contribution to the final products demanded by consumers is not feasible. Still, the byproducts have value, and this value is used to calculate the byproduct allowance and net farm values in table 1.

The total sales that an animal generates for a packer are the value of its meat and byproducts. ERS calculates the percentage of the animal’s value generated by byproducts. Call that percentage “x.” The byproduct allowance is “x” times the gross farm value. The net farm value is the gross farm value minus the byproduct allowance. You could also calculate the net farm value by multiplying the gross farm value by the percentage of the animal’s value that is meat, 1-x. For example, in January 2003, the byproducts represented 10 percent of a steer’s total wholesale value. The byproduct value for beef in January 2003 is 9 percent of the gross farm value while the net farm value is 91 percent of the gross farm value. The wholesale-to-retail spread is the difference between the wholesale value and the retail value. The farm-to-wholesale spread is the difference between the wholesale value and the net farm value. The total spread is the sum of the farm-wholesale and wholesale-retail spreads, which can also be calculated by subtracting the net farm value from the retail value.

Links

To read the full report, please click here

For more information view April's Livestock, Dairy and Poultry Outlook - April 2004

Source: U.S. Department of Agriculture, Economic Research Service - May 2004