April 3, 2023
by Christopher Pudenz and Lee Schulz
Producers and packers have been at odds over “fair” cattle price discovery ever since the first steer traded hands to be slaughtered off-farm. For decades, producers have claimed that fewer, but larger, packing companies exerted disproportionate leverage in the price discovery process.
Concerns boiled over in recent years as the spread between fed cattle prices and beef prices hit record levels. From January 2010 until August 2015, monthly price spreads averaged $34 per cwt according to USDA’s Economic Research Service. From September 2015 through the end of 2018, price spreads averaged $58 per cwt. Price spreads then widened dramatically, averaging $84 per cwt in 2019, $122 per cwt in 2020 and $156 per cwt in 2021. In 2022, the farm-to-wholesale beef price spread eased a bit, averaging $91 per cwt for the year.
Price spreads reflect marketing costs plus economic profit, especially in the long run. While the data show beef packers’ total operating margin has expanded significantly and persistently in recent years, the data shed no light on whether the wider price spreads are due to rising costs or to increasing profits.
Many analysts view the increased price spreads as transient. They suggest wider price spreads after the 2019 fire at the packing plant near Holcomb, Kan., and in 2020 during the COVID-19 induced packing plant disruptions are consistent with perfect competition in the marketplace. Producer groups generally agree that these events likely did have ripple effects.
However, persistently wide price spreads before and after those shocks to packing plant capacity suggest “something” other than external market conditions and shocks could be at work.
Cyclical impacts on prices and spreads
Some market observers think persistently wide price spreads result primarily from cattle supplies being out of step with slaughter capacity. The current cattle inventory cycle (trough to trough) began in 2014. Inventories peaked in 2019. Inventories have been declining since. Most cattle cycles run nine to 14 years. The current cycle is on the longer end.
Cyclically lower fed cattle supplies bring fewer cattle to market relative to available shackle space. That helps support cattle prices, which should narrow price spreads. Lower Jan. 1, 2023, inventories in USDA’s biannual Cattle report confirm that is where the industry is heading.
Conversely, cyclically large cattle supplies can depress cattle prices. When the packing sector is operating at or near capacity, demand for fed cattle weakens. At the same time, even when consumers are willing to pay more for beef, retailers buying wholesale beef may not be willing to pay more for that beef, and packers may not be willing to bid up for fed cattle. The primary reason is costs that can exert pressure to widen the farm-to-wholesale beef price spread. Remember, the costs of slaughtering, processing, packaging and transporting beef and required profit determine prices packers are willing and able to offer to fed cattle producers, and prices packers ask from wholesale beef buyers.
All told, large cattle supplies and correspondingly high beef packing-capacity utilization at peaks of cattle inventory cycles affect producer and packer returns, but they are not a new phenomenon.
This cycle is different
Beef packer concentration more or less plateaued in 1995. Since then, two cyclical cattle inventory peaks occurred―in 1996 and 2007. But neither case saw such wide price spreads. Something must have changed since the cattle inventory cycle peak in 2007 to fuel such persistently wide price spreads without any obvious precipitating market shock.
Most beef packers in the United States with multiple plants now openly employ multi-plant coordination. The companies coordinate procurement, slaughter and downstream marketing activities across all plants the company owns. The goal is to maximize corporate-level profits as opposed to plant-level profits.
It is intrafirm coordination. It is not coordination across separately owned firms. The latter would be illegal collusion. The former is arguably prudent business management.
A parallel might be a feedlot operator striving to maximize profit to the feedlot, rather than to individual pens. Doing so may, at times, call for selling some pens before maximum profit to the pen, while at other times delaying sales of pens beyond maximum profit to the pen. In some cases, letting a pen temporarily sit empty or closing the lot could be best.
Packers provide confirmation
The question is not if or even when beef packers shifted to using multi-plant coordination. Their own statements from public press releases confirm the use of this practice. Instead, the relevant questions are:
What are the possible implications of this business practice for the different segments of the beef supply chain?
Could multi-plant coordination help explain persistently wide price spreads?
Our peer-reviewed paper, Multi-plant Coordination in the U.S. Beef Packing Industry, was recently published in the American Journal of Agricultural Economics, the leading journal in agricultural and applied economics and the flagship journal of the Agricultural and Applied Economics Association.
Our study shows two direct effects from beef packers effectively implementing multi-plant coordination. One effect potentially narrows the spread between upstream fed cattle prices and downstream beef prices. The other effect potentially widens the price spread.
First, multi-plant coordination generates beef packing cost efficiencies that packers could pass on to producers via paying higher prices for cattle. For example, multi-plant coordination allows packers to streamline procurement staff and trim labor costs. Multi-plant coordination could also reduce the costs associated with marketing beef into consumer markets. Simply put, multi-plant coordination helps beef packers trim expenses. Our models show packers pass all of those cost savings along to cattle producers.
The second effect has to do with packing companies reducing competition among the plants they own. This effect is not unlike the result of a company that removes the negative externality of competition by merging with a rival company. The largest beef packers implementing multi-plant coordination can be thought of as 20 somewhat independent packing companies consolidating into just four. The resulting reduced market competition could result in wider price spreads between beef prices and fed cattle prices.
If the effects of this reduced competition outweigh the cost efficiencies of multi-plant coordination, this business practice provides an explanation for wider price spreads.
Interaction with pricing methods
In 2005, cash-negotiated trade represented about 55% of weekly national fed cattle sales. Formulas represented 30%. Today, cash-negotiated trade has declined to about 20%. Formula trade represents some 60%.
Formula pricing streamlines transactions for both producers and packers. Formula contracts can also help producers and packers secure beef market program premiums and meet customer demand specifications. These transaction cost savings and downstream market incentives provide a profit motive for both producers and packers to price more and more cattle via formula. Multi-plant coordination has no direct impact on the equilibrium profit maximizing quantity of cattle procured via formula — the equilibrium quantity of formula sales remains unchanged, even when multi-plant coordination is used across the industry.
Longer-term structural change
Packers, like feedlots, maximize profits by operating near capacity all of the time. Declining cattle inventories result in excess capacity, bringing pressure to idle some capacity. Multi-plant beef packers closed six major fed cattle slaughter plants between 2005 and 2015.
Our study indicates that, as cattle inventories decline, a multi-plant coordinator will permanently shut down a plant before the same plant, run as a separate profit center, will shut down. This difference has implications for both packers and cattle producers.
Excess shackle space is expensive. Each plant shutdown between 2005 and 2015 was likely prudent at the time for the respective beef packer. Keep in mind, the most antiquated and least efficient plants are usually the first ones on the chopping block. That said, the cattle industry experienced packing capacity issues since 2016 at least in part because beef packers — acting as multi-plant coordinators — trimmed shackle space from the system. These shutdowns almost certainly improved overall capacity use and packing efficiency.
At the same time, though not likely the same motivation, our study shows that these shutdowns could have widened the spread between upstream fed cattle prices and downstream beef prices. At a bare minimum, cattle must travel further to be harvested, which boosts transportation costs and increases shrink. Shrink occurs when the weight at one location is less than the subsequent weight at another location. In cattle sales, the highest price per pound does not necessarily mean the highest return per animal. The number of actual pounds involved may be more important, which is why shrinkage is an important consideration.
New entrants could help
Finally, we demonstrate that adding a strategically located packing plant, owned by an entrant firm, could narrow the farm-to-wholesale beef price spread. This means that initiatives to add independently owned shackle space, once completed, could result in better earnings for producers, as some have suggested. Our study speaks primarily to relative prices and not absolute prices, but if the definition of “better earnings” involves fed cattle prices that are closer to beef prices, then these initiatives could be effective in achieving that goal.
Our models show that whether or not this new capacity would actually affect price spreads depends on how efficiently the new entrant owners can operate the new capacity. Only time will tell.
New plants could be eligible for federal subsidies. Amounts, nature and timing of such subsidies could impact new plant-cost structures. Subsidy details will have consequential effects for packers, producers and price spreads.
If multi-plant coordination maximizes packer profit, why have packers only recently adopted it? The rise in capability and use of computing technology to manage supply chains is likely the catalyst for effectively implementing multi-plant coordination within the beef packing industry. Amazon Web Services’ Elastic Compute Cloud made cloud computing more accessible starting in 2006. Machine learning and artificial intelligence tools have since gained traction.
The world is also indescribably more connected electronically than it was in the mid-2000s. As a frame of reference, Apple Inc.’s world-changing first-generation iPhone was introduced in 2007. The implementation of multi-plant coordination has corresponded directly with new technologies.
Our research is critical for ongoing policy discussions regarding the structure, conduct and performance of the beef packing industry. Multi-plant coordination makes the level of concentration in beef packing a less reliable measure of market competitiveness in the industry than it used to be.
Furthermore, multi-plant coordination must be part of the discussions about proposed policies that would mandate certain levels of negotiated trade in fed cattle with the hope of improving price discovery. Using multi-plant coordination could give multi-plant packing firms increased flexibility in the practical implementation of any such policy that regulates fed cattle pricing methods at either the plant or the firm level.
Pudenz is a doctoral candidate and graduate research assistant in the Department of Economics at Iowa State University. Schulz is an Extension livestock economist and associate professor of economics at ISU.
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