Recognizing the evolving needs of the consumer and those who produce the cattle, IBP has established a new marketing system that combines the benefits of value-based marketing with competitive price negotiations. The Real Time Market Value grid (RTMV) pays producers premiums for the true value of their livestock based on current market conditions starting from a negotiated base price.

The introduction of a value-based marketing grid by IBP, the world's largest beef packer and purveyor, sends a loud-and-clear signal as to the direction the industry is moving in terms of cattle marketing. Considered a growing niche over the last four years, value-based marketing is becoming a dominating marketing method.

Price discovery

Value-based marketing holds great potential for improving beef quality, and producers stand to benefit from quality premiums. However, the increase in captive supplies and the decline in the number of cattle sold on the cash market have raised concerns about fair price discovery. Feeders who sell cattle on value-based formulas are often criticized by others in the industry for allowing packers to control the product without price negotiations.

"We are giving up all of our bartering power by selling captive supplies and guaranteeing the packer that we are going to bring himhis kill needs at whatever the cash price is that week," says Randy Fisher, investment broker for A.G. Edwards in Garden City, Kan. "If we could bid the base price on 100 percent of the cattle that we market, that would solve the problem."

Negotiated pricing where buyers attempt to buy low and sellers try to sell high is the most trusted approach to finding a base price reflective of product supply and demand. But as more cattle are sold on formula-based grids, fewer and fewer cattle determine the price on all of the cattle sold.

"What is going to happen when those of us who negotiate the cash price are not here? Where is the market?" asks Tom Feller owner of Feller and Co. Feedyard in Wisner, Neb.

"I don't think a set price would work because everybody doesn't feed the same type of cattle. That's why value-based marketing is going to get pushed so hard because people are going to get paid for the type of cattle they feed," says Dale Moore, feedlot manager at Diamond O Feedyard, Butler, Mo.

Real Time Market Value

The RTMV grid should calm many critics of captive supplies because fed cattle prices are negotiated or formulated the week of delivery instead of weeks in advance.

"The base price for the IBP Real Time Market Value grid can be derived in one of two ways. You can either negotiate the base price for the grid with IBP's buyer in the feedyard just like negotiations on the spot market are done. Or, you can let the market price your cattle by using IBP's clean-up price as your grid base," explains Bruce Bass, vice-president of cattle procurement for IBP.

The clean-up price means the actual cost to IBP, based on grade and yield, of all cattle purchased on the spot market during the week in which your cattle die. Despite the push for negotiated pricing, feeders often wish to maintain the ability to guarantee the week of kill for their cattle. By designating the week the feeder can sell cattle when he knows they are ready instead of convincing the packer-buyer they are ready.

"There are a lot of people who believe that IBP purposely tries to get the live price down so that their formula cattle will be that much cheaper. But by using the current week clean-up price as the base, that's not possible," says Mr. Bass. "If we buy junk at a little bit lower than the next guy buys good cattle, our Yield Grade 3, Choice price will still be dollars higher than we intended it to be."

The RTMV grid also may appeal to producers because of its flexibility. The new value-based marketing program is available to cattle feeders of all sizes. Producers do not have to be locked into the program to use it and do not have to commit cattle to a specific time period. Producers simply say they want to sell on the grid and there will be room for negotiation over delivery dates and prices within the grid.

"I would like for people to understand that you don't have to buy shares in anything to use this grid," says Mr. Bass. "This is not a program for people with 20,000 cattle, 2,000 cattle or 200 cattle. This is a program that anybody can participate in at any time. The program stops short of guaranteeing market access only because we can't guarantee access for more than we can kill."

Premiums and discounts

A big difference between IBP's grid and those of other packers is that some of the premiums and discounts will be adjusted each week to reflect weekly wholesale beef supply and demand.

"The value of premiums and discounts is determined by running a weekly price realization on all of IBP's products sold and comparing that to the choice base to figure out what they are actually worth," explains Mr. Bass. "We are tying the premiums to the boxed beef value. So it's real time, not more than five days old, real market signals."

Where some grids begin with a grading base that must be reached before premiums kick in, there is no base in the RTMV grid where par value is a Choice, Yield Grade 3 carcass. Discounts and premiums for quality grade will fluctuate with current demand for the products. Premiums and discounts for yield grade will also be adjusted in relation to demand but will remain much more stable. YG 2 carcasses will have a $2.50 per hundredweight premium and YG 1s will have a $6.50 per hundredweight premium. Discounts for YG 4s and YG 5s will also vary depending on what IBP can sell the carcass for vs. the base price.

Identifying the value

The Real Time Market Value (RTMV) program provides much higher premiums for YG 1 and 2 cattle than most traditional pricing systems in the industry. IBP is sending the signal to cattle feeders that high-yielding cattle are worth more than previously recognized. That's because a growing percentage of IBP's beef cuts are extensively trimmed and placed in retail-ready packaging. So it makes economic sense for IBP to offer a program that attracts a larger percentage of externally lean, high quality carcasses.

"Because we are now selling a really large portion of our product mix as closely trimmed, the dynamics of value have switched dramatically. Value lies in sellable red meat yields as opposed to the old commodity product when Yield Grade 1s and 2s weren't worth very much more than a Yield grade 3," says Mr. Bass. "After doing extensive cutting tests for a couple of years to figure out where the value might lie, we determined that we were over-valuing Yield Grade 3s and sending the wrong signal to our suppliers. I think the rest of the industry will eventually come along and make it at least similar."

The RTMV grid gives producers an obvious signal as to the value IBP places on fed cattle that fail to grade Choice and do not yield.

"They are saying send us your good-to-average cattle and we will pay for them. Even the average cattle will pay a little bit of a premium," says Dale Moore, feedlot manager at Diamond O Feedyard in Butler, Mo.

Bidding on grade and yield Although grid premiums are not negotiated, grade and yield does have an effect on determining the base price. That's because the packer first determines what it will pay for carcasses meeting the minimum specification such as Choice, YG 3 in IBP's grid. Packer-buyers then negotiate a live price by estimating what they think the cattle will be worth on the grid. (See sidebars)

To successfully negotiate and market cattle on a grid or a cash basis, feeders will have to be able to do the same thing.

"Before I ever sell them I look at a set of cattle and estimate if they will grade 60 percent Choice or 70 percent Choice, and if they will have a bunch of Yield Grade 3s or even a Yield Grade 4 in there. I make two columns. One of them is a grid price and one of them is a live price. Whichever one I come out higher on is how I negotiate," says Mr. Moore. "And if I have a set of cattle that I honestly think is going to pay $1.14 hanging and that figures out to be a $71.75 live price. I ask for $72. If they offer $71.75 I am going to take it because they are going to pay just as good as selling them on the grid."

The two things that will become more important to know will be the premiums and discounts and how your cattle perform on the rail. You cannot negotiate a base and premiums if you don't know what your cattle have to offer.

"We ultrasound cattle here at the feedyard, which is beginning to be my biggest negotiating tool," says Mr. Moore. "If you know what the cattle are going to be then you can negotiate because there's no guessing."
As the use of value-based marketing increases, so will the feeder's ability to negotiate premiums and base price according to Mr. Moore. "The potential is there to negotiate the base price but right now I don't really have the leverage or bargaining power to move that price. If the bid is set at $1.15 for Choice 3s, that's what it's going to be," says Mr. Moore. "But it takes two people to agree on a price. If the buyer and seller agree, then it's a deal. If we both agree that's the price, then no one should be able to say that the other one cheated him."

Mandatory price reporting may play a positive role in base-price negotiation. Supporters hope to have much better information on what the base price was for cattle sold on a value base grid, what the premiums and discounts were for different classes of cattle within the grid, and what the average value of those cattle were relative to the cash market.

Drovers' series on alternative pricing methods continues next month with a look at using the Futures' market to set the base price.