Product Pricing: Economics Beef Industry

Product Pricing

The U.S. Cattle and Beef Industry

ECO 533/ Economics for Managerial Decision Making

June 7, 2006

The U.S. beef and cattle industry has historically played a critical role in fulfilling consumer beef demand domestically and abroad. Beef tenderness, juiciness, flavor, consistent quality, consumer health and nutrition, trust and product brand are all determinants of how consumers demand beef products (Beef Update, 2005). Beef consumption and prices were high in the 1980s, but prices fell by 30% in the 1990s. "The low point in the demand index occurred in 1998" (Beef Update, 2005), but prices once again started to rise steadily in early 2000. From 2002 to 2003 Americans consumed about 48 billion pounds of beef and the U.S. beef industry averaged about $68 billion in retail sales during the same period (Economic Research Service, 2005). Prior to 2004 the U.S. beef industry had averaged 2.5 billion pounds of beef in exports but one determinant caused the number to drop significantly to 551 million pounds in 2004.

In November 2003, prior to the discovery of bovine spongiform encephalopathy BSE and the subsequent announcement by the Department of Agriculture, the average monthly price of American choice beef was $4.32/pound (USDA, 2005) One strategy used by beef producers to counter decreasing demand is price adjustment That is why the annual price for American choice beef in 2004, subsequent to BSE decreased to $4.07/pound and the numbers are even lower for the 1st Quarter of 2005, when prices were reported at $4/pound (Economic Resource Service, 2005). However, due to the elasticity of the beef industry, the decrease in consumers' demand due to BSE translated into an increase for substitute products. Consequentially, consumers' demand for poultry product, one of many substitutes of beef increased. The average wholesale price of broiler products (poultry) increased from 65.74 cents/pound to 76.7 cents/pound in 2004. The poultry industry production output has also increased by 1.4 billion pounds for the same period. The additional output in productivity means poultry producers will receive higher marginal revenues and lower marginal costs. This will translate into an increase in the profit margins of these firms. In contrast, the significant decrease in production output due to BSE and decrease in export has increased the marginal costs for U.S. beef producers. The variable costs of beef producers have also increased in terms of preventive measures and hedging against future infections. Investment in preventive technology and resources has also increased the explicit costs of most of the U.S. beef-producing firms and compounded burden of BSE. An implicit cost of BSE has been an 84% reduction in export to the leading importers of U.S beef products, which translates into a $2.4 billion loss. Firms experiencing higher variable costs than fixed cost will have to consider shutting down production or laying-off employees to reduce that cost.

A forecast by the U.S. Department of Agriculture indicates that a growing population, increased urbanization and global income will boost the demand for beef (Dyck, Nelson, 2003). Beef consumers' prefer cut parts, but preferences may vary depending geography and demographics. U.S consumers for example, prefer beefsteak to liver. As a result beefsteak prices are higher, even though a slaughtered steer produces more beefsteak than liver. Vice versa the price of liver is much higher in Japan where demand is high (Dyck, Nelson, 2003). In addition to the cut, flavor, juiciness, tenderness and quality all determines consumer satisfaction with beef palatability (Texas A&M University, 1998), also see table 1 for consumer satisfaction ratings per category. New BSE screening technology will decrease consumers' reservation regarding tainted beef. However, the challenge now for beef producers is to increasing consumer demand and output without raising the price of beef products.

Table 2. U.S.-Canada beef and cattle trade

Top markets for U.S. beef

(accounting for over 90 percent of total beef exports)

2002 2003 2004

Volume Value Volume Value Volume Value

(Million lbs. carcass weight)

($million) (Million lbs. carcass weight)

($million) (Million lbs. carcass weight)

($million)

Japan 771 843 920 1,167 12 0.6

Mexico 629 596 589 604 334 372

South Korea 597 610 588 749 1 0.4

Canada 241 286 226 321 56 94

Consumers' lifestyle changes, health risk of consuming red meat, steroids, hormones, antibiotics, bacterial contamination concerns, as evident with the discovery of BSE and inability for consumer to purchase a consistent quality of beef products are all factors that have diminished consumer utility for beef products and decreased demand. Marketers