Price discovery is simple.

"Fed cattle tend to sell in a fairly narrow range, and by making a few phone calls I can find out what a majority of the cattle are bringing today and use that to price my cattle," says Bill Mies, professor of animal science at Texas A&M University (TAMU). "Price discovery isn't about being fair. It's about knowing what the price is, and that's a really transparent number today."

Value discovery, on the other hand, is only slightly tougher than roping ghosts in a West Texas dust storm. But learning how to price cattle based upon the eating qualities consumers deem valuable could determine the future scope of the industry.

"The old (cash market price discovery) system, without any value discovery, isn't working at all. If we continue with the old system we'll continue to see eroding beef demand or stagnant demand at best," says Ted Schroeder, agricultural economist at Kansas State University (KSU). "The system is broken so badly that producers receive no economic incentive to produce what consumers want. The only thing that can be done to fix the system is change the way we value cattle and send the appropriate economic signals to encourage producers to produce the type of cattle being demanded."

For perspective, about 65% of all fed cattle were traded in the spot cash market in 1999, according to USDA, either live or on the rail. That's down from about 67% in 1998 and about 75% the year before that. Mies and other industry observers believe over half of the industry's fed cattle will trade outside of cash markets within five years.

Moreover, while price discovery may be alive and well in today's cash markets, the increasing percentage of fed cattle selling away from the spot market is changing the mix of cattle left to determine cash prices. "Over time, cash prices have had a tendency to decline compared with the futures and wholesale prices," says Schroeder. "We think what's going on is that, over time as more high quality cattle are marketed under value-based pricing systems, a larger percentage of the remaining cattle sold in the cash market are lower in quality." In other words, price is still being discovered effectively, albeit at a lower level.

Painting with a wider brush of history, Clem Ward, professor and extension economist at Oklahoma State University (OSU) says, "Price discovery in the cattle feeding business during the 80s was reasonably good from the standpoint that we had several packers bidding in the marketplace, although the downside was that they were live-weight bids." Today, he explains there is less competition for cattle in terms of which packers are in the marketplace at a given time and less--if any--pen-by-pen price negotiation.

Besides competition, Ward explains an adequate volume of accurately reported prices is also essential to price discovery. Here again, the current cash system leaves something to be desired. "The way we are reporting prices now, we know some packers and some producers won't report or report selected trades only," says Ward.

Bottom line, emphasizes Bill Helming, business consultant and economist at Olathe, Kan., "If you take the cutout value of primals and subprimals, you can find a $350 difference across a single pen of steers or heifers in the Texas Panhandle today, let alone the difference across an entire feedyard. Yet, we market these cattle today is as if they all had the same value."

Of course, some of this marketing mess has a lot to do with circumstance. Mies points out that cyclically high cattle numbers left packers in firm control of the industry power curve the past few years and feeders had to dance to the packer's tune. Now, he explains that cyclically declining cattle numbers, plus increased competition for specification cattle, give ranchers and feeders the juice needed to change the pricing system, although the window of opportunity is narrow.

"When there aren't enough cattle to fill the feedyards and there aren't enough cattle to keep packers busy, the dynamics of the power curve change. And, if feeders want to change the way we arrive at price, they have the opportunity to do so," says Mies. "If we miss this turn, it will be another 10 years before we can get it done."

The transition from price discovery to value discovery started years ago when some feeders began marketing their cattle on formulas and grids that rewarded and discounted carcass merit, relative to a pre-defined target. However, most current grids rely on a base price derived from live cattle prices, in one form or fashion. So, as more cattle capable of hitting value-added targets sell outside the cash market, pressure on cash prices increases, launching many base prices on their journey of discovery with one foot tied to a fence post.

"The price discovery issue itself is pretty contentious right now because in most value systems the price is being discovered somewhere else, either on a live or dressed basis, which has little to do with the value attributes of the carcass," says Schroeder.

Plus, Ward says, "We get premiums and discounts for quality attributes, although they may not be for the right attributes." As an example, he explains premiums based on quality grade may be heading in the right direction, but they fall short of pegging specific eating qualities, such as tenderness and flavor, that mean something to consumers.

With that said, the industry has yet to come up with or apply the technology that allows the industry to measure more specific consumer-value carcass attributes.

"That's not to say that grid pricing is detrimental to the overall price discovery process, but it is saying that we need to be careful about moving to value systems that don't have liquid price discovery correlated to them," says Schroeder. If you ever wondered just how liquid the current system of cash pricing really is, count up the number of times too little volume is reported to offer a public price on certain days in certain parts of the country.

"One alternative is negotiating the base price, just like we have negotiated live cattle prices for so long. In concept, that has some appeal. In practicality and transaction cost, that has less appeal," says Schroeder. "If you are negotiating the base price, you have to have a firm understanding of what the market conditions are today and where they are going tomorrow. Plus, when you move to a value-based system, you have an immense need to know the value attributes of the cattle in the system. So, information needs increase substantially under a grid pricing system, especially if one is negotiating prices, as well as carefully monitoring and managing cattle quality attributes."

Another alternative is using live cattle future prices for the base price, but the challenge is basis risk, says Schroeder. "If you set up a formula so that in the long run, the times that the basis is adverse to you balances out with the times the basis is adverse to the packer it could work." Which, of course, eliminates its use by anyone who is only selling a pen or two of cattle each year.

Likewise, Schroeder says the same fundamental challenge exists with wholesale boxed beef prices where packer margins ebb and flow over time. Plus, even though boxed prices are reported regularly and both feeders and packers have incentive to keep the price high, he's not sure how liquid the market is. Moreover, he points out tying to retail prices means hitching your wagon to a horse that only circles about half the product traded.

"The other alternative is to say, 'Let's forget about the base price as a separate entity and let's put it together with value," says Schroeder. "Then we can go to an arrangement where we discover value and price at the wholesale level. At that point, value is determined by both wholesalers and consumers."

Indeed. Helming says, "We're really striving for value discovery and the only way to do that is on a cutout basis…We ought not to be thinking in terms of price. We need to be thinking in terms of value. Cutout is the composite value of the entire beef animal." And that changes everything. Just ask the folks in the pig barn.

Even though about 30% of all the fed hogs still trade in the cash, Mies explains, "Now, hog producers talk in terms of their pigs being worth X dollars on the grid today, not about their hogs bringing X dollars over a cash market. They're looking at price as price, not at price as a percentage of the cash market because the cash market doesn't mean anything anymore."

Helming seconds that observation. "When we think of price, we think in terms of cattle being worth $69 per cwt. That's meaningless-- says nothing about the value…The day is coming when the typical rancher and feeder will be talking about per-head values. Live bids will be gone."

But, there is lots of ground to cover if value-per-head thinking is going to supplant the current price-per-pound mentality.

For one thing, determining individual value is as complex as it is logical. In a nutshell, Mies explains, "To discover value, I need to know what the boxed beef prices are and what the drop value is, what the average kill and fabrication costs are at the packing house, and how my cattle kill into the box. Then I can do value discovery and say if this is the packer's breakeven, then this is what my cattle are worth." At that point negotiation revolves around how the margin will be divided between the packer and feeder.

At one time, if you asked Mies to describe the necessary steps for this kind of value-based journey, he would have said, "We need to increase the percentage of boxed beef that is reported from the 24% it is today to 40-45%. Then we'll have some assurance the wholesale prices are legitimate." He believes that level of reporting is necessary once you discard forward-contracted boxes and special-order fabrication that doesn't reflect the daily market.

Today, his answer is the same, except he explains, "Now, with mandatory reporting, I think our challenge will be to sort, from the 100% of boxes that are reported, the 40-45% we wanted to see to begin with."

In the meantime, packers and value-added systems will no doubt conjure up new ways to evaluate consumer carcass value on an individual basis, be it with a boxed beef calculator or instrument evaluation. "Each system will have its own twists and turns, but the commonality will be that they are all based on determining value," says Helming.

Amid such revolutionary transition, there are still a few safe bets, though.

First, the move to value-based pricing and away from cash-based averages will accelerate for one simple reason. "It will occur because there is the economic incentive to do it," says Schroeder.

"As we develop more identification of cattle and can track them back and share information-we're just now scratching the surface of possibilities-I think the majority of cattle will sell on some kind of grid or formula, but I'm hopeful those prices will be based on value and not cash," says Mies.

In fact, Helming is convinced that before long the industry will establish a futures contract for beef cutout value that will eventually replace the live fed cattle futures contract. He explains, "This will simply represent the natural extension of determining and trading beef cutout value based on retail and consumer value discovery. That's versus the present futures contract based on commodity live cattle bids that make no determination between the tremendous value variations that exist within each pen of cattle and in each feedyard each week. This will further help to send the right signal to cow/calf operators to produce a beef product the consumer wants."

Ironically, the fact that there are so many mystery cattle in the market means there will continue to be a cash and carry checkout counter, although it's likely the non-branded generic beef sold there will come from lower quality cattle. "I think most of us agree the number of cattle selling outside of the cash market will level off at some number, that we're not going to go to 100% grid and formula cattle," says Mies. There are just too many cattle of unknown genetic origin and management.

But, the odds also say the economic gap between the unknowns in the cash market and the known quantities of the value market will widen, probably faster than plenty of folks would like to imagine.

Editor's Note-Wes Ishmael is a Fort Worth-based freelance writer.