Pilgrim’s Pride in Bankruptcy …. Amazingly “Bo” Pilgrim Still Doesn’t Get Pricing

Thanks to our contributing pricing expert, Tim Smith, PhD, for this enlightening guest post.

Cost of chicken feed is up, but the price of chicken is flat to down. What went wrong? Marshall's scissors alone would predict the current profit failures in chicken production.

Though branding and quality issues can provide price differentiation within the chicken market, the core price level of chicken is set by the willingness of producers to supply and consumers to buy. At some level, chicken is a commodity. Even where it is not, the price differential of "good" chicken to "acceptable" chicken may increase the price of the "good" chicken over "acceptable" chicken, but its total price of "good" chicken is dependent on the price of the "acceptable" chicken. The basic value approach to pricing dictates: the price of "good" chicken = price of "acceptable" chicken + price differential. Thus, if you increase supply of "acceptable" chicken while demand is flat, the market clearing price of most all chicken will go down.

Lower prices of chicken may not be all bad if the producers have sufficient economies of scale that increase with increasing production faster than prices fall with increases in supply, but such economies aren't sufficient for chicken producers today. Today, the cost of producing chickens is going up. Roughly two-thirds the price of chicken is derived from the cost of chicken feed, and during the past two years chicken feed went up from $2.40 a bushel to $7 a bushel before recently declining to a more modest level near $4 a bushel.

When marginal costs go up, prices need to increase. With increasing prices, supply will need to decrease. Simple application of Marshall's scissors.

But, instead of cutting back production, in all of Lonnie "Bo" Pilgrim's wisdom, he has decided to use the bankruptcy protection to maintain production. He seems to have an unbounded faith that somehow demand will increase and he will make a profit. He may have faith, but I will trust the science of economics – which predicts the market clearing price of chicken will continue to remain below marginal costs to produce until supply adjust appropriately to market demand. Thus, for now, Bo Pilgrim is "strategically" destroying profits.

Let's hope his bankers ask this octogenarian to step aside for someone who is using his brain intelligence rather than his faith intelligence. In the meantime, I feel bad for Tyson Foods, a competing chicken producer, as they have to deal with a nasty industry wide challenge. As is true for other industries, pricing power is subject to the actions of the stupidest competitor.

Tim Smith, PhD is an Adjunct Professor teaching Pricing at DePaul University and Managing Principal of Wiglaf Pricing. www.wiglafpricing.com.