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.
5 comments:
Two day's after the publication of this entry, Lonnie Bo Pilgrim resigned under pressure from board members.
Poor pricing will cost a CEO his/her future.
They need a Pricer to suceed !!
We just have to look at the fact that Americans pay $8B for bottled water when they can get it for free out of the tap... obviously lower prices are not the silver bullet for businesses to lead their markets! A competitive response strategy that reacts to your competitors’ price moves surrenders control over your revenue structure and inevitably locks your firm into a race-to-the-bottom pricing with the rest of the industry. I recommend to business leaders to change their perspective to be profitable in this economy: forget about what your competitors are charging and other exogenous factors that you can’t control, and instead turn your focus on effectively generating internal capital by utilizing a Revenue Optimization solution. At Sentrana, we have successfully implemented Revenue Optimization solutions with clients spanning industries as diverse as Consumer Packaged Goods to Computer Software, where these organizations were empowered to determine their prices, marketing mix, and product assortments that maximize revenue and profitability. These solutions allow companies to actively shape their markets through the probabilistic prediction of future outcomes, to stay ahead of continuously shifting market demand through the realization of market awareness, and to achieve unity of direction and coherence of decisions across organizational units. The solutions provide immediate and enduring impacts on the organization’s financial performance and competitive strength, and allow companies to lead their markets by turning complexity into competitive advantage.
A related blog posting:
Forget Your Competitors, The Power to Consistently Lead Your Market Lies In Understanding How Every Customer Values Your Product
http://blog.sentrana.com/2009/04/17/forget-your-competitors-the-power-to-consistently-lead-your-market-lies-in-understanding-how-every-customer-values-your-product/
Joe Smiley
Sentrana
http://www.sentrana.com
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