You know that managing margins is a puzzler when even meat's mightiest processors are scratching their heads over the nearly unfathomable interdependencies among available inventory, current and forecast market prices, demand, production capacity, seasonality, historical buying patterns, pre-sold positions, delivery dates and a host of other variables.  

Now scale the task of pricing product over the number of requests received in a day, a week, a month — and across countless SKUs and distribution channels — and it becomes clear why Cargill Meat Solutions, Seaboard Foods, Hormel Food Corp. and other leading processors are trading in their calculators and spreadsheets for more margin-friendly tools to generate pricing lists. 

Yes, that means software — in this case, algorithmic programs that apply advanced analytics to link market conditions with various pricing options. On the live animal side, calculations incorporate live future prices, USDA weekly cash prices and a processor's past transactional data. On the processing side, calculations account for processing costs, planned production costs and available inventory. Depending on the operation, the software can manipulate thousands of variables and hundreds of millions of permutations, all with an eye toward boosting margins by up to 3 percent of sales. 

Up to now, food and beverage companies have been reluctant to cast their lot with third-party price-management programs, but Lora Cecere, vice president of research with AMR Research, a San Francisco-based technology consultancy, says that increasingly volatile commodity markets are leaving them little choice. "As commodity markets become less predictable, and food and beverage industries more global, we're going see more and more programs involving demand orchestration — meaning programs that evaluate the true market potential of a given product," she predicts.

In Cargill's case, pricing team members found that internally devised methods were not only hampered by increasingly complex market conditions — due in part to the entry of hedge funds and retirement funds into commodity trading — but also the manufacture of a product requiring a reverse bill of materials. That is, because meat product is disassembled rather than assembled, the processor found it difficult to accurately determine its costs and profits until every cut from every carcass had been sold, says Herb Meischen, vice president of strategy and customer development for the Wichita, Kan.-based company. 

Anyone's guess

According to Meischen, Cargill might as well have been using a "Ouija board or dart board" to calculate pricing options for its beef product. Facing seemingly innumerable variables — and ones based on shifting relationships among commodity prices, inventory positions and historical sold prices, to name a few — Cargill focused on pricing core products, somewhat to the detriment of secondary ones. Meischen recalls, "We'd been interested in price optimization for more than 10 years, but had a difficult time finding an application that could contend with the complexity of the industry. For Cargill, a single carcass can yield 500 cuts of beef."  

Meantime, he says, product SKUs are proliferating as a result of greater market segmentation. "In addition to Prime, Choice and Select, USDA now lists 34 certified branded programs. On any given day in any given plant, we've got north of 3,000 SKUs now."

Fortunately for processors, software programs are coming onto the market that take a more sophisticated and strategic approach to pricing. Cargill is using such a program, developed by a third party, with positive results.

Cargill's software focuses on three key areas: pricing, product mix and supply. Pricing targets spot, medium and long-term markets, calculating the most profitable mix of contracts among the three options. Likewise, the software targets the most profitable product mix, allowing processors to identify unprofitable SKUs and replace them with better-performing products.

Supply decisions focus on reducing deep discounting as a result of inventory imbalances, while also ensuring current raw materials are used in production and mix decisions.

Among other benefits, the program removes volatility from the equation. "From highest to lowest price, we've reduced pricing volatility from 3 percent to 2 percent," Meischen says.

Ultimately, he says, generated price ranges are just that — ranges, meaning it is ultimately up to Cargill's pricing team to make of the data what it will. "This isn't a silver bullet," Meischen says. "We're merely improving our odds."

Rather than buy the software, Cargill accesses a secured server maintained by the supplier via a browser. Based on input from Cargill, the supplier's software programmers not only modified their mathematical models to account for unique pricing variables, but also vagaries associated with a reverse bill of materials. System testing was extensive, with pricing team members manually calculating pricing options alongside the software, which performed its calculations based on the same inputs.

"Using traditional methods, our pricing team required two days to make a price determination," Meischen recalls. "The software required three minutes, and the difference between the two was less than a cent per pound."

Spot, medium and long term

Cargill uses the software to calculate price recommendations for the short term (one to three weeks), midterm (four to eight weeks) and long term (nine or more weeks). On the spot market, a company may find itself priced high on Monday and holding a fire sale by Friday. The software helps establish more reasonable Monday prices based on USDA market reports and mandatory pricing information, among other inputs. Using transactional data, the software evaluates product performance and adjusts pricing based on commodity prices, market conditions and new supply information.

For the midterm and long term, the program generates forecasts for both pricing and commodity costs, fed-cattle prices, and similar variables.

The program that Cargill uses is particularly helpful in optimizing cutout margins. First, it evaluates all potential fabrication alternatives, then the demand for each candidate cut at different prices as a result of experience and available market data. Resulting price recommendations fall within parameters established by the processor. Hence, no bad deals.

Cecere says Cargill's application is "indicative of what could be. For now, programs like these are walking rather than running because they and the food industry are evolving. I call food my penguin industry — everyone looks at what everyone else is doing before they jump."