Exports of cattle hides, variety meats and tallow are the U.S. beef industry's profit margin.

Research shows that a 10% increase in by-product price increases fed steer price by 1.4% to 2.4%

Often overlooked in discussions on international beef trade, particularly where Mexico and Canada are concerned, is the trade in by-products. These consist of cattle hides, variety meats (edible offal) and tallow (edible and inedible fat).

For beef packers, by-product sales are critical. That's because the money generated by boxed beef sales are often less than the costs of purchasing fed cattle.

For example, the difference between boxed beef sales and fed cattle purchase costs was negative for most years between 1986 and 1997. It was the revenue from by-product sales that paid packers' slaughter costs (labor, energy, etc.) and generated profits.

These by-product sales are also important to cattle producers because they affect the prices that packers can pay for fed cattle. That, in turn, affects the prices that feedlot managers can pay for feeder cattle.

Data from the Livestock Marketing Information Center indicate that from 1986 to 1999, the average difference between boxed beef revenues and cattle purchase costs for a 1,000-lb. slaughter steer in the Midwest was about -$5/head. The value differences varied from +$42/head to -$22/head.

During this period, average by-product value was about $88/head, with a range of $61 to $103. There was a general increase in all by-product values (unadjusted for inflation) from 1986 to 1999.

Thus, the relationship between packer cattle margins (boxed beef revenues minus cattle purchase costs) and by-product values is easy to see. When by-product values decline, packer cattle margins tend to rise as packers bid less for fed cattle to remain viable.

International markets are an important source of demand for U.S. beef by-products. On average, the U.S. exports about 40% of its production of cattle hides, variety meats and tallow.

By comparison, the U.S. exports about 8% of total domestic beef supplies.

By-product export values averaged $1.7 billion from 1989-1999. That constitutes about 77% of average beef export value ($2.2 billion) for the same period. Cattle hides made up 60% of average by-product value.

Since 1995, by-product export values have decreased substantially due to the Asian financial crisis that reduced Asian demand for U.S. hides and variety meats.

The U.S. market share of world trade in beef by-products is significant. From 1995-1998, the U.S. share of world hide trade was about 35%, and the U.S. market share of tallow (beef and pork) trade was about 60%.

South Korea, Taiwan and Mexico collectively import 67% of U.S. cattle hide exports. Mexico, South Korea and Canada purchase 60% of U.S. tallow exports. Japan, Mexico and the Russian Federation import 69% of U.S. variety meat exports.

Foreign countries increase imports of U.S. beef by-products as their national incomes increase. For example, our analysis indicates that a 10% increase in national incomes in Asia and North America would result in a 6% increase in the demand for U.S. by-products.

As a rule, an increase in foreign demand for by-products increases the value of U.S. live cattle. That's because beef and beef by-products are produced in nearly fixed proportions. Our research shows that a 10% increase in by-product price increases fed steer price by 1.4% to 2.4%. As a result, feeder steer prices increase 1.7% to 2.9%.

What's the international by-products market worth to cattle feeders? A 1,200-lb. fed steer worth $70/cwt. ($840/head) would decrease by $9.30/cwt., or $112/head, if foreign markets for by-products didn't exist.

This research suggests that market analysts should consider volatility in by-product markets as a source of cattle price changes. For example, from 1990-1999, beef by-product value was relatively volatile, ranging from $82/head to $103/head. This resulted in changing fed steer and feeder steer prices (about their average values) by $3.57/cwt. ($43/head) and $5.12/cwt ($31/head), respectively.

Though a critical source of demand, the international market for by-products is also a risk factor for cattle prices. Consider the recent economic downturn in Asia.

From 1997-1998, Japanese and South Korean national incomes declined by an average of 3.9%. Their currencies depreciated by an average of 8.9% relative to the U.S. dollar.

Consequently, import demands for U.S. by-products decreased by 50% between 1997 and 1998. That demand plunge reduced U.S. by-product value by 24%, and fed cattle and feeder cattle prices dropped $2.20/cwt. and $2.70/cwt., respectively.

Because of their impact on packer bids for live cattle, by-product exports are nearly as important to the U.S. beef industry as beef exports. Perhaps the less politically sensitive way to improve producer returns is to liberalize trade barriers for by-product exports. These efforts could supplement efforts to improve market access for high-quality beef products.

John M. Marsh, professor in the Department of Agricultural Economics, and Gary W. Brester, professor in the Department of Economics, are both at Montana State University, Bozeman.