Beef prices hit records this summer and US consumers bought more of it than ever. The explanation involves two ideas from business school, and neither one is about beef.

Americans went into the Fourth of July weekend facing the highest beef prices on record. Steak averaged $12.80 a pound, up 16% in a year. Ground beef sat near its all-time high. Every economics textbook says the same thing about what should happen next: when the price goes up, people buy less.

In fact they bought more. Beef added roughly $352 million in sales compared with last year, the biggest gain of any food category ahead of the holiday. Kroger reported strong demand and a shift towards premium cuts. Omaha Steaks said customers were still buying steak as a gift while economising elsewhere. LongHorn Steakhouse saw more diners choosing steak, not fewer.

So why the rising demand as prices continue to soar? One explanation concerns the way people think about money. The other concerns the way industries think about time. Between them they explain not just the cost of your ribeye but a mistake that companies in every sector make, over and over.

The ribeye is not in the grocery budget

Standard economics assumes that money is fungible, which is a formal way of saying that a dollar is a dollar wherever it comes from and wherever it goes. Richard Thaler, Professor of Behavioural Sciences at Chicago Booth who won the Nobel prize in economic sciences for noticing how rarely people actually behave this way, called the alternative mental accounting. In practice we do not run one budget. We run several, in our heads, with different rules for each.

The money for the weekly shop lives in one account. The money for a birthday dinner lives in another. They are the same dollars, but we guard them differently, and we react to price rises in each in different ways. A 16% increase in the cost of washing-up liquid provokes a search for a cheaper brand. A 16% increase in the cost of the steak you are grilling for twelve people on a national holiday provokes a shrug, because that steak was never in the washing-up liquid account. It was in the account marked ‘celebration’, and that account was never going to be haggled over.

The research firm NielsenIQ arrived at the same conclusion, describing steak as an “affordable luxury” that shoppers treat as a splurge worth making while they hunt for savings elsewhere in the store. In a June report quoted by CNBC, the firm noted that consumers were entering the holiday with discipline, making more trips with clearer intent behind each one, which is what a household with several mental budgets looks like from the outside.

Thaler, who co-wrote the global best seller Nudge, which looks at how people make bad or irrational choices, added a second idea that explains the detail buried in the sales data. Alongside the pleasure we get from a thing, we get pleasure from the deal itself, from feeling that we bought well. He called this transaction utility, and it is why shoppers who have already accepted that steak will be expensive then trade up rather than down.

Forty-two per cent of shoppers named USDA Prime, the highest official quality grade assigned to beef by the US Department of Agriculture, as a factor in their meat purchases. Omaha Steaks saw sales of one premium cut rise 25% before Father’s Day. Once you have decided to spend, the question stops being how little you can pay and becomes how much you get for what you were always going to pay anyway.

Every business that has agonised over a price rise has been asking the wrong question. The question is not what your product costs. It is which of your customer’s mental envelopes it comes out of, and whether you have done enough to move it into a more generous one. Something in the “necessary expense” envelope gets shopped around. Something in the “worth it” envelope does not.

The industry that has known its own future since 1970

That is the demand side of the story. The reason steak is expensive is that the American cattle population is the smallest it has been since 1951, after years of drought and high feed costs made ranching an unrewarding business. Fewer cattle, same appetite, higher prices. 

The complication is timing. If a rancher decides today to rebuild, that decision takes a minimum of two years to produce anything anyone can buy, because the animals held back to breed have to grow up first. Every animal a rancher holds back for breeding is an animal not going to market this year. The act of fixing the shortage makes the shortage worse before it makes it better. Prices rise further, which is precisely the moment ranchers are most tempted to sell into the high prices rather than hold back, which delays the recovery again.

The result is a wave. Prices climb, ranchers eventually rebuild, supply eventually floods in, prices collapse, ranchers give up, supply shrinks, prices climb. Round it goes.

None of this is a surprise. In 1970, Dennis Meadows built a model at MIT for his PHD dissertation, “Dynamics of Commodity Production Cycles” looking at how commodity markets behave when production takes time. It reproduced the cycles in different products almost exactly, and it put the cattle cycle at roughly fifteen years. More than fifty yearsago, someone worked out the length of the wave the beef industry is riding right now. The industry rides it anyway.

The delay you cannot see

Why does knowing not help? The best answer comes from a game which is a famous rite of passage for MBA students at MIT Sloan. Professor John Sterman has spent decades running an exercise called The Beer Distribution Game, in which four players form a simple supply chain representing the production and distribution of beer, and each has one decision to make each week: how much to order from the person upstream. There is one product. Each player has exactly one customer and one supplier. Demand barely moves. You can learn the whole thing in a quarter of an hour.

Players wreck it, every time. They generate wild swings in inventory, and their average costs come out around ten times higher than optimal. Sterman has watched thousands of clever MBA students do this, and his explanation is the single most useful sentence in this article. To produce the wild swings, the delay has to be ignored. Players keep ordering more, responding to the shortage they can see, while forgetting the orders they already placed are still on their way. When those finally arrive, all at once, they panic and stop ordering entirely. The shortage becomes a glut. The glut becomes a shortage.

The ranchers are playing the beer game with cattle, and the delay in their pipeline is measured in years rather than weeks. But every business plays some version of it. The company that hires furiously through a boom and then finds itself overstaffed when the recruits finally arrive and the boom has passed. The manufacturer who orders components against a spike in demand that has evaporated by the time the container ship docks. The consultancy that trains a cohort of graduates for work that no longer exists. 

In each case the mistake is identical. People respond to the gap they can see and forget the correction already in the pipeline.

What your barbecue is really telling you

Your customers will forgive you. Your supply chain will not.

The demand side is forgiving, because customers are not calculators. They will absorb a price rise without complaint if the thing you sell has found its way into the right compartment of their thinking, Much of the work of pricing is really the work of getting it there.

The supply side forgives nothing. It does not care how good your reasoning was, only whether you accounted for the time between deciding and delivering. 

Nobody blinked at a $13 steak this summer. But the price was not set at the checkout. It was set two years ago, by ranchers reading a signal, and next summer’s price is being set right now by ranchers reading this one.

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