Show of hands: Have
you ever put together a budget and fudged or left out the forage
cost because you figured, there really wasn’t a cost because
you’d already paid for it one way or the other? Or, have you
calculated a break-even for a set of stocker calves without
including a labor charge because, well, the net return, if there
is one, will be your paycheck?
Though there are times
and situations where excluding or diluting such expenses that
you aren’t having to pay out of pocket might be appropriate,
Kevin Dhuyvetter says, “Be careful when you zero things out in a
budget. You could be sending yourself a signal that you’re
making money when you aren’t.” Dhuyvetter is an extension
agricultural specialist and professor at Kansas State University
(KSU).
Speaking at the recent
KSU Beef Conference, Dhuyvetter explained, “We can always play
games and make things look better than they are…If an operation
is to remain in business over the long term, fixed costs need to
be covered. That’s especially important when considering things
like adding cows or acres.”
Without accounting for
costs accurately, it’s easy to understand how quickly a net
return can morph into something on the wrong side of the ledger.
And, in a commodity business like a cow-calf operation, cost and
profit are eerily alike.
Commodity Economics
More specifically, over the long haul, prices in a commodity
business are the same as or similar to selling prices, says
Dhuyvetter. So, the only way to do better or to actually make a
profit is to reduce costs compared to the other commodity
producers (more latter). “Cost differences between producers
explain much of the variation in profit differences,” he
explains.
Consider some data he
pulled up from the Kansas Farm Management Association—you can
find similar datasets for most states. If you look at returns
over variable costs (hired labor, purchased feed, repairs and
the like), it has been positive every year since 1999--$66.87
per head on average. Look at return to total costs, though
(including fixed costs such as interest, depreciation, property
tax and unpaid operator labor) and there were only two years
that were positive; all told, average return for the time period
was -$28.64 per head.
“If our costs are
right, the average producer in this population is paying for the
opportunity to go out and do the work,” says Dhuyvetter.
Using the scenario of
a cow-calf operation selling calves weighing 450-650 lbs. for
2002-2006 (the same operations reporting data for at least three
of those years); net return to management for the top third was
$61.40 per head. It was -$43.87 for the middle third and
-$218.19 for the bottom third. That’s $279.59 difference between
the top and bottom tiers.
“There is considerable
variation in returns over time, but variability between producer
returns at a given point in time is much larger,” says
Dhuyvetter.
From there Dhuyvetter
demonstrated the widely varying results that occur when using
different values for key costs. For instance, penciling in a
figure for forage and harvested forage from owned land without
also accounting for the residue and opportunity cost of selling
the hay rather than keeping it. Likewise, figuring the initial
cost of an owned calf kept for stockering at zero, rather than
including market price for what the calf would have brought if
it had been sold.
“If someone would pay
you for it or to do it, use the appropriate market value in the
budget,” says Dhuyvetter. “Identifying costs accurately is not
necessarily easy, but it’s important to help understand what is
making you money, and more important, what
isn’t...Unfortunately, I think we have a lot of cow-calf
producers who think they’re making money with cattle when
they’re really making it with the land they own.” Or their free
labor.
Incidentally, some of
the same pitfalls exist when assessing how much premium you are
obtaining or might obtain in a given market. For an example,
Dhuyvetter uses premiums paid at a specific Kansas livestock
market for preconditioned calves (in a specific program and sold
in special sales). If you simply look at the average difference
in cattle prices between those sold in the regular sale and
those sold in the special preconditioned sale each week, the
premium for the preconditioned calves ranged from $0.14/cwt. to
$8.44/cwt from the spring of 1999 to the spring of 2005. Use a
regression analysis to account for lot size, however, and the
premiums really ranged from $2.30/cwt. to $8.60/cwt.
Accounting for other
variables ends up being positive in that example. In others, it
won’t be. The point is to make sure you’re identifying what you
think you are.
“The biggest mistake
typically made is failing to account for all of the factors
influencing the price,” says Dhuyvetter. “Unfortunately,
available data often precludes making ideal comparisons.”
Responses to Commodity Reality
Of course, there are ways to add value to a commodity product
and bend the rules, at least to a point.
At the same
conference, Shelby Horn, General Manager in charge of Marketing
for Farm Management Company (which includes the Deseret Ranch in
Florida) explained there are four basic responses to
commoditization as a business: surrender the notion of
differentiation and adding value, and compete on cost and
efficiency alone; consolidation, whereby you try to get large
enough to outlast the competition; innovate new products and
services; differentiate current products and services from the
competition.
Though the collective
beef industry response for at least the previous two decades has
been focusing on cost and efficiency, Horn sees a world of
opportunity for differentiation. The market already recognizes
it.
Consider premiums
paid—or discounts not rendered—for such things as age
verification, preconditioning and natural beef production.
At the end of the day,
though, the base product is still a commodity, which takes us
back to costs and identifying them accurately.
“Keep the economic
principles in mind when thinking about strategies for your
business,” suggests Dhuyvetter. “Because the beef industry is so
diverse, there are numerous ways to be successful; everyone
doesn’t have to do things the same way. There are lots of ways
to be winners in this business, and lots of ways to be a loser.” |
