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HUNTIN' DAYLIGHT -- HEDGING WITH COST INFORMATION

by: Wes Ishmael

“A new game is emerging, and in the new game score keeping will be more precise. We will not be allowed to call our own fouls, and only those with appropriate commitment and skills will be asked to join a team.”

That was the bottom line beef industry overview served up by Tom Field, a professor of animal science at Colorado State University during the Beef Stocker USA conference hosted by Kansas State University (KSU) in September.

His point was that beef consumers are demanding more accountability from their suppliers. In turn, the suppliers are demanding more food safety, animal welfare and environmental assurances from the production industry. Just selling a quality, consistent product is not enough in this emerging reality; folks want to know more about the product, and they want that knowledge verified.

Presumably, no one is offering to pay more for these added assurances, but they're demanding it. And, if recent history is any indication—think of fast food empires demanding assurance that none of the product they were buying had ever been fed mammalian protein, then packers demanding it of the feedlot, then the feedlot passing the demand on to the producer—they will get it one way or another.

Likewise, economic survival itself is demanding more exact score keeping, especially when it comes to cost.

As an example, Field points out that on average ranches with 500 or more cows have about half the expenses in cow production of herds with 50 or fewer head.

Certainly, economy of size plays a significant role in cost management. That's one reason consolidation continues to accelerate within agriculture and in about any other business you care to mention. Incidentally, Field points out the 10 largest food retailers now account for 59 percent of all food sales in this country. Wal-Mart Super Centers accounts for 10 percent of the market; a decade ago they weren't even selling groceries, per se.

But the bigger issue is the role that cost management plays in profitability. According to Southwest Standardized Performance Analysis (SPA) data from 1991 to 2000, the top 25 percent of cowherds for profitability had annual cow costs of $317 per head, compared to $539 per head for the 25 percent least profitable herds.

Cost is Every Thing

As much as some producers hate to heat the cost-control mantra, the fact is that controlling cost is the single most effective risk management tool they have at their disposal.

“Differences between high and low profit farms is often tied to differences in cost and not in prices, which suggests that producers can and do manage costs better than prices,” says Kevin Dhuyvetter, a KSU extension economist, who was also on hand for the stocker conference.

He's basing that on an analysis of Kansas Farm Management Association enterprise data from 1999-2001. On average, the top third cow-calf enterprises for profitability returned $234 per cow more to producers than the bottom third for profitability. Although price accounted for 26.6 percent of the difference, cost accounted for the remainder.

Dhuyvetter points out results are similar for the backgrounder/stocker enterprises in the data set where 69.1 percent of the difference in profitability came at the hands of cost.

“Thus, one recommendation to producers for managing risk has to be to focus on being a low cost producer first and foremost because that is what keeps businesses in business,” says Dhuyvetter.

There's nothing earth shattering about that notion, but the equity-gobbling profitability gap that currently exists between individual operations says this is where individuals and the industry as a whole can still find Everest-sized opportunity.

Of course, it could be the profitability gap is so wide and that so many producers take such an imprecise approach to cost figuring because their profit goals are too general if they exist at all.”

Information as Foundation

“Describing the break-even price and profits goals is essential to decision making,” says Field. “Without good financial information, it is virtually impossible to make the right marketing decision. Understanding breakeven process puts the producer in a position of strength in price negotiations and in the process of determining the most profitable marketing alternative.”

That's not saying that collecting and massaging such information to the point of usefulness is easy. “Information management is hard work, it's painful,” says Field.

However, as producers and the industry seek answers from information, and seek how to construct information systems, Field suggests these points and questions may be helpful to keep in mind:

*Is the information necessary?

*Is the information system user-friendly?

*How much training is required to use the system?

*Have the people who will actually use the system had a chance to provide their input?

*Does the system allow you to ask the right questions?

*If information is to be used as a value-added strategy then make sure the definition of value is accomplished according to the wants and the needs of the customers.

*There are no silver bullets. Take your time and continuously evaluate the cost and benefit.

*Be careful of Nike's “Just Do It!” advice. Without a plan, a functional process and system-wide accountability, the effort is doomed to fail.

*Don't get trapped into the commodity mindset unless you are willing to accept the lowest price possible for your product.

And that's just today.

“The movement of the industry toward a supply-chain approach will increasingly put information capture, assimilation and utilization on the forefront of the industry,” says Field. “There are no easy solutions or quick fixes. Even though information management is not a perfect science we simply can't afford to ignore its importance.”

The need grows, if not the direct incentive

After all, Jerry Bohn, manager and co-owner of Pratt Feeders at Pratt, Kansas explains, “There are some in the industry who yearn for a return to the cash-based system where all cattle bring the same price. But, that's not likely to happen because we (the industry) have fundamentally changed.”

More customers want more cattle that fit tighter specifications, including the accountability assurances cited earlier. There's more competition from pork and poultry than ever before. Consolidation is driving the bus. And, in an industry where margins are already thinner than a fly's wing, producers continue to churn out more tonnage with fewer cows.

For perspective, Bohn, who was also on the Beef Stocker USA program, notes through July of this year fed heifer and steer slaughter was up 300,000 head compared to a year earlier. On top of that, average fed steer and heifer carcass weights for the year will likely be up another 25 lb. or so, which could mean that 2002 will set a new record for total beef production.

Ironically, besides cheap feed, Bohn says one of the reasons carcass weights continue to increase is the incentive associated with marketing cattle on a carcass merit basis rather than an average live price.

“This (carcass-merit pricing) is a long-term positive trend for the beef business,” says Bohn. “This is the only way the proper signal can be sent through the entire beef system to stimulate the production of the right kind of cattle.”

Unfortunately, so far the primary incentive in carcass merit selling has revolved around pounds.

“One of the most pressing challenges to the beef industry is to develop a new and better price discovery system,” explains Bohn. “Until we develop a better system of premiums and discounts for the right kind of carcass, the industry will continue to respond the way it has the past several years, and that is to produce more pounds.”

So, increasing customer demands, along with growing tonnage, means that production margins won't likely grow significantly on the positive side any time soon. And, that places more importance and opportunity on the shoulders of information, especially as it relates to cost.

While price is obviously important in any profitability equation, Dhuyvetter emphasizes, “You need to identify how manageable that (price) is, relative to production risk. We need to manage what is manageable, and a big part of profit is driven by cost rather than price.”

It's either make a deeper commitment to ferreting out and using cost information or adopting the philosophy that Field found on a bumper sticker: “Lord, just give us one more oil boom. I promise I won't blow it all this time.”

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