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HUNTIN' DAYLIGHT -- THE PROBLEM WITH ZERO

by: Wes Ishmael

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 later). “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.”

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