Any business has only three choices: make it profitable, subsidize the business or go out of business (bankruptcy). Whether we realize it or not, most of us choose the second option - we subsidize our businesses.
I'm not talking about government subsidies but rather the ways in which we subsidize ourselves. Living off inherited wealth and appreciating land values, relying on off-farm income to make ends meet and working for less than it would cost to replace yourself are all ways we subsidize our ranches.
I assume most ranchers would rather not have to subsidize their ranches and would prefer to make profit. Businesses have only three ways to increase profit. At Ranch Management Consultants we call them the three secrets. They are:
* Reduce overhead costs.
* Improve gross margin per unit.
* Increase turnover.
Reduce overhead costs - Overhead costs are those costs that don't change much as livestock numbers change. Land and labor costs are two types of overheads. Any costs related to land (i.e., fencing or water trough repairs, property taxes, leases, etc.) are overheads. Likewise, any costs related to labor (i.e., salaries and benefits, vehicles and equipment costs, etc.) are labor overheads. Economists sometimes call these fixed costs. But, they are not fixed; they can be changed, and that is one of the three secrets for increasing profit.
Improve gross margin per unit - Gross margin is a measure of the economic efficiency of your livestock. It's calculated by subtracting the direct costs of production from gross product. Direct costs are those costs that increase or decrease as cow numbers increase or decrease. Direct costs include feed, health, freight, marketing commissions and interest on livestock loans.
Gross product refers to the gross value of production. This includes livestock sales minus purchases. It also includes changes in the value of your herd. Total gross margin is divided by the number of animals in the herd to calculate gross margin per unit. Increasing gross margin per unit (the efficiency of production) is another way to increase profit.
Increase turnover - In ranching, "turnover" is the number of animal units carried. If gross margin is positive, increasing turnover will increase profit if it doesn't increase land or labor costs or damage the resource base. Nevertheless, increasing the number of units is pointless if each unit makes a negative contribution toward overhead costs.
As an industry we historically have tried to increase profit by increasing production (increasing gross product). We have done an amazing job increasing conception rates and weaning rates. In fact, I'm told the average beef cow in Alberta produces 20% more pounds of beef/year than she did just 20 years ago. So why aren't we 20% more profitable?
Part of the answer is obvious: the increased production resulted from, among other things, increasing direct costs (i.e., feed, health products, etc.). But there is more to the story. Those direct costs had to be administered by someone (increasing labor overheads) somewhere (increasing land overheads).
On most ranches today, overheads account for 60-80% of total costs. It is the cost of building and maintaining the infrastructure we created to increase our efficiency that has depressed profit.
Imagine a chain with three economic links: overheads, gross margin per unit and turnover. If the gross margin link is weak, strengthening the overhead and turnover links won't make the chain stronger. In fact, they may make the chain weaker by putting more stress on the weak link.
In the next article, we'll discuss how to find the weak link for your business. It's critical if you want to be ranching for profit.
David Pratt of Ranch Management Consultants teaches the Ranching for Profit School. For more information visit www.ranchmanagement.com, or contact him at 707/429-2292 or e-mail: firstname.lastname@example.org.