A recent visit to Wisconsin underscores the fact that the profit margin needed to sustain an operation long term depends not only on your cost of production but also on the management of production.
The old adage that “you can’t go broke locking in a profit” is true, at least in the short term. Over the long haul, though, if your neighbor locks in an even larger profit on more hundredweights and/or more cows—you will be at a competitive disadvantage.
That lesson was driven home to me last week at the Wisconsin Dairy Business Association’s Expansion Conference in Green Bay. Jim Mlsna, a veterinarian who also milks 600 cows with his family in southwest Wisconsin, shared detailed financial information as part of a panel on risk management. “Margin equals profit,” says Mlsna. “But you need to include in your costs of depreciation, principal and interest, and family living.”
Using software developed by First Capitol Ag, Mlsna then shared his cost of production budget projections for 2012. Total production costs range from $17.50 to nearly $18/cwt. He then showed the margins he has been able to lock in for about 80% of his milk through June and for about 70% of his milk for the second half of 2012. His margins range from $1/cwt. in the second quarter to just over $2 in the fourth quarter, averaging $1.60 for the year.
In the Q&A that followed, one questioner asked what the target margin should be. None of the panelists would touch that question with a 10’ pole, saying each farm is unique. Obviously, each farm has its own goals, each manager has his or her own comfort zone with risk and each farm has its own level of liquidity and debt repayment needs.
The next morning, I happened to have breakfast with a producer and his adult daughter who milk about 1,000 cows not far from Lake Michigan. The conversation finally got around to land prices in northeast Wisconsin. The producer told me he recently bought a 30-acre piece of ground for $6,500/acre (which almost sounds like a steal in corn country).
The patch is 12 miles from his dairy—a long hike to haul haylage or corn silage. But it’s also adjacent to a city of about 35,000; the parcel came up for sale when a developer got caught in the Great Recession and couldn’t get the land sold for housing. So buying the piece now for feed production, even though it’s a 25-mile round trip, is a good hedge against inflation since the land eventually will grow houses.
So then I asked what the going interest rate was. The producer said he didn’t know because he paid cash for it. His dairy has such a low cull rate that he’s usually able to sell 200 cows for dairy each year. So they’ve been taking that cash and looking for deals on land.
The point of this breakfast digression is that the profit margin needed to sustain an operation long term is dependent not only on your cost of production but also the management of production. A $2 margin generates $400/cow on 200 hundredweight sold but it generates $520/cow on 260 hundredweights sold and $640/cwt. on 320 hundredweights sold.
Then multiply those returns per cow for a 600-cow herd versus 1,000 versus 3,000. And then if you’re able to sell 20% of your herd each year for dairy, tack on those numbers.
All of a sudden, even if you can lock in a $2.50 margin on a smaller number of cows producing 20,000/cow year that have trouble breeding back, you can see you’re at a competitive disadvantage.
Locking in a margin is important. Some years, you have to settle for $1 margin; some quarters you have to protect against a loss. Marketing can keep you in business this year. To survive long term, herd management matters much more.