At Ranching for Profit we teach the Three Secrets for Increasing Profit. Obviously, they aren’t really secrets. But considering the lack of understanding of them by most agricultural businesses, many people are not aware of them. The Three Secrets are:
- Reduce Overheads
- Improve Gross Margin/Unit
- Increase Turnover
Let’s focus on the second secret: Improve Gross Margin per Unit.
We define gross margin as gross product (the value of production) minus direct costs (those costs that change directly proportionally to the units of production, i.e. add one more cow this cost goes up). Then we divide gross margin by the number of units to get to gross margin/unit (GM/U).
For example, if the gross product for 100 cows comes to $100,000 and direct costs total $30,000 then gross margin is $70,000 and gross margin per unit is $700.
Gross margin per unit measures the economic efficiency of the enterprise. This is a very useful number for decision making in the business and one that most ag producers never consider. The unit becomes important to understand, to know what is the unit in the equation, check out this ProfitTips article: The Unit.
A common misunderstanding is that to improve GM/U the only way to do this is to cut direct costs. That simply isn’t true. Let’s look at the formula:
GM/U = (Gross Product – Direct Cost)/Number of Unit
For a given number of units there are two ways to improve GM/U: Improve gross product or cut direct costs.
Most of us in ag have been conditioned to only focus on cost cutting. I agree there is often opportunity there, but at some point, cost cutting can be a terrible idea. If we cut costs and gross product drops more than the costs we have gone backwards. For example, maybe we think our vaccine costs are too high. So we slash vaccine costs and save $10 per head per year, but one year out of ten we lose 20% of the calf crop to an outbreak. That $10 doesn’t seem so expensive anymore. These costs and returns can be difficult to evaluate in a thoughtful manner but the concept is that every direct costs should return far more than its cost on the gross product side.
There are often hidden opportunities to improve gross product. The obvious way in a cow-calf business is to raise conception rates, get more live calves to weaning and maybe to make the calves bigger. Most of these often require more direct costs that far exceed the gains that will be made. Instead the hidden opportunities can be in strategic cull cow marketing, lowering costs of replacements (both on the bull and cow side) and selling breeding animals when they reach the peak value of their lifespan. The opportunities will be unique to your ranch, your skills, your markets, and your situation. There isn’t a recipe I can hand you, but I do know that improving gross margin per unit is one of the secrets to running a profitable ranch.
Don’t get caught in the trap of blindly cutting costs or chasing productivity without a useful economic metric to track your operation’s decisions. If you need to get a handle on the economics of your business, it’s time you joined us at Ranching for Profit, head over to our schedule to see what upcoming workshops or schools you could attend.
Great article. Too many ranchers don’t have a realistic value for their costs per unit. They leave out things like cost of their time in various chores – I’ve heard it said “ranchers can’t count their time”.
Hay you produce isn’t “free”. Is that hay grinder producing increased hay utilization and saving time? Your example on vaccines is great, but on the other side, is the vaccine for “purple tail diseaase” really necessary. Not only do the vaccines cost, but there’s hours of labor in gathering and running them through the chute. Don’t just look across the fence and do what the neighbors are doing. Building a calving barn to allow earlier calving and a longer growth season seems sensible, but how many pounds does that $100000 expence put on your herd by year’s end compared to calving in May.