Our busy season of conducting Ranching for Profit Schools has just begun. Last week, I had the pleasure of dropping in on the school in Abilene, TX and meeting some outstanding participants. It is always an honor to be trusted enough to be invited to help a business discover a new path forward that will help create the outcomes they desire. Below is one family’s story, names and identifying details have been changed to protect the privacy of individuals.
The Smith family ranch doesn’t have any money left at the end of the year. At least it feels like nothing. It takes everything the ranch has, just to keep up with the basics (insurance, utilities, repair bills and routine maintenance). There is no money left to go towards ownership salary, building reserves for later, upgrading equipment or even doing a project on the ranch. What is the problem? The cattle are productive and fetch similar or even better prices then the average. The ranch facilities are modest and the family doesn’t live extravagant lives. Why does it seem like they can’t get ahead?
The Smiths finally opened up to their trusted friends and neighbors about their struggles and the neighbors suggested attending a Ranching for Profit School. They had heard of RFP but how could they make that work? They don’t have that kind of money laying around to spend on themselves. The neighbors pointed out, it’s really only the cost of a bull and they always find the money to replace a few bulls each year. Maybe it is time they invest in themselves for a change? It’s clear staying on the current path isn’t the right strategy.
One thing they were looking forward to at the school was getting into the grazing stuff. They’d always been interested in better grazing management, but just needed some confidence in what practice to implement first. While at the school the Smiths learned that in any business there are only three ways to increase profit. At the school, they call these “The Three Secrets”. They are:
1. Reduce overheads
2. Improve gross margin per unit
3. Increase turnover.
They really aren’t secrets at all, but economic principles that when applied feel like discovering a secret.
The instructor said high overhead costs is the leading problem for most ranchers today. They thought this would likely be the case for them and improving their grazing management could allow them to run more animals on their existing set of overheads. In the evenings at the school, the participants have an opportunity to dive into their own numbers and the Smiths took full advantage of this. On one evening they calculated their Gross Product (the value of their production) and by the next evening they calculated their Gross Margin. The Gross Margin is the economic contribution made by each unit of production, in this case their cows. If the Gross Margin is high, the cows are working well if it is low, there is a problem.
Ranching for Profit has benchmarks to identify a healthy Gross Margin. When the Smiths finished calculating their Gross Margin and laid it next to the benchmark it was disheartening. Their Gross Margin was half of the benchmark. How could this be? They were sure they had good cows. As the instructor helped them review their numbers it was clear that their Gross Product was good, their cows were productive, but their direct costs were off the charts. What’s more is that their ideal strategy of improving their grazing to run more cows would just create more headaches. Even if they doubled the number of cows they were running, there wasn’t enough gross margin to cover the overheads. They needed to fix the gross margin, get better, before getting bigger. After getting over the shock the Smiths got to work. As they examined their situation with fresh eyes, they found all sorts of creative solutions to improve the gross margin. In fact, in just 2 hours of running new scenarios they had doubled their gross margin and were now hitting the benchmark for gross margin.
The Smiths discovered there isn’t a one-size-fits-all strategy to improve profitability. A business must identify in which of the three secrets for profit lies the biggest problem, then develop strategies to address the problem. What if the gross margin was negative and they doubled the number of cows they were running? They’d go broke faster!
Some version of this story will play out over and over again throughout this season of RFP schools. The specifics will vary, but knowing which of the three secrets for increasing profit is the weakest link will focus management, giving the business owners the focus to develop effective strategies. We have to diagnose the problem before we start prescribing solutions. The economic model takes a shotgun blast approach to business management and turns it into a rifle shot. It tells management exactly where the problem lies and focuses management attention on solutions.
Wow!
The view from my windshield tells me that most ranches suffer from both high Overheads and high Direct Costs, but the solution proposed is always increased turnover. Obviously, that won’t work.
On a happy note, I recently worked with a young couple that was taking over the home place. In this case, cow numbers were reduced by 50%, mostly by getting rid of marginal cattle. This drove direct costs to nearly zero, and allowed them to sell the hay equipment. Results: a small herd of cows with a terrific GM and very low Overheads. Oh, and happy people, too.
Thanks for the comment John. I’m a little confused by the term “Increased Turnover.” In practical terms, does that simply mean larger herd size so there is more cattle to sell, does it mean looking for more opportunities to buy and sell more often, or does it mean to not keep the same cows as long and turn them over before they are totally depreciated?
Secondly, the author encourages getting better before getting bigger, but isn’t there a base size/scale you need to achieve profitablility?
Hi Rick.
Overheads, Gross Margin, and Turnover are all terms associated with the Ranching for Profit School, so I’m inviting Dallas to jump in here at any time and help.
First, yes, I’d say each of the examples you cite is an example if increasing Turnover, although the last one seems like more of a stand-alone enterprise or strategy. But basically, any increase in numbers of livestock on hand (cows, for instance) or an increase in the number of sets of yearlings that we cycle through in a year is an increase in Turnover.
I think understanding Gross Margin is actually the key to understanding Turnover. If an individual animal (cow, stocker, whatever) has a positive margin (after paying all its’ direct costs), then we should get more of those individual animals (increase Turnover). If your individual cows don’t show a positive margin, you clearly should not get more of them. This is why Gross Margin is calculated on a per Unit basis. In other words, Gross Margin per one cow.
As to the second part, I know this will sound counter intuitive, but my answer is no, I don’t believe there is a minimum number or scale to be profitable. Consider this: if you own a little ranchette and you only have enough grass to finish one (purchased) steer each year, but then you sell meat in a direct market scheme, well, your Gross Margin per unit would be fabulous. Better yet, your only overhead cost would be the labor of getting your kids to keep the water tank full. So, you would have a profitable enterprise.
Basically, if the economic model is strong enough, it doesn’t take as many units to be profitable. Some ranches can probably achieve profitability based on 50 head. Some others can’t reach a profit with 5,000 head, because their GM/Hd is too low.
All three issues: Gross Margin per Unit, Overheads, Turnover are all factors that influence the the outcome: Profit.
Increasing gross margin=Add more value or reduce costs per head.
Increase volume=more cows or whatever you sell.
Increased turnover=sell more animals per head or product each year. Or if you have 1000 on feed and your profit is $30 per head in 100 days do that 3 times a year. If you have a hardware store sell the hammer or nails more times for year.
Great discussion here. This helps to reinforce our understanding of the role that Overheads, Turnover & GM / Unit has in influencing our business profit. This brings us back to the original point which was focusing on the weakest link for greatest improvement to profit.