Are You Running a Marginal Business?

Over the past few decades I’ve heard more than one ranching guru give advice regarding being careful about who you hang out with.

“Stay the heck out of the coffee shop. Ranchers just sit around in there and bitch about things they can’t control, and brag about things that don’t matter.”

I know this is good advice. But in addition to coffee shops, it’s too bad they didn’t mention taverns too.

I recently found myself in a dimly-lit backroom at a local watering hole, hanging out with a couple of fellas in straw hats and pointy boots. Studiously avoiding politics and religion, the talk was mostly about markets, weather, and the government. After a while, one of my compadres noticed that I was pretty quiet. When he asked why I was adding so little to the conversation, I pointed out that it didn’t seem to me that those topics deserved much thought, as we have so little opportunity to change them.

“OK, Mr. Smarty-Pants. What sort of things are you interested in? How are we gonna make some money in this cow deal?  What is it you think we should be trying to work on?”

I took a bar napkin and made a quick list of suggestion that I thought might help my pals increase profit. Here goes:

As my pals looked over the list, I could see the furrows growing deeper and deeper on their foreheads.

“Well for goodness sake, this stuff’s all goofy! Every one of these ideas will wind up lowering my weaning weight, and making smaller frame cows, too! Who wants a bunch of 400-pound dink calves? My buyer wants calves with some bone, some frame, calves that might be ready to go to the feed lot right off the cow. And besides, we get paid by the pound, remember?”

At this point I knew I should just order another round and forget about it, but I couldn’t quite stop myself.

“Sorry fellas, but I have to disagree. We do not get paid by the pound. We get paid based on a thing called margin. Margin is the difference between what that calf sells for and the amount it costs to raise it up. And hopefully, that will be a positive number. You are correct that weaning weight is important. Turns out, there is a direct correlation between higher weaning weight and profit. But most of the time, it is a negative correlation! In other words, generally speaking, the bigger we get these cows and calves, the less profit there is in it for the rancher.

“And there are some good reasons why it works that way. Turns out, 1,000 pound cows are just more biologically efficient that 1,700 pound cows. That smaller cow takes less input to produce a pound of calf, so your calves cost less per pound to produce. Plus, you can run a higher number of small cows on the same rangeland. Finally, take a hard look at the difference in value between a 600-pound calf sold at $1.50 and a 400 pounder at $2.00. You’re only getting 50 cents per pound for the extra 200 pounds. Can we raise a calf for 50 cents a pound? I don’t know, but I don’t really want to. Are you starting to get the point?”

“Well, all that might be true, but I run a reputation outfit here. We’ve been producing good calves — calves that the buyers really like — for a long time. I’m not about to go back to running those little mongrel cows like grandpa did. And besides, we get paid by the pound, you know.”

Sigh.

So…Let’s Talk About This

Truth be told, each of the ideas I suggested above (on the bar napkin) may well lead to smaller cows and lower weaning weights, and both of those things run counter to what we’ve all been raised up to strive for. But the point of those suggestions –the purpose of each– is to increase the margin, to make the economic model work better, so the ranch actually makes more money.

There are plenty of worthy ideas floating around about ways to improve the economics of the cattle business, and it’s hard to choose which one is most important. Personally, I believe this business of understanding the concept of margin is critically important to improving our economic outcome. The formula really is pretty simple:

We could spend an entire article dissecting the different “costs” associated with running the ranch, but for the purposes of this discussion, let’s simply try to agree that it costs a certain amount of money to support a cow and her calf for a year. These costs fall into two categories: Direct Costs and Overheads.

Direct Costs are the inputs we spend on the cow herd, things like hay, minerals, medications. Sometimes I find it easiest to think about it like this: If I add another cow to the herd, what costs go up? Those costs, then, are Direct Costs.

Overheads are related to Land, Labor and Management. Adding another cow probably won’t mean hiring another employee or buying another tractor. And it won’t change your mortgage or land taxes.

When we add up all of our sales for the year (Sale Price) and deduct the amount we spent on taking care of the cows (Direct Costs) we are left with the Margin. The margin is the amount of money we have available to pay for our Overheads.

Some folks out there are probably thinking that this is all mumbo jumbo; a cost is a cost. The only thing that matters is how much money is left in the checking account at the end of the year. (Besides, we get paid by the pound, you know!)

But here’s the real bottom line:

In order to recognize where you need to make improvement in your economic model, you need to be able to identify where you are spending your money, which enterprises are working and which ones aren’t. Identifying Direct Costs allows you to calculate margin for each enterprise, and knowing your margin tells you if you can afford to pay for the ranch Overheads. If you can’t do that, you need to make a change to the enterprise, in order to improve the margin. Or – and this is generally more difficult – make a radical change to the Overhead structure of the ranch (i.e. get rid of land, your mortgage, your help etc.)

So, do we get paid by the pound? Well, sort of. Actually, I think we sell our product by the pound. But the real payday comes when we are able to take the “left-over” money from the sale and use it to pay the mortgage. If you don’t have any leftover money (margin) you won’t be living on that property for much longer. And as for weaning weight, well, I think it’s pretty clear that every increase in weaning weight comes with an attendant cost, and often that increase in weaning weight costs the rancher more than the additional sale value of the weight. In other words, even though bigger calves might bring a higher sale price, they may actually bring the ranch a lower margin. Since it is the margin that makes the land payment, maybe it’s our margin that we should be bragging about!

Happy grazing!