By Aaron Berger
Economic Risks of a Production Model
One of the primary overarching economic risks that many cattle ranchers face without realizing it, is that the economic production model that is currently in place for their operation will not consistently be profitable over the long term. It may be that since the ranch was put together the competitive advantage or circumstances that facilitated profitability changed. Over several decades, input costs for equipment, fuel, fertilizer, and labor have all increased significantly. The dollars received for cattle sold has not increased at the same rate. Therefore, a ranch production system that economically was profitable in the past may no longer be so. The increasing costs associated with operating under the ranch’s historic production model aren’t being matched with the same level of increase in revenue from cattle being marketed. The ranch may be losing money and subsidizing the business with equity, unpaid labor and off ranch income.
For commodity businesses, the value of products and services produced over the long term tends to move toward breakeven. This is especially true if there are not significant barriers for people to enter or exit from that business. If there is the opportunity to make money, and there is the freedom to do so, people will enter the business and increase the supply of the product or service that is profitable. As there is an increase in supply to the market of the product or service, eventually prices will fall. When the fall in prices causes those producing the product to have a loss, they will either decrease their cost of production, reduce the amount of the product they produce or exit the business. This is consistently seen with cattle and other commodity production cycles.
The role of the cattle cycle in a production model
Think of the long-term cattle cycle. When cattle prices are high and cow-calf producers are making money, there is the incentive to produce more calves. When raising calves is profitable, existing and new cow-calf producers will often either buy bred cows or retain more replacement heifers which further reduces the supply of cows and calves going to market. This reduced supply to the market further supports higher prices. Eventually, the heifers retained produce calves, cattle supply increases and market prices go down. When prices go down far enough that cow-calf production isn’t profitable for most producers, there is a selling down of cow herd inventories by ranchers with less equity and higher cost of production to meet financial obligations and some of these producers go out of business. As a result of people exiting the business and a subsequent reduction in cow numbers, fewer cattle are available to the market and prices rise once again.
Therefore, especially in commodity-based businesses, businesses that are continually finding ways to improve their production model, discovering ways to be more efficient, more productive or add value to the products and services they produce are consistently profitable. Ranchers that are not profitable will eventually either exit the business or subsidize the businesses with equity or outside income. An unprofitable economic production model is ultimately a threat to the long-term success of the ranch business.
Questioning a ranch production model
What are the economics and costs of production for your operation? What are the economics associated with that production model? Is the model continually being reviewed and improved to deliver a product at a price that is consistently profitable? What threats are there currently to the model and what may be threats in the future? Where are opportunities to change, simplify, or grow in ways that would enhance product value or improve economic efficiency? Continually asking these questions and being willing to address and make changes will help to ensure the ranch business is economically viable now and in the future.
The process of evaluating a ranch economic production model can be daunting, a bit unnerving and humbling. Especially when that analysis reveals an economic model that is consistently unprofitable. However, the process can also reveal opportunities to make changes that will help improve business viability and accomplish ownership goals and objectives. The risk of not assessing the economics of the business and just continuing to do what always has been done, “hoping things will work out,” is in fact a decision. It’s a decision to ignore the possibility of opportunities that could improve profitability. It’s a decision that may in fact destine the business to decline and eventual end.
Schedule some time to look at the ranch economic model. Consider the economic value of all the assets and inputs that are being utilized in the ranch operation. Where is value being generated? Where are costs occurring? If market value was paid for the grass grazed, the labor used and the capital investment made in cattle and equipment, would the operation be economically profitable? How many years out of ten would it be so? The opportune time to make changes to the economic model of a ranch is when times are good. When cattle prices are high and cash is available, there are often more options available and some margin to make a transformation to the ranch business.
Source : unl.edu