The key to increasing profit no one talks about

There are two reasons for that. First, no one stands to make any money when you cut overheads (except you). Second, most people believe that overhead costs are “fixed.” At the Ranching For Profit School, we contend that there is no such thing as a fixed cost.

Dave Pratt

Clients around the world have increased profit by radically reducing their overheads, proving that overheads don’t have to be “fixed.” That’s an essential paradigm shift if you want to ranch for profit.

There are only three ways that any business, including yours, can increase profit. We call them “the three secrets.” They are:

Reduce overhead costs (land, labor and administrative costs)
Improve gross margin per unit (the economic efficiency of production)
Increase turnover (the total volume produced by the business)

Overhead costs are those costs that don’t change much as livestock numbers change. Most overheads fall into one of two categories: land or labor.

Any costs related to land (e.g., repairs to fences, corrals or pipelines and water troughs, leases, etc.) are land overheads. Likewise, any costs related to labor (e.g., salaries and benefits, vehicles and equipment costs, etc.) are labor overheads.

Overhead costs account for 60 to 80 percent of the total costs in most ranch businesses, yet it is pretty rare to hear anyone discuss them. Historically, ranchers have focused on increasing the productivity of our cows and calves (you’ll notice this is not one of the three secrets).

A recent article in one well-known beef industry publication is typical of the prevailing wisdom. It claims that there are four key factors that determine profit: controlling feed costs, managing reproduction, planned marketing and optimizing performance.

Each of these so-called “keys” focuses on improving gross margin, but none will help reduce overhead costs or do anything to increase turnover. Since overhead costs account for most of the costs on most ranches, and most ranches work well below economies of scale for the labor and equipment they have, reducing overheads and increasing turnover are at least as important as improving gross margin.

In the workshop, I flipped through a popular beef industry magazine and asked the audience to identify what the ads were encouraging them to do besides spend money.

There were ads for vaccines, wormers, supplements, ear tags, bull sales and DNA testing (all direct costs). These things won’t help us carry more cattle. They help us make each animal more productive, but they don’t help us reduce overheads. In fact, since inputting these inputs takes labor, equipment and facilities, they increase our overheads.

One reason people believe overhead costs are fixed is because changing them often requires structural change in the operation. Examples of structural change include replacing haymaking with stockpiling and grazing forages, synchronizing the production schedule of a cowherd to get it in synch with the forage cycle or shifting from year-round enterprises to seasonal enterprises.

People are quick to look at the reduction in input costs that accompany these changes. But most people realize even bigger reductions in the overhead costs no longer needed to input the inputs.

When we think about ways to cut our overheads, we need to consider turnover and gross margins per unit too. If your gross margin is negative, it doesn’t matter how low your overheads are, you will lose money. If the gross margin per unit is high, we may still lose money if we don’t have enough units (turnover) to cover our overheads, even if the overheads are low.

It is pretty hard to pay for a pickup and a cowboy with 100 cows, even if the gross margin per unit is good. It’s a lot easier with 500 cows. We’d probably still only need one pickup and one employee with 500 cows (although it may be a different employee).

If we have machinery or labor with unutilized capacity, we’d be better off finding ways to increase turnover to reach economies of scale. But if you are serious about increasing profit, cutting overheads needs to be on the table too.

Some agricultural economists are uncomfortable with our contention that there is no such thing as a fixed cost. Responding to an article I wrote on the topic, one university economist offered his services to “set me straight.” In response to the same article, one of our Australian alumni wrote, “That was close to the best bit of advice I’ve read.”

The approach we take to assessing the economic and financial health of businesses is unconventional. It isn’t intended for accountants, the IRS or academics. It’s for people who want to make a sustainable profit from farming and ranching.