Whether we’re at the high point of a cycle or in the depths of a downturn, the best managers regularly manage their margins. They understand that margin management is an “always” mindset, one that builds stronger positions during the good times so they can get through the bad.
Margin management is built into their farm culture and supports their long-term goals. They don’t just focus on expense control; they also keep a close eye on revenue and capital efficiency as they deploy their plans. Let’s take a look at each of these areas and discuss strategies we have high-performing operations use.
Establishing a cost control culture
When a producer sees an operating expense ratio over 80% or a break-even cost of production above market prices or below cost of production, cost cutting is the go-to move for most operations when looking at improving their margins. Before we get too deep into this discussion, however, let’s address an area that doesn’t always get a lot of attention in this area: culture. If you’re truly intent on controlling costs, you need to develop a mindset and a culture around that operational core value at all levels. That is, you want everyone in your operation focused on the mission of managing costs. For example, if your cattle feeder doesn’t understand the cost of shrink, thousands of dollars of feed could be wasted relatively quickly.
You’ll have to spend some serious time developing that culture. Setting goals, communicating them clearly and often, and providing feedback on performance will be critical. It may also take a well-thought-out incentive system to reinforce performance while making sure your team understands the “why” behind these efforts. Having everyone on the team focused on managing margin for the operation can go a long way to ensuring success.
When it comes to actually addressing cost control strategies, the common advice for managing expenses is to start with the big three. For dairy, the big three are typically feed, labor and interest costs.
Feed costs
When addressing feed costs, my old dairy nutrition hat comes on – be careful what you change as a loss in production can reduce revenue far more than the cost savings.
That said, improving forage quality should be the first step in managing feed costs. If you’re already going through the effort of growing forages, make them the best quality you can while also paying attention to your storage systems to ensure shrink remains low and quality is preserved. I also typically tell clients to review their ration regularly to validate why every ingredient is used. It’s too easy to let an ingredient hang around when it may no longer be needed. Also consider improving your on-farm storage of ration ingredients to allow for discounts while improving shrink losses.
Labor costs
Regarding labor costs, controlling them is difficult in an increasing wage environment. Culture plays a role here too. The operations with the best culture for their employees see lower turnover, which helps keep labor costs down, and better overall performance. It’s often said that employees quit bosses, not jobs. Make sure you’re the kind of boss your employees deserve. It may be worth doing an employee engagement survey to see where you stand.
Other labor cost strategies could include validating your employee count overall. Conduct an audit to see if everyone is fully employed in reality versus on paper. Ask yourself if cross-training an employee would eliminate a position. Also consider which tasks should be outsourced and which ones should remain in-house. Would certain tasks be more cost-effective by outsourcing? Conversely, do you have some underutilized employees who could take on tasks you have outsourced?
Reducing debt
Cutting interest rate costs can be a challenge, but it’s certainly worth considering. This includes a conversation about reducing debt. While nobody likes to sell off a parcel of real estate, eliminating unproductive land to reduce debt can have a significant impact on interest expenses. This ties closely to the “smart leverage and dead weight asset” conversations.
Smart leverage is the use of debt to maximize return on investment. A dead weight asset is one that is not driving higher revenue. Go through your balance sheet and see which assets are not pulling their weight when it comes to generating revenue. Look for assets that are underutilized or would have very little impact on revenue if eliminated.
Capital sources
The high-performing farms also look at the cost difference between capital sources. For example, if the line of credit with your bank has a lower interest rate than what your supplier charges you, why would you carry an open account balance with the supplier? Also, be sure you include cash or prepay discounts in your math.
In tough times, restructuring and reamortizing debts to improve cash flow are common tactics. Be cautious about this as it will raise your interest costs. That said, if you’re building a bridge from a period of low profits driven by market conditions to a period of high profits, this is a viable option. Be sure, though, that when times are good again, you speed up your repayment to rebuild the cushion you need for the next down cycle.
While starting with the big three expense categories to address cost of production is smart, it’s just that: a start. The reality is the top 10% in this area get there by being 1% better in a lot of categories. They’ve developed a mindset and culture within their teams to question every expense. They’ve fully adopted the mantra that if they watch the pennies, the dollars will take care of themselves.
Revenue improvements
Addressing cost controls is only one side of the operating expense ratio equation; revenue is the other side. Ask yourself, are you getting the production you should for the dollars invested? If not, what are the limiting factors? Dig in until you find them and address them rapidly.
The quickest way to improve margins is to increase the number of turns through improved yields for the same investment. It may be as simple as increasing the number of times you push up feed, or it may involve making additional investments in technology, facilities and equipment. Be sure to do the math on every investment while asking how it impacts your balance sheet, capital efficiency and break-even cost of production.
Other strategies to improve revenue could include diversification or ways to add value. While this isn’t for every operation, looking at opportunities to add an enterprise or a new product category can be effective in improving overall farm margins. From direct-to-consumer sales opportunities to vertical integration, there are many strategies you can explore. It may be as simple as becoming a consultant for others in your space to add nonfarm income to the pot.
Risk management
Of course, no margin management discussion would be complete without including managing risk. The cycles in agriculture are real. Risk management tools in the marketing space along with insurance tools are essential to limiting losses in the depth of a cycle. These strategies need to be applied to both the revenue and expense sides of the operating expense ratio. High-performing managers understand that this is about taking margin risk off the table. That attitude results in significantly better performance over time. In baseball terms, hitting a lot of singles leads to a lot of runs.
Finally, monitor, monitor, monitor. As with any strategy you employ, monitoring the results is critical. I prefer the use of monthly variance reports – comparing planned financial outcomes to the actual results. You can use variance reports to identify areas where plans have worked and where they haven’t. That feedback can be a great tool to help you be flexible in improving plans while providing support as you develop the next plan.
Over my career, producers have often told me it’s not how much money that flows through the checkbook that matters; it’s how much you get to keep. In other words, there is more than one way to improve margins. It’s easy to get caught up in a strategy to manage margins that looks at just one part of the equation. The truth is, we need to look at all aspects: income, expenses, capital use and risk management. Managing margins in good times helps your operation build the resiliency needed to weather a downturn. Margin management matters in both good times and bad.
This article is provided for information purposes only. Readers should consult their own professional advisers for specific advice tailored to their needs. Information contained in this article may be subject to change without notice.
