People looking to place cattle with custom feeders are motivated to get the best deal on rates. That’s the nature of the business — they need to bank a return on their investment in the cattle to stay in business.
It’s equally important for custom feeding and grazing operators to see a return on their labour and investment, and yet some custom operators sell their services short accepting cost-per-pound-of-gain (COG) agreements that leave them struggling to stay afloat, says Bruce Viney, a risk management specialist with Alberta Agriculture for 12 years before taking a position this summer as director of the rural utilities section.
A custom operator’s ace in the hole is the ability to manage production risk. Viney says experienced cattle-feeding clients know how to use all of the tools to manage price risk, but they have no control over production risk beyond their choice of where to place the cattle. They totally depend on custom operators to take care of the production side and even though they will squeeze for the lowest possible COG, most investors do know the value of production risk management.
“If there is one thing you can do for clients, it is to better manage production risk and you’ll be one step ahead of the competition. How, is by making better cost-of-gain and yardage estimates and better forecasting. I say better, because there is always room for improvement,” Viney explains.
“Risk is defined as ‘uncertainty that matters.’ Uncertainty about feed conversion and average daily gain and death loss are things that matter to clients,” he says. At the end of the day, they want results close to your initial forecast, acceptable death loss, and the highest-value cattle that have the weight and flesh conditions to hit their target market.
“What clients don’t want is bad surprises,” he stresses. Be conservative in your forecasts, spend time analyzing interim performance data and keep in touch with your clients to reduce the risk of having to deliver bad surprises at the end of the feeding period.
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Agriculture is different from other stock and commodity markets where price volatility is the measure of price risk. In agriculture, volatility is only part of price risk where predictability and prediction-error are another important measure. The theory is that if the future price can be accurately predicted then the pen of cattle should be low risk.
The same logic can be applied to production risk. If, for example, you use your best knowledge to predict COG and death loss, then the pen of cattle should be low risk. On the other hand, the very common practice of asking neighbours or others in the industry to try to get a handle on a going COG rate for custom feeding might work for your clients, but it’s risky business if it doesn’t happen to cover your needs.
Knowing your goals, financial position, and cost of production underpins custom feeding agreements that are in the best interest for you and your clients whether you use a COG or cost-plus formula. It’s about meeting or exceeding expectations to build relationships and trust, Viney sums up.
Cost of Production
The Ranchers Risk and Return (RRR) calculator, a free download from Alberta Agriculture’s website, works equally well for custom feeding operations to figure out cost of production and break it down into cost per pound of gain.
Following are some of the tips covered in Viney’s 2017 publication, Business Fundamentals for Better Feeding Agreements, which includes example tables from the RRR calculator and outlines points that should be covered in COG and cost-plus agreements.
Start by importing your expenses from your accounting program. If yours is a grain and cattle operation, use your best judgement to decide on enterprise splits for each expense line. For example, if you designate wages as 60 per cent for cropping operations and 40 per cent for feeding operations, the calculator will split the total wage expense accordingly and show the dollar value transferred to the yardage calculation. Expenses related to growing and landing hay, silage, and grain in the feed yard need to be split out to the cropping side to calculate feed costs in a later step.
The yardage calculation is based on your entries for the number of animals you plan to feed and days on feed. Line expenses transferred from the financial statement include items such as fuel, machinery repairs, building/corral repairs, utilities, custom and consultant work, paid labour and benefits, interest on operating and capital loans, taxes/licences/insurance, non-paid management, equipment and building depreciation. The calculator breaks each expense into dollars per head for the feeding period and dollars per head per day to arrive at totals for each of these columns.
It’s not wrong to include the cost of bedding, veterinary/medical and other services in the base yardage amount, but these consumable types of expenses are most often added when the prices for them can be better estimated at the time of making an agreement.
Death loss and medical expenses are significant risks in forecasting, and working through some what-if scenarios will give you a better understanding of those risk levels. Your past records are a starting point, but it’s important to know the source of the cattle and a potential client’s reputation. It’s best to make reasonable forecasts on the high side to reduce the odds of having those bad surprises.
The feed cost calculation begins with knowing feed quality and cattle type to formulate the rations.
Clients need to tell you the type and quality of cattle they plan to place with you and what they expect for average daily gain (ADG). From this, you will be able to forecast dry-matter conversion.
Let clients know right away if the calves that arrive aren’t what they said they would be. All new arrivals should be weighed after they’ve had time to eat and drink. Ask your clients for pay weights for comparison and consider rejecting stressed cattle with shrinks over three per cent because they are likely to be poor doers right off the bat that could add up to a bad surprise for your client at the end of the feeding period.
CowBytes, a ration-balancing program available for $50 from Alberta Agriculture, is great for initial feed-cost budgeting.
“Play around with it and learn from it,” Viney says, “but never ever bypass the services of a nutritionist to fine-tune the ration. They can shave pennies off the cost of gain and can help manage health and performance risks.”
Forecasting performance is the biggest risk when estimating COG and many nutritionists have firsthand knowledge of the relationships between ADG, dry-matter conversions, types of cattle, and feedlot systems.
Again, run what-ifs for possible gain and conversion to decide whether a client’s proposed COG rate is high enough to account for some of the bad what-ifs.
RRR will calculate the feed cost per pound of gain from your entries for all feed ingredients in the ration, prices for each, moisture contents and amounts to be fed.
The final step adds together feed costs, base yardage costs and other charges, giving you the grand total and breaking that down into dollars per head for the feeding period, dollars per head per day, and the dollars per pound of gain.
The cost and performance summary table includes your feedlot break-even per pound fed.
“If you can accurately forecast all of these things, you are doing your client a good service,” Viney says.
The calculator does get into financial risk management with a price and profit forecast table that requires entries for futures, exchange rate and basis to predict a market price per pound, break-even futures price, maximum purchase price of calves to break even, and hedgeable profit. These are important if you are buying calves or pen sharing with a client to decide on price insurance or hedging strategy.
Between the lines
Cost-plus agreements, with clients paying the actual cost of feed, yardage and other fees regardless of weight gained, are often used by full-service feedlots with equipment to weigh feed and cattle and because the owners tend to have their cost of production pinned down.
Viney says COG agreements are very common among smaller feeding operations because they are easy and don’t require sophisticated on-farm equipment. The downside is that the client transfers all of the performance risk to the feeder. Operators who don’t know their own true cost of production to cover that risk in the rate they charge can easily be left on the short end of the stick.
He knows many of those horror stories, but says there are also many success stories. Here are a few additional tips for establishing positive relationships and better feeding agreements.
Keep accurate feed and production records to help improve future forecasting and settle disputes that may arise.
Learn from your successes and failures. Don’t waste time on clients who don’t appreciate your good work. Figure out your cutoff line and if a COG rate proposed by a client; isn’t going to cover your costs and the production risk you are taking on for the client, there’s always the option of letting some pens sit empty and waiting for a better opportunity. Better yet, go out for business by arming yourself with records of past results and approaching potential new clients.
Agreements should be simple and straightforward. If you need a lawyer to assess a client’s proposal so be it, but instead you might be better off looking for a new client.
Do consult with your lawyer about technicalities if there is a possibility that a client will default on feed bills and if a client asks you to sign off on rights under your province’s animal/livery/stable-keepers act to comply with a lender’s conditions. Viney recommends not waiving your rights because these acts provide a way to recover costs of boarding, feeding and caring for another person’s livestock in the event of payment default. There are various types of waivers in use by feeder associations and your lawyer will be able to advise you on the most suitable option or alternatives.
Keep communication lines open. Aside from letting your clients know incoming weights on their cattle and sending your feed bills out on time, stay in touch by occasionally giving them a call.
Attention to detail helps build client confidence. The state and cleanliness of the bunks, watering bowls, penning, feed storage, handling and hospital areas, equipment and even your offices will leave a lasting impression with clients. Always pay attention to drainage to prevent buildup of ice and mud, which cattle owners take very seriously because of its negative impact on performance.
Clean and well-maintained can have limits when it comes to equipment because seeing too much old equipment in use could shake clients’ confidence. On the flip side, they know that a lot of new equipment means higher costs that will ultimately be passed their way. Try to strike a balance between keeping up with capital improvements and not stretching your finances too thinly.
The quickest way to find Business Fundamentals for Better Feeding Agreements, the Rancher’s Risk and Return calculator, and the CowBytes ration balancing program is to search for them by name, or call the Alberta Ag-Info Centre at 403-742-7901.