Cost per pound of gain or cost plus — is there a right answer?

Nutrition with John McKinnon, beef cattle nutritionist

At last month’s Western Canadian Feedlot Management School, the focus was on backgrounding programs for newly weaned calves. As is often the case at these meetings, an idea for this column pops into my head as a result of discussions with producers or listening to speakers. It was no different at this year’s school where a question from the audience to one of the presenters got me thinking how the cattle-feeding industry has changed over the past 20 years. To give you background, one of the audience participants asked a speaker what method of payment he preferred for settling agreements between those who owned feeder cattle (i.e. the investor) and those who did the feeding (i.e. the custom feedlot). More specifically, the question focused on what method of payment is most appropriate for custom backgrounding arrangements “cost per pound of gain” or “cost plus?” The following is my interpretation of his response.

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The speaker’s answer was somewhat predictable in that as an investor he wanted to take performance risk out of his investment and thus preferred payment on a cost-per-pound-of-gain basis. Under this type of arrangement an investor places cattle with the custom feedlot and an agreement is struck on weighing conditions both on arrival and at the end of the program, death loss, the target end weight, daily gain and the program end date. In some cases “slides” are included where discounts are applied for heavy cattle and premiums for lighter cattle. Why was his answer predictable? Because under this type of agreement, production risk rests with the feeder, not the investor!

What really got me thinking was the speaker’s answer as to why he shies away from cost-plus agreements. Under these scenarios payment is based on the feedlot’s actual labour, health, feed, and yardage costs plus an agreed-upon margin. The feedlot benefits from a guaranteed revenue stream while the investor takes the production risk. The speaker’s answer, however, went deeper and shows how the industry has changed and unfortunately highlights that many producers have not caught up to these changes. He basically indicated that backgrounding cattle today is inherently inefficient! His argument was why background 550- to 650-pound steers for 150 days or so at two or 2.5 pounds a day gain when with today’s cattle and feeding management expertise we can move these cattle on to finishing programs with minimal or no backgrounding and reap the benefits of vastly superior gains, improved feed efficiency, reduced days on feed and interest costs and still hit live weight and carcass quality specifications demanded by packers. Feeding expertise has indeed come a long way in the last 20 years.

Today, we are feeding cattle to 1,500 pounds when we used to take them to 1,200 pounds. Cattle routinely gain 3.5 to four pounds when 3.0 pounds was acceptable 20 years ago. Similarly feed efficiency has moved from the 7 to 7.5:1 of 20 years ago, to today’s targets of less than 7:1 and in very efficient lots approaching 6:1.

So the speaker was saying, if he is going to own the cattle and take the production risk as he would with a cost-plus program, then he would want the efficiency of a finishing program over the inherent inefficiency of a backgrounding program. In other words, from a performance, economic and environmental (i.e. methane production) standpoint, backgrounding calves, particularly those weighing 550 or better is becoming obsolete.

Now, there are still plenty of good reasons for producers to background their cattle. Many are calving later and due to lighter weaning weights hold their calves over all or part of the winter. These calves need to be placed on growing programs to get them to target markets. Others are interested in backgrounding lighter calves to prepare them for grass. As well, backgrounding your calves or custom-fed calves may be an integral part of your pasture, hay or silage marketing program.

All of these reasons make sense and I would not argue with your reasoning.

If, however, you argue that you are confident in your ability to precisely grow cattle and know your production costs and therefore have no issues with signing a cost-per-pound-of-gain contract, then I would advise you to at least think twice before doing so.

As this speaker pointed out, production risk including poor gains, feed efficiency and high death loss rests with you. You need to be able to account for this risk, generally through a high level of management, if you are going to be successful. Also remember that in many cases investors who feed cattle likely know your costs as well as your neighbour’s and those of your counterparts in neighbouring provinces.

In my experience, when they negotiate cost-per-pound-of-gain agreements, they don’t leave a lot of margin on the table for the feeder. Testament to this is the fact that there are numerous examples of backgrounding operations that have gone broke trying to make a living under this type of agreement.

About the author

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John McKinnon

John McKinnon is a Professor Emeritus at the University of Saskatchewan and a consulting nutritionist who can be reached at [email protected].

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