How Chasing Return on Equity May Lower Return on Equity

    Reducing variation requires first an understanding of the source(s) of variation, the likelihood of mitigation strategies to successfully reduce the variation and the cost/benefit trade-off in source mitigation. As we have discussed, the typical farm record systems and the procedures which are considered practical to perform, work against developing the necessary data and anaylysis to gain a clear understanding of the return for variance reduction.

    However, one of the most powerful aspects of variance reduction strategies is that if they are successful, they favorably affect both revenue and cost simultaneously. This results in a double bang for the buck when considering the potential financial outcomes of variance reduction investments.

    Since little was understood about the role of production variance on net income; building systems, equipment systems, management systems, contract production systems and pig flow rules of thumb etc. have been put in place over the years causing inflexibility and making it difficult to deploy certain new strategies.

    For instance, contract production systems save equity and allow for greater expansion of the sow base since the capital of the grower forms a significant portion of the total investment required. Many growers elect to make this investment because the returns are generally very high to equity and the value of the manure has been increasing dramatically where it can be used as a commercial fertilizer substitute.

    However, contract production can and often does introduce substantial variation into the system since control by the owner of the animals is often sacrificed compared to outright ownership with employees performing the work. While standard operating procedures may be defined and implemented within a contract system, when the value of variance reduction is high (and it is higher than you think), many firms choose to internalize these functions.

    Some of the largest production firms in the industry have choosen not to use contract production or use it on a very limited portion of their total production. This strategy has dominated when stricter control over the production process has yielded higher income potential. More and more systems are recognizing the value in variance reduction and some which previously expanded with contract partners have eliminated this strategy for current and future expansion.