Variation

It's time to get intensive. By that I mean we need to focus on existing but overlooked means to extract more value from our production. One way to do that is to focus on our revenue stream and the process which generates it so we become just as celebrated in our knowledge of this as we are for knowing our cost of production. Once that happens, we will have the components which make up profits (revenue and cost) and some really big changes will start to happen. But since almost no production workers have full access to the revenue numbers of the farm, they are continually focused only on cost of production and production metrics. Because of that, we still operate in a fifteen year old notion/and the "irrational exuberance" that believes if production rises and/or costs fall, we will automatically make more profits. The key error in this thinking is that pounds and pigs are not measures of value, they are measures of physical output and weight.

     The externality crowd (the politicizers, activists and interest groups who believe that agricultural producers are pushing a multitude of costs off on the globe and their community without paying for them), should take a look in the mirror.  When a small group of the population, such as those who have a true willingness to pay for things like country of origin labeling, organic food, locally produced food, carbon-neutral food, etc. gain the political clout to force the costs of these attributes on everyone (willing to pay or not), they have used the government to structuralize a huge cost externality.  Which is to say, they have forced others to pay for attributes only they demand. 

     For years, modern swine producers thought about cost of production as a point or single number.  For almost a decade, a cost of production of 38 cents a pound was consider standard, high efficiency cost control.  Those days are gone and I don't mean just that number.  There is no new number which is or will be the normal cost of production for all of us who love to live by rules of thumb.  The cost of production for meat animals is largely determined by the cost of the underlying feed ingredients which have entered a phase of volatilty that is not likely to abate.  The continued mandates for ethanol production which will absorb four billion bushels of US corn production will keep key feed ingredient prices on a perpetual "stocks-to-use" razor and provide another source of price volatility here-to-fore reserved for weather events alone.  The combined impact of weather and reduced stocks-to-use values will force the volatility of the grain sector into the

     I had an opportunity to spend some time at VION, one of the largest food companies in the EU and one of the largest slaughterhouses for pigs due to recent expansions by merger and acquisiton.  They provide a website for their producers which gives a tremendous amount of very valuable information regarding their performance.  From the website the producer can download their individual animal kill stats as well as benchmark against the plant average and top performing farms.  In addition, they are provided information about lung health for instance and can also benchmark that against the plant.

     Let's take another crack at this optimal selling weight idea.  In general, for a single pig (to get the theory down), you want to add weight as long as the next lb added returns a profit.  That is, the cost of adding that pound is less than the return it receives.  Somewhere in late finishing, a pig will start receiving less and less for each pound added.  This is because feed efficiency is deteriorating and the packer matrix will at some point discount the lb because the pig is too heavy.  Even though all lbs are discounted when the sort matrix indicates a penalty, as long as the last pound was at a profit, it should be added.

     Since we have no studies which tell us this, I leave the question to you:  Is contract production of swine a low variance production method?  Which is to say, given the emerging strategies to control variation in production, will contract production systems be successful in implementing them?

     It is typical now for contract producers to be paid by the pig space instead of on performance.  This trend began a little over 10 years ago and was largely brought about for a couple of important reasons.  The typical payment schemes prior to this had paid on lbs of gain and occasionally a death loss premium and a sort loss bonus (where the grower was actually selecting the animals for harvest).  Some contracts also had a feed efficiency bonus which tried to give the grower a good incentive to adjust feeders.

Normally, lenders allow contract producers with a dependable, modern production system to put up only 15-20% of the new cost of the building as inital equity. This is because the cash flow from the unit is dependable and uniform. Because such a small amount of initial equity is required, returns on equity (ROE), the primary measure of financial outcome tend to be very high for the grower.

As mentioned previously, the payment is calculated to reimburse the grower for all costs including principal and interest on the note at a relatively small initial equity. Returns on equity (ROE) can run in the 40-70% range depending on the length of the contract and the terms of the note. Usually, this return does not calculate or factor in the cost reduction in fertilizer which accrues to those who can use the manure nutrients to offset fertilzer needs on a cash crop such as corn. When these returns are included, net of application cost, the total returns to a contract wean to finish or finishing building become some of the best that can be achieved in agriculture.

     The principal motivation for contract swine production by those who employ it has been to allow the growth of the operation.  The owner of the animals typically invests in the sow farm, animals, feed mill and related capital items and lets contracts for the facilities post-weaning.  By inviting investment in the very capital intensive production process by others, added scale can be achieved.

     I'm not sure anyone has ever thought that contract production was a low cost method of production but it allows additional scale to be achieved which offsets some of the added cost associated with it.

So let’s play around a bit with this variation stuff and see how the future cost of production might look for hogs if we forecast it by first forecasting corn and soybean meal prices and then putting those forecasts into a cost of production model to generate a forecast for future carcass prices.

This hog cost forecast was generated assuming that corn would average about $3.50/bushel and that soybean meal would be about $250/ton on average.  Under those circumstances and some stuff I will share in a minute, the average hog cost of production for a 270lb animal would be about $62.50/cwt on a carcass basis.  However, by using the variances and the correlation between the input prices in the forecast model, we can create a forecast not only of the average price but the range over which it is likely to wander and the probability it will reach any one price in the range.

     Variation in a group or population is usually described with reference to one or more basic statistical functions.  The mean or average of a group or distribution is the most common statistic used.  It is calculated simply by adding all of the observations and dividing by the number of observations.  The mean is sometimes referred to as the expected value since it is a measure of central tendenancy and in one single oberservation, represents all of the different observations in the population.  All of the observations, when taken together, will be closer to the mean than any other single number.