Market Advisor: Unlike Market Prices, Unit Cost of Production Is Under Management's Direct Control

NEWS for North Dakotans
Agriculture Communication, North Dakota State University
7 Morrill Hall, Fargo, ND 58105-5665

August 20, 1998

The Market Advisor: Unlike Market Prices, Unit Cost of Production Is Under Management's Direct Control

Harlan Hughes, Extension Livestock Economist
NDSU Extension Service

In spite of the beef industry's significant emphasis on value-based marketing and marketing alliances, most 1998 feeder calves will still be produced and marketed as part of a commodity beef marketing program. The key to competing in a commodity-based marketing program is to be a low-cost producer. Those who can produce feeder calves the cheapest, win.

The economic key to profitability is not cost-per-cow but cost-per-unit-of-production. Cost-per-cow only measures costs while unit-cost-of-production measures both production costs and physical calf production. I suggest to producers that unit-cost-of-production is the single most important index number that a beef cow producer can calculate.

Average unit-costs-of-producing-a-hundredweight of calf for my Northern Plains Integrated Resource Management (IRM) cooperators was $67 in 1994, $66 in 1995, $76 in 1996 and $75 in 1997 the toughest years, economically, of this decade for calf producers. My worst fear during 1996, the year of the lowest calf prices, was that costs of production would go up due to over-ambitious cost-cutting. I worried that producers might cut costs one dollar which, in turn, would cut gross income two dollars. The data indicates that the combination of cost-cutting and rock-bottom calf prices lead to a record loss in running beef cows in 1996. The net result was an average net return of a negative $37 per cow.

Even in the tough times during 1996, the low-cost one third of my IRM cooperators netted a positive $22 average net income per hundredweight of calf produced. My high-cost one third of IRM cooperators lost $20 per hundredweight of calf produced. My IRM data suggests that the impact of a rancher's unit costs of production equaled or exceeded the impact of the low market prices. This suggests that unit cost of production is the single most important factor impacting net income for today's beef cow producers.

Unit cost of production is directly under the control of management and yet, most producers do not even calculate their unit costs of production.

While the cattle cycle is the single most important force impacting calf prices and beef cow producers' gross income, it is the second most important factor impacting net income of beef cow producers. The alternative economic "booms and busts" associated with cattle cycles have been a matter of great concern to the beef cattle industry for years. The question always arises as to why the beef industry can not attain a sustainable growth pattern that would prevent these economic gyrations.

Cattle cycles, and their resulting beef price cycles, tend to go in approximately 9-11 year cycles. As one cattleman said, "You talk about 10-year cattle cycles and beef price cycles but our memories only go back 7 years." The repetitiveness of the cattle cycle and beef price cycles is generally missed by most cattlemen.

Price changes during a beef price cycle are the greatest for feeder calves and the least for slaughter cattle.

The underlying force behind cattle cycles is the biological lag between the time that cattlemen get the price signal to expand beef production and the time that they actually do expand beef productionby which time prices have tilted downward, giving a new price signal to reduce beef cattle numbers. Since we can not change the biology of the beef cow, we will continue to have cattle cycles.

The decade of the 1990s has followed the traditional "boom and bust" model. Net return per cow was quite favorable in the 1990 through 1993 time period.

Cattle producers received a wake-up call in 1994. Net income for North Dakota's Farm Business Management cooperators (defined as earned returns to unpaid labor, management, and equity capital) in the Northern Plains dropped 72 percent from the $178 per cow in 1993 to $49 per cow in 1994. Average net income in 1995 deteriorated even more to a minus $29 per cow. Record feed grain prices in 1996, along with the drought in the Southern Plains, reduced net income even more in 1996 with an average net return of a minus $51 per cow. As I noted earlier, a key to profitability in those years was low unit cost of production.

Net income turned around in 1997 with a positive $30 per cow. The first half of the typical "U" shaped profit curve of the cattle cycle was completed in 1996 and the average positive $30 per cow net returns in 1997 suggests that the last half of the typical "U" shaped profit curve is starting to materialize.

The USDA Jan. 1, 1998, All-Cattle Inventory confirmed that the current cattle cycle is firmly into its liquidation phase. The Jan. 1, 1998, inventory set the all-cattle number at 99.5 million head down 2 percent from a year earlier. The 1998 beef cow inventory was set at 33.7 million head, also down 2 percent from a year earlier. The 1997 calf crop was down 3 percent, implying that there will be fewer cattle on feed in the last half of 1998. As cattle numbers continue to decrease over the next 2 to 3 years, some feedlots are simply not going to have cattle to feed. This also happened during the last cattle cycle of the 1980s.

The most striking number in the Jan. 1, 1998, inventory was the 5 percent fewer beef heifers held for replacements. Instead of breeding 1996 heifers, we fed them. The continued diversion of 1997 heifer calves to feedlots confirms that the current liquidation should continue into year 2000. The current drought in the Southern Plains and the early drought in the Western Canadian Provinces may well accelerate the current liquidation phase.

When these drought stricken areas repopulate after the rains return, we will see heifers diverted from feedlots to breeding which, in turn, will amplifying the shortage of feeder cattle. The July 1998 mid-year All-Cattle Report shows that the liquidation phase is still underway for the third consecutive year. Beef replacements are at the lowest level since 1990 and the calf crop is the smallest in recent history. This July inventory confirms that producers will not be building the beef herd through at least Jan. 1, 2000; and, given the biological lag, beef production will not increase again until year 2002.

The primary implications of all of this is that cow-calf producers are now in the drivers seat with respect to feeder calf prices. Baring no below-average corn crops in the U.S. Corn Belt, good times for cow/calf producers should return yet this decade. And as in bad times it will be low-unit-cost producers who profit most.

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Source: Harlan Hughes (701) 231-7380 hhughes@ndsuext.nodak.edu

Editor: Tom Jirik (701) 231-9629

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