Using marginal economics to profit better from your dairy herd
With milk prices and costs of production both currently on a high, many dairy farmers will be looking to minimise input costs to maximise profitability.
This is the message from Ben Watts of Kite Consulting, who says it is important to ensure the inputs which impact upon yield or productivity are not axed without careful consideration, as this would be counterproductive.
“A good rule of thumb is to ask ‘if I cut this cost, will the cow know about it?’
“If the answer is yes, then the cost-cutting exercise will more than likely be a bad business decision.”
Mr Watts says the most profitable milk produced on any dairy unit, regardless of size, yield or system, is the litre of milk produced after all fixed or overhead costs have been covered.
“For example, if you have 100 cows producing 30 litres per day, and you can increase production to 31 litres, then that extra litre is extremely profitable.
“This ‘marginal litre’ does not have to cover borrowings, loans, rent, utility bills or even feed costs, as you have already paid these bills on the other litres, and fed the cow for her maintenance and a certain level of production.”
He says this area of ‘marginal economics’ is crucial for maximising profitability, but to fully understand the concept it is necessary to know the difference between ‘marginal’ and ‘average’ in terms of costs of production.
“Using ‘average’ costs of production can be risky when considering business strategy,” he says.
“Equally, it is easy to get fixated with pence per litre costs of production, which is a very valid measure, but not always useful when considering strategies for improving profits.”
He says for most dairy farmers, the limiting factor in terms of output is not the number of litres the farm can produce, but the number of cows it can carry.
“So if the number of cows is the first limiting resource, we should focus on margin per cow, not margin per litre.”
As an example of marginal litre economics Mr Watts uses a scenario with four yield levels from 7,000 to 10,000 litres, with feed use increased for each yield level (see table 1).
“The milk price and feed cost per tonne has been kept the same and we have put in a few extra variable costs to maintain a higher yield.”
Mr Watts’ calculations show the 7,000-litre cow has a higher margin over total feed and quota per litre than the 10,000-litre cow. But if number of cows is the limiting factor then looking at margin per cow is a better bet - and the difference between the lower and higher yield levels is £386/cow or £38,600 for a 100-cow herd.
“Producing 10,000 litres is not for everyone, but the 7,000-litre producer feeding 0.3kg per litre could feed a tiny bit more, bring yields up to 8,000 litres and effectively achieve an extra profit of £12,500 per annum.”
This is the difference in margin over total feed and quota between the 8,000 and 7,000 litre levels or £1,304 minus £1,179 multiplied by 100 cows.
Mr Watts says many would argue increasing the feed rate at a time of high feed prices is a false economy, and the law of diminishing marginal returns needs to be considered.
“So what does the feed cost have to be before these marginal litres are uneconomic?
“Currently the milk price to feed price ratio is in the region of a 4:1 payback.
“This means the concentrate price would have to reach £380/t before extra feeding did not deliver a return. In other words, it does still pay to feed” (see table 2).
Mr Watts says although the situation of marginal cow economics applies to fewer farms, if you have additional cow spaces not being utilised then increasing herd size makes sense - as long as overstocking is avoided.
“If you have 150 cubicles and only 125 cows, then it makes economic sense to increase cow numbers. Overheads will not rise and, in most circumstances, labour requirements will not change as milking times would hardly be affected.
“Many of the other costs would also be ‘marginal’, rather than being average. For example, if you have an annual vet and med bill of £100/cow, then adding another 10 cows into the herd will not increase the bill by £1,000.
“If anything, the ‘average’vet bill will come down on a per cow basis, as the costs of regular visits are spread over more animals.”
Mr Watts says a £40,000 investment would be needed to buy an additional 25 cows at £1,600 each.
“Assuming a 25 per cent culling rate, these will last four years. We’ll give them an assumed final cull price of £600 and assume the feed rate is 0.35kg per litre, and feed costs are £200/tonne.
“We will have some other ‘marginal costs’, but the assumption is we have not had to put up another shed to house them - the scenario is about making sure our ‘productive places’ are filled with ‘productive cows’.”
He says when taking an interest rate of 6 per cent, the extra profit would be in the region of £1,000 per cow per annum, or £25,000 on the bottom line.
“That’s equivalent to 11ppl, making these animals the most profitable cows and the most profitable litres you have on the farm.
“Remember, this is not about having the biggest herd or the highest yielding herd. Marginal economics is a principle appropriate to every dairy farmer, whatever the herd size, whatever the system and whatever the milk yield.”