What Does That Production Input Really Cost You?
Tips from Scotts Professional's Fred Hulme on how to analyze production inputs for a better return on investment for profitable results.
December 3, 2010
In today's tight economy, it's only natural that growers are carefully monitoring all their production costs and cutting back on expenses in the hopes of maximizing margins and profits. It's easy to understand their motivation; however, some growers may perform an inadequate analysis of their cost structure. This may result in some production decisions that are penny wise and pound foolish. There are a number of approaches growers can take when analyzing production costs, and some may require additional time to conduct. Still, a proper analysis must include sufficient detail to provide growers with the information they need to make a thoughtful, informed decision.
There are three common methods used to determine what production inputs (fertilizer, pesticide, fungicide or herbicide, for example) are most likely to contribute to a higher profit margin: Cost Per Bag, Cost-In-Use and Return on Investment.
Cost Per Bag
Cost per bag is the simplest metric to understand. The entire annual budget for a production input is easily calculated by multiplying total number of bags or containers of fertilizer, pesticide, fungicide, etc. used per year times the unit cost per bag. Therefore, when taking this approach, a grower can put the annual order for these items out to a number of suppliers for bidding and choose the bid with the lowest unit cost in order to minimize expenses. This approach is fine when dealing with well-defined commodities that can easily be substituted for one another; however, when comparing different nutrition or plant protection products, formulations and/or brands, cost shouldn't be the only determining factor.
Method 1 - Cost Per Bag:
- Product A costs $35/ 40 lb. bag
- Product B costs $55/ 50 lb. bag
Using the Cost-Per-Bag method of analysis, Product A seems like a great value upon first glance. Obviously, the cost per bag of Product B is more than 50% higher. Product A is a great deal, right?
Not necessarily. Different products may have extremely diverse properties, values or use directions, and these differences may not show up in a simple cost-per-bag comparison. Products may differ by any combination of the following variables:
- Product bags or containers may be of different sizes.
- Products may have different rate recommendations.
- Some products may require more frequent application.
- Some products may be more labor intensive to use.
- Some products may be easier to apply or use.
- Different products may have varying efficiencies or waste factors.
- Some products may contain unique components or attributes that can't be easily substituted.
- Some products may more frequently result in better outcomes that have economic consequences.
Cost-in-Use is one analysis method that can account for some of the variables mentioned above. Cost-in-Use goes a few important steps beyond a simple unit bag cost comparison. Bag size, rates, number of applications and labor cost are factored into the equation in this model so a grower can calculate the true material cost per unit crop. In this case, the grower will consider the final product cost per bag, effective product rate, number of product applications per crop, application labor, etc. for a more well-rounded picture of the actual production cost per crop unit. If one product is missing some component (e.g. micronutrients), the cost analysis should include the cost of adding the additional component needed for a successful crop.
Method 2 - Cost in Use:
- Product A costs $35/ 40 lb. bag; suggested application rate is 30 grams per unit container and only one application is needed to finish the crop. Since this product contains only N-P-K and is missing micronutrients, there is an additional factor that must per accounted for. Cost-in-use of Product A = $35 Ã· 605 (number of containers treated per bag) + $0.025 (estimated cost of micronutrients) = $0.058 + $0.025 = $0.083 per container.
- Product B costs $55/ 50 lb. bag; suggested application rate is 36 grams per unit container and only one application is needed to finish the crop. This product already contains micronutrients. Cost-in-use of Product A = $55 Ã· 630 (number of containers treated per bag) = $0.087 per container.
In this example -- assuming there is no additional labor cost to apply either product (or to supplement Product A with micronutrients) -- Product A still seems like a better value. Product A costs less per bag and is used at a lower rate, but the bag is smaller and it requires the addition of a micronutrient supplement. Product B costs more per bag and the suggested rate is higher, but it has a bigger bag that can treat more containers and it doesn't require any supplements. The cost-in-use of Product B is slightly higher (by 4.8%), but the differences are nowhere as significant when considering only bag cost. Still, the grower still might be inclined to choose the less expensive option.
Again, if we're comparing commodities with similar performance, this may be a reasonable analysis to account for varying bag sizes or rates. The Cost-in-Use method only analyzes unit production costs, but if you don't consider the economic results of production, it's still offering an incomplete picture of the actual scenario. If one product option will result in better crop performance (and better economic return) than another, further analysis is required to decide which is best for your operation.
Return on Investment
A wise grower will certainly always strive try to control raw material and labor costs, but the principal objective of any production operation is to invest in raw materials that will lead to the most profitable return once the crop is sold. A well designed trial can quantify the performance differences between different products. After different products are applied and crops are grown and marketed, a detailed analysis can then determine if any product treatment results in significant economic advantages -- or disadvantages.
The performance of different product treatments might result in:
- Faster average production time (days to bloom, days to desired plant size)
- Lower than average plant loss or shrink
- Higher than average plant grade - bigger, better, fuller, greener (tied to value)
- More efficiency or less environmental waste
Bench space costs money. If you can turn a crop faster by using a more expensive product, it may make economic sense. A greater investment in fertilizer or pesticide, for example, might be warranted if it results in a crop with a higher percentage rated "top grade" or if reduces shrinkage (culls/ discards) in the production and post-production phases. Some products may result in less waste because more of the product is being used by the plant. In this case, the cost of losing nutrients or other active ingredients into the environment due to spillage or leaching should also be considered.
The Return on Investment analysis method looks at the relative return that any specific product treatment might bring to help you maximize profitability.
Method 3 - Return on Investment (ROI):
o Product A costs $0.083 per container. Product A yields a crop that is 30 percent top grade (wholesale at $4/ plant), 55 percent second grade (wholesale at $2/ plant) and 15 percent culls (no value). The average value of the crop = ($4 x 0.3) + ($2 x 0.55) + ($0 x 0.15) = $2.30. The ROI = $2.30/ $0.083 = 27.7 or a return of approximately 28 times the product cost.
o Product B costs $0.087 per container. Product B yields a crop that is 60 percent top grade (wholesale at $4/ plant), 30 percent second grade (wholesale at $2/ plant) and 10 percent culls (no value). The average value of the crop = ($4 x 0.6) + ($2 x 0.3) + ($0 x 0.1) = $3.00. The ROI = $3.00/ $0.087 = 34.5 or a return of approximately 34 times the product cost.
In this example, if the grower is willing to invest $0.004 more per container, there will be an incremental return of $0.70 per container. Product B is a much better investment here as its use leads to a much more profitable crop.
Because it offers the most accurate data related to profitability, Scotts Professional often uses the Return on Investment analysis method when creating trial data sheets for sales purposes. Our territory managers also use the ROI method when working with growers on their own trials in the field. Here's an example of some charts from a recent trial of our Osmocote Plus patterned nutrient release fertilizer on rhododendrons. These charts offer a good visual representation of how different quality products can impact the mix of Class 1, 2 and 3 plants within a crop as well as the sales value of these plants.
When analyzing the value of various products, cost per bag can be quite deceptive. For very similar products, a Cost-in-Use analysis will account for differences in bag size, rate and application difference and provide a better comparison. For more complex products, an ROI analysis is best since it accounts for differences in product performance that can significantly boost the bottom line.
|Different analysis can lead to different decisions from examples above.|
|Cost Per Bag||Product A Is much less expensive||Product A seems like a good choice||Bag size and rate differences are disregarded|
|Cost-In-Use||Product A is slightly less expensive per unit container||Product A still seems like a better value||Cost of product is accurate, but production results are ignored|
|ROI||Product B returns more profit||Product B is a much better value||Grower maximizes economic return by selecting the best product that will lead to greater profitability|
Fred Hulme, Ph.D.; is Director of Technical Services at Scotts Professional. You can email him at firstname.lastname@example.org.