Use Production Inputs Wisely
Make the right supply decisions to maximize profits.
September 5, 2012
During the Great Recession, I witnessed a cost-centricity like I had never seen before in my nearly four decades of being affiliated with the green industry. By cost-centricity, I am referring to the tendency on the part of growers to reduce costs. After all, there are only two ways to increase profit margins — either increase sales or reduce costs.
It’s easier (or at least perceived to be easier) to do the latter. Having grown up in the family nursery business, I know all too well the mentality of shaving every single cent from the value chain that is possible, but this last economic downturn forced us to tighten our belts even further than we had thought possible.
Belt-tightening in depressed economic conditions involves reexamining both the demand and supply side of profitability. On the demand side, growers ask what products and how many of each they should be growing and how they can reduce the risk of speculated production.
On the supply side, the questions include, can I reduce costs by cutting back on certain inputs, which ones can I get at a cheaper price and which ones do I really need to produce the minimally acceptable level of quality required by the marketplace? It’s these questions on the supply side of the equation and the decisions regarding the use of inputs that I want to focus on in this column.
Optimal Inputs Maximize Profit
If you have ever taken an economics course, then you’ll remember that there is a body of economic theory that talks about the “optimal” combinations of inputs. But what folks don’t often realize is that cost-minimization (through the optimal use of inputs) is the same as profit-maximization (through the optimal mix of outputs).
Consider the following from California State University’s Stephen Shmanske:
“There is an often-missed opportunity in the teaching of intermediate microeconomic theory. Invariably, the presentation of the firm’s calculation of the profit maximizing output level is covered in a different chapter than the firm’s optimal input decision, even though these two decisions are actually the same problem in two different guises. It is not improper that the topics of the profit maximizing output level and the profit maximizing input level each get their own chapter, but because of this, unfortunately, the connection between the two topics is not stressed.
“As such, many students remember the logic and mathematics of MC = MR (marginal cost equals marginal revenue) but fail to make the connection to the same equation expressed in different variables and presented as: VMPL = PL (value of marginal product of labor equals price of labor) or in its more general form: MRPL = MFCL (marginal revenue product of labor equals marginal factor cost of labor). Students think they are learning (or perhaps attempting to memorize the alphabet soup of) two different models when it is really the same model.”
— “Connecting the Firm’s Optimal Output and Input Decisions,” Perspectives on Economic Education Research.
Growing: More Science Than Art
But growers rarely consider the alphabet soup of cost-minimization formulas when they are making decisions about which and how much of what input to use. Nor do they have the luxury of developing a sophisticated mathematical model to determine optimal levels of each resource (input) to use. Instead, it often comes down to which allied trade vendor can supply the magic silver bullet chemical, fertilizer, seed, etc. at the cheapest price. This may have worked in the old paradigm of production, but this train has wrecked and is no longer functional.
In today’s paradigm, it helps to consider the optimal combination of inputs in a systems type of framework. In other words, growing quality plants has become more science than art and, as such, requires more technical consideration of the right combinations of inputs that fit into the production system rather than simply selecting the popular input of the month or, heaven forbid, the portfolio of cheapest products available. There’s an old adage that says, “You get what you pay for,” and I have seen growers save money in the short run to only lose a lot of money in the long run. In addition to cost, other things need to be factored into the decision regarding the optimal inputs to use (see Questions To Ask Before Buying sidebar).
Of course, it’s impossible to answer these questions in a vacuum. Relationships between allied trade vendors and growers are critical because it’s the long-term relationships that generally result in a win-win situation for both parties. This was reinforced to me just recently at the recent North American Horticultural Suppliers Association conference where the focus of many discussions was, “How can we enhance the success (i.e. profitability) of our grower customers?”
It also helps to bear in mind that, like Shmanske wrote, the most expensive input a grower ever uses is labor. Adopting some lean flow principles may be the single greatest investment a grower can make in terms of saving on input costs. Yet it is ironic that so much time is spent getting the absolute lowest price on production inputs.
Hire A Procurement Specialist For Better Buying
The last thing I should touch on is the branded versus non-branded/organic decision. There are some very good products to choose from on both sides of the coin. Efficacy is seldom the sole reason for making a decision to buy one way or another. It often comes down to the service-related dimension I discussed earlier, and I’ve noticed that growers ultimately go with who they trust the most. The growers that I have seen do this the best have a dedicated person that focuses on procurement. This person interacts externally with allied trade vendors to develop key long-term relationship and internally with growers and other managers in a concerted effort to reduce shrink and excess inventory of inputs.
Let me close by reinforcing the notion that growing quality plants should be looked at as a science-based system, particularly if you want to make money doing it. Even though input costs are a smaller part of the cost of goods sold on the income statement, it doesn’t mean that you can take input adoption decisions lightly. Nor does it mean that you are going to dramatically increase profitability simply by choosing the cheapest inputs. So be wise and be profitable.
Charlie Hall is a professor and Ellison Chair in International Floriculture at Texas A&M University. You can eMail him at firstname.lastname@example.org.