Dairy businesses must take control of overhead costs

Sometimes the most technically excellent dairy businesses make only modest amounts of profit, while others may be only modest technical operators, but make good levels of profit.

The control of overhead costs (dominated by labour, power and depreciation) varies hugely.

Overhead costs are also referred to in some cases as fixed costs, as they are not supposed to vary with output. This may be true to some extent, but they do vary with cow numbers.

Furthermore, in economics all costs are considered variable in the long run. It is this point that is perhaps most pertinent when comparing different systems. The rationale for increasing output on a per cow basis (yield) is often cited as spreading the fixed costs, thus improving profit, as long as the additional variable costs incurred do not exceed the additional revenue.

Some may consider this to be marginal litres or marginal economics – additional litres after everything is paid for and therefore very profitable, as they are perceived to be the cheapest to produce.

The first 15 litres

It is possible to achieve 15 litres a day for the duration of a lactation while incurring very little cost. Only a basic milking facility of appropriate scale to ensure labour efficiency and some good pasture management should suffice. Certainly very little expenditure in overheads beyond rent, a basic milking facility and labour is required.

Increasing to 20 litres

At this point it arguably becomes necessary to incur more costs; grass will not suffice alone, so additional conserved forage is required. This involves not only the cost of making the silage in power and machinery, but also storage facility.

Let’s assume self-feeding will be adequate to achieve such production, thus minimising additional power and machinery requirements to feed out. Nevertheless, some degree of concentrate feeding may be required, necessitating investment in a method of dispensing this. It may also become necessary to provide some level of cow housing. Possibly the cost of these additional litres are relatively more than the first 15 litres.

Increasing to 25-30 litres

Self-feed silage may no longer be adequate and the farmer has to deliver feed. The level of output necessitates a higher degree of individual cow management, such as electronic recording in parlour. Basic housing is no longer sufficient, as stock need to spend longer there to achieve the correct feed intakes, comfort needs to be enhanced to maintain output, necessitating deluxe cubicles. Slurry storage demands increase consequentially and so on.

Marginal litres

So which of the litres are the so-called marginal litres or those that are cheapest to produce?

The points outlined above are somewhat spurious for many situations. Many existing dairy businesses already have a level of costs built in and it is these that are inherently “sticky” – they are hard to shed when milk price is unfavourable and production costs need to be reduced. Nevertheless, it is important to consider this, especially when planning expansion or evolution of a dairy business, not to create a system which is inherently high-cost.

The retailer and milk purchaser are paying little attention to cost of production by system and investment levels. Collectively, by reinforcing the perception that a dairy farmer should calve all year round they are driving cost into the dairy industry, not helping to take it out.

Despite the points outlined it is still possible to dilute fixed costs a litre (but not fixed costs a cow) by increasing yield. However, because of increased winter feed costs, it will depend on an individual herd’s response rate and milk-to-feed price ratio as to whether this is profitable or not. The key is to have a level of output appropriate to costs.

The concept of calculating the profit requirement for a business and having the discipline to pay an appropriate return on capital (10%) is key to ensuring this is achieved.

Keeping control of overheads: key points

  • Aim to keep overhead costs below 25% of output and rent and finance cost below 15%

  • Labour and power and machinery cost are key profit drivers across all system of production

  • Labour costs are often similar on a p/litre basis (due to the dilution effect of litres) across systems, but labour hours a cow frequently increase with output/system intensity

  • Direct correlation between increasing equipment and machinery costs and total cost of production, while increasing labour costs decreases net margin. (Milkbench+ 2012)

  • The argument of substituting labour with machinery does not hold true; as machinery depreciation increases, so does labour. (Milkbench+ 2012)

  • Many farms carry excessive power and machinery costs when the work could be more cost-effectively carried out by contractors

  • Tony Evans is head of dairy business consultancy at The Andersons Centre.

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