Read the current Progressive Forage digital edition
advertisement

How much does that hay cost and what should I charge?

Gordon Groover Published on 28 September 2012

Popular press and other media outlets are saturated with simple and very complex strategies on how to price a product or service. Yet they all start with four basic concepts:

1. Know your cost of production.
2. Know the prevailing market price.
3. Produce what a customer wants.
4. Sell quality products at reasonable prices and with quality service.

Producing hay as a cash crop is a challenge to meet all the items above when weather, labor shortages, high land costs and so on work to reduce both the quantity and quality of the hay you have for sale.

This article is designed to help you consider some of the major issues in developing a hay enterprise.

Know your cost of production
The best marketing and pricing strategies will eventually fail if you do not know and control your cost of production and price your product accordingly.

Cost of production starts with a sound production and financial record-keeping system. To determine the costs per ton of hay, you need to know the yield and costs.

Knowing yield sounds simple, yet keeping accurate yield records requires that hay from each field be recorded and that you weigh loads or estimate weights.

Defining a few words and explaining how they are used when making decisions will aid your understanding.

• Fixed costs (also known as sunk costs) are items that do not vary with level of use. The most common are depreciation, interest, taxes and insurance on equipment and machinery; and depreciation, insurance, taxes and maintenance on buildings.

Fixed costs do not change with the level of use. For example, if hay equipment is used on an additional 30 acres, the interest, taxes or insurance charge do not change.

However, fixed cost measured on the basis of either per acre or per ton of hay harvested decreases as more hay is harvested.

• Variable costs (also known as out-of-pocket costs) increase with use: an increase in the tons of hay harvested will certainly result in more fuel consumed and higher repair costs.

If a farmer stops making hay altogether, variable costs will drop to near zero, but fixed costs will remain essentially unchanged.

• Long-run decisions are made based on all costs being covered – that is, the income from hay sales will exceed the fixed and variable costs of machinery and equipment, hay production, storage, labor, management and return on investment. These costs are important when you start a new venture requiring additional investments.

• Short-run decisions are made day-to-day, year-to-year to help improve the profitability or reduce the losses of an ongoing venture.

Short-run decisions consider only variable costs: as long as the income from hay sales are greater than the total variable costs to produce that hay, the farmer is better off continuing to produce hay.

When the income from hay sales no longer cover the variable costs to produce that ton of hay, the farm business has reached the “shut down” point.

What does it cost to grow mixed hay and alfalfa hay?
To answer this question, some of the basics of budgeting must be explained. The purpose of a budget is to list the annual qualities and prices of inputs involved in the production of hay.

The sum of the income items less total expense leaves an estimate of net income or returns to land, risk and management. Since the sales price is often the most variable, most budgets concentrate on the cost of inputs like fertilizer.

Gross receipts are the sales price of a bale or ton of hay times the estimated production units. Hay from different fields may not have the same value and should be reflected as separate items or as an average price representation quality from poor to excellent. The yield should indicate long-term average yields, not just the best of the last 10 years.

0812fg gordon tb 1 full

Pre-harvest variable costs
The current budget estimates of pre-harvest variable costs for mixed hay are shown in Table 1 and alfalfa in Table 2.

The level of complexity increases when you move to the pre-harvest costs.

In the case of hay, the cost of establishing the crop is more expensive than the year-to-year maintenance and needs to be prorated over the life of the crop.

Calculating establishment costs requires a separate budget.

0812fg gordon tb 2 full

The total is prorated over seven years for grass hay and five years for alfalfa.

The remaining items are a listing of the estimated units of inputs like fertilizer, lime, herbicides and so on, priced at rates that are reflective of 2011.

Harvest variable costs
The first step in addressing the fixed costs is to select the harvest equipment.

Then the costs must be annualized over the life of each piece of equipment.

Calculating annual fixed costs for the machinery complements requires allocating those costs over the life of the farm machinery. Allocation of fixed costs is accomplished by using the capital recovery method.

The capital recovery method sets up a payment schedule to fully recover the value of the machinery and interest on the investment over the life of the equipment.

Capital recovery is based on the assumption that when the machinery is worn out or obsolete, enough money will be available to fully replace the machinery with equivalent but updated technology.

Know the prevailing market price
The prevailing market price is a question, not a fact. You can say with a fair amount of certainty what market price of #2 yellow corn grain allows both buyers and sellers to gauge the market conditions and know the prevailing price. Yet when you ask, “What’s the price of a ton of hay?” the certainty quickly diminishes.

To get an estimate of local hay prices, check all sources of information, e.g. newspapers, local feed dealers, local hay brokers, Internet sales for large loads and so on.

Pay close attention to all the attributes that affect price and costs; for example, quality measures, delivery charges or discount if picked up at the farm, who unloads, quantity for sale, payment requirements, cutting time – first, second, etc., bale packages (rectangular, square, or round), customer satisfaction policy and priced by bale or ton.

When you sell hay, you are assuming all the functions of a commodity market. That is, specific grades and standards regulated by a third party; for example, corn grain: 56-pound bushels at 15.5 percent moisture with less than a specific percentage of foreign matter, broken kernels and so on.

The current market structure for hay does not provide these services; therefore, as a hay seller, you must address many of these functions for your customer base.

Setting a price
Ok, you know your total cost of production and have estimated the prevailing market price for alfalfa hay at $5 per 50-pound bale and you now want to know how you should price that hay.

0812fg gordon tb 3 full

The first step is to know your breakeven prices. Total variable costs (fertilizer, repairs, fuel, etc) are $117.99 per ton (see Table 3).

This amount defines your rock-bottom price. What does this mean? This is the cash cost of producing that ton of hay.

Unless you can average more than $117.99 per ton, you are losing more money by growing hay rather than by letting the farm lie idle.

What about the other costs – machinery and equipment and storage?

Both of these items are associated with capital investments and will be an expense to your farm business regardless of the enterprise.

In the long run, you must cover these costs for the farm business to remain viable; however, in the short-run these fixed costs may or may not be paid each year.

The breakeven costs for all costs (fixed and variable) in this alfalfa example must average more than $143.05 per ton or $2.87 per 50-pound bale. This estimate is for hay at the farm. Getting the hay to the customer (loading, transportation, marketing, phone calls, bad checks, collecting sales tax, etc.) will add to this cost.

Produce what your customer wants
The old adage in sales is “the customer is always right.” Knowing your customer is the most important factor in marketing.

First, start local; do your homework on the type of hay wanted and in what form and quantities (weekly, monthly, annually). Contact local horse owners who buy hay; contact smaller feed dealers and tack shops.

Ask if they are satisfied with their local supplier and what services are very important from a supplier; for example, monthly delivery and forage test results. Analyze this information to determine if you can supply the hay and additional services and still cover your costs.

Establishing and keeping a sound customer base
Unlike other commodities, there is no structured market for hay. If you do not create and maintain a customer base, it is unlikely that you will survive in the hay business.

Services need to be tailored to the individual customer and might range from individuals who buy only on price to individuals that want hay delivered only on Friday afternoons and stacked in the barn.

The real question is: “Can you find a way to meet each customer’s need without excessive cost?”

Ask your customers to comment on what’s important to them by sending them a thank-you note and include a stamped postcard with a few questions that will help you understand their hay needs.

To create a client base, offer your current customers a discount on their next load if they help you get new customers near their farm. Think creatively about how to meet your customers’ needs.

To meet the needs of your customers make sure you maintain a quality product and have documentation, which may include a forage test. Be honest about the product and your policies and expect the same from your customers.

To make sure your customers understand your business practices, write them down and give them to all potential and new customers. In your business policy, also discuss how you would resolve problems of dissatisfaction with your hay or service.

It could be a simple statement that your customers have a right to inspect the hay at your farm and once it is delivered, full payment is required before unloading.

Finally, “the customer is always right,” but you do not have to sell to them. If you have a written statement of business practices, you can also have a statement of customer expectations.

A bounced check now requires full payment with interest in cash before you load the truck with the next load to that customer.  FG

References omitted due to space but are available upon request. Click here to email an editor

—Excerpts from “Farm Business Management Update,” January 2012

Gordon Groover
Gordon Groover
Extension Economist
Virginia Tech

 

LATEST BLOG

LATEST NEWS