| | Summary
Custom cattle feeding is a very competitive segment of the Canadian cattle industry. Since feedlots compete with each other for cattle investor clients, benchmark yardage and cost of gain information is difficult to obtain. Margins on the investment side of the business tend to be small, and along with added risk; cattle owners are motivated to negotiate the lowest possible cost, and lowest possible risk feeding arrangements. Unfortunately, sometimes cattle feeders tend to feed cattle for much less than their true cost of production.
This discussion paper examines the traits that make agribusinesses successful, and then applies those principles to the custom feedlot business. Time is spent discussing the need for a basic business plan, complete with a financial analysis section. The financial analysis is then taken one step further to describe how feedlots can use their own expense statements to calculate a realistic yardage cost. The discussion goes on to describe how custom feedlots can do a better job of forecasting gain costs and managing risk. The final section of this paper highlights some of the areas that potential long term cattle owner clients look at when making their decisions.
This discussion paper is written with an underlying objective of developing better financial risk management culture for custom feedlots. When custom feedlots have a better understanding of their own financial risk and their own production costs, it is more likely that future cattle feeding agreements will achieve business objectives.
Background
Cattle feeding agreements have been used in the custom feeding industry for many years to protect the interests of both the custom feedlot and the cattle owner. The most common types are ‘cost per pound of gain’ (COG) and ‘cost plus’. Both of these systems have unique features and risks that need to be assessed prior to entering into an agreement.
In cost per pound of gain arrangements, the feedlot operator is paid for the weight gain on the cattle while in the feedlot. Typically, the owner specifies a target average daily gain for the cattle, depending on the future sale date, and grazing or finishing program that the cattle will be entering after they leave the feedlot. COG arrangements have been very common in the backgrounding sector, and have been widely used by large cattle owners when dealing with smaller backgrounders and newer cattle feeders.
Cost plus systems have been more common in finishing feedlots where there has traditionally been a good knowledge of all production costs. In this system, the cattle owners pay yardage fees, in addition to the cost of feed, medicine, and other specified fees to the feedlot.
Regardless of the system used, a formal written agreement should be in place between cattle owners and the custom feedlot. A written agreement is even more important when establishing new relationships because it will clarify the agreed details, and minimize the chances of having misunderstandings during the feeding process. After a positive relationship is built, signed written agreements are rarely used, but the example of previous feeding activities is used as the model. Nevertheless, a written agreement is just good business risk management.
While recognizing that written agreements are important, this document focusses more on the feedlot
Regardless of the system used, a formal written agreement should be in place between cattle owners and the custom feedlot. A written agreement is even more important when establishing new relationships because it will clarify the agreed details, and minimize the chances of having misunderstandings during the feeding process. After a positive relationship is built, signed written agreements are rarely used, but the example of previous feeding activities is used as the model. Nevertheless, a written agreement is just good business risk management.
While recognizing that written agreements are important, this document focusses more on the feedlot business management practices that will help form the basis of an agreement. It will also deal with the process of calculating yardage and establishing appropriate rates for COG agreements. The document will address risks and rewards with the intent of finding a fair balance that will create and sustain long term relationships.
A strong understanding of business management fundamentals is necessary to establish mutually profitable cattle feeding arrangements. To that end, the following definitions are included for clarity.
A cattle feeding agreement is typically a negotiated understanding between two or more people or companies. It documents the “give-and-take” of a negotiated settlement, and specifies the minimum acceptable performance levels, on both sides. As long as simple agreements are understood by all parties, they are generally considered legally binding. For the purposes of this discussion, an agreement will be considered a plain language list of terms and conditions that are mutually agreed upon in writing or verbally.
Also for the purposes of this discussion, a cattle feeding contract will be considered a legally binding, formal, and all-encompassing agreement between a feedlot and a cattle owner. Contracts are typically prepared by one party’s legal counsel to protect that party from various risks.
Objective of This Paper
Based on the assumption that there is very little, or no relevant benchmark feedlot cost data, the primary objective of this paper is to assist readers with:
- Identifying feeding agreement areas that may need attention,
- Understanding the business side of the feedlot,
- Calculating true yardage, and
- Making better cost of gain forecasts.
Introduction to a Simple cattle Feeding Agreement
Sometimes cattle feeders enter into feeding agreements where all of the details are agreed to prior to the cattle arriving. While it is very difficult to foresee every possible scenario, the list below identifies some of the major points and questions that need to be considered, agreed to, and written down.
1. General Information
- Contact information for all parties
- Cattle location
- Movement plan and notification requirements
- Date and expected length of feeding term
2a. Terms and Conditions - Cost Per Pound of Gain Agreements
- Type of cattle to feed
- Heifers vs. steers
- Type and quality of cattle - i.e. medium flesh, large frame exotic vs. fleshy small frame British
- Beginning weights with specified shrink conditions
- Cost per pound of gain to be invoiced
- Induction fees
- Implanting protocol and fees
- Professional veterinary fees
- Bedding
- Discounts or penalties for excess weight gain
- Discounts or premiums for under-gaining Death loss consideration
- Incoming weight adjustments
- Maximum allowable percentage
- Percent of incoming value credited to owner
- Postmortem requirements
- Ending weight
- Shrink conditions
- Scale locations with freight adjustments
2b. Terms and Conditions – Fee Structure for Cost Plus
- Yardage cost per head per day
- Induction fees – detail
- Implanting protocol and fees
- Professional veterinary fees
- Feed commodity costs
- Bedding – cost per day or cost plus
- Other costs
- Unsuitable animal disposal
- Other
- Death loss protocol
- Owner notification
- Postmortem requirements
3. Billing and Payment
a. Monthly by the 15th of the next month?
b. Final shipment pre-payment for new customers
i. Estimated final payment on account before loading?
4. Removal Terms
a. Cattle to be left in the lot for a minimum of ___days
b. Cattle to be removed after a maximum of ___ days
c. Special removal conditions for poor performance, or extenuating circumstances at the feedlot.
5. Inspection Terms
a. Anytime during normal business hours?
b. Notice on weekends?
c. Custom feedlot notification to the owner upon arrival of loads?
d. Other
6. Agreement Amending Conditions
a. Mutual verbal or written amending agreement?
7. Independent Third Party Dispute Resolution System
8. Signatures and Dates
9. Other Attachments
1. Feed rations to be used
2. Feed test results with dry matter contents
3. Cost per pound gain forecasts
4. Dry Matter (DM) conversion forecast
5. Average Daily Gain (ADG) forecast
This general cattle feeding agreement framework is fairly straight forward and logical. While it captures most of the agreement details, it is far from the be-all-to-end-all. Individual feedlots and cattle owners may require specific terms and conditions that are not captured here. In drafting an agreement like this, it is important to keep everything simple and easy to understand.
The Challenge
The biggest challenge in drafting and executing an effective cattle feeding agreement comes down to determining the right fee structure. Whether it is cost per pound of gain, or cost plus, the fees charged to the cattle owner must be both competitive for the cattle owner, and provide sustainable returns to the feedlot.
Far too often, cattle feeders look to neighbors and other industry contacts to determine the right prices to charge. It would be so simple if there was a central data base or some benchmarking system where one could quickly research the appropriate rates to charge. Unfortunately, there is not central benchmarking information database for cost of gain, yardage, or other feedlot costs. There has been some survey work done by the Western Beef Development Center (WBDC), but those publically available results tend to be out of date.
In 2002, the WBDC suggested that backgrounding operations surveyed had yardage costs of 44 to 45 cents per head per day. As reported in the Alberta Express newspaper for January 31, 2011, it was suggested that, “Although yardage costs may vary, they are typically comprised of 36 per cent for labour, 18 per cent for custom work, 12 per cent for depreciation, 10 per cent for machinery repair, and nine per cent each for utilities and fuel. Taxes, leases, insurance, building and corral repairs account for the remainder (WBDC). In both cow-calf and feeding operations, the largest share of yardage cost is labour.”
Alberta Agriculture reported in 2003 that the yardage cost for wintering cows was in a range from 75 cents to one dollar per head per day. This is consistent with a 2003 WBDC study that showed an average of 92 cents per head per day. Sean Magrath stated in his February 25, 2015 Grainews article that, “realistically many operations have yardage costs that are well over $1, without even paying the operator for their time.”
In a 2006 study, the WBDC reported that the lowest cost producers, representing 25% of the survey, incurred yardage costs of 75 cents per head per day. In contrast, the other respondents had well over double the yardage costs.
While most of the previous survey information is for cow-calf operations, the WBDC work highlights the extreme cost variance between operations, and the need for producers to calculate their own production costs.
CanFax is another source of market price and general costing information. However, that costing information has typically been of the hearsay variety. Cattle buyers and auction markets are another source of hearsay cost and feeding agreement information. While all of this information is useful, it is important to remember the ultimate source, and understand the financial motivation behind that source. Astute cattle owners will always try their very best to keep yardage and gain costs low.
The reality is that cattle feeding is a very competitive business, and there is a reluctance to share all of the information among feedlots. Cost of gain rates do trend with commodity prices but all too often, some cattle feeders end up working under some highly restrictive rate structures, with very little to show for it in the end. Occasionally over the years, feedlots have been known to provide services that do not cover their cash production costs, or make any contribution to management and capital costs.
With limited upside for feedlots under some agreement structures, every effort must be taken to insure that every agreement supports the feedlot’s business plan objectives. This implies the critical need to insure that variable costs are covered, and there is a reasonable chance of experiencing positive contributions to fixed costs, and to feedlot management.
To see the full paper click here or on pdf at the top
Prepared by Bruce Viney
Alberta Agriculture and Forestry |
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