It’s a crisp morning with a hint of autumn in the air. Mike pulls up to the elevator in his pickup and shuts off the engine, pausing before climbing out to open the office and start another harvest day. As the trucks and wagons begin to arrive and farmers stop in for some morning coffee, Mike sits in his office looking over the year-to-date financials. Volume looks promising — he expects local crops will overrun the capacity of area elevators this harvest — but Mike wishes the fiscal year grain results were better. Soybean merchandising revenue has been surprisingly good given the extreme volatility in basis and the summer’s huge futures inverses. But corn has been a challenge in recent months. The ethanol plants drained volume from the co-op and farmers held stubbornly as futures prices declined. Now Mike wonders how this crop year will turn out. The co-op’s board wants to see a bigger return but the nearby ethanol plant outbids Mike. At least the co-op’s interest expense has declined this year!
Mike switches on his computer and opens a spreadsheet. He wants to look at this situation objectively. Mike is already working on ways to reinforce relations with farm customers, and he thinks that will help maintain volume. But does matching the competitor’s bids also make sense? Despite the big crops, Mike is still concerned he’ll lose volume this fall if he doesn’t cut his margin a little and raise his bids. But could he possibly come out ahead by handling less volume at a bigger margin?
He pauses and jots on a notepad the numbers he needs to consider:
- estimated volume at different handling margins
- possible handling margins
- variable cost of handling a bushel
- other income from volume
Figuring the variable cost is difficult. Mike thinks to himself for a moment, “What costs do I incur only when I put grain through this house. Let’s see . . . I’ll figure the fixed costs first: electricity to turn on the lights, wages for the guys who work 8 to 5 even when we’re idle, insurance, depreciation, vehicles, office staff, etc. So what’s left must be mostly the variable costs: electricity to run the legs and conveyors, repairs, any overtime labor, fuel for trucks, fumigants and so on. These costs are hard to break out, so I need to run scenarios using two or three different variable costs per bushel and see a range of outcomes. I also know that some variable costs (per bushel) decline a little on higher volume but I can only tweak this so far.”
He enters a starting volume number (see above table) of 1 million bushels, some possible handling “back to back” margins, and an estimated variable cost to handle each bushel. Next he varies his expected volume as he raises the bid margin.
Mike sets up the spreadsheet so he can easily change the margins and the impact on volume. He quickly determines that if working on a slightly higher margin may cost him some volume, it won’t cost him dollars in this scenario. Higher volume would bring in more gross dollars, but depending on the variable cost per bushel and the impact on volume, Mike’s net revenue may be better at lower volumes. In this situation Mike defines “net” as the revenue left after variable costs; the revenue available to cover fixed and other overhead costs, and provide a return for the business.
His scenario shows that handling 1 million bushels at a 6¢ “back to back” margin earns him less than handling 600,000 bushels at an 8¢ margin, assuming a 4¢/bushel variable cost.
There’s more to consider, however. At harvest Mike fills bins and holds grain (hedged) for basis appreciation. He figures this year basis gains should net (after interest) about 15¢ per bushel. So Mike adds some columns to the spreadsheet to factor in that revenue. He also adds columns where he can plug in higher or lower numbers for basis appreciation.