The preliminary results show that reducing his back to back margin to get more volume is effective when filling bins with company-owned grain (But only if he would have missed the bushels otherwise. see chart above). The dollars earned from the basis appreciation quickly offset the reduced revenue from the lower handling margin. It isn’t logical to cut margins just to fill faster than his competitor, however.
Mike suddenly stops: “What if the basis doesn’t pay a good carry?” He lowers his estimated basis gain from 15¢ to 5¢ (net of interest) just to see the impact and is shocked that the higher volume then only nets a few thousand extra dollars.
Mike quickly realizes that he needs to be more cautious once the bins are full and he can’t earn basis appreciation, or if market carries disappear. At that time he should widen his bid margin on grain he’ll have to ship immediately, even though he may risk losing a few bushels.
He’s also shocked to see just how little revenue his “back to back” margin really brings to the business. If he handled 5 million bushels at a 6¢ gross margin and 4¢ variable cost, it still only brings $200,000 towards fixed costs. But these situations assume nothing goes wrong — no quality loss, no excess shrink, and so on. Mike’s 1,000,000 bushel scenario nets just $20,000, a margin of 2½¢/bushel. No wonder the financials aren’t showing better returns,.
The challenge is to find the point where increasing the “back to back” margin doesn’t cost the elevator too much volume. When crops are wet there will be drying revenue. Mike also sells fertilizer and feed and wants to retain those customers as well as keep the farmers coming for future grain business. Feed margins are very good and Mike wonders if losing grain bushels might mean losing feed business. Who knows, maybe the farmers will bring their grain in regardless of price, because of the co-op’s excellent service and quality of feed products.
Mike pushes back from his desk, resolved to do this more often. Quantifying possible scenarios and outcomes has cleared his thinking. He’s resolved to stand the line more and not push bids so readily, and to focus even more on maximizing basis gains.
Mike also makes a note to himself to create another spreadsheet to analyze storage, DP, and drying rates and revenue. He wonders if he’ll see comparable results.
Some may look at this spreadsheet and see a different story: that the higher volume still brings at least some dollars to the table as long as you cover variable costs. Then you can focus on the related revenue and benefits. Some elevators make much of their money on “mix and blend,” for example, and volume can help that.
Running an elevator costs a lot of money — far more than in the past. Prior to 2008 the grain industry had long been noted for its fear of missing volume. Many facilities chased competitors and pushed bids to the point where the handling revenue wasn’t enough to sustain the business and success depended on service charges and hedging/basis revenue. That meant that when carrying charges vanished, so did elevators’ profits. Mike vows to make sure this co-op can survive volatility and maximize revenue.
Footnote: The handling margins and basis appreciation figures shown in the tables are strictly for illustration. These numbers should not be taken as a recommendation for any individual business.