AgDM newsletter article, September 1997

Strategies for high cost feed mills

By: C. Phillip Baumel, Charles F. Curtiss Distinguished Professor in Agriculture and Professor of Economics, 515/294-6263, pbaumel@iastate.edu

The cost structure of four feed mills operated by a local Iowa cooperative were analyzed to determine strategies for reducing costs.  The data from the four mills were adjusted to make the costs as comparable as possible.  These feed mills are thought to be “typical” of feed mills in Iowa.

Manufacturing costs

The average annual sales volume and manufacturing cost per ton for the four plants over the 1993 through 1996 period are shown in Table 1.  Each mills is given an alphabetic designation from A through D.  Mill A has the highest level of technology and Mill D the lowest. 

Table 1.   Feed Manufacturing Cost for Four Feed Mills (cost per ton)

Tons Sold

Manufacturing Costs

Mill

A

30,650

$16.20

B

3,329

16.89

C

10,158

9.35

D

3,545

21.52

The average manufacturing cost per ton declined sharply with increased tons sold as shown in Table 2.  From 1993 through 1995, total tons sold increased 43 percent while average cost per ton declined 32 percent.  As tons sold declined 19 percent from 1995 to 1996, cost per ton increased 31 percent.  This strongly suggests that a large portion of feed manufacturing costs are relatively fixed.  Under this condition, increased volume reduces cost per ton and increases profits.

Table 2.  Feed Manufacturing Cost for Four Years (cost per ton)

Tons Sold

Manufacturing Costs

Year

1993

40,941

$16.95

1994

43,619

15.70

1995

58,723

11.48

1996

47,447

15.04

Sales costs

As shown in Table 3, sales cost per ton for 1996 also varied inversely with the number of tons sold.  Using the data from Table 3 and the previous three years shows that sales cost per ton declined sharply as tons sold increased above the 3,000-4,000 ton range and decreased at a decreasing rate as sales approached 10,000 tons per year.

Table 3.  1996 Sales Cost for Four Feed Mills (cost per ton) 

Tons sold

Cost per ton

Mill

A

28,393

$1.71

B

3,473

2.22

C

11,194

1.82

D

4,387

5.91

Trucking costs

The four mills own the following sizes of trucks:

The estimated cost for 1996 of operating the four sizes of feed trucks is shown in Table 4.  The total cost per mile is lowest for the 6-ton truck and highest for the semi.  However, based on a cost per ton per mile the reverse is true.  The per ton per mile cost of the 6-ton truck is over three times larger than the semi.

Table 4.  Estimated Feed Trucking Cost by Truck Size

Cost per mile

6-ton

12 ton

18 ton

24 ton

Variable

$.59

$.69

$.83

$.91

Fixed

.48

.45

.35

.38

Total cost

1.07

$1.14

$1.18

$1.29

Cost per ton per mile

.18

.10

.7

.05

The larger mills tend to use larger trucks.  So Mill A has a delivery cost advantage over the other three mills.

Cost reducing strategies

Given that feed manufacturing, sales, and delivery costs decline with increased tons sold, one strategy is to increase sales at all four locations.  However, large gains from this strategy are difficult unless the mill has a competitive advantage such as new or improved services or lower prices. 

Another strategy is to concentrate selling more tons in fewer mills.  This can be accomplished by closing low-volume, high cost mills and serving those customers out of larger, more efficient mills.

The cost of serving Mill D’s customers out of Mill A, compared with the cost of serving these customers out of Mill D, is shown in Table 4.  The manufacturing and sales cost savings resulting from serving Mill D’s customers from Mill A is due to spreading Mill A’s fixed costs over more tons. 

The estimated direct total cost saving from serving Mill D customers out of Mill A is $2.46 ($24.61 - $22.16).  Thus, the total direct saving would have been $10,792 in 1996 ($2.46 x 4,387 tons).

Table 5.  Estimated cost saving from serving Mill D customers from  Mill D or Mill A.                                                      

Cost per ton mile

Mill D

Mill A

Manufacturing cost

$15.94

$16.97

Cost saving  1/

-2.19

Net Cost

$14.78

Sales cost

$5.91

$1.71

Cost savings  1/

   -.18

Net Cost

$1.53

Delivery cost   2/

2.76

5.85

Total cost

$24.61

$22.16

1/  Cost reduction per ton resulting from additional feed (for Mill D customers) manufactured and sold by Mill A.
2/  Mill D = 12 miles round trip at 23 cents.  Mill A = 45 miles round trip at 13 cents.

In addition, the $2.19 manufacturing and $0.18 sales cost savings from the additional volume at Mill A also apply to the feed traditionally sold from Mill A.  Thus, the additional saving from the higher utilization of Mill A would have been $67,291 in 1996 ($2.37 x 28,393 tons). 

The total annual efficiency gain from closing Mill D would have been $78,083 in 1996 ($10,792 + $67,291).  In addition, closing Mill D will save approximately $150,000 to replace a wooden leg, a distributor, and loadout system. 

Other issues

Historically, many farmers, local community development organizations, and the local media have opposed the closing of most businesses in rural communities.  Part of this opposition is based on the perceived loss of employment in rural communities.  Also, in areas with declining livestock numbers, the feed mill is a symbol of the prosperity of a past era; closing a feed mill is a stark reminder that the area is losing one of its principal sources of income.  Finally, some local feed mills are social centers for local livestock feeders and the mill has a large sentimental value.  Even a hint that the local feed mill may close will likely lead some livestock feeders to threaten to not only take their feed business elsewhere, but also their grain, fertilizer, and chemical business.  Therefore, a decision to close a feed mill involves more than just analyzing the potential cost savings from the closing.

Conclusions

Based on the information presented above for the four feed mills, the following conclusions can be made.

Implication

If these cost relationships hold in other feed mills, we can expect to see a major restructuring of the local feed mill industry by closing low-volume, high-cost feed mills and serving their current customers out of larger more efficient feed mills.

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