Ranchers know baling hay is expensive, however some ranchers still sell their hay for remarkably low prices. Throughout this article, I will refer to hay balers/sellers as ranchers. To produce a bale of hay, there are variable cost and fixed cost. Hay that is sold cheap only takes the variable cost in consideration. Let me back up some. Fuel, net, wire, labor, fertilizer, and herbicide are variable costs. As we all know, not all hay is fertilized and sprayed, thus some cheap hay does not have that added variable costs.
Assuming the hay was fertilized and sprayed, did the rancher pay for the fertilizer and herbicide? I know of cases where those costs were not included in the cost of the hay. Some ranchers have no idea what those costs are. Papa charges everything and Mama pays all of the bills. When Papa quotes a price to his neighbor, he has no idea what his variable costs are. Other times, the variable costs are subsidized by oil and gas revenue. The rancher bases his selling price on the current market price. Ranchers that are subsidized by the oil and gas goodness, don’t really care if all of their basis are covered. Some ranchers just rape the land. Typically, in that case, it is not their land. They don’t care if the ground nutrients are being replenished. Some unscrupulous hay sellers don’t even care if the hay is fit for consumption. Note, to be a sustainable business, the expendable resources must be replaced.
Fixed costs in baling hay are the depreciation of the equipment. Land does not depreciate so there is no cost there, but some hay fields are leased, therefore the lease payment would be included in the fixed costs. Many ranchers do not include any fixed cost when determining how much to sell their hay for. Many times the equipment is owned by another person and the hay baler/seller just takes advantage of their generosity. Sometimes the equipment’s owner does not know his equipment is being used for another’s benefit. Also, once again, many times oil and gas goodness pays for the equipment, and thus the rancher does not need to include the equipment fixed costs when determining the price of his hay.
It is hard to talk about the true cost of baling hay without discussing “Economies of Scale”. When calculating the cost per bale, yield is king. All of the variable and fixed cost are totaled and divided by the total number of bales to determine the cost per bale. It would be nice if ranchers could also include some general overhead costs when determining the cost per bale, but that is dreaming. Economies of Scale, is the basis that large producers are more efficient and thus able to supply their product cheaper. That means, increase the yield to lower the cost per bale. There are several way a rancher can increase his hay yield. Increase hay production acreage. Increase fertilizer, herbicide. Speed up the baling process. All of the ways to increase yield also increase costs. The trick is to increase yield more than costs, thus Economies of Scale. Larger tractors, cutters, rakes, balers, accumulators, grapples, trailers, and barns are all fixed costs. As mentioned previously, not all ranchers are on a level playing field. Even though all fixed costs should be included, that is not always the case. A large operator may produce a great yield to offset his variable and fixed costs. Remember, the fixed cost are constant for the year. A rancher with equipment depreciation of $40,000 per year, and charges $10 per bale for depreciation expense, had better produce 4,000 bales per year. A small rancher may have equipment depreciation of $20,000 per year, and charges $20 per bale for depreciation expense, had better produce 1,000 bales per year. Economies of Scale, gives the advantage to the rancher with the lowest, per bale, depreciation expense. Remember, depreciation expense is a fixed cost and not all ranchers include their fixed cost when calculating their price per bale. That is not fair, but life is not fair.
What’s also not fair about the hay business, is when I referred above to, “Had better produce” so many bales per year. Of course a 300 acre field is going to produce more hay than a 30 acre field. Yield is tracked in, “Bales per Acre”. The total acres of production is important and bales per acre is important. Many ranchers believe that fertilizer will pay for itself with the increased yield. Fertilizer is the difference between ½ ton per acre and 1 ton per acre. In round bales that could be 1 bale per acre verses 2 bales per acre. In square bales, that could be 20 bales per acre verses 40 bales per acre. Here is a square bale example. Unfertilized hay selling for $4 a bale ($80 per acre) verses fertilized hay selling for $5 a bale ($200 per acre). If the rancher put out 200 pounds per acre of fertilizer, costing $400 per ton, the fertilizer cost per acre would be $40, and the fertilizer cost per bale would be $1 per bale. The rancher is getting his $1 per bale fertilizer cost back in the price per bale, plus he is able to sell twice as much hay. Twice as much hay yield, lowers the equipment depreciation expense, per bale, by half. The unfair part that I mentioned is the fact that all of the above is assuming Mother Nature cooperates. Rain is a must for hay to grow. More rain increases the yield. Without the rain, fertilizer can cost you money rather than make you money.
Accountants have special terms for costs.
- Cost of Goods Sold (COGS), also called Full Absorption, are the direct material, direct labor, variable overhead, and fixed overhead costs.
- Conversion Cost, are the direct labor and both variable and fixed overhead costs.
- Full Cost, are the direct material, direct labor, variable overhead, fixed overhead, variable marketing and administrative, and fixed marketing and administrative costs.
- Direct Cost, (Prime Cost) are only the direct costs; direct material and direct labor.
- Indirect Cost, are the overhead costs.
- Contribution Margin, is the revenue (price) less the variable costs.
- Variable Cost, are the direct material, direct labor, variable overhead, and variable marketing and administrative costs.
- Total price, are the direct material, direct labor, variable overhead, fixed overhead, variable marketing and administrative, fixed marketing and administrative costs, and profit.
So, in summary, the answer to the question of, the true cost of baling hay, is just like any legal or tax question. The answer is, “It Depends”.
Brett Bickham, 7/11/2020
Owner, Bickham Ranch & Rule Accounting
Clifton, TX