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0208 PD: Internal asset growth: Generate profits through replacement management

Jason Karszes Published on 14 January 2008

Production agriculture is unique because raising replacement animals is a normal part of day-to-day business operations and is an operating expense. The replacements are an asset on the balance sheet and for most dairies become the primary productive asset of the business.

While there are different ways dairy businesses can grow asset value, the ability to generate more animals than are needed and capturing this value is most significant and is largely under the control of the management of the business.

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Generating more replacements than needed, or generating high internal herd growth, is often recognized as one way more profitable farms separate themselves from other dairies. Businesses that do a better job of building asset value, increasing herd performance or lowering costs of raising replacements have increased ability to generate business profits over time. When looking at herd-driven asset growth, three key management areas emerge:

•How many replacements are needed to maintain herd size?

•How many replacements are being generated?

•How is the value of the excess animals captured?

How many replacementsare needed?
The first area focuses on the management of the dairy herd and the number of animals needed to maintain average herd size. Key management questions associated with this question are:

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•How many animals need to be replaced?

•Why do they need to be replaced?

–Died

–Unprofitable
(mastitis, reproduction, low milk production, etc.)

–Less profitable
The animal available to replace is projected to be more profitable than the current animal

•What can be done to decrease the number that need to be replaced?

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By requiring fewer animals to maintain herd size, the replacement expense associated with maintaining herd size for the year is minimized. Because most dairies [...] don’t itemize the costs associated with raising dairy replacements, it is difficult to use historical data to look at the difference in costs to maintain herds on farms that raise replacements. However, by assuming that a dairy purchases all their replacements, we can look at the differences between different replacement rates.

•If paying $1,500 per replacement with a replacement rate of 50 percent, you will spend $75,000 per year to maintain a 100-cow dairy.

•If you can reduce the replacement rate to 30 percent, you will spend $45,000 to maintain the same 100-cow dairy.

By requiring fewer replacements, the dairy decreased the replacement expense by $30,000. However, one should be careful when examining the replacement cost difference, as reductions in replacement costs don’t always transfer to increased profits. For instance, there may have been increased herd expenses associated with the lower replacement rate or there may be decreased herd performance due to keeping less profitable cows in the herd longer. There is lower or little financial gain, or actually loss of profits, if:
1. The replacement rate is lowered by keeping unprofitable or less profitable cows in the herd.

2. The costs associated with preventing cows in general from leaving the herd are too high.

A key management objective for dairy managers is to understand why cattle are leaving the herd and to minimize the number of animals that are required to be culled and increasing the flexibility of deciding which animals should be replaced.

How many replacements are generated
The second area associated with internal asset growth of the dairy herd is how many replacements are being generated. This is influenced by management activity in both the milking herd and the replacement program.

Key factors influencing the number of replacements being generated are:

•How many calves born per year?

Calving interval

•Ratio of heifer calves to bull calves

•How many heifer calves are born dead?

•How many replacements don’t complete the replacement program?

Non-completion percent or “heifer cull rate”

•For farms with increasing herd size, calving age of replacements

The combination of these five factors, especially the first four, determine the number of replacements available each year. Given average herd turnover rates and a stable herd, if the first four factors are strengths, then there will be a surplus of replacements. If only three of the first four factors are strengths, this farm may still be able to generate more heifers than are needed. For farms that struggle with any two of the first four factors, it may be difficult to generate any excess animals.

If only one factor of the first four is a strength, then it may be difficult to even maintain herd size. For a herd of 100 cows with a dairy herd replacement rate of 45 percent and a non-completion rate of 14 percent for replacements, the farm needs to have over 55 cows calving with a heifer calf to maintain herd size. If the dairy herd replacement rate drops to 33 percent, with the same non-completion rate, then only 41 animals need to be calving during the year with a heifer calf.

By generating more heifers than what is required for replacement needs, the business has the ability to generate additional earnings by having extra animals to do something with.

•If 50 replacements are required to maintain herd size, and only 50 are generated, then there are no excess animals for growth. The expenses associated with raising the replacements are all expenses, and there is no increase of asset value.

•If the dairy generates the same 50 replacements, but only needs 40 to maintain herd size, then they have generated 10 extra animals. These extra animals lead to an increase of inventory on the balance sheet. Now instead of all the costs associated with raising replacements being strictly an expense, some of the costs lead to an increase in assets.

The fifth factor influencing the number of replacements being generated is the calving age of the replacements. This impacts the business in several different ways. With older calving ages, there are increased numbers of heifers being raised, leading to increased inventory costs for the replacement program. The animals are also delayed from entering the herd. For farms that are increasing herd size, this can slow down the rate of internal growth. For example, if 15 heifers calves were started in January of 2004 and the calving age is 28 months, then it will be until May of 2006 before they enter the herd. If the calving age is 22 months, then they will be entering the herd in November of 2005 – six months earlier.

However, even if generating more replacements than what are needed, there is no guarantee that the profitability of the business is enhanced. There is little or no financial gain from the replacements being generated if:

•The cost to raise the replacements is high

–labor

–feed

–inventory – older calving age

•If the quality of the replacement is low

–less profitable animal in the herd

–stunted growth

–too fat

–mastitis

–becomes unprofitable too quickly

How to capture value
The third management area associated with generating asset growth with cattle is how the value of excess animals is captured on the farm. There are many different ways that value can be captured. The mission, vision, values and goals of the family and the business are all important when evaluating and choosing different ways to capture the value. Growing herd size, selling milking cows, selling springing heifers, selling calves and leasing of animals are all ways that can be used to capture the value of generating more replacements than are needed.

Growing herd size

•Extra animals generated enter the dairy herd.

•Grow the herd size from within.

•Key assumption – the farm has the ability to handle increased numbers or can easily add the capacity.

•Increase profits through increased utilization of existing assets, along with increasing inventories of cattle.

There are several advantages to using these animals to grow the business. First, the farm has more control of the genetics and quality of the animals. Second, it can generate slow and steady growth over time, which may be easier to manage than large increases over a short time. Third, the farm can continually utilize operating expenses associated with raising replacements, such as feed, labor, etc., to build balance sheet assets in the total cattle inventory. However, it has to be economical to grow, and if it costs too much to handle the increased cattle numbers, the value gained by keeping the replacements may be offset by the costs to do so.

Selling milking cows

•All replacements enter the dairy herd.

•Sell the least profitable dairy cows in the herd.

•Market them for dairy purposes if possible.

•Milking cows average a higher price than beef value.

If the farm is at a stable herd size with no plans to grow in the near term, then working on improving the milking herd may be a good way to capture the value of the excess replacements. Assuming the dairy has a good genetic selection program, then the replacements will have the highest genetic potential in the herd and the calf they are carrying would be the next genetic step forward. The herd may be improved by replacing cattle with an animal that has higher profit potential. The number of heifers entering the herd is maximized by not selling many pregnant animals. Additional income can also be realized if the additional cows available to the dairy are marketed as dairy cows in lieu of beef.

Selling springing heifers

•Excess replacements are sold as springing heifers and don’t enter the dairy herd.

A second option for farms with stable herd sizes is to sell the replacements as close-up springing heifers. The dairy can choose which animals to sell, and it doesn’t carry any risk associated with the animals calving. However, this option does have the potential to slow down genetic progress and also may slightly decrease the number of calves entering the replacement system as pregnant animals are being sold.

Selling calves

•The farm only raises enough replacements to meet needs to maintain herd size.

•Excess replacements are sold as calves.

This may be a viable alternative for farms that are limited in resources to raise replacements. The dairy can choose which calves to raise, minimize the total replacement expense for the farm and have increased calf sales. However, there is a limited number of replacements, and if there is an unexpected problem in either the dairy herd or the replacement program, there may not be enough replacements to maintain herd size.

Leasing animals

•Keep ownership of all animals.

•Lease out excess milking animals.

For farms that may be thinking about adding herd size in the future, or those that are interested in increasing their cattle inventory beyond their farm capacity, leasing out the excess animals may a good choice. All animals stay in inventory, maximizing the genetic progress and the number of heifer calves entering the system each year. Total cattle inventory should increase, depending on the herd turnover rates of the herds leasing the cattle along with the home herd. The lease program may generate sufficient income to show a return on the investment for the cattle that are leased.

However, there is risk associated with leasing cows, and the return could be negative if the dairy herd turnover rate is too high, reproductive programs are not efficient or if the lease rate isn’t sufficient. Also, if the cattle are brought home, there may be increased exposure to herd health issues that may not have been faced before.

Summary
Generating internal asset growth by producing more replacements than are needed to maintain herd size is one means to generate profit that is under management control. Interaction among many different aspects of the business is critical to successfully generating internal growth in cattle.

By generating more animals than are needed, and capturing the value through different approaches, profits are enhanced by using operating expenses to build balance sheet assets. How a farm chooses to capture value is a management choice. Having the option to decide how to utilize excess animals should be the goal of all dairy managers. PD

References omitted but are available upon request at

—From 2005 Cornell University Fall Dairy Conference Proceedings

Jason Karszes, Farm Management Specialist, Cornell University

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