It’s decision time. This fall, cow-calf producers are deciding whether to keep or cull a cow from the herd. With weigh-up cow prices at historical highs, is it better to sell that older bred cow now and immediately replace her, or try to hold her for another year and get one more calf? What about replacements? How much can be spent to develop or purchase a bred replacement? If the operation has extra pasture and feed on hand and could run more cows, should heifers be retained? Should bred cows be purchased? How much can be spent on these replacements?

A contribution margin analysis can help producers evaluate and make decisions to keep or cull a cow, along with the potential financial impact of building or reducing cow numbers.

What is the contribution margin?

To understand contribution margin, we must first understand fixed costs and variable costs as they relate to a cowherd. Variable costs, or direct costs as they are sometimes referred to, are costs that increase incrementally for every cow added to the herd. Things such as cow depreciation, hay, protein supplement, salt and mineral, vaccine, ear tags, etc., are direct costs for which the total amount increases with each additional cow.

Fixed costs, or overhead costs, generally don’t change very much based on the number of cows in production. The cost of owned land, labor and equipment are all examples of fixed costs. If an operation has owned land or land rented by the acre, as well as labor and equipment that is used to care for 100 cows, adding one more cow will not change these overhead costs.

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Contribution margin represents the revenue remaining from an additional cow in the herd less the variable costs associated with her annual carrying costs.

Dr. Clay Mathis, department head of animal science at Texas A&M University, wrote an article when he was director of the King Ranch Institute for Ranch Management titled “Contribution Margin, A Valuable Decision-Making Tool.” The article can be found in the Winter 2018 Volume 13, Issue 3 edition at krirm.tamuk.edu.

In the article, Mathis highlights the importance of understanding the contribution margin of adding one more cow to a herd as an instructive tool for decision-making. The following example comes from the content in that article.

As an example

Contemplate a cow herd of 100 head that is producing $1,500 of revenue per cow per year with $1,300 of costs. The net income for the operation is as follows:

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Now, let’s break down the cow-calf enterprise into overhead costs and direct costs. Let’s assume that it costs $85,000 per year for overhead costs and $45,000 per year in direct costs to run the 100 cows.

How much additional income would be made by adding one cow and increasing the herd to 101 cows? The initial thought would be $200, right? If the operation is making $200 of net income per cow and one additional cow is added, then it would make $200 more in profit, or $20,200 for 101 cows. But the actual answer is $21,050.

How can that be?

In this example, when the cowherd owner adds one more cow, the total overhead costs from land, labor and equipment don’t change. Overhead costs related to these expenses are still $85,000. Costs that will increase are direct costs of $450 per cow that come with adding one more cow to the herd.

The revenue that comes from adding one more cow to the herd is the “contribution margin.” Knowing overhead costs and direct costs for a cowherd and the contribution margin of adding another cow is extremely helpful when making management decisions related to the impact on profitability of keeping or culling a cow and replacing her. This analysis also can be helpful when making decisions on how much a producer can afford to spend to buy or to develop a bred replacement. When land, labor and equipment are already in place and those resources are not being fully used by the cowherd, the addition of another cow will not significantly increase overhead costs.

Understanding herd reduction

Analysis related to contribution margin also provides a framework for understanding the impact of reducing cow numbers when overhead costs stay the same. If bred replacements are thought to be too expensive to develop or purchase and the decision is made to reduce the cow herd from 100 to 90 cows, overhead costs per cow will increase, significantly affecting profitability.

Now, 90 cows are only generating a profit of $9,540, where 100 cows were generating a profit of $20,000. A 10% reduction in cow numbers reduced profit by 52%. This example demonstrates the importance of knowing cowherd overhead costs, direct costs and the contribution margin that results from adding or subtracting a cow from the herd. The use of a contribution margin analysis can be eye-opening, showing the effects of changes in inventory and cost structure on cowherd enterprise profit.

Berger is a Nebraska Extension beef educator.