What a Margin Management Plan Makes Possible

In previous articles, we discussed the topic of having a Margin Management Plan and how it can provide a roadmap or give direction to achieving profitability within an organization. We also discussed basic components of a plan and how one might be constructed and implemented. One of the items that perhaps didn’t get as much attention in those two articles though is what a margin management plan makes possible.

We recently reviewed some margin management plans our clients had written that included very specific longer-term goals to help them gain greater control over their operations. By developing a consistent approach to managing forward margins, these producers were rewarded by viewing annual profitability targets as stepping stones to accomplishing future goals. In this article, we will share with you some success stories of producers who have employed a Margin Management Policy over the years and what their plan has allowed them to accomplish today.

By developing a consistent approach to managing forward margins, these producers were rewarded by viewing annual profitability targets as stepping stones to accomplishing future goals.

A pork producer in the Upper Midwest committed to a longer term goal of expanding their production through additional sow ownership. They developed a margin management plan to achieve set profitability targets in order to start building equity for their expansion plans. As equity built in the operation following a few good years of profitability, the company began talks of expanding and doubling their production. The plan had been approved by ownership and required additional capital from the company’s lender to get the project underway. Discussions with the lender began in late 2011 when the company disclosed their forward hedge positions that represented future profits for the organization at historically strong levels for all of 2012 production. As the year progressed and discussions continued with the lender, the profitability of hog producers on the open market changed dramatically, going from a historically strong level to an extremely poor situation that represented large losses. Still hedged, the operation showed its lender how their 2012 year would pan out. In addition, they also had the ability to show what the profitability on the proposed expansion production would look like for the initial farrowings, as well as their plan on managing that forward risk. The consistency of positive margins in previous years coupled with a well-defined plan gave the lender confidence to outlay capital for expansion during one of the worst times of profitability for a hog producer in the last 20 years, and as a result, they are now reaping large returns on that additional production today.

Another pork producer in the Western Corn Belt had been working through a margin management plan determining how profitability would be protected over the years. This producer was at a competitive disadvantage relative to his peers given that the operation had to purchase weaned pigs on the open market as they did not own sows. This added to the operation’s costs and resulted in tighter margins. The producer modified his margin management plan to achieve multiple goals, but principally wanted to gain greater control of the bottom line by owning their pig supply. Over three years of wild profitability swings on the open market, the operation achieved steady returns following their margin management plan and eventually was able to purchase enough sows to reach the same output that they had been producing the previous three years. With the main goal accomplished, the producer modified his margin management plan to focus on growing the sow herd and expanding production. Over the past five years, this operation has taken control of their pig supply and has also doubled their previous production, achieving two separate long-term goals the company had defined as strategically important.

As a third example, a dairy producer had been new to using futures and options as contracting tools, but understood the importance of having a plan and setting targets to protect profitability. This was particularly evident to the producer following the devastating negative margins suffered in the open market during 2009 into early 2010. This operation had issues in the past sourcing feed for the dairy herd and wanted to alleviate that burden. After some time educating himself on futures and options through his consultant, the dairy producer incorporated strategies in the company’s margin management plan that allowed for flexibility to participate in better margins over time. Posting performance bonds and meeting margin calls were things this operation could not support, so using a combination of cash contracts along with options that complimented those positions allowed the producer to retain flexibility in their pricing. Challenging as it was to spend money on option premium, the dairy executed this new plan while continuing the operation’s typical cash transactions. The flexibility proved useful as margins began a period of volatility, and having the ability to manage the option positions over time resulted in better margins than initial expectations. Today, the dairy now owns enough crop ground to feed the operation’s herd and also has excess to sell on the open market.

Well-defined, long-term goals and consistency in managing forward margins are the common threads among all three of these success stories. Regardless of the operation’s goal or industry, a structured, disciplined approach to managing profitability can be the most powerful tool a producer has to attain the goals it sets out to achieve. Building a margin management plan that visualizes each year as a building block to achieving these goals has contributed to the success and growth in these operations over time. What are your goals and how will you set out to achieve them? What is your plan?