Product Mix: Determining My Winners and Losers

Dr. Charles R. Hall
Associate Professor of Agricultrual Economics & Extension Specialist
Texas A&M University
College Station, Texas

 

Every single day in the life of the nursery manager is filled with the monumental task of making decisions. Some of these decisions are general in nature. Is the operation profitable enough to ensure survivability for the next five or ten years or longer? Am I marketing a quality product at a price that is competitive with industry prices? Does my business have a reputation of being honest, fair, and considerate of the customer?

Other decisions tend to be more detailed in nature. What size plants should I grow? Should I invest in new machinery or technology? What price should I try to negotiate for this item? What product mix will yield the highest profit? Should I produce my own cuttings or buy them from someone else? How many cuttings should I put in each pot?

The primary responsibility of any greenhouse manager is to make decisions that will answer these types of questions and achieve the objectives of the firm. And, of course, maximizing profits is generally one of the most important objectives of any operation. But not only are managers faced with making decisions that potentially impact revenues and costs of the firm, they must implement solutions in a manner that is both efficient and effective.

One of the most important decisions facing the nursery manager is determining the optimal product mix — which plants will be grown and how many of them? But what determines whether or not a product mix in optimal or not? This question is complicated by the fact that an optimal product mix for one

grower may not be the optimal product mix for another grower. In reality, optimal;may encompass many things including:

  • utilizing resources in their most efficient and productive manner
  • providing favorable cash flows
  • satisfying “attractiveness” constraints of buyers
  • maximizing profits in the short and long run
  • satisfying current demand trends and preventing oversupply situation

The real challenge is to find a product mix that accomplishes all or most of these things. It is certainly not easy. But there are procedural steps that nursery managers can follow to determine an optimal product mix for their particular operations. These steps include: (1) analyzing current demand trends, (2) performing a cost of production analysis, and, if possible and if the appropriate records and expertise are available, (3) developing a linear programming analysis to aid in product mix decision making. Each of these steps are discussed below.

Analyzing Demand Trends

Many sources of information may be used to access the current demand situation. Industry-related trade journals (i.e. American Nurserymen, Nursery Business, Nursery Retailer, Greenhouse Manager, Nursery Manager, GrowerTalks, etc.) do an excellent job in providing nursery managers with an overview of general production and marketing trends. Participation in local and regional trade shows, seminars, and conferences is also an excellent way of soliciting information. The interaction with buyers and other nurserymen alone is advantageous.

All of the above sources of industry trends and demand information are external to your business. But one of the best sources of information that indicates various demand trends affecting your own particular nursery can be found in your own sales records. A complete customer and sales analysis should be performed routinely to determine your who your top 10-20 customers are, what plant materials are they buying, what products are slow to turn over, etc.

Cost of Production Analysis

Cost of production analysis or budgeting is the next tool that may be used to help make product mix decisions. In general terms, cost analysis or budgeting can be defined as a plan to allocate resources among alternative uses. That includes labor, water, capital, and any other resources that may be scarce or limited. Budgets can also be used to provide a basis for planning labor needs and for financing -deciding when to borrow and how much. They also provide a plan for when to buy supplies and when to sell your products.

Cost analysis budgets are especially effective when a record system designed for managing is already in place. Records are especially important in that they provide feedback for evaluating performance and provide information for developing and refining budgets. Thus, the effectiveness of budgeting is a function of how good your record keeping system is. Tax records are the most common type of records kept by nursery managers. They provide a good picture of the costs and returns of your entire business from a tax accounting standpoint. However, since most producers grow numerous crops, tax records will not provide information on the costs and returns from any individual crop that you produce. Only through cost accounting procedures can you allocate cost involved in operating your business to specific crops.

Though cost accounting and record-keeping are valuable managerial tools, they require time to maintain and therefore represent a cost themselves. These costs of preparing and maintaining budgets and records must be included in the total cost of the business. But if they aid the manager in making sound management decisions, then the benefits certainly outweigh any costs involved.

As an example of cost accounting, information regarding the production of geraniums from unrooted cuttings is included. These figures represent updated information originally reported by Brumfield in; Tips in Growing Zonal Geraniums. It was assumed in this analysis that 1 cutting per 4″ pot was used at a cost of $0.14 per cutting and the geraniums took 13 weeks to finish.

Costs are generally categorized into fixed (overhead) and variable costs because they are treated differently. Variable costs increase as the number of plants produced increases and vice versa. Fixed or overhead costs do not vary directly with production. They remain constant regardless of level of output, and are incurred even if production does not take place.

Variable Costs

Variable costs are estimated by multiplying the quantities of each input used by their input prices. Their costs can be determined easily from invoices, but may have to be allocated to the appropriate enterprise. Materials should be charged directly to each enterprise according to the amount used. It is a little more difficult to allocate the costs of labor, machinery, and equipment to any one enterprise. That is where detailed records really pay off. They greatly simplify this allocation process.

Material costs are the easiest variable costs to allocate, and include the costs of cuttings, pots, growing medium, fertilizer, and other chemicals. Costs of individual inputs will vary from producer to producer, depending on quantity discounts, method of payment, rate of fertilization, pesticide practices, and other managerial decisions. Materials costs per 4″; geranium totaled $0.26 and are summarized below.

Production labor is slightly more difficult to allocate to each unit, but with some simple record keeping, it can be accomplished. Many of these tasks are done for one size container over a period of several hours. Simply note the number of people performing the operation and when they start and finish. Then count the number of units they finish in that time period. From this you can calculate the time per unit and multiply it by the wage rate, including benefits. This will give you the cost of that specific labor task per unit. Even though this method is not exactly precise, you will be amazed at how consistent the time per flat will be if you time the operation on several different days. So once you time an operation, you can use that time frame in your cost accounting with a good deal of confidence. Of course, you will always have some unallocated labor (trips to and from the greenhouse, breaks, etc.), which can be included in overhead costs and allocated on a per square-foot-week basis.

Production labor costs for this example were estimated using a wage rate of $6.45 per hour. This includes a base wage of $5.00 and $1.45 per hour for benefits including social security, workman’s compensation, unemployment insurance, and vacation and sick days. The total amount of labor needed to produce one 4″; geranium was 73.60 seconds (15 seconds to stick the cutting, 15,50 seconds to pot the cutting, 4.80 seconds to apply pesticides, 14.60 seconds to water and fertilize, and 23.70 seconds to harvest). Thus, the production labor charge totaled $0.13 per 4″; geranium.

Interest on the amount of money it takes to cover materials and production labor costs must also be accounted for. First, determine the annual interest rate and divide by 52 to obtain the weekly interest rate. Next, multiply that figure by the number of weeks your money has been used from the time production costs are first incurred until the 4″; geraniums are sold. The interest rate is assumed to be 12% for this example.

Overhead Costs

Overhead costs include depreciation, interest on fixed assets, repairs, taxes, insurance, and general categories such as managerial salaries, utilities, office expenses, professional fees, advertising and promotional expenses, and bad debts. These costs cannot be allocated to specific crops, but can be allocated on some other basis such as cost per square-foot-week. To do this, take all overhead costs and divide by the number of weeks in production to obtain an annual overhead cost per week. Next divide that number by the actual square footage of greenhouse space. Finally, divide by the percentage of greenhouse space utilized by the 4″; geraniums to determine the bench cost per square foot-week.

Overhead costs for a typical 100,000 sq.ft. Southwestern greenhouse operation are estimated to be about $0.082 per square foot per week ($0.025 for depreciation, $0.005 for insurance, $0.006 for repairs, $0.001 for taxes, $0.024 for interest, and $0.021 for general overhead items). The overhead cost per 4″ geranium may be calculated as follows: 13 weeks in production X $0.082/sq.ft./week X 0.25 sq.ft./plant = $0.27/plant.

Total Costs

As seen in the table below, total costs for producing a 4″; geranium total $0.68 per plant. This is assuming an ideal situation where all the geraniums produced were saleable. Unfortunately, in reality, this is not the case. Some plants are lost to insects, diseases, or cultural problems, while others may be of such poor quality that they just cannot be sold. When losses occur, the empty bed space increases overhead costs per week, in addition to the variable costs which are lost. These types of factors must be considered when determining the true costs of production.

Uses of Cost Accounting Information

Now that we’ve discussed about how cost accounting budgets are developed, let’s talk about how they can be used. First of all, one of the most important uses of cost accounting budgets is that they help establish a minimum selling price based on production costs. There are many different ways of pricing horticultural products — some are good, and some not so good. Probably one of the most frequent pricing methods is to check what your competitors are charging for similar products and ask about the same price for yours. However, if you do this, you are assuming that (1) your competitors know their production costs and are pricing their products to cover these costs and (2) that your production costs are the same or less than your competitors. If either of these assumptions is incorrect, the possibility of losing money exists.

Another popular pricing strategy is to increase prices on all products a given percentage every year or so. This strategy assumes that any changes in costs of production affect all enterprises similarly, which is simply not true.

Probably the best pricing strategy is one based on costs of production that are determined through cost accounting procedures. Once the total costs of an enterprise are determined, then you know the base minimum price that should be charged to that product. The final selling price you charge ultimately depends on what you feel is a fair return on your investment and the risks associated with producing greenhouse crops. Again, by using costs of production as guide to pricing your products, you are at least guaranteeing that all your costs are covered and you are not producing products which are not profitable.

Please keep in mind that every business faces different costs. Do not assume that your costs are the same as this example! Every greenhouse firm faces it own unique set of circumstances and, thus, its own unique set of costs. Cost vary from greenhouse to greenhouse because of differences in climatic location, size, managerial skill and style, market channel, time of year, space utilization, wage rates, age and condition of facilities, and many other factors. Comparing your costs to industry averages will reveal areas where your costs are too high or other areas where your costs are too high or other areas where your costs are low and you have a market advantage. However, looking at industry averages is no substitute for doing your own cost accounting.

 

Costs of producing geraniums grown in 4-inch pots from unrooted cuttings. 

Variable costs $/pot
Materials
Oasis cube $0.020
4″; plastic pot $0.049
Fertilizer $0.032
Root medium $0.012
Chemicals $0.007
Labor $0.410
Interest on operating capital $0.020
Overhead costs
Depreciation $0.025
Insurance $0.005
Repairs $0.006
Taxes $0.001
Interest on fixed assets $0.024
General overhead items $0.024
Total cost per 4″ geranium $0.68

 

Linear programming

Since the early 1950s, linear programming has become one of the important research techniques as an economic engineering procedure in agricultural economics. Linear programming is a computational method to determine the best plan or course of action. When there are many alternatives for the plan, a specific or numerical objective (or solution) exists for the optimal solution, and the means or resources available for attaining the solution to the decision problem are limited. These conditions prevail widely and typically in agriculture, including the nursery business. Since most managerial problems are of the nature just described, linear programming is a useful analytical technique for managerial decision making.

The individual firm always has limited resources or restrictions on production. These are fields with different soil characteristics, family and/or hired labor in different months of the year, funds available for operation, specific buildings useful for different purposes, tractor capacity or machine specificity, and other physical resources. Restrictions can also be subjective, based on the risk involved or the personal likes/preferences or the enjoyment of this type of enterprise. When such constraints exist, managers must exercise careful judgement to ensure that scarce resources are used in the most efficient manner to produce those products that achieve the firm’s objective.

A firm has alternative ways to formulate the plan, which compete for the scarce resources or restrictions and whose proportions will determine the magnitude of profit or other objective. Linear programming may be used by nursery operators to estimate the most profitable combination of enterprises given the resources available to the nursery, the appropriate input-output coefficients, and enterprise budgets. All economic and social entities have the three characteristics of a choice or decision problem: (1) an objective; (2) limited resources; and (3) competing means of using resources in achieving the objective. If these three characteristics can be quantified, then mathematics no more complex than multiplication of constraints can be used in the calculation of an optimal plan by linear programming. It is especially helpful since nursery operators are faced with the problem of growing a variety of plants in order to meet consumer demand in spite of the fact that some plant species may be more profitable than others. An example of the use of linear programming is found in the Southern Cooperative Series Bulletin 365 entitled “Optimal Product Mix and Monthly Cash Flows for Container-Grown Landscape Plants in Climatic Zones 8 and 9″.

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