## Cost of Production

### Maximize profits and manage risk - understand your cost of production

Curtis Talley and James DeDecker, MSU Extension

Imagine that you are a wholesale Christmas tree grower and in July you are offered a contract to sell your trees for \$20.00 each. Perhaps you have a retail lot or a choose-and-cut farm and you plan to charge \$50.00 per tree this coming season. Are these strategies profitable for you? If so, by how much? How can you know?

Growing Christmas trees is economically important to many of the Great Lakes states, but it may not continue to be if producers unwittingly sell their trees at a loss. As the costs of fuel, fertilizer, labor, etc. have increased there is no doubt that the cost of growing Christmas trees has also increased.  Due to the slim profit margins of Christmas tree production, it is important that growers understand their per tree costs and potential revenue associated with all of their enterprises (trees, wreaths, garland, live trees, etc.) to determine the break-even prices and potential profit for each tree.

The break-even price per tree is determined by calculating total production (variable) and fixed costs and dividing that total by the number of trees sold. For example, if total production and fixed costs per acre are \$18,330 over a nine year production cycle and 900 trees per acre will be sold, the breakeven price per tree = \$18,330/900 trees, or about \$20/tree.  Armed with this break-even price information, one can determine that a wholesale price of \$20 per tree, as is the example above, would allow the grower to just break even. On the other hand, the suggested retail plan, selling trees for \$50.00 would net \$30.00 profit per tree.

To determine your actual costs, utilize a bookkeeping system that is designed for agricultural operations and allocate those costs associated with Christmas tree production to that profit center. You can then compare your costs for each expenditure category to an industry benchmark, such as a university cost of production report. For example, if your repair costs are much higher than the benchmark, this should be a red flag to you and encourage investigation of why this is occurring. If your costs are in line with the benchmark, it is an indication that you are at least on par with the industry standard.

For a Christmas tree farm, common variable expenses include transplants, shearing, fertilizer, pesticides, fuel, repairs and hourly or seasonal labor expenses. Costs that do not vary with output are known as fixed costs. These include expenses such as depreciation, real estate taxes, land charges, salaried labor and liability or fire insurance. These costs are incurred whether or not production occurs. One fixed cost that producers sometimes neglect to address is the owner’s unpaid labor. As an example, a tart cherry cost of production study in Michigan valued owner’s labor at \$25/hr.[1] plus self-employment tax of 15.3%, for a total of \$28.83/hour.

There are resources available to help you determine your cost of production and break-even price for Christmas trees. The MSU Department of Forestry has been conducting periodic studies of cost and return for Christmas tree production in Michigan for a number of years. The most current study (2006) can be found at the link below. These studies are intended to help growers understand their cost of production and selling price in order to make appropriate management decisions that are critical to remaining competitive. Other MSU Extension budgeting resources can be accessed online on the Budgets, Cost of Production and Decision-Making Tools page. There you can also find custom machine and work rate estimates, current land values, rental rates and more. These tools are an excellent resource for producers interested in developing a deeper understanding of their production costs, a fundamental step toward managing risk and maximizing profit.

[1] Roy Black, James Nugent, Nikki Rothwell, Suzanne Thornsbury and Nicole Olynk, “Michigan Production Costs for Tart Cherries by Production Region,” Extension Bulletin E-1108 (January 2009):7