Study: Step-by-step dairy expansion pays off

For more than a decade now, Wisconsin’s dairy farmers have seen and heard a great deal about the trend toward larger operations. Some farmers want no part of a major expansion. Others look at their old barns and wonder if there’s a reasonable way to move to a larger operation without spinning out of control financially.

“We’re at a crossroads in dairying,” says Bruce Jones, a College of Agricultural and Life Sciences economist who directs the UW-Extension’s Center for Dairy Profitability. “Today, Wisconsin dairy producers are asking: ‘Should I build a larger operation, and how can I do it with a minimal investment?’ There are thousands of Wisconsin farms with 50-cow to 80-cow herds. Many are trying to work through that decision right now.”

According to Jones, these farmers have increased their herds to the capacity of their old stanchion barns. Now they are considering a transition to a larger herd, one or more freestall barns and a milking parlor.

The parlor is crucial in modernizing a dairy farm, Jones says. Compared with milking cows in a stanchion barn, a parlor saves wear and tear on milkers’ bodies and increases productivity by allowing farmers to milk cows two to three times faster. However, a conventional double-10 parlor can cost $300,000. Therefore it’s a drag on a dairy’s profitability unless the operator increases herd size to ensure that the parlor runs at or near its peak capacity. But the cost of buying 400 cows and building housing would add more than $900,000 to the plan.

At this point, red lights start flashing for Jones, most dairy farmers and all farm lenders.

“Ambitious growth plans aren’t always feasible because lenders won’t finance them,” says Jones, who analyzed the financial implications of six theoretical expansion plans. “Borrowing money to add a state-of the-art milking parlor, hundreds of cows and the barns to house them increases farm debt too much for lenders. Even if you could borrow that money, you would soon be facing bankruptcy and loss of your farm if you had an emergency and needed to borrow more money.”

The expansion plans that made financial sense to Jones all began with farmers remodeling their existing barn by installing a double-six parlor the first year at a cost of $30,000.

“It’s an approach farmers might consider,” Jones says. “It doesn’t require the huge investment in a conventional parlor initially. Yet it gives farmers many of the advantages of a parlor and the profits from milking more cows.”

Many dairy producers think it makes no sense to pay to retrofit their old stall barns with a parlor when they are going to move into a new parlor in five or ten years, Jones says. But he has calculated that it costs $1.65 a hundredweight to milk 100 cows in a stall barn and $1.34 in a double-six parlor.

“This 30-cent savings is evidence that it pays to invest in a modest parlor system. The savings per hundredweight jumps to 50 cents when you are milking 200 cows,” Jones notes. “Retrofitting a parlor for use over ten years is like investing in repairs on an old car for a year rather than buying a new one. Since you can milk two to three times as many cows an hour, investing in a low-cost parlor should be weighed against the expenses of hiring help,” he says.

Jones analyzed six options that farmers might take in expanding from 50 cows to either 400 or 800 over 20 years. The options differed in the types of parlors used and the timing of their installation. Jones also looked at adding cows and housing every five years in increments of 100 or 200 cows. The extreme cases included adding 750 cows and a conventional parlor all in the first year, versus making no changes and continuing to milk 50 cows during the 20 years.

Jones calculated how the six options would affect farm income, cash flow, working capital, debt-to-asset ratio and change in the net worth over 20 years.

Two options that made financial sense to Jones begin with farmers remodeling their existing barn by installing a double-six parlor the first year and simultaneously adding either 50 or 150 cows and a freestall barn or two for the herd. Jones says when dairy operators get those cows paid off, they add in increments of 100 or 200 cows and additional housing. He put the cows into his calculations after five, 10 and 15 years so those two hypothetical farms ended with either 400 or 800 cows at 20 years. Jones assumed that farmers would milk in the retrofitted parlor for 10 years before tearing down the old barn and building a conventional double-10 parlor.

In the first of these options – expanding to 400 cows – farm income ranged from $1,366 to $102,862, cash flow ranged from minus $27,416 to $75,896, and working capital ranged from minus $114,080 to $283,117 during the 20 years. In the second option – increasing to 800 cows – farm income ranged from $20,650 to $347,900, cash flow ranged from minus $25,152 to $291,920, and working capital ranged from minus $97,942 to $1,872,952 during the 20 years. In these options the debt-to asset ratios were similar and remained less than 0.60. The net worth of the first farm increase by $697,712 while the second farm increase by $1,367,952.

“The debt-to-asset ratios of these two hypothetical expansion options were not significantly different,” Jones says. “But the second of these two options shows how expanding in larger increments can yield greater financial returns.”

In his calculations, Jones had to make many assumptions, including the following: a milk price of $13 per hundredweight, milk production that averaged 21,000 pounds per cow per year, 25 hours of labor per cow per year at $10 per hour, total variable costs per cow per year of $1,599 and total breeding stock cost per cow per year of $304. Jones also assumed that expanding farmers would purchase new cows at $1,250 per head and house them in freestall barns at a cost of $1,200 per stall. Finally, loans used in predicting these outcomes were set at 9 percent interest rate over a five-year repayment period for cows, and 9 percent over a 20-year repayment period for parlors and freestall housing. Those interested in reading the paper, “Growth in dairy farms: The consequences of taking big steps or small ones when expanding,” can find a PDF version of it on the Center for Dairy Profitability web page, http://www.wisc.edu/dairy-profit/expallv12.pdf The research was supported by state funding to the College of Agricultural and Life Sciences and the UW-Extension Cooperative Extension Service.