June 1, 2011

Growing for profit

Nursery growers need good costing information to quantify the impact of decisions


Photo: Jeff Moss
The reality is that the business climate today is much more complex for nursery growers than it has ever been. Savvy homeowners, big box stores and cut-price plants from south of the border have put downward pressure on pricing, while rising labour costs and inflation require growers to sharpen their pencils and be more competitive.

Growers face many other challenges, not the least of which is the fact they must plan production and inventory on a lengthy time line. This is a critical success/failure factor for growers — they must chose wisely.

But, what if despite extensive research and planning, you find that lots of other nurserymen chose to grow the same variety as you, and the market is flooded? Or, the species you chose has been labeled invasive and is now persona non grata in the plant world? Or, despite all your expertise, weather conditions have resulted in an undersized plant that needs one more year in production?

John Chisholm, CEO of SB Partners in Burlington, Ont., explains that in order to make tough decisions, growers need to have an accurate financial picture of their operations, and understand the exact costs of doing business. Last winter, Landscape Ontario hosted a think tank for its nursery growers, and one thing that became obvious was growers are looking for help understanding their costs.
Chisholm, who was a presenter at the think tank, explains that the cost of producing a plant includes direct costs, variable costs and production overheads.

Direct costs, which are everything needed to produce the plant, include seeds, liners, pots, equipment, fertilizer, etc., and variable costs include labour and production overheads. These make up the important figure known as the cost of goods sold (COGS).

Another vital number to know is gross margin — typically measured as a percentage of sales. For example if sales are $100, cost of goods sold is $50, then gross margin is $50 or 50 per cent.
Gross margin (%) = Sales - COGS  

Once gross margin has been determined, the rest of the expenses can be applied to the calculations, including figures for general and administration expenses and selling expenses (what did it cost me to sell this plant?).

Chisholm admits that a critical success factor for growers is having the know-how to produce an excellent product, but if they can't generate a sufficient gross margin, growers are not going to be able to create net profit within their company. "At the end of the day, this is a business. Nursery growers have a huge amount of capital, and need to obtain a good rate of return on their investment, or they can get into trouble. Pricing by rule of thumb will catch up with them," says Chisholm, "usually in regard to cash flow."

Management tool
By understanding the costs of doing business, growers can then learn to manage inputs to get the rate of return they are looking for. By taking the time to set up a method to understand what drives fixed and variable costs, inputs can be managed to produce the product most efficiently, with the goal of maximizing the selling price — and gross margin.

This means drilling down into every aspect of each plant's production to show all the costs and inputs needed to grow it to a saleable size. Chisholm notes the importance of this process, as producers need a handle on all their costs in order to make decisions on putting prices up, or discounting them.

"Fundamentally, growers need to have a breakeven analysis — they need to know what they need to sell in order to break even. Growers can't sell plants at their breakeven point, as they will lose money after applying the general administrative and selling expenses."

Price-point variables
An age-old issue is, how is price determined? Does the pricing pressure come from the consumer or the producer? Typically, it is the consumer, with the end result that growers are getting much the same price for their plants as they did five years ago.

Chisholm explains, "If the plant's price is inelastic, growers need to drive down direct and indirect costs in order to improve gross margins and their returns." Once growers have a model in place that helps them understand and track costs, they can start looking at what he refers to as Profit Improvement Potential, and see the effect small savings will have on net profits. In order to save on inputs, growers might look at automation to reduce the number of times a plant is handled, or conduct an efficiency study to speed up processes within the production cycle. 

Gaining an understanding of costs will help growers be more proactive in decision-making and improve return on investment.