Ways to Create Advantages – Increase Production, Maximize Revenue, and Diversify Revenue Streams – in Times of Tight Ethanol Margins
The one constant in the ethanol industry is that there will be fluctuations in the price of ethanol and grains and this will cause tight margins from time to time. What doesn’t have to be constant is your response in the times of tight margins.
By being proactive, you can:
utilize your greatest assets: your people,
understand and control your cost structure, and
consider your diversification.
Taking these steps will not only increase your profitability or decrease losses, they will also allow you to take advantage of tight margins and differentiate your plant – all crucial factors for survival.
Pay Attention to the Three P’s: People. Production. Plans.
Being proactive with your business during times of tight margins includes more than just assessing and tweaking the financials. It’s equally important to give attention to those factors which are often assumed to be taken care of…
ASSESS YOUR PEOPLE FACTOR – Communication aligns plans, production, and financials.
The best laid plans are completely worthless without your people to carry the plan out. Quite simply, it can be the difference between success and failure.
Communicate on the front and back end. The more employees know about plant goals and the steps being taken to reach those goals, the more they can willingly contribute to the process. Being told to do something without understanding why is demotivating and can negatively impact employee engagement and production. We need to create a sense of ownership in the work they do to unleash their fullest potential. To achieve this, they need information on the front and back end.
Step 1: Strategic plans for plant production and the intended results need to be communicated to the employees, both in terms of the production information and financial information.
Result: If done correctly, there will be full alignment throughout the company – for you to be able to relay the intended information and plans, and for employees to offer input to enhance the plans and possible outcomes.
Step 2: To enable full alignment, the results of the plans must also be communicated. Employees should know how well the plans were executed and what the results were. This closes the loop and allows them to see how their piece of the production process made a difference to the company as a whole. Employees will gain a sense of ownership in the company and its results.
Result: When ownership in your job is accomplished, you are able to maximize the productivity of your most valuable asset—your people, and add cost reductions that would not have been attainable otherwise.
PRODUCTION (COST) FACTOR – Understanding and controlling cost structure to maximize revenue.
To determine which costs can be better controlled, ethanol plants need to first discern the differences between which of their costs are static or fixed, and which costs are variable. The hardest part for ethanol plants is that fixed costs can appear to be variable, and vice versa, and some are even a hybrid.
- Static costs. Fixed costs are those which (whether the plant is running or not) will remain the same.
- Example: plants typically have set pricing through stated contracts of minimum usages for electricity or natural gas. Whether the plant is producing 5,000,000 gallons of ethanol or five gallons of ethanol, we know that those costs will be incurred. These are easy to assess and generally straight-forward.
- Variable costs. Variable costs fluctuate due to the environment around them.Example: chemicals and denaturant in the plant. The cost of chemicals varies greatly if a plant is operating at 110% of nameplate versus running at 75%. With this, you have much greater control on the expenses when the costs are variable as opposed to fixed, but it does take more work to be able to model these expenses out.
- Hybrid costs. Where the true artistry of running a plant comes into play is in the identification of when costs are hybrids, meaning that they take on the nature of both fixed and variable costs.
- Example: grain costs. Grain usage fluctuates based on how fast and efficient the plant is running, thus a variable cost. However, many plants will hedge the grain to lock in the cost, acting like a fixed cost. If a plant implements a strategic plan, this hybrid cost can be turned into a full fixed cost, or a full variable cost, to capture the most benefit.
Mastering the art of managing production costs. To be able to maximize profits and reduce losses in times of tight margins, it’s important to identify what structure our costs are taking on, as well as know how to influence them to perform as we’d like. If hybrid costs are assumed to be fixed costs, our answer will always be to run the plant at maximum capacity. For any given period, we would be maximizing revenues. The problem is, revenue is not the most important part of the business financially – it is the income.
The only way to truly model and have better control on the income of the company is to understand the hybrid costs and treat them like variable costs. Many times, when this is accomplished, there will be a sweet spot where the plant will run at less than maximum capacity and thus, less than maximum revenues, and increase overall profitability.
PLANNING FACTOR – Reevaluate your diversification strategy to help mitigate tight margins.
One of the best ways to mitigate tight margins in the ethanol industry is to have diversified revenue streams outside of the ethanol market. Hence, the need for strategic planning. But diversification is often a term that many look at too narrowly.
- For example, we worked with a plant that believed they were well diversified because they had a number of revenue streams. Unfortunately, when we really broke those revenue streams down, all of the streams were either in the ethanol or feed market. All too many times, businesses think that as long as it’s a product they do not currently offer, then they are diversifying. Unfortunately, this is not diversification that will mitigate tight margins.
Take time to consider the true diversification of any investment. There are a lot of great investments in which you do not diversify the company, but attain synergies within your core business to allow for greater success. With that said, the importance of diversification cannot be overshadowed. The officers and board members of your companies have a fiduciary responsibility to the owners to ensure the longevity and success of an investment.
- A great example of this can be witnessed through the pelletization of distiller grains. While this is still in the core business of producing ethanol, it has also opened markets as a feed product to animals other than cattle, as well as started to open additional international markets.
Taking these three steps will help to stabilize the people, production, and plans of your plant so that it can endure the times of tight margins.
K·Coe Isom’s team of ethanol advisors can help to assess and secure advantages for your business. Contact our advisors to evaluate your plant’s cost structure and financial strategy.