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How to Price a Product (Part 2/2)

The second aspect of pricing a product, then, is “what do you need to make?”  There’s room for some artistic license here, but “two times variable costs” is a good rule of thumb.  To explain, let’s start with two definitions:

Fixed Costs:  The money it takes to run your farm or business, without ever making a product.  This includes property taxes, building maintenance, and most electricity bills.  Conveniently, in a small farm, many of the fixed costs are part of running your household anyway. 

Variable Costs:  These increase when you make a product.  For example, chicken feed for broilers is a variable cost.  It increases only when you’re feeding a chicken for sale.  Packaging for eggs is also a variable cost.  Labor directly related to production is a variable cost, like the hourly rate for feeding the chickens. 

Lets go back to the egg example, a dozen eggs selling for $6.  As mentioned before, the variable cost (also known as cost of goods sold in this case), should be half of the selling price.  Thus, if you can make a dozen eggs with $3 in variable cost, and sell it for $6, you make a $3 gross profit per dozen, and should be decently happy with yourself. 

The gross profit, of course, exists to first absorb your fixed costs (if you sell 1,000 dozen eggs, your gross profit can absorb $3 x 1,000 or $3,000 of fixed costs).  Once your fixed costs are absorbed, the rest is PROFIT!

To summarize, (1) the market determines price in direct competition.  You determine price when you have a unique product that customers want.  (2) You should be happy to sell your product for two times the variable costs you spent to produce it.  And (bonus), once your gross margin (the money left over after variable costs are covered) exceeds your fixed costs, you make a profit!

That’s a mouthful, I know.  Write me a note or a comment with any questions!

Christian

 

 

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How to Price a Product (Part 1/2)

“If I sell eggs and lose $1 per dozen, how many dozen do I have to sell to break even?”  It’s a silly question, of course, but I’ve seen countless well-meaning farmers try to answer it by trial-and-error, on their way to getting a job in town.

I’d rather ask, “if I sell eggs and make $3 per dozen, how many do I have to sell to quit my job in town and make my dream job my real job?”

What’s the difference between the two farmers asking the questions? One of them knows how to price a product for sale. 

There are two aspects to pricing any product:

1.  What will the customer pay?

2.  What do you need to make?

Let’s start with the first one, “what will the customer pay?”  It’s really the most important, because it doesn’t matter what you need to make on a product if no customers will buy it at that price.  To begin, consider existing pricing in the market for products similar to yours.  If three farmers in your town are selling a dozen eggs for $6, that’s probably what people will pay.  Its not likely, if your eggs cost $9, that people will buy them.  That is, UNLESS (and this is a BIG idea when it comes to small business strategy) your product is BETTER.  If all the farmers in your town are selling eggs (pasture raised) for $6, you can charge more money if you offer something better, like pasture raised PLUS organic certification.

A strategic aside:  The best businesses in the world grow not by offering incremental improvements on existing products in the market, but by offering something completely different.  A famous egg farmer in Italy sells his eggs for $18/dozen.  How?  His chickens roost in trees.  He feeds them organic grains raised on the property and soaked in milk from a goat herd that exists only for the chickens.  He spends several hours each day hunting for eggs in trees, on buildings, and in shrubs.  And he’s happy to have help from every journalist and high-end restaurateur who wants to join him.  His product is better.  It’s more fun, and has NO EQUAL.  In that case, he gets to be more creative with the price.  (The opposite, of course, is what economists call “perfect competition.”  The best example is corn sold to the co-op; all suppliers bring an equal product, and the market dictates the price.  This environment is bad news, and best suited for going out of business unless you are the most efficient producer in the market.)

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This Farmer’s Freedom to Fail

I walked in to the world of farming a bit naive.  Okay, fine.  I walked into the world of farming A LOT naive.

When we first jumped into grass-fed beef at Six Sigma Ranch,  beef seemed simple.  We had a lot of grass (4,000 acres worth), surrounding the vineyards for which the property had been purchased.  The plan was as follows:  Buy a handful of cows.  Add a bull.  Get more cows.  Disassemble and deliver to customers.  Repeat.

After a few weeks it became obvious that we needed to move the cows around.  Having never been much of a horse person, I did some homework and found that some cattlemen (the really smart ones, obviously), saved themselves the trouble of boarding a 1000lb+ equine by acquiring instead a trained cattle dog, a particularly charismatic type of border collie with an eye to stare a 2,000lb bull into submission.  A quick Google search revealed a breeder and trainer (who will remain anonymous to protect the nearly innocent), and Isaac the border collie joined the family.

Our new partnership, I envisioned, would leave me waiting at the gate while Isaac silently collected the cattle from acres of hillsides and installed them into the cattle trailer.  I worked with the trainer a few times, paid a surprisingly large sum of money for a 40lb dog, and went on my way to find the herd.

At this point I’ll summarize a lot of details into a few sentences:  It didn’t work.  Those guys that move hundreds of cows with dogs?  They understand both cows and dogs.  And they’ve spent thousands of hours learning to do so.  Me?  I expected the dog (and the cattle for that matter) to work like a remote controlled car.  They didn’t.

Lesson learned?  Make room for some failures.  Design them small, with limited chance of fatalities.  Enjoy, and reflect.  Sir Richard Branson, the epic entrepreneur of hundreds of companies including Virgin Atlantic Airlines, won’t invest  into a company with an owner who hasn’t failed at at least three businesses.  Why?  Because they learned.  They got back on the horse (no pun intended), and they tried again.

Christian

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5 REASONS WHY YOU CAN AND SHOULD START A FARM

I love America.  There’s an entrepreneurial spirit here, a can-do attitude that has impressed me since I moved here as a kid from Denmark.  In many countries, exposing a business idea in public results in a list of reasons why it can’t or shouldn’t be done.  In America, sharing a business idea often results in encouragement and an offer by a stranger to provide capital.

And within this environment of entrepreneurship, there is no better business to start than a farm.  Here are 5 reasons why:

1.  You can start a farm for the price of your daily Starbucks habit.  If you own a yard, you can grow something.  If you don’t own a yard, you can likely talk a landowner into lending you a corner in exchange for produce.  Seeds are cheap.  And, very likely, you’re already buying water and fertilizer for your lawn.   Sell your first tomato crop to buy a beehive.  Sell the honey and buy a chicken coop.  You get the idea.

2.  You can eat the inventory.  This one is important.  If you start a keychain factory in your garage, there’s a limit to how many keychains your friends and family can utilize in the event that it goes bust.  But, if you start an agricultural operation at a reasonable size, and don’t sell anything, you just cut down on your family’s grocery budget.

3.  You can scale any size.  Sierra Nevada Brewing Co. started in a garage, and now makes a million barrels of beer per year (that’s 8-figure annual revenue, for anybody keeping score).  If you’re making the world’s finest jam from a quarter acre, you can expand as customers demand it.  If you get carried away with inventory, refer to the paragraph above.

4.  You’re changing the world.  Every small farm making delicious, healthy products gets us one step closer to a better world.

5.  It’s March, the beginning of the growing season.  Now go buy some seeds, if you haven’t already.  You should be planting something!

Christian Ahlmann

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OUR “WHY”

In his famous TED Talk on “The Power of Why,” Simon Sinek explains that all projects of value, all ideas worth following, come from a compelling reason, a purpose for operating, “the why.”  Before we share OUR “why,” let us explain the three cows.

“You have two cows,” begins a series of satirical economics jokes to explain the advantages and disadvantages of any economic system.  The jokes may go something like:

Capitalism:  You have two cows.  You sell one and buy a bull.

Socialism:  You have two cows.  The government takes one and gives it to your neighbor.

Communism:  You have two cows.  You give them to the government, and the government gives you some milk.

Based on that idea, American agriculture is meant to look like this:

You have two cows.  You sell some milk and buy some chickens.  You sell some eggs and some more milk and buy another cow.  You have three cows. You raise a barn and invite the neighborhood.  You get the idea.

Unfortunately, during the last few decades, the story of American Agriculture goes more like this:

You have two cows.  The market price for milk drops.  You get a job in town.  With a daily commute, you don’t have time or energy to milk the cows.  You sell them both.

We LOVE farming.  We love small farms, big farms and most of all healthy farms.  Healthy farms serve their community, food system and the families that run them.  We hate to see great farmers lose their farms in challenging environments.  That’s why we write this blog.  It is a collection of stories and wisdom we’ve gained building a farm, working with really smart people and reading really smart people’s books.  We hope you enjoy it.

Rachel and Christian Ahlmann

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