Is herd expansion the answer to dairy profitability? The options assessed

Farmers must be realistic about the investment required for herd expansion and the potential returns.

It is easy to assume that having more cows will enable you to spread costs and increase profitability, but it is essential to consider all factors.

You should think about capital requirements, implications on land availability and NVZ restrictions, labour resources and the management skill and time that a larger herd will need.

Sensitivities like milk price drops or feed price increases should also be considered because these could affect your future cashflow, ability to service debt and overall profitability.

See also: Share farming facilitates expansion to five dairy units

But perhaps more than anything else you should look at your current business first.

Many people think that adding additional cows will help solve a problem in their current set-up, but that is rarely the case.

Before you even think about more cows, you should be achieving above-average performance with your current herd or be able to get there fairly easily. If not, ask yourself what can be improved on your unit first that would have an effect on profitability.

Farmers should start by benchmarking their cost of production and physical performance against other farms.

Once farmers are confident they are optimising the performance of their herd and chosen management system, then expansion might be worth considering. 

Kite Consultant Will Jones assesses the expansion options farmers could consider.

Option 1: Marginal cows

Adding a few more cows is relatively straightforward. If assuming an average yield of 8,000 litres a lactation, an additional marginal cow would bring about £2,465 in additional income a year at a milk price of 28p/litre – as shown below.

If you account for variable costs associated with keeping that additional cow, then the gross margin a cow is about £978 a year, as detailed below.

Finally, you must allow for overheads to cover electricity and water, repairs, contractor costs, machinery and fuel, labour, land rent and interest.

This would typically add up to £471 a cow a year, giving a total profit margin of £507 an additional cow (£978 gross margin minus £471 overheads) at current prices.

Assuming you can add 10 more cows without any significant capital expenditure or changes to management, this could return additional profits of £5,070/year – something definitely worth considering.

Option 2: 50 additional cows

If cow numbers are to be increased significantly, the capital consideration becomes more important, because this will require additional housing, possibly a parlour extension, more silage and a larger slurry storage.

A worked example is shown below.

If this amount was borrowed over 10 years at 4% interest, the annual capital repayment would be £21,000 and the annual interest cost would be £3,330, giving a total annual cost of £24,330.

Assuming the same profit margin as the worked example in option 1 above of £507 a cow a year, this would deliver a total additional margin of £25,350/year with a loan repayment of £24,330, giving a positive cashflow of £1,020/year and a profit (before tax) of £22,020.

Again, this seems pretty attractive at first glance, but that is where sensitivity analysis needs to be completed.

In this example milk price changes of +/- 1p/litre equate to £4,000/year, so a volatile milk price could quickly make this example cashflow negative, resulting in difficulty servicing debt.

Of course, not all of this capital investment might be required on every farm.

If you already have heifers in the pipeline and can cope with 50 additional cows with less changes to farm infrastructure, the economics quickly become more promising, as shown below.

If you have no capital cost for heifers and limited cost for new building works, total cash investment could be reduced to £90,000.

Assuming the same additional margin of £25,350/year and a loan repayment of only £10,428/year (on the same terms as our initial calculation), the positive cashflow becomes £14,922/year with additional profit (before tax) of £23,921/year.

While overall profitability is not massively different in this example, the end result would be an expansion plan that was much more resilient, as the positive cashflow effect is far greater, making sensitivity to price changes less of an issue.

Option 3: Increase cows at the expense of another enterprise

On many farms there may be merit in considering increasing cow numbers while reducing another livestock enterprise that uses similar resources – heifer rearing being a typical example.

If you assume you had a 200-cow herd with a 25% replacement rate (50 animals/year) and calving at 24 months, then rearing your own heifers requires 50 livestock units.

Moving to a flying herd or having heifers contract-reared would mean cow numbers could be increased to 250 with no additional land requirement, saving £156 a cow in overhead cost compared with previous worked examples.

Assuming the same loan terms as above, this would result in a capital repayment of £14,000/year and interest of £2,222, giving a total cost of £16,222/year.

With the increased margin of £739 a cow (because there is no cost for additional land), this would increase the margin by £36,950/year, resulting in positive cashflow after servicing debt of £20,728/year and profit (before tax) of £34,728. Once again, something worth considering.

Option 4: Greenfield site

Perhaps unsurprisingly, this option is by far and away the most complex to budget for, as there are so many potential variables, including the management system chosen.

The return on capital can vary enormously and the most important consideration is to choose a system that suits the farm and your milk buyer, as well as your own skills and preferences.

The most common mistakes people make when embarking on a greenfield site project are underbudgeting, not being realistic on timescales, underestimating the requirement for management, not doing enough research on housing designs and not considering the implications on cashflow.