Sensitivity Analysis Identifies Risk, Benefit

Assessment tool helps prioritize investment and management plans. Sensitivity analysis in the context of this article does not refer to a personality trait measuring one's reaction to criticism, nor does it refer to how a disease-producing organism reacts to a given antimicrobial product. In this discussion, sensitivity analysis refers to a model in which inputs are changed one at a time or in combination,

Sensitivity analysis in the context of this article does not refer to a personality trait measuring one's reaction to criticism, nor does it refer to how a disease-producing organism reacts to a given antimicrobial product.

In this discussion, sensitivity analysis refers to a model in which inputs are changed one at a time or in combination, while the effect of the change upon the variable of cash flow or profit-and-loss (P&L) projection is observed. The information gained from this procedure can be used in assessing risk and/or developing a risk management plan.

Start with Simple Variables

In pork production, there are many variables that can be used. If you have never developed a sensitivity analysis, it is best to start with a simple and straightforward variable like the carcass price of hogs or the price per bushel of corn. These types of variables have a direct correlation between the price change and the effect on either cash flow or P&L.

For example, a 1,000-sow, farrow-to-finish unit projects selling 20,000 head annually with an average carcass weight of 200 lb., or 4 million pounds of carcass, total. For every $1.00 the actual carcass price differs from the projected price, there will be a $40,000 change in the P&L or cash flow projections.

Other straightforward or simple variables are the price of corn or soybean meal (or other energy and protein sources), and feed efficiency (provided the ration formulation isn't changed).

A slightly more complex variable would be sort loss. If sort loss could be reduced by $0.25/cwt. by loading hogs from two different barns and the trucker charged $25 extra to reset the truck, the potential added income on a semi load of 181 hogs averaging 265 lb., live weight (200 lb. average carcass weight or 36,000 lb. of carcass, total) would be $65 ($90 - $25 reset charge). With the yearly average sort loss at $1.26/cwt., reducing it to $1.00/cwt. would increase income by $10,400, less added costs on 20,000 head, if the average sale weight remained constant.

An even more complex variable that affects P&L or cash flow projections would be sale weight. Changing sale weight also changes the tons of feed required because of changes in feed efficiency and average feed cost.

An example of an extremely complex variable is age at weaning. Weaning age affects the cost of nursery feed, veterinary costs, labor costs, plus it will likely affect performance and mortality rates in the nursery and finisher. These differences vary greatly from farm to farm and should be developed and used with great care.

Risk vs. Payback

What can be learned from using sensitivity analysis?

First, it is important to understand that increased productivity does not necessarily mean increased profitability. In some instances, the increased cost or lower carcass value cannot be offset by an increase in productivity.

A good example is when feed costs are high and carcass value is low. Carrying hogs to heavier weights will increase the pounds of pork sold per farrowing crate or per finishing space, but the increased cost of gain and lower carcass price — due to higher sort loss and/or reduced lean percentage in the carcass — more than offsets the gross price increase of more pounds of carcasses being sold.

Second, sensitivity analysis can help management focus on where opportunities lie for improving cash flow or profitability. Taking a hard look at the historical range of variables can help us understand the risk/benefit or threat/opportunity of achieving an incremental value above or below those used to prepare the cash flow or P&L projections.

Table 1 lists values for the daily closing prices for several variables for a five-year period (Oct. 1 to Sept. 30, respectively), and for Oct. 1 to Nov. 30, 2009. These values show the variation in prices during the time periods. Prices will vary in different areas, but the amount of variation should be similar.

When considering variables, present values should be used. But if those values are not known, a “best estimate” is used. Another option is to use average values from group or industry benchmarks.

For a simple demonstration, let's again use a 1,000-sow, farrow-to-finish operation marketing 20 pigs/sow/year (20,000 market hogs). These pigs average 200 lb., carcass weight (265 lb., live) with a whole herd feed efficiency of 3.0. Their diet, on a per-ton basis, averages 1,390 lb. of corn ($3.60/bu.), 440 lb. of soybean meal ($320/ton), and 170 lb. of other ingredients, plus grinding, mixing and delivery costs of $47/ton.

This production unit will use 193,607 bushels of corn and 1,716 tons of soybean meal, or roughly 7,800 tons of feed at an average cost of $206.76/ton to produce 4 million pounds of pork carcasses.

Using this information, a spreadsheet can be constructed showing how an incremental change in the values used will affect cash flow or the P&L projection (Table 2). Reading from left to right, the first block of figures shows the result of an incremental change in each variable, the second block shows a 10% variation from a five-year average and the third block shows the change for the same dollar amount.

Caution must be used to change only one variable at a time. For example, changing ration formulations may improve feed efficiency, but the added cost may result in lower profit or a greater loss. The opposite can also be true. A diet formulation change may decrease feed efficiency, but a lower cost may result in more profit or less loss.

Next Page: Isowean Example

Isowean Example

If the 1,000-sow unit decides to sell Isowean pigs instead of finishing them, a sensitivity analysis that looks at weaned pigs sold/sow/year with a projected cost of $30/pig, selling 24 pigs/sow with a variable cost of $2/pig, the baseline is highlighted in Table 3. In this case, a one-pig variation (+/-) per sow is worth $28,000 annually to this production system.

One management consideration could be whether or not to vaccinate the sow herd to prevent an outbreak of a disease. If the cost of vaccination is $3.00/sow annually, the cost of the change would be $3,000. That cost must be weighed against the risk (cost) if the vaccination was eliminated and the disease occurred or the benefit (savings) if the disease did not occur.

Another management consideration to improve present sales by one pig per sow might be to add a night farrowing room attendant at a cost of $25,000 annually. If a pig/litter could be gained, the net benefit is $3,000 — but the risk is fairly high that this change would not work.

Another management option would be to change the source of breeding animals. If a genetic line with a proven record of being able to produce at least one more pig/litter than the current sow herd could be identified, and the replacement gilts cost $30/head more than the present source, and we assume a 50% replacement rate in the breeding herd, there would be a $13,000/year benefit. The risk that this option would fail is much lower than the first option. Other possible changes can be analyzed in a similar manner.

If your risk management strategy on feed purchases and/or market hog sales has consistently given below average results, an option would be to contract with a firm or individual specializing in this area. This may provide benefits in two ways: 1) better average prices that offset the cost, and 2) providing more time to better manage other areas of the operation.

When used properly, sensitivity analysis can help determine how the extent of variation from factors used in creating cash flow or P&L projections will affect them. Sensitivity analysis can also be used to decide whether a management change should be made. Start with simple variables, then proceed to more complex variables as you and/or your financial advisor or consultants become familiar with them. Sensitivity analysis can help make an operation more sustainable over the long term.

Linden Olson is a swine management and records consultant and custom feeds Isowean pigs near Worthington, MN.