Profit Manager:
A Systems Approach to Managing Risk
Bradley J. Hilty
Information Management Specialist
Penn State Dairy Alliance
bhilty@psu.edu
Sponsored in part by a grant
from NECRME
Profit Manager:
Program Overview
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Many programs offered on RM Topics
Most focused on a single form of risk
Business managers - manage Profit Margins
Multiple forms of risk impact Profit Margins
Develop an integrated approach to RM
Focused on managing risk associated w/
 Feeding and Nutrition
 Milk Price
Sponsored by Grant $ from
NECRME
Profit Manager:
Program Objectives

Increase Producers’ awareness of and
develop their skills in the use of BMP’s in:
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Managing Milk Price Risk
Managing Feed Expense Risk
Hedging Strategies to Manage Profit Margins
Nutrition and Feed Management Strategies
Labor Management practices
Sponsored by Grant $ from
NECRME
Profit Manager:
Program Objectives


Provide a systematic approach to manage
the multiple forms of risk that impact profit
margins.
Encourage the use of a planning &
budgeting tool in implementing risk
management strategies.
Sponsored by Grant $ from
NECRME
Profit Manager:
Program Collaborators
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Lisa Holden – Dairy & Animal Science
Virginia Ishler – Dairy Alliance
Rich Stup – Dairy Alliance
Ken Bailey – Dept of Ag Econ & Rural Soc
Downes-O’Neill Brokerage Firm

Jeff DeGrand / Mike Downes
Sponsored by Grant $ from
NECRME
Profit Manager: Managing Risk
Types of Risk
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Financial Risk
Price Risk
Production Risk
Legal Risk
Environmental Risk
Human Error Risk
Others???
Sponsored by Grant $ from
NECRME
Profit Manager: Managing Risk
Two Focus Area
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Focused on the Nutrition
and Feeding Program
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Production Risk
Price Risk
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Milk
Feed
Human Risk
Milk Price Hedging
Sponsored by Grant $ from
NECRME
Profit Manager:
Workshop Topics
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Milk Price Comparison
Controlling Risk in Nutrition
and Feeding
Calculating Production
Costs
Hedging Tools
Managing Labor Risks
Penn State Hedging Game
Profit Manager Planning tool
Sponsored by Grant $ from
NECRME
Profit Manager:
Workshop Methods
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Combination of class room
and hands-on sessions in:
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Comparing Milk Prices
Evaluating Nutrition Programs
Calculating Costs of
Production
Implementing Hedging
Strategies
Planning and Budgeting
Sponsored by Grant $ from
NECRME
Results of 2004 Penn State
/Cornell Milk Check Survey
Sponsored in part by a grant
from NECRME
Profit Manager
Managing The PROFIT Equation
PROFIT
PRICE X
Marketing
Who, When, Where
How, How Much, QC
Sponsored by Grant $ from
NECRME
VOLUME
Management
Genetics, Nutrition, FQ
Repro, Disease
EXPENSES
Variable or Fixed
Productive
Non-Productive
Profit Manager
“Control the Controllables”
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What factors are
controllable?
 Volume
 Expenses
Is price controllable?
Sponsored by Grant $ from
NECRME
Milk Price Data
by Geographic Location
All
Central NC/NE
SC
SE
Other
Gross Milk $
14.24
14.29
13.96
14.39
13.46
13.64
Risk Mngt $
(0.25)
(0.14)
(0.10)
(0.55)
(0.17)
(0.46)
PPD
(0.44)
(0.26)
(0.54)
(0.38)
(0.41)
(0.83)
Milk Mark $
0.87
1.01
0.89
0.77
0.85
0.84
Net Milk $
13.12
13.14
12.98
13.07
13.44
12.34
Net – Min
11.35
12.41
11.91
11.59
12.42
11.35
Net - Max
14.30
13.87
14.30
14.17
14.09
12.98
Sponsored by Grant $ from
NECRME
Milk Price Data
by Volume Shipped
All
> 1.5 M 1-1.5M
.5-1 M
100 K.5M
< 100 K
Gross Milk $
14.24
14.99
14.39
14.67
13.94
13.99
Risk Mngt $
(0.25)
(0.30)
(0.49)
(0.79)
(0.05)
0.00
PPD
(0.44)
(0.10)
(0.39)
(0.36)
(0.49)
(0.63)
Milk Mark $
0.87
1.01
0.80
0.83
0.81
1.04
Net Milk $
13.12
13.69
13.11
13.05
13.08
12.95
Net – Min
11.35
12.94
12.42
11.59
11.91
11.35
Net – Max
14.30
14.09
13.92
14.17
14.04
14.30
Sponsored by Grant $ from
NECRME
Strategies for Managing
Milk Production and Components
Virginia Ishler
Penn State Dairy Alliance
Sponsored in part by a grant
from NECRME
What are your objectives?

Improve profit
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Improved milk production?
Improved milk components?
Decreased feed costs?
…………….
Manage risk
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How?
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Sponsored by Grant $ from
NECRME
Home grown feeds
Purchased feeds
Monitor performance information
What are my objectives
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Not to make you nutritionists!
Manage the feed consultant
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Take control of the situation
Managers need to take
responsibility when programs fail
Change is not bad
Sponsored by Grant $ from
NECRME
Key Performance Indicators
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Why
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Feeding is the single largest controllable
expense on the dairy
Largest impact on health and production
Examples of KPI
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Sponsored by Grant $ from
NECRME
DMI
Production (volume and components)
IOFC
Analyzing Cost of Production
Bradley J. Hilty
Penn State Dairy Alliance
bhilty@psu.edu
Sponsored in part by a grant
from NECRME
Profit Manager
Milk Price Trends (1987-2002)
$17.00
$16.50
$16.00
$15.50
$15.00
$14.50
$14.00
$13.50
$13.00
$12.50
$12.00
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Sponsored by Grant $ from
NECRME
Profit Manager
Hands-On:
Sponsored in part by a grant
from NECRME
Cost of Production DataDairyCOP$
Milk Production Costs/ CWT
6
5
# Herds
4
3
2
1
0
< $ 12.00 $12-$13 $13-$14 $14-$15 $15-$16 $16-$17 > $17.00
$/Cwt
Sponsored by Grant $ from
NECRME
Penn State Hedging Game
by Downes-O’Neill
Profit Manager
Hands-On:
Sponsored in part by a grant
from NECRME
Trading Simulation


The goal of this trading exercise is to
lock-in optimal profit margins as
market conditions change over the
course of a marketing year.
A “snapshot” of nine trading days will
be given with futures and options
prices and a market conditions update
on each date.
Sponsored by Grant $ from
NECRME
Exercise Rules
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Producers paired
All teams assume a fictitious 1,000,000 lb.
per month dairy operation that uses 500
MT of soymeal per month.
Producers can lock-in 100 percent of their
milk production in 200,000 lb. increments
using the October Class III futures and
options
Producers can lock-in 100 percent of their
input costs in 100 MT increments using the
October soy meal futures contracts
Sponsored by Grant $ from
NECRME
Exercise Rules

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Upon viewing the current Class III and soymeal
prices, teams will have five minutes to make their
marketing decisions.
Teams are allowed to initiate, as well as liquidate,
hedge positions, prior to contract expiration on
November 5.

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
Sponsored by Grant $ from
NECRME
All team are responsible for tracking any liquidated
(realized) profits or losses throughout the exercise
All liquidated futures reconcile to the oldest initiated
position.
Brokerage commissions will be calculated but margins
requirements will not.
Exercise Rules
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Producers will be allowed to use the following
strategies to initiate hedges:
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Sell Class III futures
Buy Class III put option
Sell Class III futures and Buy Class III call option
Buy Soymeal future
Teams can liquidate any positions at current
market prices but cannot be long a call option
without having a corresponding short futures
position.
Sponsored by Grant $ from
NECRME
Exercise Rules
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What marketing strategy will you use?
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Sponsored by Grant $ from
NECRME
Sell Futures
Buy Put Option
Sell Futures/Buy Call Option
Sell Futures
Lock in a specific price – zero price uncertainty!
Sponsored by Grant $ from
NECRME
Buy Put Option
Insurance against falling prices.
Producer pays
premium and receives floor price. Leaves upside
open when prices rise.
Sponsored by Grant $ from
NECRME
Sell Futures/Buy Call Option
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A call option may be purchased in conjunction with a
short futures position which allows a producer to
“participate” on upward price moves even when
locked-in with a futures contract.
A call option is essentially paying a premium to insure
the futures position in the event of upward milk price
movements.
Call options don’t need to be purchased
simultaneously with futures. Calls can be purchased
at later date to match with existing futures
positions.
Call options may not be purchased prior to sale of
futures contract.
Sponsored by Grant $ from
NECRME
January 4
October Class III:
13.40
It’s the start of a new milk marketing
year and the futures market is
offering producers a well-above
average Class III price for the
October contract. Milk prices
finished strong the previous year so
traders are still leaning toward
higher prices as we enter the New
Year.
Sponsored by Grant $ from
NECRME
January 4 (cont.)
On the other hand, milk production and
cow numbers are rapidly increasing in
response to the high milk prices. Most
analysts are projecting a 2 ½ to 3 percent
increase in milk production for the month.
Sponsored by Grant $ from
NECRME
January 4 Futures Quotes:
October Class III
October Soymeal
13.40 cwt.
148.60 MT
The following table is the current Class III options
quotes for today.
Sponsored by Grant $ from
NECRME
Put/Call
Strike
Premium
Change
Put
13.00
0.60
-
Call
14.25
0.47
-
March 15
October Class III:
12.98
What a difference two months make! Cheese and
butter stocks have grown significantly since the
beginning of the year and analysts are projecting
February milk production to be up 4 percent or
more on the USDA report released later this
afternoon. Retail prices are slow to reflect the
decline in farm-level prices as the drop is not
being passed along to consumers.
Sponsored by Grant $ from
NECRME
March 15 (cont.)
The Chicago Mercantile Exchange(CME) spot
cheese market has dropped sharply since
the beginning of the year, now at its
current level of $1.33/lb. Ideal weather
on the West Coast has some traders
wondering if an early flush will leave
production tight at the start of the
summer grilling and ice cream season.
Lower milk prices have also slightly
increased the cull rate.
Sponsored by Grant $ from
NECRME
March 15 Futures Quotes:
October Class III 12.98 cwt.
October Soymeal 135.60 MT
-0.42
-13.00
The following table is the current Class III options quotes
for today.
Put/Call
Strike
Premium
Change
Put
Put
Call
13.00
12.50
14.25
0.60
0.43
0.25
-0.02
-0.22
Call
13.50
0.42
-
Sponsored by Grant $ from
NECRME
June 18
October Class III:
14.40
Cheese prices have unexpectedly climbed
almost $0.20 lb. over the past month to
$1.43/lb. Traders question whether the
current production and demand
fundamentals support the current uptick in
cheese. Buyers watched cheese prices
climb sharply higher the previous year and
are nervously accumulating product on the
current run-up.
Sponsored by Grant $ from
NECRME
June 18
Milk production continues to surge seasonally
with the May production data released this
week up 3.5 percent versus the previous
year. American cheese production for
April was up a whopping 10.6 percent
versus last year. Although dairy product
consumption is above average, trader
question whether the current cheese price
will hold these levels.
Sponsored by Grant $ from
NECRME
June 18 Futures Quotes:
October Class III
October Soymeal
14.40 cwt.
141.20 MT
+0.85
+9.80
The following table is the current Class III options quotes for today.
Put/Call
Put
Put
Strike
14.00
13.00
Premium
0.46
0.21
Change
-0.05
Put
Call
Call
12.50
14.50
14.25
0.14
0.48
0.58
-0.01
+0.28
Call
Call
13.75
13.50
0.90
1.08
+0.46
+0.55
Sponsored by Grant $ from
NECRME
August 13
October Class III:
17.62
There appears to be no end in sight for the
upward surge in Class III futures.
September and October contracts have
smashed through the $17.00 level and
appear to be headed higher. The CME spot
block cheese market is trading at $1.9325
lb. and many sources say $2.00 to $2.10 lb.
is possible. However, the deferred futures
contracts are starting to sell-off,
suggesting traders think the up-move’s
sustainability will be short-lived.
Sponsored by Grant $ from
NECRME
August 13 (cont.)
Despite the hoopla surrounding record milk
prices, milk production has remained strong.
The USDA July milk production report, to be
released next week, is still expected to show
milk production 3 ½ to 4 percent above year
ago levels. The weather out West has
moderated and California production is
expected to be 12 percent over last year.
More good news for producers is that feed
costs have backed-off.
Sponsored by Grant $ from
NECRME
August 13 Futures Quotes:
October Class III
October Soy meal
Sponsored by Grant $ from
NECRME
17.62 cwt.
136.50 MT
+ 0.97
+ 4.40
Current August 13 Put Option Quotes
Put/Call
Strike
Premium
Change
Put
16.00
0.25
-
Put
15.25
0.12
-0.11
Put
14.00
0.04
-0.03
Put
13.75
0.03
-0.03
Put
13.00
0.01
-0.02
Put
12.50
0.01
0.00
Sponsored by Grant $ from
NECRME
Current August 13 Call Option Quotes
Call
18.00
0.55
-
Call
17.00
0.92
+0.32
Call
14.75
3.01
+1.03
Call
14.50
3.24
+1.04
Call
14.25
3.48
+1.06
Call
14.00
3.72
+1.07
Call
13.75
3.96
+1.07
Call
13.50
4.20
+1.00
Sponsored by Grant $ from
NECRME
September 2
October Class III:
12.90
Class III futures continue their collapse in the
wake of last month’s cold storage report
revision. Despite the futures market freefall,
the CME spot block cheese market still
remains at $1.70 lb. This would calculate out
to a $15.00+ Class III price even though
October futures are sitting over $2.00 cwt.
beneath that level. CME cheese prices will
start calculating toward the October Class
III in three weeks.
Sponsored by Grant $ from
NECRME
September 2 (cont.)
With milk production still running strong and
increasing cow numbers, traders don’t look
for much upside price recovery.
Furthermore, retail grocery prices still
remain strong ruling out much in the way of
dairy product features in the near-term.
However, the market is approaching price
levels where commercial buyers may reenter the futures arena, supporting prices.
Sponsored by Grant $ from
NECRME
September 2 Futures Quotes:
October Class III
October Soymeal
Sponsored by Grant $ from
NECRME
12.90 cwt. - 2.53
146.30 MT +5.20
Current September 2 Put Option Quotes
Put/Call
Strike
Premium
Change
Put
16.00
3.20
+2.15
Put
15.25
2.37
+1.68
Put
14.50
1.86
+1.45
Put
14.00
1.34
+1.06
Put
13.75
1.26
+1.03
Put
13.00
0.84
+0.72
Put
12.50
0.61
+0.54
Put
12.00
0.42
-
Sponsored by Grant $ from
NECRME
Current September 2 Call Option Quotes
Call
18.00
0.01
-0.03
Call
17.00
0.01
-0.09
Call
16.00
0.03
-0.37
Call
14.75
0.12
-0.91
Call
14.50
0.15
-1.05
Call
14.25
0.18
-1.20
Call
14.00
0.23
-1.24
Call
13.75
0.30
-1.46
Call
13.50
0.40
-1.56
Sponsored by Grant $ from
NECRME
November 5
USDA Class Price Announcements
October Class III Price $11.49 cwt
October Soy meal Settle $154.10 MT
Sponsored by Grant $ from
NECRME
Final Option Settlement Values
Put
Call
16.00
4.51
18.00
0.00
15.25
3.76
17.00
0.00
14.50
3.01
16.00
0.00
14.00
2.51
14.75
0.00
13.75
2.26
14.50
0.00
13.00
1.51
14.25
0.00
12.50
1.01
14.00
0.00
12.00
0.51
13.75
0.00
13.50
0.00
12.50
0.00
Sponsored by Grant $ from
NECRME
Account Reconciliation

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Reconcile all outstanding futures and options
positions to the announced Class price and soymeal
settlement price.
Account for all realized profits and losses that
were liquidated during the exercise.
Deduct any call option premium that expired with
no value from ending P/L.
Deduct original put option premium cost from
hedge profit.
Calculate net hedge profit on a cents per
hundredweight basis.
Multiply total transactions by $40.00 for
brokerage commission total.
Sponsored by Grant $ from
NECRME
Profit Manager Budgeting &
Planning Tool
Profit Manager
Hands-On:
Sponsored in part by a grant
from NECRME
PROFIT MANAGER
Planning & Budgeting Tool
Profit Manager Tool
Excel Spreadsheet which:



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Allows producers to calculate basis
Calculate feed needs
Project Expenses
 With feed price hedging
Project Milk Income
 With milk price hedging
Examine Impact of Strategies on Profit Margin
Develop monthly Cash flow Budget
Sponsored by Grant $ from
NECRME
Results – 3 workshops


32 Participants
 21 producers
 8 Industry Professionals
 3 PSU Students
Knowledge Level – Pre & Post Test
 Pre-Test Score
57.9 %
SD - 17.8
 Post-Test
77.9 %
SD - 10.6
Sponsored by Grant $ from
NECRME
Results:
(6 month follow up survey)

52% of Producer Participants Responded




100 % implemented at least 1 management change
83 % implemented over 4 management changes
91.7 % experienced at least 1 positive impact
50 % experienced 3 or more positive impacts
Sponsored by Grant $ from
NECRME
Thank You!
?? Questions ??
Sponsored by Grant $ from
NECRME