October - December 2012
Guest Editorial Article
I was recently asked a question which I think is a common curiosity among many people, which is: how does the price of a board foot of lumber go from $0.30 on the stump to $6.00 in a store? It seems like an awfully large difference. Where is all the money going? For those of you who are loggers or sawyers, I'm sure it feels like you are getting a much too small slice of the pie. To help answer illustrate this process, I put together the table below to show how this could be happening. The reality is, based on industry data I have reviewed, as well as general observations of what has gone on in the industry, none of the participants (loggers, landowners, sawmills, etc.) are making a killing. To the contrary, many are losing money and going out of business. Ever since the recession started, there has been a glut of supply, which has caused prices to drop along with profit margins for firms large and small. But if that is true, then where is all the money going—that $5.70/bd. ft. difference between the retail price and the stumpage price?
| # | Step | Revenue | Purchase Cost | Operating Cost | Profit | Gross Margin % | Profit Margin % |
|---|---|---|---|---|---|---|---|
| 1 | Landowner | $0.30 | $0.00 | $0.12 | $0.18 | n/a | n/a |
| 2 | Logger | $0.55 | $0.30 | $0.22 | $0.03 | 45.1% | 5.1% |
| 3 | Sawmill | $0.99 | $0.55 | $0.40 | $0.05 | 45.1% | 5.1% |
| 4 | Kiln Operator | $1.81 | $0.99 | $0.72 | $0.09 | 45.1% | 5.1% |
| 5 | Wholesaler | $3.30 | $1.81 | $1.32 | $0.17 | 45.1% | 5.1% |
| 6 | Retailer | $6.00 | $3.30 | $2.40 | $0.30 | 45.1% | 5.1% |
| TOTAL | $6.00 | $0.00 | $5.18 | $0.82 | 100% | 13.7% | |
| NOTE: | |||||||
| 1) Purchase cost is the cost of acquiring raw material for the step in question and is equal to the revenue of the entity in the prior step | |||||||
| 2) Operating cost is the cost of running an operation, including payroll, general, and administrative expenses and depreciation of equipment and rent. | |||||||
| 3) In reality, the profitability of each step above will vary based on the level of involvement of each party in the process and their relative degree of negotiating leverage on parties above and below them in the process (e.g.,the power of a sawmill over a logger). | |||||||
The analysis above takes that example of a $0.30/bd. ft. input and a $6.00/bd. ft. retail price one step further. In business, we call this the "Value Chain". As you move down the table, the product gets closer and closer to the final form. The companies that operate in each subsequent step down the chain must purchase products from the previous step and the price that they purchase at is both the product cost to the current step and the sales/revenue to the prior step. I've assumed about a 5% profit margin for the industry for the sake of this analysis. That feels about right to me and is consistent with data that I reviewed (IBISWorld). If anything, it is high in the current state of affairs. For simplicity, I've assumed that this stays the same in each step of the process. In reality, this won't be the case. Some will be higher, some will be lower, depending on the importance of the step and the negotiating leverage that one step has on other steps (think sawmills vs. loggers).
Ultimately, what this shows is that no one is stealing the others' slices of the pie. So, where is all the money going? Well, if you look at the "TOTAL" line, you see that total operating costs for all steps involved equals $5.18, leaving total profitability for every one of only $0.82/bd. ft. That's not a lot to go around. Who gets the $5.18? Well, this goes to pay employees, rent for buildings, general overhead costs, depreciation of the equipment (which is significant) and taxes, among other things. This $5.18 boosts the economy to be sure, but it doesn't end up in anyone's pockets as profits.
I'm sure that some of you may take issue with some of the numbers in this table or the profitability of a given segment. That is okay. This analysis is only meant to illustrate the broader picture of how this all works. It is not meant to be a completely accurate portrayal of the actual profitability of the industry as of right now. Profits and margins change between steps of the process and from year to year, so what is true this year may not hold next year.
One takeaway of this analysis is that you begin to improve your profit margins as you become "vertically integrated," meaning, as you perform more and more steps of the process yourself. For example, a sawmill operator having a logging operation, and possibly timberland holdings, and possibly also a kiln and warehousing facility. This is the case for the large firms like Rayonier, Weyerhauser and Plum Creek Timber. With this in mind, is it any surprise that these firms became integrated in the first place, or that they were better positioned to weather the recession than companies with only a single line of business? I don't think so. The more steps of the process you control, not only the more profits you make, but the higher your profit margins (profit divided by revenue) become. Let me give you an example.
Say you are a logger in the table above. You would make a 5.1% profit margin. Now, assume that you are a logger that also owns a sawmill and a kiln operation (i.e., you control 3 out of 6 steps of this process). Your cost of acquiring material is $0.30/bd. ft. from the landowner. You can sell kiln dried lumber for $1.81/bd. ft. to wholesalers and your total operating costs for the three steps are $1.34/bd. ft. ($0.22 + $0.40 + $0.72). Therefore, revenue is $1.81/bd. ft. and total costs are $1.64/bd. ft. ($0.30 + 1.34), leaving a profit of $0.17/bd. ft. This equates to a profit margin of 9.4%, which is 84% more profitable than just being a logger! Note that if you controlled all steps of the process, you would make a profit margin of 13.7% (from the "TOTAL" line of the table) versus 5.1% if you only operated in a single line of business.