Profitability Pointers

If your nursery identifies with any of the following quotes: “These staggering costs have us scared to death;” “We are surviving, but profit-wise, it’s a squeeze;” “Costs of energy, labor, fumigants, pots, polyethylene, delivery – everything is going up. It’s really beginning to hurt;” then you are not alone. What you may find interesting is the fact that these quotes are from a green-industry article published in 1979. At that time the green industry was experiencing a period of double-digit sales growth almost every year. It’s not surprising to see the increase in the number of nurseries entering the market at that time, as entrepreneurs saw plenty of opportunity.

Today, if we look at the composition of green industry, two-thirds of firms started their business after 1990. Almost 44 percent have only been in business for the last decade. The increase brings more competition to the industry and a reduction in profit margins. The economy provides a natural way of increasing efficiency of production and use of resources, and only those firms that adapt to the changing environment are able to survive. This is what the famous economist Adam Smith referred to as the “invisible hand,” with supply and demand forces interacting to either attract new firms into the market when profits are being made or to drive firms out of business during periods of contraction. This process is even more evident in the last few years with the latest economic recession that brought a significant reduction in green industry sales. However, even throughout the recession and with estimates as high as a 25 percent reduction in the number of businesses in the industry, a small number of businesses continued to grow.

What makes these growers different than the rest? It is about efficiency, but also about consistency; consistency in cost reduction, use of resources and innovation. In short, it is about anticipating and adapting to change before everybody else.

This year, Flowerwood Nursery in Mobile, Ala., invested in the lean flow process to eliminate waste in production, said Todd Carnley, vice president of sales and marketing. The nursery also added a potting machine to improve quality, output and decrease employee fatigue — all good steps toward increasing efficiency.

The big three
There are three main factors that will impact your profitability: cost of production, crop mix and pricing strategies. The first step is to know your cost of production. It will help you identify crops you can grow at a low cost, and also help determine your price floors for every product. The costs are different for every nursery because of the location and size of the operation, cost and availability of labor, the time of the year, managerial practices, etc. Cost analysis is the only way to make accurate product mix and pricing decisions. This starts with good record keeping. The cost structure of your firm will provide you with an indication of which competitive strategy is right for your business. Some nurseries are able to compete as low cost/low price operators, while others need to do branding or product differentiation. Another competitive strategy is to increase margins through value-added and vertical integration.

Which strategy is right for you? It depends on several factors, including the size of your nursery, the type of products you sell and who you sell those products to. About half of the companies in the green industry have annual sales of $250,000 or less. However all those businesses combined only represent about 1.8 percent of total green industry sales. On the other hand, less than 1 percent of green industry firms have sales of $50 million or more, and they represent almost 32 percent of industry sales. When deciding which strategy is right for your business you need to consider where your nursery fits on this scale. The larger you are, the more likely you will be able to benefit from economies of scale and reduce per unit costs of production. This process happens as you increase purchase size, obtain better prices and your fixed costs are distributed to more units of production.

Differentiate your product
For smaller nurseries, product differentiation is key for profitability. Differentiation is highly linked to innovation and perceived value. It goes beyond the physical attributes of your products and it also includes any services provided. Differentiation exists when customers (under conditions of competitive supply and faced with a range of choices): (a) perceive that product offerings do not have the same value and (b) are prepared to dispose of unequal levels of resource (usually money) in acquiring as many of the available offerings as they wish. Customers generally use one or more of five major attributes in making decisions about what products/services to buy and from whom to buy them from, including quality, price, service, convenience, and selection. In a study conducted this summer, we studied consumer sensitivity to price changes for branded/differentiated products. We found that businesses with effective differentiation of products can raise their prices and even though the quantity sold goes down, total sales went up because the price increase more than offset the reduction in quantity. This notion is referred to in economics as price elasticity of demand. This is a very important concept, because it measures whether the product is a necessity good or a luxury product.

Get the word out
What about advertising and promotion? It’s your opportunity to tell consumers why your products are different and why they should buy them from you. Promotion success depends on five main activities: 1. the purpose of your message, 2. media used, 3. who is the audience, 4. how much is spent and 5. promotion coordination. On average, green industry businesses spend about 4 percent of total sales in promotion and advertising activities, including internet and social media, printed materials and mass media advertising. The return on investment for promotion and advertising ranges from $1.7 to $7.5 per dollar invested depending on the type of promotion activity and the size of your firm. Social media is becoming a more important and widespread tool to interact and connect with consumers. You may be effective in creating value and differentiating your products and services, but if you don’t tell your consumers, you can’t reap the benefits.

Marco A. Palma is associate professor and extension economist at Texas A&M University; mapalma@tamu.edu.