Primer on the Profitability of the Logging and Lumber Business

[asca65290]

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?



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 everyone 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.

[SwampDonkey]

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.

Up here, a lot of the sawmills are, but only because the system allows them to use most of the volumes they require off public land and they don't put enough money into silviculture on their own holdings. Hundreds of acres are cut and left to the elements on Freehold land, especially if it's not growing back to spruce. This is also evident on new private lots they acquire. As one fellow at a mill told one woodlot owner who had plantation for sale, "We only buy land that we can harvest now." ;)

Did your margins for the landowner include management costs, income tax of the wood sales, and property taxes? Assuming a 100 acre woodlot averages 24 cord/acre and the owner clearcuts, maybe 30% is logs up here (that's optimal). So 360,000 bf @ $250/th = $90,000,  less 40% income tax = $54000, less $120/th management costs= $10800. Bottom line $0.03/th net. Forest land taxes are low here, almost insignificant.

[Ron Wenrich]

What I see wrong with the value chain is that there are so many sorts in the logs, lumber and other products that its really hard to put some of those numbers to the test.  Landowners may get $300/Mbf for stumpage of a certain species.  A lot would depend on lump sum or sold on shares.  A lot would depend on quality and species.  Loggers figure that in when bidding on jobs.

Loggers will take veneer and possibly the low grade for pulp or fuelwood.  They might average $550/Mbf for their sales, but the sawmill probably wouldn't be paying that as an average.  That would raise the profit margin of the mill, since the value of the logs is less.  $400/Mbf for operating costs for the mill?  Seems really high to me.  Same goes for the kiln prices of $720/Mbf.  I know that you kept that in line to keep everyone's profit margin the same.

The way I've looked at the hardwood sales from the retail end is what the final product is and what it would be graded at in the mill level.  Most of the hardwoods I've seen have been not much better than a piece of select grade at best, and many are just 1 Com.  Those short clears can be made from 1 Com and possibly 2 Com. 

What I've seen have basically come from cut up shops after the kiln process.  Some boards have been glued up.  They have also been S4S and double end trimmed.  They are visually a very salable product.  But, the underlying grade value is a little suspect to me.

Your analysis of value added processes can be right, depending on the circumstances.  I've always used the formula of profit = final sales price - operating costs - raw materials costs.  In markets with stiffer competition, the sales price and raw materials costs are generally in the hands of the marketplace, and not the operator.   Many operators that lack the ability to contain costs will try to drive their costs back to the stump.  But, competition will keep that in check, as will trying to move the costs ahead to the customer.  That leaves the cost of production in the hands of the operator, and that's where the profit and losses come in.

Vertical operations are only profitable if you can do it cheaper than someone upstream or downstream from your operation.  Supply & demand plays a role in there as well.  Holding costs carry a premium.

[DouginUtah]

                     
I guess this fits in with the subject at hand...

Lumbercalc

LumberCalc is a simple VB5 program which attempts to answer the question: Why does lumber cost so much? You may change any or all of the values which contribute to the price of lumber, or reduce to zero charges which do not apply. When you get the values set properly for your operation, you can save them and they will be available the next time you open the program by pressing "Load Defaults".

http://www.xmission.com/~sherwin/download1.htm