The Impact of Weekly Production Variability on Logging Cost , Return and Risk by Jefferson

Production variability is a significant determinant of logging investment outcome. This variability may result from either process variation or zero production weeks. Using assumptions for a “typical” Southern logging system, the Auburn Harvest Analyzer and a simulation model, the impacts of production variation on logging cost, investment return and risk were estimated. The expected value of logging cost remains constant across increasing levels of production variability except when the level of zero weeks is increased. Logging cost increases modestly as the number of zero weeks is increased due to high fixed cost. The expected value of logging investment returns, as measured by the internal rate of return (IRR), remains constant across increasing levels of production variability. The magnitude of the expected IRR depends primarily on percent profit margin, not on cut and haul rate. The greatest impact of production variability on logging investment is the impact on investment risk. In general, risk increases as production variability increases. This is true of production variation driven by either increased process variation or an increase in the average number of zero weeks. The effects of rising production variation are reduced by increases in profit margin. Given the adverse impacts of production variability on logging investment, there may be incentive for wood procurement organizations to manage production variation for the purpose of cost containment (reduction) and fiber supply security. 1 Authors are, respectively, Assistant Professor Forest Finance and Business, Assistant Research Scientist Forest Business and Professor Forest Engineering, Warnell School of Forest Resources, University of Georgia, Athens, GA 30602-2152. INTRODUCTION A byproduct of the difficult business climate in the forest products industry of the U.S. Southeast in recent years has been the hardships endured by those investing in a logging business (Stuart and Grace, 1998). It seems that logging is a tough way to make a living. The nature of a typical logging enterprise explains some of this difficulty. Loggers are generally contract service providers that offer the service of harvesting and transporting trees from the stump to designated delivery locations. Their efforts are tied very closely to the immediate needs of their clients and as such, they are usually unable to plan or move independently. Their method of management is often reactionary. Loggers are also price takers. They conduct business in a very competitive environment where there is little opportunity for an individual to significantly alter the rate of payment for their services. The sales rate for logging services (or cut and haul rate) is typically set by market forces. Logging is a capital-intensive enterprise (Greene and Zinkhan, 1997). Dun and Bradstreet (1993) reports that 55% of the logging businesses surveyed had total assets of greater than $500,000 and 30% had total assets greater than $1,000,000. Most of these assets are investment in heavy equipment that is required to conduct today’s highly mechanized timber harvesting. Another characteristic of the logging business is that weekly production is highly variable. Sources of logging production variability include both those that are internal to the business and those that are external or outside of the business. Internal sources include on-the-ground management of the crew, equipment or mechanical failures and the myriad of labor issues that can impact production. External sources include tract conditions (both ground conditions and timber quality), weather and local market conditions or wood procurement systems. Production variation is both a characteristic of the business environment in which a logger must function and also a determinant of business success. What is the relationship between production variability and logging investment financial performance? The objective of this study is to address this question by investigating the impact of production variability on: 1) average logging cost, 2) logging investment return and 3) logging investment risk.