Expansion won’t help if you don’t have a low cost structure.
Expansion won’t help if you don’t have a low cost structure.
By Lorne McClinton
Not all farmers’ balance sheets are created equal. Even two located down the road from each other can have dramatically different levels of profitability. While luck plays a role sometimes, the relative size of the operations isn’t as big of a factor as many would assume. In fact there’s solid evidence that suggests that management skills might matter more.
“For example the average dairy farmer in the United Kingdom needs to milk 413 cows to earn the average national wage using a milk price of 28 pence (USD$.36) per liter,” says John Roche, an international dairy consultant based in New Zealand. “The top 25% only need 53. Since only the top 25% are profitable when prices drop, what matters more, skill or scale?”
Roger Mills, a dairy business consultant from Steinbach, Manitoba says, that major differences in profitability are also highlighted in benchmark comparisons between participating producers in his management group. The most efficient farmers are between 10 to 15 times more profitable than the average ones are regardless of farm size. They can do this by keeping tight control of their total costs while still maintaining production levels.
Producers have long accepted that expanding their operations will make them more profitable as a matter of faith. While economies of scale do exist in farming they are greatly overrated at the levels of expansion most people are considering, says Brent Gloy, a farmer from Grant, Nebraska, a visiting professor at Perdue University in Lafayette, Indiana and a contributor at ageconomist.com. Adding ten percent more acreage to your farm isn’t going to offer much improvement in your cost structure and if you don’t already have a low cost structure for the size of your operation, expansion will probably make things worse.
“I can assure you that if you are losing a $1,000 on every cow you are milking then you would rather have 150 cows than 1,500,” says Roche. “Expanding without first addressing the factors that are contributing to your losses is a recipe for disaster.”
“It doesn’t do you any good to try and get bigger just for the sake of getting bigger,” Mills says. “If you aren’t efficient at the size you are currently then it doesn’t matter how much bigger you are going to get, you are not going to become anymore efficient.”
Understand your costs. The first step to manage your cost of production is to develop a detailed understanding of what your true costs are, Gloy says. Know what it will cost you to grow every crop in every field.
“Most of us have a good understanding of variable input costs; how much we plan to spend on seed and fertilizer,” Gloy says. “However it is more difficult to get a good understanding and control of fixed overhead costs, for things like land, equipment, and family living expenses. But they’re a critical piece of the puzzle, they add up to about half of a farm’s total expenses. I think many of us struggle with those.”
Personal withdrawals can’t be ignored either, Mills says. Taking out $40,000 might be a minimal expenditure on a large farm but it could be a major expense for a small one.
“One useful step can be to challenge yourself to put down real numbers and not just use ones you come to intuitively,” Gloy says. “The next step is to think about what is driving them. Are you getting the most out of what you already have or could you make changes to become more efficient. For example looking into which of your parcels of land are more profitable can help you know how much to pay for rent. It can be a eye opening experience when you really dig into some of these different numbers.”
“You have to focus on the details in your reports to spot trends and find ways to make your operation more efficient,” says Ed Friesen, a dairy farmer from Kleefeld, Manitoba. This type of attention to details is challenging but it’s really what separates the best farmers from the average ones.”
Friesen tries not to worry about things like the weather that are beyond his control and focus his energy on things he can. He tasks himself to try to find and improve the weakest area of his operation each year. This pays dividends. It takes 100 cows for the average herd in Canada to fill 100 kilograms of quota but Friesen’s breeding program and feeding regimen allows him to do it with just 65.
“My feed costs per cow will be higher than the average herd but my cost per liter of milk is considerably lower,” Friesen says. “It doesn’t matter whether a cow is producing 20 liters of milk a day or 40 there is still a base feed cost to sustain the animal. So at the end of the day my overall costs are lower because I need fewer cows to produce the same amount of milk.”
Manage debt. Managing your debt level is a critical part of increasing your efficiency, Mills says. Devoting more than 30% of a farm’s gross revenue to servicing debt can place a severe strain on your operation. So he recommends taking the time to analyze every part of the business to see if an investment in land, buildings, equipment or quota is justified.
“Properly sizing your equipment to fit your operation can have a big impact on your overall profitability too,” Gloy says. “These aren’t easy calculations to make because some of these costs, like economic depreciation on machinery, don’t come out of most accounting programs. But if you take the time to have good estimates you’ll get information that can help you make decisions about things like renting or buying new ground to become more profitable.”
Ongoing process. Agriculture has become a data driven industry so it’s critical to analyze what we’re collecting to make good decisions, Friesen says. If you can’t measure it you can’t manage it. Ten years from now the average farmer in Canada will need to be as efficient as the top 15% to 20% are now. So farmers’ management skills are going to need to continually improve to stay on top of their game.
Friesen joined a farm management group of his peers that is lead by Mills to help improve his operation. Comparing his farm’s benchmarks to others in the group shows where he can find opportunities for improvement.
“If for example, they show that their feed costs are 10% to 20% higher than the top ones then we know to look dig deeper to find out why,” Friesen says. “Being part of a management group gave us the tools we needed to dig deeper and really do an in-depth analysis of our farm. It showed us where we could improve the farm’s profitability and helped us drastically increase our production in just the past few years.”