The high cost of success

If you’re farming in Canada, the odds are that you’re in the business of producing commodities. So, whether you like it or not, your competition is global, and in such a commodity marketplace, the lowest-cost producer wins. 


Not long ago, it was considered vital to know your costs and to keep striving for lower cost of production. Then came the surge in commodity markets, and somewhere in the last few years of agricultural trade pacts, large-scale expansions, monster machinery and unbelievable volatility in prices, we seem to have lost sight of cost management.


Some of our costs have doubled in 10 years, but we tell ourselves that at today’s grain and oilseed prices, it make sense to invest in our crops.


Does the opportunity to make money by throwing everything at a crop in order to get the biggest possible yield mean we shouldn’t track and compare production costs?


If you want an answer, you’re basically on your own. Of all the money that gets spent on ag research in Canada, virtually none goes to studying our competitiveness. In fact, when I contacted Agriculture and Agri-Food Canada (AAFC) in my hunt for analysis on Canada’s farm competitiveness, I was essentially told that we must be competitive. Otherwise, we wouldn’t be producing wheat or soybeans, beef or pork. Case closed.


Still, AAFC can be a useful place to start.


A 2007 AAFC survey on farm business management practices found only 42 per cent of farmers create an enterprise budget, calculating their revenues and expenses for each product. While the format of such cost-of-production (COP) budgets varies, typically they include gross revenue, direct variable expenses, indirect variable costs (i.e. fuel, labour and utilities), fixed costs and net profit.


As most farmers know, many provincial ag websites offer fill-in COP spreadsheets, making it easier to establish break-even points that can be used in marketing and buying decisions.


To assess our individual competitiveness, then, the next strategic step could be to compare our numbers against our competitors, whether they’re regional, in-province or even national. Such comparisons could then help us refine our marketing plans or uncover ways to improve production costs. 


Rarely do we take a hard look at how our cost of production compares with farmers in other parts of the world, yet this is the bottom line for competitiveness. A case can even be made that trade deals should be preferentially sought for products that Canadian farmers can grow at a competitive cost of production. 


Still, the AAFC attitude does have some justification. The competitiveness of the agriculture and agri-food sector is linked to its ability to remain viable and profitable over the long term, especially in relation to its competitors in relevant markets. 


“Long-run sales growth in domestic and international markets shows that Canada has remained relatively competitive in markets for agriculture and agri-food products,” says Julie Smith, AAFC data analyst.


Even so, Canada’s impressive export record doesn’t necessarily mean that Canadian farmers are producing commodities at a lower cost than our global competitors. It only means that someone out there is buying what we produce.


The difficulties in coming up with meaningful data on competitiveness are also compounded by the complex nature of our industry and the volume of farmers and products, including widespread variations in production systems and farm size, not to mention the endless and heavily politicized implications of food trade policy. 


Think about the spread in cost of production between different canola production systems, or between no-till Roundup Ready soybeans and conventional non-GMO soybeans. Then factor in the spread in yields and regional land costs, and it quickly becomes mind-numbingly complicated.


And that’s in a country with a developed agricultural economy and reasonable statistics. No wonder global COP comparisons have been relegated to internal comparisons and doctorate theses.


One interesting approach comes from the Institute of Farm Economics in Germany. This think-tank links up with other teams of economists spread throughout the world to gather real numbers from what they perceive to be typical farms. Under a project called Agri Benchmark, these researchers collect, compile and compare economic farm-level data for the world’s major crops and livestock. 


Yelto Zimmer, head of Agri Benchmark’s crop team, is immersed in the cold reality of global COP numbers. “The ongoing liberalization of agricultural trade policy will lead to reallocation of agricultural production worldwide,” Zimmer says.


Since 2005, Agri Benchmark has been quantifying production costs for the major production areas of globally significant crops, as well as documenting how farming is done in various regions. It has also looked at the drivers of international agricultural competitiveness, and it looks at who may be the industry leaders in the future.


For each location, Agri Benchmark creates a typical, hypothetical farm based on standardized questionnaires that explore whole-farm and enterprise data. Local experts then cross-check the results and discuss the changing technical, economic and political situation in each country.


Allowances are also made for what Zimmer coins “entrepreneurial profit” or opportunity costs, and the study also looks at valuing family labour at alternative income levels, as well as comparing family-owned land versus farms that need to make mortgage payments. 


Zimmer’s team also runs projection models of the effect of policy changes, although the group is not supposed to judge. “We provide numbers from which to navigate policy, trade deals and make management changes,” says Zimmer.


The result is a snapshot of a country based on fairly small sampling. Admittedly then, there are some pretty big holes. Not all crops in a rotation are considered, and only some regions are represented in some countries. For example, in Canada, the only place data is collected is Saskatchewan, through Richard Schoney, economist at the University of Saskatchewan.


However, this isn’t supposed to be a comprehensive COP. It’s strictly for comparisons particularly around the effects of government policy and production methods.


Based on these numbers, Canada looks pretty good. “The latest figures from Saskatchewan indicate that crop production in Canada is very, very attractive,” says Zimmer.


Still, it can be frustrating for farmers who are trying to assess whether it makes sense to pay $10,000 an acre for Ontario corn and soybean ground.


Agri Benchmark’s thick annual cash crop report looks at a wide variety of issues affecting cost of production. One of the key lessons is how much direct cost of production varies compared to revenues throughout the world.


For example, in a number of European countries on smaller farms, growers hardly cover their cash costs growing oilseeds. Farmers in these countries are most likely to continue growing rapeseed due to government payments encouraging the production of biodiesel.


For wheat, lacklustre margins have permeated the globe. Yet the differences between countries are stark, especially when you consider how government tops up revenues. (See chart Total Cost and Gross Revenue Wheat.)


The other lesson is that uncompetitive costs of production are primarily driven by operating costs, not inputs. In canola, for instance, the report puts the average operating cost at about 40 per cent of total costs, but it ranges from 60 to 20 per cent.


That’s enough to give Canada and Ukraine an advantage of close to $200 per tonne compared to the least efficient countries, where farmers’ cost of production was inflated by operating costs, production systems and size of farms, as well as by opportunity costs for labour, land and capital.


Weather still controls the bottom line in farming, especially in snapshot annual comparisons. Several areas of drought show up pretty quickly in the Agri Benchmark study because of lower yields. For example, drought-stricken western Australia and Denmark’s Funen Island were the highest per-tonne cost of production among rapeseed areas in the world in 2011. 


Size


Agri Benchmark’s original crop analysis in 2005 confirms the link between farm size and lower cost of production for oilseeds, as an “L” shaped cost curve.


Land costs


Agri Benchmark’s 2010 analysis found that Saskatchewan, Ukraine and Romania had the lowest total production costs for canola — including land — at less than $300 per tonne. 


The biggest advantage eastern European areas have is their almost non-existent cost of land. In Europe the leases are much more stable with most being seven, 12 or 18 years, and they are rarely adjusted over that time. “Rental is almost nothing there,” says Zimmer. “That gives them a competitive edge over North America.”


At the opposite extreme, says Zimmer, “Argentina has extremely transparent land markets. Basically if land goes up in value, that is transformed overnight into higher land rent.”


In the last few years Russia and Ukraine have improved their cost of production slowly. However, they also face unseen costs, like theft. “Russia and Ukraine have enormous potential to reduce cost of production,” says Zimmer. “But the current system of having large tracts of land managed under one operation has led to some inefficiencies.”


There are also some red flags for Canada. “Two regions have extraordinary higher costs of labour, Australia and Canada (the study area in Canada is only in Saskatchewan),” says Zimmer. “Both those countries have the mining industry drawing away farm labour.”


Yields


As intensive farming methods are adopted in more and more countries, global yield patterns are shifting. Technology is also impacting cost of production. For example, herbicide-resistant GM canola is grown on about 80 per cent of the acres in Western Canada where GM canola was first introduced in 1995. Coupled with no-till seeding, Canada has enjoyed this cost of production advantage over Europe for 15 years.


In other crops, however, the trend can be reversed. According to the Agri Benchmark study, for instance, Canada is near the bottom for global wheat yields. However, Canada is among the most efficient in terms of our direct per-tonne cost of production.


So, the question remains. Are we competitive? At this point, the only answer appears to be: if you’re profitable, you must be. CG



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