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Beyond commodity agriculture: Business decisions for your farm

AME Management: Whatever approach you take, the aim should be to improve your bottom line

When commodity prices are on their way to finding a bottom, many producers look to change their business model away from commodity crop and livestock production. While this is not a new phenomenon, it is becoming a more important strategy as the traditional commodity strategy — i.e. to increase scale — becomes harder to execute.

We can examine the crux of this phenomenon with a very simple income statement. The top line is revenues, basically price x tons. The bottom line is profit. The middle line is expenses, made up of fixed and variable costs.

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Traditional commodity strategy has been to increase the top line by increasing tons of output by adding hectares or animal units. This strategy works if the expense line doesn’t rise as fast as the top line. We all know producers who paid too much for that additional land parcel, so that the middle line grew faster than the top line. And the bottom line declined.

The allure of a post-commodity business strategy is to increase the top line by securing a price per unit sold that surpasses the prevailing commodity price. The middle line is muddier, but most strategies require a lower capital budget for production, though it may be offset in part by additional marketing expenses (more on this below). In any case, the firm seeks a higher bottom line driven by superior prices.

Where do these superior prices come from? There is some confusion of terms, notably around “value-added agriculture.” Often, this phrase really denotes high-valued alternative crops and not adding value to crops and livestock at, or just after, the farm gate. (Think growing Montreal melons versus doing custom butchering for direct-to-consumer sales.)

I wish to lay out the decisions on a new business model by posing three questions:

First, do you wish to move to specialty crops or livestock?

Second, do you wish to do any value-adding activities with your on-farm production?

Third, will you sell directly to consumers (DTC) or restaurants (DTR), or will you use an intermediary?

We will take these in order. Much of the new wave of crop and livestock production turn on the use of specialty genetics for value creation. Heritage breeds in cattle, pork and poultry are the darlings of white tablecloth and farm-to-table restaurants. Farm names and breed names are front and centre on the menus.

Consumers who buy directly or through specialty intermediaries look for origin and breed names. The heritage seed industry used to serve the home gardener market. Now it supplies commercial producers who sell into specialty retail and restaurant markets.

The effect on the top line is significant. DTC and DTR markets are much less price sensitive than commodity markets. (If you took your undergraduate ag economics class from Larry Martin, he called them price-inelastic.) The downside is that if you choose this strategy, you need to establish new norms for yields. You need to have customers lined up before you start production, as you want minimal marketing costs at harvest. Plus you need to tout the specific attributes of your specialty genetics — no more one-size-fits-all commodity approach.

As to the second question, do you wish to do any on-farm processing? It may consist of grading and sorting, chilling, or other non-destructive processes. You may wish to do small-scale grinding and milling of specialty grains if you serve the home or local bakers’ markets or if you are selling to the granola crowd. (That’s how Bob’s Red Mill started.) If you are raising livestock, will you kill and process on-farm? If yes, will you have on-premise retail or will you deliver?

At this juncture, you may feel better answering this question if you share the processing with a small number of producers located near you. Don’t start big. Every provincial-scale meat processing facility I have seen in recent years has failed, often more than once. Like it or not, that is part of the commodity meat industry — with really poor economies of scale!

Across the U.S., there are a large number of small meat lockers that have thrived by cutting specialty meats, often acting as shippers to consumers and restaurants on behalf of a half-dozen livestock farms. The logic for specialty grains is comparable. The jump from small mills to regional mills requires a significant increase in equipment capacity and the consequent need for constant throughput to maintain profitability per ton.

The third question is all about your willingness to give up the comfortable anonymity of commodity sales and engage directly or indirectly with customers. The extreme case is when your customers come to your farm to make purchases. Congratulations! You are in the hospitality industry!

I do not overstate it if I say your new business model is closer to Disneyland than to the commodity business. A significant portion of your time must be reallocated from fields, paddocks and barns to personal selling. It’s hard on introverts. And you need new liability insurance, new metrics for measuring success and (probably) a new relationship with your lender.

If you sell DTC off-farm, you will have to deliver. The same is true of DTR sales. And suddenly, you are working to their schedules and their specifications. If you do those things well and graciously, you can have all the market share you want.

Finally, let us consider a less direct connection to the end user: an intermediary, who will collect product from several farms, do any requisite processing, and make the deliveries — locally or across Canada. This model is really growing in the States. Typically, a farmers market, a family-owned meat plant or a restaurant supplier will expand its scope of business by taking on the intermediary role.

They benefit from having a broader or more specialized product mix. They can offer the “farm story” — how you and other growers produce high-quality products that they will deliver with care to their valued customers. These generic intermediaries are called food hubs. They will help solve the biggest problem with DTC and DTR marketing in Canada: distance.

All the strategies I have introduced above are clearly about increasing the top line. The individual grower will match up the farm’s human, physical and financial resources to pick a single or mixed strategy from this smorgasbord to manage the middle line. All of this with an eye on the bottom line.

Randall Westgren of the University of Missouri is a faculty member of Agri-Food Management Excellence, which runs the Canadian Total Excellence in Agricultural Management (CTEAM) program.

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