Ask any farmer what the number-one problem is in agriculture and they will likely reply: “Low prices.” But is it really the low commodity prices or is it high costs which have led to the income crisis that the industry has been mired in for more than a generation?
Many farmers equate productivity with profitability. After all, it’s a strategy that used to work. For decades, growers relied on boosting their output to mitigate low prices. Economics of scale and increased efficiencies enabled farmers to compensate for prices trending lower.
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But that also meant a lot more inputs, and now, top farm managers, researchers and even farm lenders realize that farmers can no longer simply produce their way to profitability. Cost management is critical.
Not everybody is on board, as the case of Brent Rendel shows.
Rendel farms at Miami, Oklahoma and six years ago he introduced a new nitrogen management system on his farm to reduce his fertilizer bill. “I was approached by researchers at the University of Oklahoma who asked me to field test a new fertilizermanagement program,” Rendel recalls. “I was really skeptical when they told me not to apply the rates of fertilizer I traditionally applied and which soil tests indicated I needed. Yet the yield on those 120 acres of wheat which I reduced fertilizer rates on was a bushel above my 2,000-acre average.”
Rendel reports he now averages $10 to $15 more net profit per acre because of this new fertilizermanagement system. “By better management of my N, I have slightly lower yields but also lower costs which results in a higher profit,” Rendel says, and then adds: “I live on profit, not yield!”
Yet even though this additional profit is easy for any farmer to capture, few farmers are not adopting the new system, Rendel says. “It is so hard to shift farmers into a new mode of thinking. But the key to profitability is to concentrate on profit per acre versus yield per acre.”
FOCUS ON COST
“Farmers need to worry about costs,” says Fabio Mattos, a behavioural economist at University of Manitoba. “It is likely easier to protect profits by managing costs than by trying to maximize production and prices.”
Mattos agrees it takes an attitude shift. Part of the problem is overconfidence by farmers in their ability to maximize yields, he says. There’s also a natural tendency for farmers to overestimate future prices and to underestimate price volatility and the risk that prices will fall.
“There tends to be overconfidence in decisions,” Mattos says. “People tend to overweigh small possibilities and underweigh large possibilities.
Farmers are also under continual pressure from the ag industry to invest in new products and to increase applications of crop inputs. Use of new seed varieties, new pesticides, seed inoculants, soil additives, and a host of other products are all being promoted on promises of increased production and efficiency. But are farmers actually seeing an improved bottom line from increasing inputs and the use of the newest technology?
European agriculture relies on a very high-input regime and for the past 11 years this high-input practice has been analyzed by the Irish agricultural research organization Teagasc. In a report “Can we Reduce Costs and Increase Profits,” Dermont Forristal, acting head of the crop science department reports that over the long term, Irish winter wheat growers can actually realize greater profits by using a low-input system instead of trying to maximize yields through high inputs. By contrast, in spring barley over the 11-year period, Forristal found a high-input regime yielded the best profit.
Forristal reminds readers that Irish input use is much higher than in most of North America. “Up to three applications of fungicide are made each year due to the climatic conditions and disease pressure, so a direct correlation of our research to Canada is not possible.” However, he asserts farmers everywhere need to find the optimal balance between costs and production. This cost optimization is difficult to determine due to variability of growing conditions but unless growers know and track production and actual costs each year, they have no way of determining the cost balance for optimum profitability.
Forristal did reach two conclusions that may be transferable here. First, he says, “Cost control is vital, particularly in low price years or when there is volatility with input prices lagging behind cereal prices.”
Second, says Forristal, “A low input system is probably the better insurance-type policy in volatile markets. It is certainly the most profitable when input costs are fairly high and when grain prices are low.
“The year after a ‘good’ grain price year is the one to go for low inputs,” Forristal adds. “2008 was good for low inputs and if I were a betting man, 2011 might be too.”
PUT OFF THAT NEW TRACTOR?
“Costs are now foremost on most farmers’ minds,” says Brian Lemon, Bank of Montreal commercial business area manager for Manitoba. “Farmers have to know what their costs of production are. Farmers are trying to deal with possible cost increases with strategies like buying in advance and bulk buying. However, these are only short-term strategies. Farmers also need to consider equipment, labour and land costs.”
Lemon says farmers need to look at costs on a mid-term and long-term basis, not just in the short term. They have to make sure future debt-servicing obligations will be met.
Managing costs doesn’t mean simply putting off purchases of capital assets, Lemon says. A new capital asset may be more efficient and economical, thereby reducing costs over the longer term. He suggests farmers should be sitting down with their financial adviser and closely examining their costs.
Lemon suggests farmers should also be looking at their current management practices to critically determine if there is a different way of doing things which will reduce costs.
A TONNE OF COST ANALYSIS
How costs are analyzed is especially important. Most farmers know their cost per acre, but from a management standpoint, Kansas State University economist Kevin Dhuyvetter says it is important for growers to relate costs to units of production. For grain farmers this means cost per bushel. “Growers need to minimize their costs per bushel of grains produced,” Dhuyvetter says.
Studies show that farmers’ costs per bushel vary widely. A 1998 USDA study found the average cost of wheat produced to be $3.47 that year. However costs ranged from $1.25 per bushel all the way to $6 per bushel.
A Kansas Farm Management Association survey of farm costs from 2004 to 2008 reveals the cost of producing a bushel of wheat ranged from under $3 to over $10 on the surveyed farms. While the average cost per bushel of wheat produced in this period was $4.81 per bushel, the top-third managers had an average cost of $3.88 per bushel. On the other hand, the average of the bottom-third producers was over $2 a bushel higher at $5.95 per bushel.
With this wide a cost spread, is it actually prices that have led to the farm income crisis or are costs the real problem?
Since many grain and oilseed markets are global, we not only have to compare our costs with our next-door neighbour but also with farmers around the world. After all, grain producers are price takers and prices received are not based on cost of production, but on the lowest price growers are willing to sell at. And that includes growers in all major production areas around the world.
In the paper “A Comparative Marketing Analysis of Major Agricultural Products in the United States and Argentina,” author Sergio Lence compares the production costs of wheat, corn, and cattle feeding in Argentina and the U.S.
Unfortunately for North American producers, in 2000 Argentina’s cost of production for wheat was 81 cents per bushel lower than for their Kansas competitors. Corn costs were 32 cents per bushel lower than for Iowa producers, and it cost Argentine cattle feeders $8.89 per cwt less than high plain U.S. ranchers to feed cattle. According to David Coltrain, a Kansas extension agent, cost control is all about taking control of what you have the power to control. North America growers have limited control over production due to climate, Coltrain points out, and they can have even less control over world prices.
Profitability starts with controlling costs, Coltrain says. “Only low-cost and efficient producers will be able to survive and compete in production agriculture.”CG
