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Re-think the basics

An investment broker who cold-called me last month was more than a bit miffed by the time we hung up. Here’s why

During his sales pitch, the investment broker on the phone asked me what the value of land was where I farm. I told him I didn’t know.

He sounded peeved and he questioned how as a farmer I could not know the cost of land in my area. I replied that he had not asked me about the cost of land, but about the value of land, which is not the same thing. I added that I also could not tell him the cost of land because I had not created or produced any new land.

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Clearly frustrated, he said he wanted to know the price of farmland! I told him I could tell him the asking price for land listed for sale, but that was not necessarily the selling price.

Admittedly, I knew from his first question what he was seeking. But this was an unsolicited call from an “investment expert” phishing for financial information. After trying to wow me with his knowledge of economics, investments, markets, and the “sure thing” he was offering, he moved on to Step 2, trying to figure out how much equity I might have available for making an investment.

But he made the mistake of assuming I would equate price, cost, and value as the same thing. I still don’t know if this “expert” understands the differences between price, cost, and value, but his misuse of the terms gave me a valid reason for challenging his expertise, and his reaction ended any possibility that I would ever invest with him.

Since that call I have listened closely to farmers in conversation and it is astounding how frequently we substitute the terms “price of land,” “cost of land,” and “land value.” Furthermore, this confusion extends to many other things. Equipment is often defined by cost rather than price. “Commodity value” is as familiar a term as “commodity price.”

Many readers may feel it is nitpicking since “everyone” likely knows what you mean by the context you use the terms in. But do they really?

More importantly, I feel we may be missing opportunities because we are not differentiating between cost, price, and value.

Price is the easiest to define. It is the amount paid for any good or service and is usually expressed in monetary terms. In cases where payment is made by barter or even with a crypto currency, the exchange can be calculated back to a monetary value before it is accepted by the buyer and seller.

One grey area is understanding how price is established. Anyone who has taken a basic economics course will answer that in a free, open, and competitive market, price is a function of supply and demand. The supply/demand graph, where the equilibrium price is the intersection of the supply line and the demand line, has been seared into minds of many farmers. This method of price determination is an easy sell to producers who likely have grown up with auction sales and auction selling.

But I question how relevant this simple economic model is to global agriculture today. Are there actually a large number of both buyers and sellers, as are required for supply and demand price analysis? Is the demand real, or is demand skewed by speculative buying and selling? Are the global markets that we rely on truly free and open?

Perhaps the most important question that has to be asked is: Are producers of agricultural commodities rational? After all, this is a basic assumption of supply/demand price analysis.

If prices fall below the level that returns a profit, do farmers actually cut back production to reduce supply so prices will rise in order to ensure a profit, or do they produce more hoping to spread fixed costs over increased production?

While supply and demand certainly plays a role in price determination, the price we are offered for our commodities or the asking price for inputs and equipment is more likely determined by company policy.

Most importantly, no matter how price is determined, it does not mean the price is fair. Price is simply what the consumer (farmer) accepts.

While most farmers are fixated on price, costs are just as important — as we are finding out since Canada has become a high cost producer of many agricultural commodities.

Cost is the actual expense required to produce what you are selling. Cost is unique to every producer. It is a factual recording of the amount paid for the inputs used in production, plus wages, amounts assessed for use of fixed assets including land and equipment, as well as charges for management.

The cost of equipment is not the price you paid for it or the depreciation you are able to deduct on your tax return. Rather, it is an amount that reflects the difference in the worth of the equipment at the beginning of the production period compared to when the product you are producing is sold. While many grain farmers can tell you their cost of equipment each year, or even per acre, a much better calculation is equipment cost per tonne or bushel of production. After all, a grain farmer’s product is tonnes or bushels of grain, not acres of farmland.

It is only when we break down costs on the basis of actual production that we truly know the real cost of production. It is then we can actually determine the profitability of the products or commodities we are producing. Knowing the actual costs of production opens our eyes to inefficiencies in the production process that may be addressed by changing the production system. Or it may be the signal that we need to produce a different product altogether if the business is to remain viable in the future.

It is critical to know your cost of production!

Of the economic trinity of price, cost, and value, value is the most misunderstood. Yet it likely offers the most potential to business success.

Value is the worth or usefulness of a product or service to a consumer. It represents what a person is willing to give up to acquire a specific good or service.

Value is a determination based on the unique perspective and opinion of each consumer. The value placed on any item will be different for everyone. The value I see in something will be different than how you value it.

With respect to farmland, the value of a quarter of land will likely have a significantly higher value to an established farmer who would be able to square off a section by purchasing the missing fourth quarter than it would be to a person with little equity hoping to start farming. Yet an investor looking for a long-term, secure investment that will provide a minimal return by renting it out to a corporate farm operation may value that quarter even higher than the established farmer does. And the investor may be outbid by someone seeking a picturesque quarter for a hobby farm and eventual retirement retreat out in the country.

Even though the value of the land to each of the four would be significantly different, the land would be still be farmed regardless of who ends up paying the price to purchase it.

Value is not a monetary calculation but a validation every time a consumer makes a purchase. A person will only buy a product when the value they see in that product is equal to or exceeds the price.

The marketplace is full of examples where the value placed on a specific product far exceeds the market price. For example, designer labels and brands are typically priced much higher than commercial products yet consumers are willing to pay the higher price because of the value they place on that label.

Value does not represent need or importance of a good or service to a person or society. I will never forget a mid-’90s trip to a slum area in India where people were crowded in shacks built of whatever they were able to salvage, with no water or sanitary facilities. Many residents were lacking the basic necessities we take for granted, yet flat screen TVs were a common fixture in these “homes.”

Compare the difference in value placed on water, which is essential to life and a cut diamond, whose primary purpose is adornment. Today, even though most of the western world offers safe, clean, drinking water piped right into the homes, people willingly pay a premium price for bottled water which has been further filtered or treated. There are premium brands of water available at even higher prices. And now the “raw water” is being marketed. Live Water, a California company, is selling and delivering, “raw” mountain spring water for $16 for a 2.5 U.S. gallon jug (minimum four jug order with additional $22 per jug deposit) to the San Francisco and Los Angeles areas.

Consumers are willing to pay this price because they see higher value in a water the company advertises as offering: “Better oxygenation of cells, more hydration of cells and tissues, optimal transportation of minerals and nutrients throughout the body, super effective detoxification and elimination of wastes, immune system activation and support, and to reverse the aging process” according to the Live Water website.

Value plays just as big a role in our food system. Consider the organic movement, GMO labelling, natural beef, free range, chemical free, pesticide free, no antibiotics, and a host of other labels used to portray a higher value to consumers. Are these claims of additional value valid? It doesn’t matter as long as the consumer believes in the value the claim makes. Rather, it presents a sales opportunity for someone willing to supply a product which meets the consumer’s values. Does marketing go too far in pursing these values? Well, that is an entirely different issue that warrants further discussion another time. The question farmers need to be asking themselves is: What is the value of my production to the consumer?

The point of this article is that farmers focus on commodity price, which they have very little control over. They tend to ignore costs until profitability suffers. Then, rather than purse value opportunities to increase returns, they strive for even greater production of commodities which results in a race to the bottom. It is a “dollar store” mentality in a world overrun with low-priced commodities increasingly supplied by producers and countries which have lower costs of production than we do.

Instead, Canadian farmers and our agricultural industry need to look for price opportunities by targeting the consumer’s values. And to do this we will have to accept the costs of market research and development that identify and supply value-focused consumers.

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