http://www.nzipim.co.nz [1]
Comments on this article can be made by any athenticated user. Contents [1]
http://www.treasury.govt.nz/publications/research-policy/wp/2006/06-01 [2]
An advanced ability to filter out information we don’t want to know should perhaps be added high on our list of issues to address. Together with a tax system that distorts investment decisions and principal-agency problems (managerial capitalism).
http://www.agprodecon.org/node/99 [3]
The concepts contained within that paper, and they go far beyond correct stocking rate, are now critical. With the low payout expected for the current season, knowledge of that work and its application will be the difference between some farms surviving or not.
The concept of producing to where marginal cost equals marginal revenue is still poorly understood in agriculture. This blind spot is the cause of poor farm financial performance, and also for high externalities.
Concepts of marginal costs and revenue must predominate over the current mantra of more production and holding external factors such as markets, exchange rates, tariffs or subsidies responsible for poor on farm profit performance.
Every accountant, farm consultant, banker, land agent and most importantly each farmer needs at least to understand what their marginal costs look like.
The two graphs that follow are from the link above and should be considered as illustrating concepts. The data represented by the graphs is modeled with cows fed optimally and was precise for 2006, but we are now in 2009 and I don’t want specific detail to distract from the concepts being illustrated. In 2006 this farm typically had a herd size exceeding 300 cows. Reducing its herd size would have improved the farm’s operating surplus.
Figure 9. Marginal Operating surplus per Cow.
Marginal operating surplus per cow is the amount each additional cow in the herd individually contributes to farm operating surplus. Figure 9 shows that contribution switching from a positive contribution of $400 per cow to a negative impact of in excess of $400 per cow over a change in herd size of ten cows. Who wants to milk additional cows when each of them is costing $400, $600 or $800 in farm operating surplus? The correct herd size matters. The point to take is that in pastoral farming marginal operating surplus can change quickly and dramatically.
The correspondence of the switch from a positive contribution to operating surplus to a negative contribution with the introduction of purchased maize silage is no coincidence. It is pure cause and effect. Each additional cow makes a negative contribution to farm operating surplus. This conclusion is clear and precise for the combination of revenue and costs illustrated.
An alternative with even more drastic impacts on operating surplus is adding cows without also providing optimal levels of dry matter to feed them.
For the technically inclined, substitution of dry matter between silage made and pasture feed in situ moderates the negative impact on operating surplus of additional cows until such time as silage is no longer being made. Then the full negative impact of feeding additional cows is seen.
The second graph is for exactly the same farm, costs and production but presented in a different form i.e. in terms of costs per unit of production but also showing average costs, average revenue and farm operating surplus.
Figure 10. Marginal Operating Costs per Cow.
In Figure 10 operating surplus is maximized where marginal revenue equals marginal costs (MC=MR). Payout is a good proxy for marginal revenue. Therefore, at a $5.50 payout, operating surplus should be maximized where marginal cost equals $5.50 per Kg of milk solids. True. Average cost and revenue are changing, but neither can provide a clear indication of the level of production to maximize operating surplus. Beware averages!
Anyone advising dairy production who is not aware of, or who does not understand, the implications of producing beyond the point where marginal cost equals marginal revenue will be to some extent derelict in their duty.
Levels of debt for individual farms provide stark contrasts. It is clear from RBNZ data on the distribution of dairy farm debt that many farms have little or no debt while others have levels of debt that can never be repaid. The data is though complicated by sharemilking properties having two potential sources of debt – the farm owner and the sharemilker.
Figure 11. Average Debt per Production Debt Quintile.
The lines in Figure 11 plot quintile averages, and as such there will be considerable individual farm variation about them especially for the higher debt quintiles. Irrespective, the data is a stark illustration of the problem some dairy farms have with debt, and how the problem is compounding.
Those attempting to farm with debt levels in Quintile5 have almost certainly passed the point of no return. Debt levels are such that they can’t be serviced at any foreseeable combination of payout and interest rates meaning debt will only increase. In many cases the debt will need to be repudiated.
Debt should not be an issue for farms with debt in Quintiles 1 and 2 but access to new finance may be restricted and more costly than it would otherwise have been due to the finance industry’s current adverse attitude towards agriculture.
Prospects for farms with debt in Quintiles 3 and 4 will depend on the level of debt, the ownership structure, other sources of equity or income, and managerial ability in terms of maximizing the operating surplus that can be generated.
Risk Management
Risk management is not something that can be done after the event. The key times to have considered the risks to New Zealand agriculture were: First, during the Douglas/Treasury reforms of the 1980’s; Second, at the time the dairy industry moved to the mega co-op model and: Last, after it was made clear to first Treasury then MAF in 2006 and 2007 that agriculture’s dependence for viability on inflating asset values could not be sustained.
Farms:
Despite it being too late in some cases to save farms, individuals can, and perhaps should:
1. Work towards acceptance of a very different environment from the past. In some cases responsibility for the situation a business finds itself in is personal. In others farmers have been badly misled - sometimes by systemic failures of their industry. Questions should be asked. There are two opposed perspectives on agriculture. Only one is right – sorting that out sooner rather than later is essential
2. Get involved. Attempt to bring about the industry changes below
3. Engage production economics - that will provide your best chance of a viable farm operation. Most importantly increased profitability will be reflected several fold in farm asset valuations
4. Be wary of the status quo being rehashed as change e.g. merged or renamed institutions with the same school of people in control.
Industry:
Industry entoto is in much the same state as individual farmers, but with much greater need of fundamental change. While farmers individually are reasonably smart, their delegated decisions often are not:
1. Turn the industry ethos (production, privilege, and paying professionals to do their thinking) upside down. The main pillars of that ethos are Agresearch, DairyNZ and Fonterra.
2. NZ agriculture will not remain viable for long if any of the three pillars continue in any way recognisable as their current form. Central to reform will be changes to leadership.
3. Regulators, research and research funding are problems far bigger than agriculture, but possibly equally or more in need of drastic restructuring. In these cases there are though far more stakeholders involved.
4. Demand industry costs are reduced.
Individuals not farmers:
1. Wise up on production economics – otherwise you will remain part of the problem
2. Reflect before choosing one side of the fence
3. Question, analyse and challenge the existing ethos
4. Take care what you are seen to put your name to
Political and cultural leaders need to decide where they draw the line between their constituents and defending existing privilege. The latter, and especially any socialisation of private debt, will likely be judged harshly if not necessarily immediately.