Agricultural Production Economics

Dairy Industry Restructuring

Wind back to 2000 and 2001 and the expectation was that the formation of a mega co-op would ensure the future of New Zealand’s dairy industry.

Ten years on and questions remain as to whether the future of NZ dairying is still through a variant of Fonterra. That shouldn’t be the case after eight years of Fonterra effectively calling the shots for the industry.

The question of Fonterra’s restructuring should be put into the context of whether it will make a material difference to saving the NZ dairy industry.

That question is not being considered – rather it is being deflected by interest in redemption risk and capital restructuring. Neither of which are amongst the two most important issues facing diary farmers.

Acknowledgement

This article is as submitted - an edited version was first published in The Official Journal of the New Zealand Institute of Primary Industry Management Incorporated: Vol 13 No 3 September 2009 ISSN 1174-524X
The New Zealand Institute of Primary Industry Management's Website is: http://www.nzipim.co.nz

Prologue

In 2007 MAF policy engaged Four Cubed Limited to explore the potential from optimising resource allocation on NZ dairy farms. The assignment was the outcome of discussions over the preceding year with Treasury and MAF Policy by Four Cubed and others on subjects that could broadly be described as agricultural production economics. It was expected that the results would be published, or at least presented in an appropriate forum.

MAF circulated a draft of the results around interested government agencies and industry parties. The dairy industry hotly contested aspects of the work. No attempt was made to formally present or publish the findings, but agprodecon.org received a boost.

The passage of time reveals much. Optimising resource allocation is now entering the lexicon of the dairy industry, the 2009 Dairy Industry Strategy’s focus is on systems – systems of course being the basis of production economics, and Agresearch and Lincoln University have been jointly funded $1 million to develop LP farm models. The latter should be questioned given that the technology already exists, is NZ owned and developed, works well and is available commercially.

The following is work done for MAF Policy as it should have been published in August 2007.

The findings are still relevant today, but would be more precise if redone with current costs. A rough heuristic given increases in on-farm costs would be that farm operating surplus in 2006 from a milk solids payout of $4.24 is equivalent to that from a $5.20 payout in 2009.

Concluding analysis on NZ Agricultural Debt, June 2009

This month’s analysis should complete a picture of debt in NZ agriculture. The picture has been painted, the data is solid, and both are out in the open. Some institutions are still in denial, but that is only a matter of time.

We would like to move on and in future concentrate more on:

• a) Looking at the issue of profitability i.e. presuming debt is no longer an issue and
• b) The culture underlying both agriculture’s excessive debt and low profitability.

Profitability has been the primary objective of this site. Changing culture was not a direct objective but is critical to achieving the former, and if there is to be sustainable agriculture in NZ i.e. if we are to avoid a repeat of farming for asset gains.

Achieving profitable and/or sustainable agriculture would appear to require first understanding the availability, contestability and control of information and ideas within NZ.

Update on Fonterra's 31st January 2009 interim financial report
The Mega Co-operative Model – an evolutionary dead end?
Performance Assessment of Fonterra
Annual Financial Data from 2002 to 2008

Interim reports to January 2009
Note: When comparing a six month interim report for a seasonal agricultural industry i.e. dairying that differs from the previous report in that two mid winter months (June and July) have been removed and replaced by two mid summer ones (December and January), only balance sheet data will meaningful.

Highlights from Fonterra’s just released interim financials would therefore be:

Data Source: Fonterra Annual Reports, Interim Reports, Annual Reviews, and Statutory information provided

June Update
We earlier looked at the implications of dairy farm debt to September 2008 (further below). That work was based on a sophisticated approach estimating the present values of farms based on their profit under normal or optimised production – something a little too complicated for many to wade through. While the approach is still valid it also requires work on costs for the 2009-2010 season – something not yet completed.

This update takes a simpler approach - still using that earlier work but with updated debt figures and ignoring farm present value calculations. We provide data for a range of three market asset values and rely on the reader to select the value matching their perceptions, or to interpolate.

This article is intended to promote political and economic debate as well as provide information. It was originally inteded to be a technical paper explaining aspects of production intensification in pastoral agriculture. It now provides a less detached but more pointed analysis of the changing nature and risks of high intensity dairy production under conditions of uncertain payout.

The Marginal Cow – Part I (TMC I) stressed maximizing operating surpluses by producing to the point where marginal cost equaled marginal revenue (MC=MR). This is the point of allocative efficiency – the right level of resources being used to provide the maximum operating surplus. TMC II is not about moving along a production function to the point where MC=MR, but looking at different production functions – presumably still with the intention of setting production to MC=MR.

The world for the most part uses economics that dictate that for a business income is maximized at the point where marginal cost (MC) equals marginal revenue (MR). The logic behind this is simple: for a given business system (firm or farm) production is increased until the next unit of output will return less than the additional cost of the inputs i.e. increasing production further loses money.