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The Secret To Farm Profits

On a typical grain farm, management , l ike labour and cash, is a limited resource. There is only so much time and energy to devote to running the business, no matter how passionate you are about farming.

So where does management get the greatest bang for its buck? Where should managers focus their efforts to ensure that their farm businesses stay ahead of the pack in terms of profitability and efficiency?

This is a topic that Kevin Dhuyvetter of the department of agricultural economics at Kansas State University (KSU) has studied extensively. He presented some of his findings at the 2010 Manitoba Agronomists’ Conference that was held at the University of Manitoba in early December.

For a ten-year period between 1999 and 2008, researchers from KSU worked with over 700 grain farmers enrolled in the Kansas Farm Management Association. As expected, they found significant differences in the profitability of the farm businesses they studied. What may be more surprising, however, are the reasons they found for the variation in profitability and the advice they have for managers, based on this research.

Farmers were surveyed for things like profit, average costs per acre, yield, price, the adoption of technology (use of herbicides versus tillage), rent (percentage of acres rented versus owned), government payments received and size.

ECONOMIES OF SCALE

Dhuyvetter and his colleagues then looked at how being in the top-third of each of these categories affected the profitability of farms. The factor that had the largest impact on profits was farm size. Operations in the top-third for farm size achieved profits that were $26.09 per acre higher than the average. When compared to results from earlier 10-year periods, this spread has grown, suggesting that the economies of size advantages are increasing over time.

COST OF PRODUCTION

The factor with the second greatest impact was cost of production. Farms with lower costs of production were $20.51 per acre more profitable than the average. Next in line were planting intensity (which measures reliance on fallow in Western Kansas), technology and rent at $16.86, $11.51 and $9.63 per acre respectively.

PRICE AND YIELD

The two factors with the least effect on per acre profits were price and yield. The impact of higher prices was still significant at $8.57 per acre, while yield came in at $4.25. So while farm managers in the top-third of the group for price and yield did make more money on average, a high standing in the other traits (size, cost, etc.) was far more advantageous.

Then the persistence of these various management traits was measured. Persistence refers to the extent to which something can be reproduced year after year. For example, farm size can be expected to be a persistent management trait: a farm that is larger or smaller than average will typically continue to be so from one year to the next. A rapid increase or loss of acres can occur but this is the exception and not the rule. From a management perspective, the idea of persistence is important because it means that the manager can reliably count on this factor to contribute to profitability. The opposite of this is something that is random, that is unpredictable, that can happen one year but not the next.

Dhuyvetter found, in his work with Kansas farmers, that farm size was indeed a very persistent management trait. Over the 10-year period, 88.2 per cent of farms were consistently either larger or smaller than the average. Other persistent traits were the percentage of rented versus owned land, planting intensity (that is, the use of continuous cropping versus fallow) and cost of production (61.6 per cent of farms consistently had costs of production that either exceeded or were less than the average). At the other end of the scale was price. Its persistence rating was only 21.2 per cent. This means that the vast majority of farmers in the Kansas study did not consistently get better or worse prices than their peers. For the most part, their performance on the pricing front was random, sometimes better but sometimes worse than average.

FOCUS ON LAND BASE, COSTS

Based on this research, Dhuyvetter arrived at some important conclusions for farm managers, especially in the context of today’s volatile markets and the ever-increasing amounts of information with which they are expected to deal. As he states in the paper presented at the Manitoba Agronomists’ Conference “producers should focus their management efforts in areas that are more persistent”. These are things like farm size, land tenure and cost of production. Picking the best price over the course of the year is good but the chances of pulling it off year after year are slim. With hindsight, a manager can always see where crops could have been priced at higher levels but in real time — as events unfold — it is not something that farm managers can do consistently. So while prices certainly affect profit in the short-term, they are not as important, over the long-haul, “as capturing benefits associated with economies of size, controlling costs and adopting technology as ways to improve profitability.”

Derek Brewin, who teaches in the department of agribusiness and agricultural economics at U of M, agrees with the research Dhuyvetter and his colleagues have done at KSU. He says that it makes sense for managers to focus on what they can control like costs and adoption of technology.

“Farmer managers have to deal with a lot of events over which they have no control,” Brewin says. “They try to take some of the randomness of prices and production away through the use of things

like price contracts and insurance. But there is no way to eliminate it completely.”

A CANADIAN EXAMPLE

As well, he says that Dhuyvetter’s research is very much in line with a study that was done on wheat farming in Saskatchewan in the 1980s and 90s. Konstantinos Giannakas from the University of Nebraska — Lincoln, along with Richard Schoney from the University of Saskatchewan and another visiting scholar from Greece published a paper entitled “The Technical Efficiency, Technological Change and Output

Growth of Wheat Farms in Saskatchewan” found that farm efficiency was positively related to things like how specialized the farm was, its participation in ongoing extension training, its use of variable inputs, its investment in machinery capital and the level of farm debts (operations with higher debt loads tended to be more efficient). This particular study found no positive relationship between farm size and efficiency although the authors did note there would be many arguments in support of some link between the two.

A QUARTER-MILLION DOLLAR DIFFERENCE

Dhuyvetter and his colleagues at KSU also drilled down into enterprise budgets to get a better sense of how management can affect financial outcomes. Once again, they found there is a considerable difference between the results achieved by managers in the top-third of farms, from the standpoint of return to management, and those ranked in the bottom-third. For wheat, the difference was $126.28 per acre; for non-irrigated corn, it was $140.72 per acre; and for soybeans, it was just a little bit more at $141.18.

These are huge amounts. On a 2,000-acre farm, this represents an annual difference of over $250,000!

Once again, price differentials have a pretty minor role to play here. In the case of wheat, for example, the price advantage for the top one-third of farms was $.29 per bushel. This is a significant premium but overall, it only accounts for about 10 per cent of the greater return that top farms enjoy.

Now let’s look at yields. For wheat, on average, they are about 7.5 bushels per acre more for the top-third of farms compared to the bottom-third, good for about 34 per cent of the added returns.

The biggest difference, however, comes in the area of costs. Wheat production costs for the top-third of farms come in at a whopping $74.59 per acre less than for the bottom-third. Of this amount, lower machinery costs (fuel, repairs, interest and depreciation) account for $30.52 and fertilizer for $15.32. As a result, lower production costs for wheat make up more than half of the per acre advantage for top farms. Results for soybeans and corn are similar, although not quite as striking as in wheat.

The secret of the most profitable farms, it would seem then, is finding a way to keep costs down without sacrificing production. On the contrary, they seem to produce above-average crops while spending up to 50 per cent less than some of their counterparts. They get more for their crops as well but the price advantage is much smaller, relative to the effect of yields and especially costs.

So what can Prairie grain producers take from this important research on what drives profitability? “Focusing management efforts on ‘picking prices,’” as the summary to Kevin Dhuyvetter’s paper states, “does not seem to be a wise use of limited management time or resources. Rather producers should focus their efforts on those areas that impact profitability and are persistent. Over time, differences in profitability are driven principally by cost and yield differences, with cost being the most important of the two.”

For a copy of the paper that Kevin Dhuyvetter gave at the Manitoba Agronomists Conference, please go to:

http://www.agmanager. info/ crops/prodecon/production/ default. asp

The slides that he presented are available at:

http://www.agmanager. info/ Faculty/dhuyvetter/presentations/ default. asp

RhealCeneriniwritesfromLaSalle,Man.

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The most profitable farms seem to produce above-average crops while spending up to 50 per cent less than their less profitable counterparts

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