February 3, 2012

Price Received is Not the Issue

The other day during a question-and-answer session in Rochester, MN, a producer asked another speaker and me if he should sell his grain. A similar question was raised by a dairyman at a seminar a week later who was concerned about what the milk price was going to be for the next year.

In many cases, the issue is not the price received for the agricultural output. Yes, price received is an important variable, but one needs to also examine the other side of the equation, and that is the cost of production. Some producers can be very profitable at a given price, while others are left to struggle.

In a two-day seminar just before Christmas that was designed to assist 10 family farms in developing “lite” business plans for 2012, this point was never so true. Each family developed a 2012 projected cash flow before debt service. Many used recent years’ actual results as a guide for projections. By inputting the producers’ projections on a spreadsheet and examining the projections that evening, we found some interesting variation in cost of production per hundredweight (cwt) of milk among the 10 farms.

First, the cost of production ranged from a high of $22.14 per cwt to a low of $14.84 per cwt, given the producers’ most likely scenarios. The variation from best-case to worst-case scenario on each of the dairy businesses averaged approximately $5 per cwt. When these results were posted anonymously on a flipchart the next morning, the producers reminded me of a group of students waiting on final exam grades, and wondering which result was their projection. The whole group was surprised at the variation that existed among the 10 producers, irrespective of debt.

Once these producers got their own results back, they quickly identified their bottom line cost of production, and then developed strategies, actions, and timelines to improve cost efficiencies. It was amazing how these producers focused very little on prices received for the milk, yet they were fixated on the cost of production and ways to improve their margins.

The bottom line is that business managers must first know and understand their cost of production. Once the cost is ascertained, then conducting a margin analysis can lead to the development of strategies, actions, timelines, and responsibilities.