Keith Woodford finds no silver bullet on how to make the right choices in the cost control battle - but he does find 'lots of little things' will give cost efficiency

Keith Woodford finds no silver bullet on how to make the right choices in the cost control battle - but he does find 'lots of little things' will give cost efficiency

By Keith Woodford*

The key dairy priority at the moment, which stands above all else, is to minimise the number of New Zealand dairy farmers who will succumb to the current downturn. In particular, we all need to try and limit the damage to the latest generation of younger farmers who are often the most indebted.

It is all about getting the cost of production under control. 

I have previously written about survival strategies and the need for each farm and farmer to chart his or her own path.  I have also tried to caution against panicking and making big system changes when in a crisis.   More particularly, I have tried to emphasise that hungry cows always kick their owners in the back pocket. Also, I regularly try and remind people that cost of production has both a numerator (which is cost) and a denominator (which is production).

Factoring in El Nino

We have been fortunate this year that drought predictions were wrong.  The El Nino has been real, with high water temperatures throughout the tropics and a strongly negative Southern Oscillation index (SOI). But the dominant mantra, that this would cause drought here in New Zealand, was always overworked.   The reality is that both climate and climate change remain full of puzzles.

Fortunately, the false predictions of drought have done little damage to most farmers.  And being ready for a drought that does not come is much better than the reverse.

One of the current positives is that cows on most farms are going into the autumn in good condition. Given the dairy farm economics, this is a huge plus, and I have no doubt it has prevented many farmers making some bad decisions around the need to keep the feed up to the cows.

Right now, we are still not free of the El Nino.  The tropical sea temperatures appear to be in decline and it is likely that this decline will gain momentum in coming weeks. But the SOI is still strongly negative – indeed it has been plummeting further in recent weeks – and so the outlook for late autumn rains remains uncertain.  Either way, there are big decisions ahead.

Targeting $3.50 for farm working expenses

In the last two weeks I have been fortunate to talk with many farmers, most of whom have their budgets under control for the coming year. I have spoken to farmers from Northland to Southland, and from low input to high input.

Independent of either geography or farming system, there is a lead group of farmers who have their farm working expenses down at about $3.50 per kg milksolids.  And this is the basis for confidence going forwards.  However, this lead group is apparently in a minority.

Farm working expenses of about $3.50 per kg milksolids is a good target for everyone.  Anything over $4 needs particularly close scrutiny, unless it is buttressed by winter milking or other price premiums.

Interest rate margins

These same lead farmers who have their working expenses under control also have their banks ‘on side’, and they are paying interest rates of typically between 4.5% and 4.75%.   A few of them are paying slightly more than this, but only a little, and their costs will come down as they come to the end of longer term loans.

And there lies the first point. Any farmers currently paying an interest rate of much more than 5% needs to realise that they are paying considerable risk margins to their bank.  It might be time for a little talk with the bank.

That talk may or may not lead to a shaving of margins, but at the very least it will confirm where the bank has positioned the farmer within its dairy risk profile.   If the interest rate is high, then the bank is nervous.

DairyNZ exemplar farms

While pondering on the challenges of getting farm working expenses down to about $3.50 per kg milksolids, I came across an excellent DairyNZ website where they are documenting the income and expenses of nine New Zealand dairy farms, with a particular focus on farm working expenses. As with the farmers that I have been talking to, these farms range from Northland to Southland, and from System 2 (low intensity) to System 5 (high intensity).

The DairyNZ exemplar farm budgets have been updated in February, and all except possibly one, which has faced difficult seasonal conditions, remain on target to keep their farm working expenses under $3.50.

First some clarification for those who are not used to monitoring farm finances. The farm working expenses (FWE) include all cash outlays associated with running the farm. That includes feed, labour, animal health, repairs and maintenance, plus all the fixed costs such as rates and insurances. It does not include depreciation, which is important in the long term, but largely irrelevant when facing a cash crisis.

I wanted to see whether I could see any relationship between cash cost of production and the system of farming. More specifically, I wanted to see if there was evidence that the farms with low feed costs ended up with a lower cost of production.

The simple answer was that amongst these exemplar farms there was no evidence that low input farms end up with lower costs of production.  The Bay of Plenty System 2 farm had, on paper, the lowest farm working expenses, but this was because of minimal labour expenses, with farm drawings for the living of the owners not included. The Taranaki System 2 farm came out at the higher end relative to other exemplar farms once drawings were included.  Most of the other farms already had these drawings included as salaries.

The South Waikato System 5 farm had the highest feed costs at $1.95 per kg milksolids but still came out with only $3.30 per kg milksolids for overall farm working expenses. This was primarily because the high production diluted all the other costs, including labour. Also, with 40% of feed being purchased, there was minimal need for fertiliser. 

Once figures were converted to a cash operating surplus per hectare, the System 3 and 4 farms came to the fore, followed by the System 5.  These farms had considerably greater capacity to pay interest on their debt than the lower input farms. However, all of the farms appear to have enough debt paying capacity over the next year to keep their bankers comfortable.

Per cow production

All but one of these exemplar farms has above average production per cow relative to the region and system. The Bay of Plenty and Taranaki farms were each producing 385kg per cow. The Northland farm was over 400kg. The South Island System 3, 4 and 5 farms were all well above 400 kg, with most in the high 400s and through to mid 500s. Production was typically more than 90% of liveweight, which is an important measure of efficiency on these more intensive farms.

High production per cow, relative to district and farming system averages, was something I noticed time and again over the years when judging the best performing farms for the Redsky and Intelact Farm Business of the Year competitions.  These same top-performing businesses, measured primarily by return on capital, were also characterised by a low cost of production as a direct outcome of the denominator effect. 

My point in bringing out these issues is not to argue for any specific system. I have seen plenty of evidence over the years that a low cost of production is achievable within all systems. It is what one does within the system that is important. Good use of pasture is always important. Also, good per cow production is achieved by many factors in addition to feed.

Getting ready for next year

In general, these DairyNZ exemplar farms plan little change next year. Quite simply, they don’t need to change. However, looking more broadly across New Zealand dairy farms, it is clear that many farmers are reducing cow numbers for next season. My best guess is that numbers will be down at least 6% on this year, which in turn are some 6% to 10% down on last year.

If less cows leads to better production per cow, then I have no argument with that. Also, with beef prices high, those culls cows do bring in ready cash.  But farmers need to be careful of the denominator effect. If production declines, it is not only the fixed costs within the working expenses that have to be spread over less production. There is also the same debt to service with less kg of milksolids.

All of the DairyNZ exemplar farmers deserve praise for being willing to put their numbers in the public domain. It is not easy in these times to be so forthcoming.  Regardless of farming system and region, they are setting targets for others to aspire to.

In trying to emulate these lead farmers, there is no one big decision that will make the difference. Rather, it is lots of little things that all add up to give cost efficiency. And that is what makes it so challenging.


Keith Woodford is Honorary Professor of Agri-Food Systems at Lincoln University. He combines this with project and consulting work in agri-food systems. His archived writings are available at http://keithwoodford.wordpress.com

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23 Comments

Hi Keith, interesting article. My comment over these costs per kgms is this. A budget is just a budget. Many will be unrealistic. We all get awfully optimistic at times doing the forecast cashflow. And when under pressure from a bank those figures are twisted and tortured into a place they will never get to. Currently the latest boast from dairy farmers is how low their cost of production can be made. Figures are thrown around like a pitbull with a frisbee. I live by my excel cashflow budget, but it is very hard to get it to stay true. The meat schedule is never a sane beast to predict. So no matter what, constant updating of income and expense and forward budgeting beats a one off budget or guesstimate.

Too true Belle, I lease to 2 dairy farmers, both have diggers, one can afford to put new tracks on his digger
the other one cant. The digger that needs to be going the most to put in the new settling pond for may 31
is not moving....

Did you read Louise Giltraps latest two articles in the feds Nz Farmer mag? I like her articles but my sympathies fell quite flat recently. Two things , the confession interest costs them $2/kg and the refusal to do up to date cashflows. Just claiming you work hard and spend as little as possible doesnt cut it in business. And it doesnt cut it when you owe that much money. Head in sand.

Beyond choices toward wellness.

One of my farmers is going backwards fast, weeds everywhere stock through fences, no drains fenced,
he expanded big time, result big shed on small farm and leases most of his land off me. Alot of people in
Their 50's ger arrogant and believe their own bulls@@t and take on long term debt and lease....!

We read and hear about costs and how difficult life can be down on the farm, but I have never ever seen any costs detailed on here

What I would like to see is a few examples of what the "variable" costs are for a typical dairy farm - excluding fixed costs such as interest and any other debt financing costs. I want to see what the revenue is less variable costs leading to "gross profit" per unit before fixed and administration costs

Shouldn't be too hard - do it on a per kg basis

Keith Woodford refers to "Farm Working Expenses" of $3.50 per kg
What makes up those expenses?

It's not secret men's business is it?

About 2 years ago Cowboy stated his variable on farm production costs were $2 per kg before lease costs and overheads. He didn't provide a breakdown of those costs.

iconoclast: Here's where you can find the actual breakdown of expenses of the DairyNZ farm budget case studies. Have to take your hat off to these folks to go public with their finances.
http://www.dairynz.co.nz/farm/financial/budgets/budget-case-studies/

Thanks CO - exactly what I was looking for

Examined System 2, Bay Of Plenty, stripped out a couple of overheads, and the on-farm production costs come to just over $2.00 per kg

I selected that farm as it was the smaller of the bunch - will examine the others tonight

.

Regardless of the size of the operation, if your variable costs exceed your revenue (per unit) you have a farm problem. If the gross profit contribution from operations does not cover your "fixed costs" (overheads) then you don't have a farm problem, you have a business model problem

Not really a secret iconoclast, the better managed the farm the less variable costs, if you dont constantly
upgrade and maintain one day everything will crap itself....I think it takes less than 3 months of
deferred maintenance before it starts to hurt production wise?

I read an article by Barrie Riddler somewhere yesterday. He reminded us all how a lot of costs arent appointed to an excercise when they should be. Take the South Waikato farm above. Is the large tractor required factored in. Not only the cost and msintenance, but the larger implements to be attached. Then a large tractor leaves a large mark. (Any damn tractor makes a goddam mess) So you add in the not insignificant cost of redoing races and tracks. Then you feed extra cows, milk extra cows need more labour etc etc. These so called systems and $/kg ms have to be carefully budgeted. All I am sure the farmers know, but from my own experience you believe what you want to believe so you can do what you fancy doing. Times like this what you fancy doing needs to go out the window.

Yes, exactly, people buy 20 tonne diggers because they are cheaper than a 12 tonne one.They trash
Bridges and fords and dont like being walked around all over the shop! Then the tracks start coming off!!

Ah No Helmet I love your moniker...You can call me Belle no helmet....um speaking of diggers I know a great young contractor fellow who bemoans the fact that farmers everywhere like to buy their own digger. They fart around and make a big mess then call him in to ASK how to fix it. He grimly told me he tells them to sell their digger and hire the expert. Just checking out Shaggers post from Southland -9.9% growth. My young Southland contractor friend has had an awful lot of work cancelled over the last 6 months. They had a lot pencilled in and bought machinery to do the work. Now little to do. Remember that chch rebuild. I reckoned the NZ dairy experiment was at least 100 times that. So now what....

Couldn't agree more, I recently had my local digger driver out here for a few days tidying some things up and I think getting a professional in is well worth the cost because of the huge output and great finish they can achieve.
It made even more sense when he accidentally slid it down a hill and just managed to save it before it went over the bank and into the river, farms can be an extreme environment for diggers and are really not the place for an amateur operator.

The Waikato is currently awash with young Irish blokes who have been laid off from contracting jobs in the south Island, I am told that most dairy farms down there are now extremely tight and not spending anything so the contractors are feeling it.
It is all go in the Waikato, there doesn't seem to be any obvious changes in the way farms are run yet so contractors are flat out harvesting maize now.
I guess that sort of illustrates a bit about where NZs dairy debt is, and which regions have higher costs than others.

With OCD, the second largest NZ dairy company, reducing payout to $3.55, a budget of $3.50 FWE is not going to cut it. I realise that Keith wrote this article before this announcement, but this latest reduction does show the shifting income environment farmers are having to work with at the moment.

Thats the thing that put you guys crook I reckon. Monthly payments staggered throughout the year. It must have felt like a salary. It got too easy. Most other businesses fight tooth and nail for cash flow. And for many there is months of no income. Hort crops. Most sheep and beef systems. Tourism. Retail.

There's been a paradigm shift in the way payout is paid out by the company and the way it is announced. Previously to Fonterra, dairy companies used to 'smooth' payout - to an extent. Funds were kept back in the good years to help bolster payout in the bad years. This did two things - it kept costs fairly steady, as suppliers knew farmers had an income range that was reasonably steady, and it kept payout reasonably steady - due to the 'smoothing' effect.

Once they did away with that, with higher payouts, costs went up, in some cases exponentially and have never come down. Animal health costs such as mastitis treatments, skyrocketed etc. It also had the effect on keeping a lid on land prices as farms were valued on their productive value.

The second shift is the way payout is announced and set at teh beginning of the season. It used to be set low(ish) and raised as the season went on. Now with disruptive tactics at work, it is set high (to force the opposition to pay their suppliers a higher rate) and then seems to be reduced during the season. For many farmers this is what they find difficult. Announcing lower payout at this time of the season means that the bulk of your costs have already been incurred so there is little you can do now to make changes.

The increases in farm prices has had an effect - but only on those buying/wanting to buy land. To me the biggest issue that few talk about is the increase in FWE. This can probably said of many of the ag sectors.

Yes you detail good points. It seems to me Fonterra as a concept was practical, in practise has been a disruptive force. Do you think you would have been better off CasOb if Fonterra had never existed? Would these other companies have come in if we had stuck with the status quo?

Yes belle, the diggers they buy have no side to side hydrallics, and therefore cant do any tidying up!

I understand that Casual Observer's quoted payout of $3.55 from Open Country Dairy is not actually correct, if the implication is, as it appears to be, that this figure is the final payout equivalent to Fonterra's $3.90 before dividend payment.

OCD's company policy is to communicate only with its suppliers, not with the press, so possibly another OCD supplier will be able and willing to confirm the correct position. However my understanding is that $3.55 is at the bottom of a range of possible payment for the first three quarters with the fourth quarter yet to come. The final payment will presumably be announced towards the end of the dairy year in May.

This doesn't necessarily make life much better for dairy farmers and sharemilkers, but it does not appear to be fact that OCD's final payout is only $3.55.

I stand corrected Allan. The information I received was from OCD suppliers. However when I approached them today, they corrected their comment to say that they were taking the lowest figure of $3.55 as their expectation, but that the range for Settlement period 3 was $3.55 - $3.85, a drop of 35cents.

Perhaps OCD needs to review their policy of not communicating with the press? After all, farmers do talk to each other. ;-)