Klinefelter: By the Numbers

By Danny Klinefelter
DTN Farm Business Adviser

First, DTN's Marcia Taylor and Elizabeth Williams have written a couple of great articles recently on DTN and in The Progressive Farmer. Marcia's was direct advice on how progressive operators plan to skin a profit in 2015 (see http://goo.gl/…). Elizabeth's was insight she gathered from some bright and experienced people who survived the 1980s and wanted to share lessons with the next generation (see http://goo.gl/…). One sage's advice: Bad times don't last forever, so you don't become so negative that you overlook the opportunities that occur during a downturn. Remember you could have bought prime Iowa farmland for almost nothing in 1986.

Both articles remind me that it is an economic reality that the function of a competitive market is to drive the economic return to the average producer to breakeven through supply and demand response in both the input and output markets. At that point, the top end is still profitable, the average is hanging in there, and the bottom end is losing money and exiting the industry. I bet you're sick of hearing that by now.

The thing is, the best and the worst performers aren't always the same. Growing by renting wasn't and isn't a bad thing, especially using flex and share rents. The problem is where people grew just hoping to capture economies of scale and ended up locking in multi-year fixed cash rents that could only be supported by continued high commodity prices. Right now, someone who is no better than an average manager could be making out just fine because they own most of the land they farm, aren't highly leveraged and are cash flowing by living off the opportunity cost of their land (its rental equivalent that they don't have to pay out of their pocket).

The problem is while you can see it coming, no one can exactly time the aggregate turns in the markets. Another is that while history can offer general lessons, it can't be relied on for estimating absolute cycle lengths. For example, the markets are global now and the U.S. is no longer the tail that wags the dog. In the early 1990s, we accounted for 80% of the corn moving in the export market; by 2012 it was down to 20%.

In this environment, relative exchange rates (e.g., dollars versus the yuan), geopolitics, and global weather conditions play a much bigger role and are not as predictable in terms of timing. Next to politics and weather, biological, information, communication, and mechanical technology rule the world. They didn't in the 1980s. A Boeing 787 Dreamliner now carries three computers, each with as much computing capacity as the most advanced computer in the world in 2000. Plus, the rate of change is exponential. Change is certain, but people's ability to adapt and adjust to it isn't.

Marcia mentioned 10 ways to skin a profit in her article, so I won't belabor them here. But, there are a few things farmers need to be doing at a more sophisticated level than what I typically observe.

-- Analyze overhead costs: living expenses, hired labor, machinery costs and obviously rent, as these are the items that have most inflated in recent years.

-- Use an accrual adjusted managerial accounting system that drills down beyond the whole farms level, e.g., individual farms and enterprises on specific farms, preferably down to the field or individual animal level. It helps you pinpoint exactly where you are making money. This may seem extreme, but it's nowhere near as detailed as we'll have the ability to be in less than 10 years.

-- Monitor actual spending versus budget, and internal assumptions versus changes in the external environment on a more timely basis, e.g., at a minimum monthly. Timing in terms of correcting problems or capitalizing on opportunities is the number one differentiator between winners and losers.

-- Look for more ways to be collaborative. Economies and markets are becoming more interdependent. Don't let the structure of your business arrangements lag behind.

-- Finally, diversification is widely recommended as a risk mitigator. It is important for activities to complement core competencies; but, all too often I see businesses investment in ventures that are directly economically correlated with the core business, e.g., crop production and farm equipment dealerships. That just compounds problems. Risk is reduced when activities aren't positively correlated in how they respond to adversities, whether markets or weather.

These times are stressful; but, they bring out the best in those who are innovative and able to adapt to capitalize on the opportunities that are or will be created.

EDITOR'S NOTE: Danny Klinefelter is an agricultural finance professor and economist with Texas AgriLIFE Extension and Texas A&M University. He also is the founder of the mid-career Texas A&M management course for executive farmers called TEPAP. Grains Pro subscribers can access all of his columns online using the News Search feature under News.

(MZT/AG)

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