growing lentils to increase gross margin

Gross Margin or Operating & Fixed Costs – What Comes First?

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The question may seem redundant or nonsensical, 6 of one and a half-dozen of the other…

Do you build your crop plan in an effort to generate sufficient gross margin to cover operating and fixed expenses, or do you budget your operating and fixed expenses to fit within your typical gross margin?

For most high cost operations I speak with, they know their costs are high and then find themselves working hard to generate adequate gross margin to cover their costs and , hopefully, leave a profit at the end.

The challenge that many high cost operators are facing is the run up of their expenses during the recent string of bullish years (land, buildings, equipment, pickups, etc.) and are now trying to manage those residual expenses during a period of tighter margins. They are focusing heavily on one of two areas:

  1. Seek out every opportunity possible to increase yields and to expose marketing opportunities, or
  2. Cut expenses to a level more in line with their farm’s historical gross margins.

It seems that the most common strategy that would fall under Point 1 above is to bring lentils into the crop rotation for 2016. The high prices are just too tantalizing to bear for most high cost producers. We will see lentils being grown in non-lentil growing areas in an effort to boost gross margin. I spoke with a young seed grower this month who told me he received a call this winter from north-east of Prince Albert looking for lentil seed. Good luck with that.

I learned of another operation, in an area that is typical for lentil failures, that dabbled in lentils in 2015. While this region can typically produce 30-50 bushel pea yields, this farm enjoyed a solid 5 bu/ac lentil yield. What is the opportunity cost of using land for a 5 bu lentil crop that could have produced a 30 bu, or even 50 bu, pea crop? Chasing rainbows? I’d say so.

A number of my clients are focusing on Point 2 above, and have been quite successful in reducing the one cost that is most controllable, yet has gotten quite high over the last few years: they are selling equipment to reduce their overall equipment cost. Whether it be liquidating the extravagant tillage tool that is only needed once in a while, moving out that sprayer that is too big for the farm size, or not acquiring that “nice to have” tractor, these farms are working to bring, and keep, their costs more in line with their expected gross margin.

Moe Russell has been quoted in these articles before, and he is on record saying, “Over the long term, the price of agricultural commodities will level out at the cost of production of the highest cost producer.” Essentially, if you’re a “highest cost producer,” over the long term you’re looking at a break even.

Direct Questions

What strategies have you employed to manage costs in the wake of tightening gross margins?

Do you budget your expenses to a level your gross margin will cover, or do you try to achieve gross margin to cover existing expenses?

From the Home Quarter

One of these approaches is top-down, the other is bottom-up. If you caught my presentation at Sask Young Ag Entrepreneur’s Annual Conference earlier in January, then you’ll have already heard my explanation of why top-down is better.

Top-down is managing your farm by budgeting your operating and fixed expenses to fall in line with your typical and expected gross margin. You have likely enjoyed a regular profit.

Bottom-up is reacting to a long line of expenses that were incurred during a short period of high profitability by trying to create a gross margin that is not very likely.

The view from the top is better.

grain2

Innovation in Agriculture

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Innovation
Noun | in·no·va·tion | \ˌi-nə-ˈvā-shən\
: a new idea, device, or method
: the act or process of introducing new ideas, devices, or methods
(Source: http://www.merriam-webster.com/dictionary/innovation)

No one could ever decry the innovation of Canadian agriculture. Often looked favorably upon for
consistently being on the leading edge, Canadian farmers are typically the envy of other nations’
producers for our advanced processes and our willingness to constantly strive for something better.
Innovation takes many forms. It need not be monumental. It does not require a farm to re-identify itself.
While significant innovations like direct seeding and minimum tillage required major capital
investments, many others do not. If you’re like virtually every farm, there is innovation all around you…if
you take the time to look.

Consider the changes you’ve made to your farm since you began farming. Again, not just the big obvious
changes, but the little things too. The little things often make the biggest difference, and yet they are so
easy to overlook. Just think about the positive effect of doing your own grain moisture tests on farm.
I was having a conversation with a client recently about the impact of grain sampling and how the
grading at delivery points can sometimes be a bone of contention. He described in detail how and why
he samples every load as it is being augered from the bin onto the truck. This is an innovation he has
employed to ensure he has taken appropriate measures to protect himself during a dispute. It has paid
off several times in the past, and will likely be of continued value in the future.

An interesting conversation, to which I was privy, among a group of very progressive farmers was about
how each of them managed the challenge of “feeding their help” during harvest. Crews that number
well into the teens require more than a cooler full of sandwiches and donuts. One innovation that I
thought was most creative was the customization of an old Class C motorhome into a quasi food-truck.
While we automatically focus on operations when considering our success with innovation, we cannot
ignore the management side of business. A common issue among my clients this fall is land rent
renewals. Many of them are seeking better ways to access their rented land without taking on so much
risk with these high cost all cash arrangements. As with land prices, rents have also increased
substantially over the last several years (thank you Captain Obvious for contributing to this week’s
article.) Farmers, generally, are becoming less comfortable with the $70-$100+/ac they’ve added to
their LBF (Land, Buildings, Finance) costs for land rent over the years and are now recognizing that they
often can’t make money on that rented land. Unless you’re running a charity, one that benefits your
landlords, “re-think profit” becomes an innovation all on its own.

Innovation is refining your record keeping, automating your payroll services, or focusing on improving
your working capital. While innovation also includes variable rate, advanced water management, or
specialized grain monitoring systems, it need not always be BIG and OBVIOUS. I think the best
innovation for every farm is to examine how it views profit, growth, and wealth.

Direct Questions

How do you view profit, growth, and wealth? I define each as,

Wealth: – discretionary time.

Profit: – that what is required to fuel “wealth.”

Growth: – not necessarily “expansion.” Growth is innovation at any and all levels.
(Remember “always grow; grow all ways!”)

How can you bring about innovation in your management arsenal?

How does innovation make its way into your business? Do you invite it in, or does it have to force its way
in?

From the Home Quarter

I am a firm believer that change will continue to be rapid and drastic in the future. In terms of record
keeping and data management, it will one day be mandatory, so why not get on board before you’re
forced? Regarding my client’s issue on his grain sampling, I believe that future farmers will be forced to
manage their inventory similar to that of a food processor today. And if you have not heard the term
“social license” yet, then let this be the first. A farmer’s social license to farm could face scrutiny like
we’ve never seen before. All of this will require significant innovation. But, don’t fret over the big issues
yet. Start small with manageable innovations today.

Our proprietary Farm Profit Improvement Program™ includes analysis and advice on negotiating land
rental agreements. Please call or email for further details.

GFP FI 4

Knowing Your Costs – Part 2: “Misplaced Priorities”

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Last week, this article weighed in on the trend of increasing costs in certain areas of the farm, namely
Operations (equipment, fuel, people,) and Facilities (buildings, land, financing.) These are the two most
controllable expense areas in farm management. These are the two cost areas that have seen the
biggest increases.

Over the winter, an old colleague and friend made the following tweet through @RCGFarmWise:
tweetMoe Russell has spent well over 30 years in farm finance
and management, and he has been tracking this kind of
info for a long time. I trust his integrity and his
information. Essentially over 5 crop years, this says that
farmers have increased equipment costs 100% faster
and land costs 400% faster than they’ve increased input
costs. In a time of high commodity prices with yields that
were typically above the long term average, this was not
uncommon.

Recently I took part in a Farm Business Development Initiative (FBDI) seminar that brought together
approved consultants and learning providers (of which I am both) to discuss updates to the program.
(Lean more at https://fbdi.gov.sk.ca/) During a conversation there, I overheard one attendee saying
how he listens to farmers “bemoaning the $60/ac they spend on seed, but nary a word to the $60/ac
increase in equipment costs they just took on.”

It is not surprising to see farmers looking to inputs first when trying to find ways to cut costs. We justify
it by lamenting increases to seed, fertilizer, and chemical prices. We validate cutting inputs by
acknowledging that inputs require the highest cash cost per acre of anything else on the farm. There are
sound ways to cut inputs; I was enjoying listening to many clients describing how they are using generic
herbicides this year, focusing heavily on scouting to verify the need for fungicides versus just spraying
anyway, etc. But when I heard one who wanted to eliminate a broadleaf herbicide in his cereals to cut
costs, even though I’m no agronomist, I quickly brought risk management to that conversation. Every
decision needs to have a risk/benefit or cost/benefit consideration. There is too much at stake!
More to the tweet above, looking under the right rock is not easy because it will force each of us to
acknowledge how and where we’ve allocated our capital. If we know we should not have increased our
“operations” cost, it’s difficult to face that reality, swallow pride, and make a better (or corrective)
decision. This is magnified in year like 2015 when excess moisture ahead of seeding turned into drought
for most of the growing season, and adding to that the late spring & early fall frosts, we could find that
many will miss their production targets. Are you confident you were using the most efficient agronomic
plan possible? Will your “operations” costs be harder to manage with missed production targets? Will
you be looking under the “inputs rock” to find ways to cut costs?

It has been said many times that “you cannot shrink your way to greatness.” Cutting inputs for the sake
of reducing costs is “shrinking” your ability to generate strong revenue. Even the best marketing cannot
make up for lost production. Your priorities need to continue for you to be:

1. The most proficient manager you can be to build a strategic and tactical plan that maximizes
ROI, personal wealth, and family values;

2. The most efficient producer you can be to lower your Unit Cost of Production;

3. The most equipped marketer you can be to hedge market risk, and generate sufficient gross
margin.

By misplacing your cost cutting priority onto the critical facets of your business as listed in the 3 points
above, you would be doing more harm than good, despite best intentions.

Direct Questions

Where have your costs experienced the greatest increase (inputs, operations, facilities)?
In recognizing the 3 critical facets above that require your full investment (management, production,
marketing,) where can you find costs that can you live without?

How confident are you in your awareness and abilities to enact appropriate cost management
strategies?

From the Home Quarter

You won’t hear me condone a general prescription of “more fertilizer,” but you will hear me advocate
for “better use of fertilizer.” It’s not about the producing biggest yield; it’s not about producing at the
lowest cost; it’s about producing the best yield at the most efficient cost. And the most efficient cost
also refers to “operations” and “facilities.” The allocation of your finite resources to those costs also
needs to be highly efficient. As a banker friend of mine likes to say, “Your crop doesn’t care what color
your equipment is.”
…or how new it is.
…or how much rent the landlord is squeezing out of you.
The purpose of your business is to grow your profits, maximize your ROI (return on investment,) and
increase your wealth. Spending over $200/ac on “operations & facilities” costs will not get you there.

grain2

Knowing Your Costs

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My clients continually educate me on the regional anomalies relating to land prices, and specifically land
rents. The common opinion among most farmers I speak with is that some of their neighbors just don’t
understand how to measure costs, and this leaves many farmers (including some of those I speak with)
feeling left out in the cold as they watch land get snapped up by someone willing to pay a rental rate
that can appear astronomical.

Based on third party feedback, meaning info shared with me by a farmer from his/her conversation with
a friend/neighbor/competitor, most decisions to take on land are being justified under the guise of
“reducing equipment costs per acre” and/or “the drive to be bigger.”

Popular ag-economics has drilled in to everyone’s head that fixed costs, like equipment, need to be
spread out over more acres to reduce the fixed costs per acre. This is simple arithmetic, and is
mathematically correct if we stop there. Stopping there allows us to feel good about the decisions we’ve
made to increase our fixed costs because “over ‘X’ acres, we’re only spending ‘Y’ dollars per acre.”

graph16

 

 

 

 

 

 

 

 

 

 

 

Of all the costs that farmers face, the costs they have most control over seem to be the costs that are
least controlled. MNP has coined the term LPM, and what I’ll call “operations” are a farm’s labor, power,
and machinery costs which have ballooned in recent years. Next in line is Land, Buildings, and Finance
costs, or what I’ll call “facilities,” which have also grown significantly. Increase land costs (rent) to justify
increased equipment costs: think about it, we’re increasing costs to validate increased costs…
We expect to make a profit from taking risk. The more risk we take, the more profit we expect. My
concern comes from witnessing decisions that magnify risk and leave the expectation of profit as a
secondary, or even tertiary, consideration.

Direct Questions

Take a look at your expected gross margin this harvest. How much gross margin will you have available
to contribute to “operations,” “facilities,” administration costs, and PROFIT?

What is your “operations” cost? What are your target costs for “operations?” Did you know the most
profitable farmers keep their “operations” cost below $100/ac?

Have you traced your line from gross revenue and gross margin through to costs and down to profit?
Where can you improve?

From the Home Quarter

We cannot eliminate risk, we can only manage it. We cannot eliminate expenses, we can only manage
them. We cannot manage what we do not measure. If the purpose of your business is to increase profits
and grow your wealth, should you not ensure that the risks you take and the expenses you incur fit into a plan
for profit?

 

Understanding Costs – a graphical simulation

graph17

 

 

 

 

 

 

 

 

 

In the example above, which illustrates a generic but common scenario on average grain farms in 2015,
a net loss of $9/ac is expected. But the top 10% of farms with a similar gross margin could show a net
profit of $40/ac, simply from excellent management of their controllable expenses: operations, facilities,
and admin.

horizon2

Austerity

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We’ve been hearing the word “austerity” in the media for quite a while now. Whether it be issues in the
EU, or right here in Canada (Quebec), it’s become a “buzz-word” as of late.

Merriam-Webster defines austerity as “a simple and plain quality; a situation in which there is not much
money and it is spent only on things that are necessary; austerities: things that are done to live in a
simple and plain way.” http://www.merriam-webster.com/dictionary/austerity

Based on that definition, I like what that word represents. Maybe that’s because I grew up on a small
mixed farm in Saskatchewan in the 80’s. There wasn’t a lot to be had that wasn’t “necessary.” Don’t get
me wrong, we never went without the necessities, but I wore $20 running shoes from Army & Navy, not
Nike Air. I guess I was raised under austerity.

There was an article published in Country Guide this spring titled “Have Higher Farm Incomes Changed
the Way You Think?” It opens by describing the near perfect correlation of rising farm income to rising
new farm equipment sales. The fourth paragraph reads; “So the question is, do those periods of high
incomes create a kind of euphoria or recklessness that induces farm managers to make longterm financial decisions that could seriously reduce profits in future years, especially if revenues
fall?”

I think we know the answer to that question. And, so what now?

Well, who is considering an austerity plan for their farm?

Remember, austerity is spending only on things that are necessary. It’s easy for us a humans to blur the
lines between “nice to have” and “need to have” because we allow emotion to interfere with our
decision making.

Needs

  1. Bushels.
    You need to maximize yield in the most efficient way possible to produce at the lowest Unit Cost
    of Production your farm can provide. An Agrologist can help and should prove his/her value
    every year.
  2. Cash Flow.
    You need positive cash flow to meet debt and lease obligations, pay for inputs, land rent, wages,
    etc, etc, etc. Grain marketing is often where the best gains can be had, or can be lost. Diligent
    marketing with quality information (or lack thereof) can make or break any farm.
  3. Above Average Management.
    As you read in Growing Farm Profits Weekly Issue #17, average management was sufficient in
    the boom years, but it won’t get you through the next business cycle. Even above average
    managers find confidence in having a business advisor offer independent, unbiased advice on
    current situations, strategic plans, and risk management.

The list of “nice to have” could fill more pages that you’d care to read, or than I’d care to write. The list
of NEEDS is not exhaustive either, but in the spirit of austerity, those are the big 3 that NEED focus
(pardon the pun.)

Direct Questions

Production alone will not keep every farm afloat through the next business cycle. Are you able to
elevate your management abilities (no matter what level you’re currently at) to offer your farm its best
chance to thrive (or at least survive?)

Somebody shared a quote on Twitter that I read today: “Successful people are like a turtle on a fence
post. They didn’t get there by themselves.” -Michael Pinball Clemons
Do you have an arsenal of trusted advisors working for you to ensure you do everything it takes to be
successful?

Will your austerity plan be cutting the right costs or just the easy ones?

From the Home Quarter

It’s been said “You can’t shrink your way to greatness.” When it comes to cost cutting in an effort to
preserve cash, there is a wrong way to do it. Similar to the thinking of “good debt and bad debt,” there
are costs that should be cut, and costs that must not be cut. Interestingly enough, my phone has been
ringing lately with the voice on the other end saying, “Things are looking tough, I can’t afford to make
any mistakes. I need your help now more than ever.”
That’s what I’m here for, glad you called.

If you want help with building an austerity plan or just guidance on daily strategic decisions, call me or send an email.