(THE GOOD, THE BAD, AND THE UGLY)

In the interest of saving paper, only the philosophy of this talk will be included in this abstract. Much of the economic analysis discussed is included on the Dakota Lakes Research Farm’s home page. The URL of the home page is listed above. Much thanks goes to Jason Miller who works for NRCS but has spent the last two years working with us in an effort to increase technology transfer capabilities. He has done much of the web site work.

Difficult times in agriculture are frequent. When they occur it often sends producers and their advisers madly searching for ways to reduce costs. The good news (for many producers) is there are often ways of reducing costs substantially. The bad news is that the best of these methods cannot be easily turned on and off. Rather they result from careful planning and management over a long period of time. The ugly truth is many of the attempts made to reduce short-term costs could ultimately make the producer less profitable. In essence, the producer often reacts to lack of profitability when it happens (too late) rather than acting during profitable times to have a plan when the inevitable downturns occur.

Discussion of economics by the author of this paper must be viewed in light of the fact that he has no formal training in economics. That allows him the power to create definitions that differ from those accepted by the discipline, propose theories that would create professional turmoil, and view things in a very non-conventional manner. His only claim of economic knowledge stems from the need for the production enterprise at the Dakota Lakes Research Farm to generate profits necessary to support a majority of the research enterprise. This paper should therefore be viewed as "farmer economics 001".

Costs associated with crop production are generally classed as being either fixed or variable. Fixed costs are those that remain constant from year to year and are not appreciably impacted by short-term management decisions. Examples of fixed costs include land costs, machinery ownership costs, etc. Variable costs include such things as seed, fertilizer, chemicals, fuel, etc. These costs change or vary depending on short-term management decisions. Both types of costs are commonly expressed on a per acre or hectare basis

The first thing that needs to be done in analyzing methods of keeping an operation afloat is to perform a complete and HONEST analysis of every aspect of the enterprise. The most important part of this analysis is to develop a comprehensive Mission Statement for the farm. In other words what do you and your family wish to accomplish by being in the farming profession. This needs to be specific. Phrases such as " We wish to maintain a good and healthy lifestyle for our family" are too general. This statement should include family income targets, quality of life definitions, and an indication of where the principals intend the operation to be in the future.

This mission statement then needs to be addressed with a specific series of short and long term goals. If part of the mission is to allow bringing one or more children into the operation, specific goals (with deadlines) need to be established to define how the operation will change to allow that to occur. This document needs to be developed through consultation with all members of the operation. It needs to be reviewed and updated frequently.

Family living expense is a fixed cost for a family farming operation. It can change some in response to bad times but (in most cases) it cannot change a great deal without jeopardizing what probably will be one of the cornerstones of the Mission Statement. Namely to provide the "desired" lifestyle for the family. The lifestyle "desired" will differ amongst operators but it is a number only they can define. A common mistake is to operate the farm hoping that there will be sufficient income to meet "desired "family living expenses when other costs are paid. Pay yourself first. You would expect any other business to have the money allocated to pay you if you were going to work for them. Expect the same from your business. If full-time employees are a part of the operation, their base salary and benefits package is also a fixed expense. Profit sharing incentive packages would be variable costs. At Dakota Lakes overtime is treated as a variable cost.

Actual family living expense, in most cases, is much greater than the number normally allocated for this category. Actual family living expense is the amount of money it would take to maintain the present (or desired) standard of living if the farm were not involved. Items that are commonly hidden (by default) in farming enterprises include much of the household support cost associated with items such as utilities (heat, electricity, telephone, etc), insurance (life, health, auto, accident, and the household), much of the transportation, etc. Also included are some family vacation costs, computer and office costs, etc which often are included as a farm expense but would be necessary to some extent if a decision is made to significantly change or cease running the operation. It is important to know this value accurately in order to make plans to meet this cost first.

Once "real" family living expense level is determined the process can begin to determine how that income will be generated within the criteria of the Mission Statement. In many cases, part of this expense is being met through one (or both) of the partners being employed off the farm. This is legitimate, but may incur more costs for transportation, custom services, etc. It may reduce the cost for health insurance. In a few cases, all of the family living expense is being met from off-farm sources. This too is legitimate as long as it does not conflict with the Mission. It is highly unlikely that this type of scenario would be included in most operators’ plans if they intended to oversee viable farming enterprises.

The rest of this paper will deal with what can be considered "commercially viable" farming operations having as a major goal the generation of the entire family living expense from the farming enterprise. A desired family living expense of $54,000 US will be used. What remains to be done is determining how to reach this goal. It must be realized that some of the options presented here may conflict with parts of some producer’s mission statements. They are presented as examples only.

It is impossible to determine how to get to where you want to be without knowing where you are. (Although my wife claims I try to do this all of the time when we are traveling). Consequently, it is important to review the economic characteristics of your present farming operation. Most producers have the needed records already available. If not, there are several adequate analysis packages available either commercially or from numerous government agencies. A good spreadsheet will also work for most producers with even moderate computer skills.

The idea is to analyze the present operation in common ways and also to look at the figures differently as well. Determining cost per acre (or hectare) is commonly done. This changes very little as the price of the commodity and yields vary. More enlightening analysis includes determining cost per unit of production (bushel, tonne, kg, or pound) at average, high, and low yield levels for each crop (or by year). This analysis provides insight into how the operation will fare under differing potential environmental conditions. If cost per unit stays high relative to expected prices even when yields are good, major rethinking of the commodity needs to occur. In reality, the goal should be to have cost per unit of production below expected price at the low yield level.

A similar analysis calculates break-even yields under at least two price scenarios. One would be expected price and the other the low limit price. For US farmers the loan rate could be used as a low limit price. In reality the better scenario would be to use the futures price minus the premium of a put option to protect that price (at the money put). The goal must be to have a break-even yield (at the low price scenario) that is below the lowest non-disaster yield attained in the last five years. Non-disaster yield is a yield level that would not "kick in" crop or income insurance.

At the Dakota Lakes Research Farm, analysis is conducted for each commodity within a rotation and for the rotation as a whole. Calculating results for a commodity across rotations would not be valid since rotation has profound impact on the results achieved. There are times when individual crops within a rotation produce less than desirable results when viewed individually, but contribute significantly to the profitability of the rotation. There are times when an individual crop within a rotation has not been profitable and it was replaced with a different crop of the same basic type. This has only minor impact on the agronomic characteristics of the rotation but is economically beneficial to the rotation as a whole. This is commonly done by switching only part of the acreage for a few years. Doing so limits the risks associated with learning to grow and market the crop.

There are times when rotations themselves have been modified in terms of both crop types and sequences. This is done only after very careful analysis since changing the rotation impacts all areas of the operation. It also takes several years for all of the rotational benefits to be expressed. It is true that some workload spreading benefit occurs immediately. This may be limited by the fact that machinery and manpower resources may not have changed. Therefore, unless the resources were being overtaxed or more land is being operated, the main benefit initially is to timeliness. Likewise, increased yields and many of the cost reductions associated with lower weed, disease, and insect pressures are not realized until the new rotation has time to work its magic.

As you can see changing crops or rotations and crops may not be a short-term fix for lack of profitability. Many of the best impacts are not immediate. On a more long-term basis however, utilizing proper rotations (and understanding how they can modified to meet changing goals) is the backbone of developing a farming operation that is profitable, sustainable, and flexible.

Cost-per-acre is irrelevant other than when talking to the banker or when a total crop failure occurs. The most important number is cost per unit of production.

Reducing fixed costs per unit of production is one of the easiest and surest ways to add to profitability. Increasing yields without changing fixed costs is the most straightforward way of reducing fixed cost per unit. This is the reason that most farmers focus intently on achieving high yields. Attempts to reduce costs by reducing required variable inputs such as fertilizers and pesticides could reduce yields and increase the fixed cost per unit of production. Unwise reduction of necessary inputs may also reduce quality.

Another method of reducing the fixed cost per unit of production is to increase the acreage managed with the same machinery and family labor resources. This is the area where the use of diverse crop rotations plays a major role. Many producers have attempted to reduce fixed costs per unit of production by managing more land utilizing the same rotations. This often backfires due to problems with timeliness. Buying bigger machinery, hiring more labor, or obtaining custom services can either work or fail depending on the circumstances. Using no-till in conjunction with diverse rotations provides complimentary interactions not otherwise possible. The tillage involved in conventional system limits workload spreading potential. No-till without diversity leaves manpower and machinery resources underutilized. Just as importantly, the rotational effect leads to increased yields without increased fixed costs.

Producers that diversify rotations without either increasing the acreage operated or reducing machinery and manpower resources can take advantage of the available capacity to perform custom operations for other producers. This tool will be used predominantly on a short-term basis because it is more profitable (in the long-term) to expand the operation. The additional variable cost capital may not be available to expand acreage until the benefits of the improved rotations begin to manifest themselves.

Refinancing land debt is an excellent way of immediately reducing fixed costs assuming there is appreciable equity present in the land. This may conflict with the mission statement of the operation (i.e. land debt to be retired in 10 years), but should be considered a good business decision. In good times extra principle payments can be made. Extra payments are not required in bad times. This is not a viable option unless the operation can be made profitable on a long-term basis. It also requires discipline to make the extra payments in good times instead of buying more machinery or increasing family spending.

Refinancing land debt should not be confused with using land equity to reduce the capital costs of operating money. This option has potential for some operators but should not be used unless changes are made to assure the operation will be sufficiently profitable to retire this debt in short order. This option should only be considered as a parachute to be used when total crop loss occurs. It could be used to tide an operation over until an improved management system (such as the use of diverse rotations) can be put in place.

Remember, family living expense should be seen as primarily a fixed cost. Diverse rotations used in conjunction with no-till may allow manpower resources to be devoted to other enterprises. In its simplest form this would be taking an off farm job. It also could mean adding other enterprises to the operation. Examples would include processing or livestock components. Part of the family living expense is then allocated to these alternate ventures. This approach needs to be considered carefully since it adds potential risk to the operation as a whole. It also may require fixed and variable cost inputs of its own.

Variable costs: The details are important. Be prepared to write the check.

Variable costs are often reduced in tough times because it is easier to not write the check for expenses in this category than for fixed costs. Fixed expenses often are associated with tangible assets. Variable costs are not. Not writing a check for a fixed expense could mean loss of that asset. Failing to write a check for a variable expense rarely produces such a dramatically visible loss. The invisible loss incurred could be dramatic without the farmer’s wife or banker realizing a loss occurred. In fact, unless comparisons are made, low yields or pest problems could be blamed on bad luck or bad weather rather than bad management decisions. A good example of this is the preponderance of low-protein wheat in the winter wheat belt this year. The problem was not enough N fertilizer for the yields attained.

As with fixed costs, cost per acre is much less important than cost per unit of production. Reducing per acre costs by omitting needed fertilizer or pesticide, using low quality seed, etc. can easily decrease yield. This can be a "double whammy" since often both variable and fixed costs per unit of production are increased.

When it comes to variable costs the goal should be to optimize the costs not necessarily reduce the costs. Obtaining good yields is important to reaching this goal. This does not mean spending funds on unnecessary "magic". Predominately it means doing a good job of the little things. Basic management practices such as soil testing, field scouting, equipment calibration, etc. become increasingly important in tough times. Reducing variable costs by eliminating soil-testing expenses is not a wise move.

Proper crop rotation is without a doubt the most powerful tool used to optimize variable costs at the Dakota Lakes Research Farm. Diverse rotations have reduced pesticide inputs dramatically and increased yields. This increased yield has required more per acre inputs in terms of N fertility, transportation, etc. but overall cost per unit of production is quite low.

The rotations used on the production enterprise at the Dakota Lakes Research Farm are designed to produce characteristics that fit the environment and the needs of the enterprise. Each rotation occupies approximately one-third of the dryland acreage. Using a range of rotations allows varying risk and returns relationships more than would be possible with one simple rotation (four years or less). In a "real" farm situation these rotations could be combined into a longer complex rotation to attain similar or superior effect.

The tables on the following page contain the cost per unit of production for some of the common crops grown in these three rotations at the Dakota Lakes Research Farm. To aid in making comparisons, fixed costs are calculated as if the entire dryland enterprise was devoted to only one rotation. The exact details on how these numbers were generated are on our web site. In summary, they include land costs, overhead costs, and all production inputs including labor. The family living expense in excess of the labor used is not included in this analysis. This is the traditional method of handling labor. Another approach is to use the entire living expense as an overhead cost as mentioned previously. Doing that would change the values in this analysis only slightly since the rotations are all somewhat diverse. Capital costs are calculated based on not making crop sales until the end of the calendar year following harvest. This makes them higher than what would normally be incurred.

The costs per unit of production for the crops shown are all quite reasonable in relation to the base prices for those commodities. Sunflowers probably have the worst ratio of price to costs. Most of this is due to the proximity to the Missouri River of the Research Station. Bird damage reduces yields significantly almost every year. Winter and spring wheat show good ratios. Corn and soybeans are intermediate.

There is not a single simple rotation that will produce the best results every year. Some rotations (or rotation sequences) work the best in dry years. Others in wet years. No one can out guess the weather. Therefore a mix of rotations (or rotation sequences) spreads the risk. In general, the rotations (or rotational sequences) that are hedges against overly wet or dry conditions do not perform the best overall. They do provide income protection

during extraordinary events. The SW-WW-Corn-Soybean/Sunflower rotation is used to protect against a dry year for corn production. It also protects winter wheat from drought

and winterkill conditions. This rotation produces the cheapest wheat and corn when these conditions occur but can have the highest costs when conditions are wet. The spring wheat and broadleaf (soybean/sunflower) sequences in this rotation perform best in normal to wetter than normal years. Overall this produces the lowest costs for these commodities.

The alternate year broadleaf rotation is most similar to the wheat-canola-wheat-pea rotation that is predominating on the prairies of Canada. The corn and wheat crops perform very well in this rotation when wet conditions occur and winterkill is not a problem. There is not sufficient residue for them to perform well during drought. The alternate year pattern in the broadleaf crops has led to higher costs for weed control and more disease losses than where they are used in a 1 in 3 or 1 in 4 pattern. Consequently, this rotation is not extremely stable. It can produce very good profitability but it can also have very high costs per unit of production. Substituting wheat for the corn in this rotation would cause it to suffer disease and weed problems during the grass sequences also. In addition, part of the workload spreading benefit would be lost.

In designing the three rotations used for the production enterprise care was taken to include crops which had differing seeding and harvesting dates. This means that the acres of wheat seeded are the maximum that can be seeded and harvested (in a timely manner) with the machinery and manpower available. These fixed resources are then utilized to also seed and harvest an equal number of acres of two or three other crops in the rotation. This spreads the fixed costs associated with overhead, machinery, and fixed (family) manpower over more acreage. This is similar to McDonalds serving breakfast. They do not concentrate strictly on the most profitable part of the day.

As you look through these data, remember the three-way rotation suffers somewhat from a lack of workload spreading as compared to the four way rotations. It has slightly higher fixed costs. Pay attention to not only the average cost per unit of production but also the range in values that have been experienced during dry and wet years. Sequences with high variability represent more risk. If they produce overall lower costs, this may be acceptable to some producers or on a portion of the operation of many producers. If sequences produce high variability and also higher overall costs, careful analysis is advised to determine if this sequence should be modified. One example of this is the winter wheat in the alternate year broadleaf rotation. Costs are highly variable and overall costs are substantially higher than in the other rotations. The problem lies in lack of residue even when low-disturbance no-till is used. The solution is to reduce the proportion of broadleaf crops in the rotation. This makes sense because the broadleaf component is itself plagued by problems. This rotation has been maintained since it is used as a site for winter wheat breeding trials testing for winter hardiness characteristics. If this rotation were to be modified, the broadleaf to corn sequence would be maintained. Its strong performance and the diversity it brings to the corn enterprise needs to be preserved.

To emphasize some of the points made earlier, one crop in one rotation will be analyzed more closely. The winter wheat in the alternate year broadleaf rotation (Wwheat-Soybean-Corn-Pea) provides a worst case scenario because it has highest overall costs and the most variability. Non-land costs for the 1999 crop totaled $117.19. Land cost was $30 per acre for rent giving total costs of $147.19. (A higher than average rental value is used even on owned land. If the enterprise cannot produce this amount of land rent it might be better to rent the land out (we separate the land ownership enterprise from the farming enterprise.). A very good yield of 92.4 bu/acre was achieved. This produced a cost per bushel of $1.59.

If costs do not change for the 2000 crop, break-even yield is slightly greater than 56 bu/acre at $2.60. This is loan rate. It would be possible to protect a price at this level using put options for September wheat. This yield has been achieved or surpassed in all but one of the last 5 years. That year experienced winterkill and yielded 45 bu/acre. It would aid the comfort level if costs could be reduced by $25/acre or so to make it possible to break even in this worst case year. In analyzing the costs, the $30/acre rent needs to be paid since we have chosen to operate the farm. Likewise, little can be done to reduce the $13.15 of machinery ownership cost associated with this rotation. If the rotation was less diverse this value would be higher.

Analyzing the variable costs associated with this rotation in 1999 as compared to 1998 reveals that material costs and capital costs both increased. This was due to the use of registered seed in 1999. This field was chosen as the seed increase field. This additional cost and the capital cost associated with it added up to over $17/acre. It was money well spent in terms of reducing the need to buy certified seed from outside sources for the 2000 year. In reality, if seed of this caliber is to be used, the selling price should reflect the higher value of the grain produced. Use of this seed reduced material costs for the 2000 crop by $17 and should reduce total costs by approximately $18/acre. This is not low quality seed. It is a lead variety that was handled and cleaned properly.

The goal of reducing costs by $25/acre has not entirely been met at this time. Nitrogen fertilizer rates have not been reduced (150 total units of actual N) and will not be. Depending on the circumstances next spring, adjustments will be made to attempt to pare the remaining savings out if necessary. Weed control costs in wheat in this rotation are not high. We normally use this crop as a place where non-ALS chemistry is used to assure resistance does not develop. This technique will probably not be changed unless major disaster occurs.

Reducing cost per unit of production is a good idea. Reducing cost per acre may not result in extra money after the crop is sold. The devil is in the detail. A short-term goal should be to make the changes needed to survive. More importantly, another short-term goal should be to make the changes needed to become profitable on a long-term basis.