Don’t Play Their Game, Play Yours! Focusing on Efficiency Creates Profitability

This article by Joe Carey, Vice President and Senior Ag Loan Officer at Arbor Bank, comes to us from the Ficke Cattle Company newsletter and Del Ficke. Thank you!  Thanks too to Jason Gross, former extension specialist at University of Nebraska Lincoln who has shared these concepts with lots of folks.

Farms and ranches have always been as unique as the people running them; and, they can range greatly in size and scope. A lot of this diversity depends on the geography of the particular area. Different areas are better-suited for different types of agricultural production – from row-crop to cow/calf production and everything in-between.

There are all sorts of approaches on farms and ranches that vary significantly from region to region, including: terminology, equipment and overall strategy. A cow/calf operation in Iowa isn’t likely to function very similarly to one in say, Nevada. So, it’s important to keep those things in mind when you look at any operation. In order to get a clear picture of what’s going on, you have to first take time to really understand it. There is no magic bullet to ag lending and generalizing can get lenders in trouble quickly.

That being said, there are a few things that hold true across the board, regardless of what the operation produces, where it’s located or who is running it. I will try to highlight a few of those I’ve picked up on throughout the years. Some of these are things I have learned working as an ag lender. Some of them are things I have learned while operating a small herd of my own cows and working during the day to keep the bills paid. All of them are concepts I believe very strongly in for one reason or another. Hopefully some of these ideas will be useful.

Efficiency is probably the single, biggest difference-maker I see out there today – it’s the central theme for me in successful operations.

Efficiency is kind of a “concept within a concept.”

Let’s start with profitability. Now cash may be king, but profitability is the kingdom. Profitability is simple really. It’s nothing more than:

It’s literally the money left over after we subtract our costs from what we made from selling what we produced.

If I showed you the simple equation above and asked you how to increase profitability, how would you answer?

There are a lot of ways to increase the income side of your operation; but, they might not all lead to increased profitability. This is where efficiency comes in. Those who generate the most income with the lowest costs are not only the most efficient, they are the most profitable as well. There is a direct correlation between the two. To truly understand and track this, you have to start with accurate data.

First and foremost, you must know your costs.

What are you putting into the operation to generate the income? If you don’t know exactly what it costs to produce a bushel of corn or run a cow for a year, it’s going to be very difficult to measure your success. You’ll be dealing with big, vague numbers that don’t really help you make proactive changes.

When you don’t know what it’s costing you to produce your product, how can you develop (or execute) an effective strategy to market it? If you were selling shoes and didn’t know what they cost you to produce, what would you price them at?

If you don’t know your costs, you are finding out how you did after you did it.

That would be like listening to last year’s weather report to decide what to pack for the trip you’re taking six months from now. It could work (if you’re lucky) and sometimes it will. However, there’s the more likely chance that you’ll be standing on the ski slopes in shorts and flip flops while everyone else has a nice warm parka. In order for predictive indices to be valuable, the data has to be accurate. In other words, you must know your costs as exactly as possible to avoid financial hypothermia.

Another valuable concept relative to efficiency is more income doesn’t always mean more money.

This is harder to get people to buy into than you might think. I recently dealt with a young farm couple who were needing to make some adjustments to their operation or face losing everything they had worked for.

They were excellent record keepers and were really on top of their numbers.
They were engaged in precision farming and had very thorough data on all the acres they operated.
They tracked living expenses down to the penny and were not living extravagantly by any means.
Their cash rent was very reasonable and their yields were strong. 
They had also done a fantastic job of marketing grain at prices that should have all but ensured success.
They just weren’t the type of people you would typically expect to see struggling, even in a challenging commodity price environment.

I started working with them and dove into the numbers. One of the first things I noticed was that they were spending a TON of money on inputs. They were pumping inputs into rented ground in excess of what most people do on ground they own. They might have been out-yielding their neighbors; but, they were going broke to do it.

One of the metrics I really like is an operation’s efficiency ratio. This is a simple one too. It’s just total operating expense/gross farm revenue.

Think of 100 percent as a dollar. What the equation tells you is how many pennies it cost you to produce that dollar. The operation above was spending $0.92 to produce their dollar. That left only $0.08 of every dollar they produced to service debt, pay taxes and live. That’s simply not enough to make it work.

It’s important to understand where your break-over point is between what your land can naturally produce and how much you can artificially move that ceiling. Let’s say you are farming 160 acres and planting it to corn. Your cash price for corn is $3.40 per bushel and your ground can produce 130 bushel corn. It costs you $300 per acre to produce that crop.

Gross Income: $70,720
-Total Expense: $48,000
Gross Profit: $22,720
Profit per Acre: $142
Efficiency: 68%

This is pretty solid. Now, let’s say you can increase yield to 150 bushels if you spend another $80 per acre on inputs. That doesn’t sound like a bad idea. We’re yielding 20 bushels more per acre than the neighbors and we’re already profitable. What does that look like? Well let’s see …

Gross Income: $81,600
-Total Expense: $60,800
Gross Profit: $20,800
Profit per Acre: $130
Efficiency: 75%

We generated more income; but, it cost a lot more to do it. This is a simplified look at a made-up operation; but, it’s the concept I want to help clarify.

Now, what if I told you that same ground would produce 75 bushel corn with no inputs beyond the cost of seed?

Gross Income: $40,800
-Total Expense: $12,800
Gross Profit: $28,000
Profit per Acre: $175
Efficiency: 31%

Now the third scenario is the one that makes everyone shake their head and say, “That won’t work.” I’m not saying it isn’t extreme; but, if you can average that yield with minimal input cost, the numbers don’t lie. All other factors are the same.

If these farms all bordered each other, the farmer with the lowest yields is also the farmer putting the most money in his or her pocket when harvest is over. They made $45 per acre more profit than the farmer with the highest yield; and, they have the most money of the three to service debt, live on and pay taxes.

To put it into perspective, consider this – one of the most common “solutions” offered by challenged producers I’ve worked with is “picking up more acres.”

If you’re losing $40 per acre on the acres you’re farming right now, farming more acres is the last thing you should want to do.

It can be very hard to get people to understand this and look at what they can do with the acres they already have to get the operation back into the black. In fact, rather than add more acres, it could even be that we can restore profitability by shrinking the operation.

Why is that so hard to get people to buy into? Traditions are a huge part of what we do in agriculture. Many of the operations in business today were built on traditions like:

“You can’t run a 1,100-pound cow because she can’t raise a big enough calf.”
“The guy with the highest yields is the best farmer.”

Does any of this sound familiar? I have a lot of respect for some traditions; but, I’m also cautious of “what everyone knows to be true.” Remember that at one point, everyone knew the earth was flat too.

That leads me to the final point I want to make. Successful producers have vision. They see ways to make money that others just can’t. They are the folks that took a worthless by-product and figured out how to sell it, turning it into a previously unrealized income stream for their operation. They may be that “weird guy” giving people tours of his farm all the time and selling his meat to those same people for $1.50 more per pound than some other producers can because his consumers like knowing where their food comes from.

Sometimes they’re the people in the community that everyone wonders how they manage to keep going every year; but, who haven’t borrowed money in years and only go to the bank to deposit money. My point is they are not afraid to try something different. The people who can be successful where others fail tend to have an understanding of their operation beyond the status quo. They aren’t trying to compete with the neighbors; they’re trying to be profitable.

There is an old saying in sports that to be successful, you compete against yourself every day and not your opponent. Don’t play their game, play yours, right? Agriculture is the exact same thing. Have a plan and execute it. Don’t be concerned with how the competition is doing. They don’t pay your bills anyway.

In closing, the key components of most successful operations will typically include efficiency-driven profitability, knowing exact costs, dealing with accurate data, vision and the ability to develop and execute a strategic plan. There are certainly other things involved with determining success; but, these additional characteristics tend to fall into the categories listed above.

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