The 2016 financial performance results from the University of Minnesota Center for Farm Financial Management show a persistent, wide gap in farming results. For the approximately 2,300 operators represented in the Minnesota database, the performance gap remains significant. The good news is that the financial losses for the weaker operators were less in 2016 than 2015. The bad news is that the gap between weak and strong operators remains large. A $260,000 difference existed between the median income of the strongest and the weakest 20% groups in both years.
Why do the farmers get such different results in the same year? Is it the size of operation? Does it depend on the percentage of rented versus owned ground? Could it be marketing results? The list of potential drivers is very long, and most farmers would like a simple answer.
Source: U of MN Center for Farm Financial Management
Of the long list of suspect answers, one answer that I would rule out is marketing. Just as every investor dreams of outsmarting the stock market, every farmer dreams of picking the highs and lows of the commodity market. However, going back and looking at the corn data, we see that dollar-for-dollar cost advantage has five times the impact of marketing. Take 2016 as a good example. The higher income operators sold their corn for $3.34/bushel and the lower income operators managed $3.28/bushel, so the cost gap hit them much harder. The higher income operators had a total cost per bushel of $2.92, and the lower income operators’ cost per bushel was $3.90. The higher income operator picked up 6 cents a bushel, a difference of 2% from marketing, but they picked up 98 cents a bushel, a 34% difference from lower cost of production.
And, 2016 was not an aberration. Year after year, the results show that cost of production dominates the marketing piece.
Over the course of the last 21 years of data, cost advantage contributed $1.04 per bushel to the higher income operators while marketing contributed 21 cents per bushel. If a farmer has managed to stay in the higher income group through operations and marketing, they have built up an advantage that will propel them for a generation. It’s likely that the high performing farms will gain size through cash rents and land purchases. And, this is the type of organic growth that input and equipment sellers need to focus on to guide their own success.
So, the obvious question is, “how can there be such a big gap in the cost of production for a commodity like corn?” Over and over, it isn’t just one thing causing this gap. In 2016, the higher income producers had a variable cost advantage per acre of $111 compared to the lower income producers. They somehow managed to find a $13 and $30 per acre in savings for seed and fertilizer respectively. They also managed $30 per acre lower cash rents. Not surprisingly, they had $5 lower interest expenses per acre, thanks to their stronger working capital. And, to top it all off, they produced 8 bushels per acre more, spreading the direct cost and lowering their cost even further. That created a 69 cents-per-bushel direct expense advantage, and to that they added lower overhead costs per acre.
It is my belief that the lower cost producers are the better marketers because they are confident enough to make early sales. Historically, the markets pay a risk premium early in the year since the buyers want to assure themselves of some level of supply before the crop gets going. They know that the weather risks could make it much more expensive later, but typically the weather risks come and go without impacting the national crop. And, this premium typically disappears as each weather risk passes. The lower cost producers with strong crop insurance positions also take more advantage of the risk premium. Meanwhile, the higher cost producers keep dreaming of a home run to make up for last year’s weak results, and, on average, they end up selling after the risk premium has left the market. So, the irony is that weaker producers should focus exclusively on their operational improvements which will also make them better marketers.
There’s an old story where a bank robber (supposedly Willie Sutton) was asked why he robbed banks, and he replied that banks are where the money is kept. In farming, the secret to success is operational excellence because that’s where the money is found.