Even if the revised strategy was based on this article it would...

Even if the revised strategy was based on this article it would capitulate the share price north, so long as the resulting milk wasn't sold through the backdoor or some other shonky arrangement that increased farm costs and hide profit from shareholders or gawd help us hides milk from CDC so it can produce consumer products.

...and this article is just at the farm level when they are selling the milk to another party, imagine the upside if you own the farms, the bio-assets and a processing plant and the product to market channels.....oh thats sounds like AHF to me.

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Dairy industry advice comes at a cost to farm profits


Farmers should produce at a level of production where profit is maximised, not where costs/MS are minimised

OPINION: A number of readers have responded to my previous articles by noting that farmers are advised to produce at the lowest cost per milksolid to avoid risk and increase resilience. Industry leaders and others, who should know better, are recommending that farmers should reduce their profit to increase resilience.

One would think that the most profitable farmers would be the most resilient, but apparently not? This is in direct contrast to what Dairy Australia is recommending.

There is a renewed fervour in New Zealand to produce from pasture only. This was made patently clear at the DairyNZ Farmers Forums and in recent articles in NZ Farmer. This article is not a push for supplements, rather for common sense and sound economic principles.

It is about the whole system, not the oversimplified lowest farm working expense per MS.

READ MORE:
The data is clear: Supplements increase total profit
The difference between base and marginal milk

The incorrect financial advice that farmers should produce at a level (base milk) where production costs are lowest, irrespective of production level, is costing the dairy industry millions. Understanding the basic economic principle called marginal analysis proves this poor advice is hurting the dairy farmer.

Farmers should produce at a level of production where profit is maximised, not where costs/MS are minimised as this is probably occurs at different levels of production. This does not mean cost control is not important. The lowest cost for a given production will be the most profitable, but cutting input costs is likely to change the level of production and impact on profitability.

Total profit is a function of the cost of production as well as the number of milk solids produced and must be considered simultaneously. This economic rule can be mathematically explained with a simple example.

A farmer produces 1 MS per day from pasture at a marginal cost of $4 for that MS. With a $5.50 milk price he makes $1.50 profit on that MS and $1.50 for the day. He adds additional input costs, which could be fertilizer, grain, another cow etc. to increase production. Marginal analysis is used to determine what level of production would maximise total profit.

Notice how the marginal cost (the cost to produce that extra MS) increases from $4/MS on pasture to $6/MS with extra inputs. The average cost of production/MS may also increase as production increases. It is normal for the profit per additional MS to decline with each additional MS produced.

Despite this increasing cost for each additional MS produced, the total daily profit increases until a level where it costs as much to produce the extra MS as what you can sell it for. Producing the 4th MS above did not add to the overall profit because that MS cost just as much to produce as the milk price of $5.50. The 5th milk solid cost more to produce than what it is worth and starts reducing overall profit.

Profit is therefore maximised at 3-4 MS/day, NOT at 1 MS where production costs per MS is lowest. DairyNZ data, presented at the Southland Farmers Forum, suggested that the average marginal cost over the past decade was lower than the milk price.

In other words, farmers were losing potential profit. Chasing production at all costs could be just as costly a mistake as chasing lowest cost/MS. It is not about highest production or lowest cost/MS, but rather about maximising total profit.

The favourite reason for this bad economic advice is that New Zealand must maintain the lowest cost of production to remain resilient or reduce farmer risk to international price volatility.

How does lowering your profit make you more resilient? The greater the profit the more principal can be paid back, increasing equity and resilience. There is apparently a huge danger that farmers will be "locked into" a high input system and be held hostage by the grain. Apparently we would be trying to compete with the US.

Let's put this in perspective.

A farmer on 200 ha irrigated land in Canterbury pays $50k/ha, locked in for the next 25 years. He belongs to a water scheme that costs $180,000 ($900/ha) every year for the next 25 years. He invests $1.6 million in cows to utilise the grass. He invests $2.4m in shares to sell his grass as value added milk. He invests $250,000 in a tractor and implements to tend to the pasture. Total investment is of around $14 million with interest of $700,000 "locked in" for the next 25 years.

Apparently, none of these locked in fixed costs carry much risk compared to a few dollars spent on supplement?

At these input costs, a kilogram DM of pasture costs 22c/kg DM for interest, fertiliser and irrigation only. No depreciation, labour, weed and pest, mowing, re-grassing or other variable costs have been included. As the costs for the pasture has already been incurred it would be folly not to fully utilise the, not so cheap, pasture. As it would only cost $150,000 per year, plus a slight increase in a few variable costs, to feed the cows a few kilograms grain/day, it is difficult to see how this is the major threat to the industry.

Should the cost ratio of grain to milk change, a farmer can reconsider how much grain to feed. How is a variable cost a "locked in" cost? The increasing debt from $8 to $21/MS over the past 15 years is by far the biggest risk to the dairy industry. Seen in perspective, this supplement argument is laughable.

It is bizarre that Dairy Australia's Tasmilk 60 study, on similar pasture based systems, is never discussed in New Zealand, especially when the messages differ so radically from local messages.

Besides debunking the substitution bogyman, Dairy Australia considered the risks in dairy farming. A leading agricultural economist, concluded that a number of measures of risk common in the industry, were erroneous.

These risks included favourite measures like striving for the lowest cost per MS. They concluded that attempting to avoid risk was futile or counterproductive and that farmers should reduce risk by spreading, selling or averaging risk. The study found that the emphasis to minimise risk was misplaced.

They concluded that with an increasingly volatile operating environment, farmers need "to make hay while the sun shines" – increasing equity/profits in good years to better cope with more difficult years. This is completely opposite to local messages, yet there is no debate?

The economic and mathematical myth that farmers should produce at a base level where profit per milksolid is maximised, rather than at the level where total profit is maximised, has been repeated so often by industry leaders, prominent bankers and even some university lecturers, that it has become dairy folklore. It contradicts universal economic principles and is the economic equivalent of a Flat Earth Society and dangerous group-think.

Perhaps it is time to have some of the controversial messages and statistical methods reviewed by an independent panel of internationally renowned economists and statisticians to ensure dairy farmers are being provided with sound economic advice.

Dairy farms are complex systems. Determinants of profit should be assessed collectively, not separately when analysing farm performance. Lowest farm working expenses per MS, which excludes interest, is focussing on one determinant and missing the bigger picture.

Farmers and their consultants should be developing the most profitable system, not the most profitable milk solid.

Howard de Klerk is a consulting dairy nutritionist specialising in maximising profit from grass-based systems.

- Stuff
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