Economies of scale: how does dairy farming fit in

Dairy farming is changing as smaller farmers fall by the wayside and bigger operations expand. David Beca, director of Australian company Red Sky and CEO of NZ Farming Uruguay, dispels some misconceptions about economies of scale.

Economies of scale
David Beca
Photo: Courtesy of David Beca

In an interview with David Beca, we discus  dairy farming’s place in economies of scale.

Let’s start with your background and your link to South Africa

I spoke at the 2005 Large Herds Conference and after that started visiting South Africa three times a year to develop Intelact, a dairy consultancy business, and to promote the use of my software, Red Sky. I now live in Uruguay and am CEO of NZ Farming Systems Uruguay, which has 48 dairy farms, 46 000 milking cows and 40 000 young stock (this is an example of economies of scale). I also oversee a dairy operation in Russia. I travel to South Africa at least once a year to visit clients. Red Sky has about 50 dairy farms on its data base, mainly from KwaZulu-Natal and the Eastern Cape, most of whom are Intelact clients.

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Economies of scale

Many small and medium-sized dairy farmers in South Africa are throwing in the towel because of inadequate returns, while large-scale farmers are expanding. Do you believe dairy farmers should ‘get big or get out’?
I feel very strongly that this is the wrong message. It should be ‘get better or get out’. Dairy business owners should work at becoming more efficient managers, producing more milk and growing their businesses. This is unrelated to economies of scale.

What do you think the minimum herd size should be?
I estimate that for a farmer to get a good return on invested capital, he must have at least 150 to 200 cows. Of course, if two or three families want to live off the business, it may need to be double that.

What do you consider to be the most economic herd size?
As a result of the comparative disadvantages of both small and large farms, the most economic size is between 200 and 800 cows. But given the complexities of managing pasture-based dairy systems, this is not to say that farms outside these parameters cannot be highly profitable.

What are the disadvantages of growing a herd to more than 850 cows?
There are normally losses in efficiency once the farmer is substantially removed from the interface between cows, pastures and supplements, which is likely to occur in a herd of more than 850 to 900 cows. This can, at times, be offset by the lower value of capital infrastructure per hectare associated with larger farms.

Can dairy farmers achieve true economies of scale?
To a limited degree. In a pasture-based dairy business, over 95% of operating costs are directly related to hectares and cows farmed, and proportionately increase with farm size. The investment per hectare in land, buildings, livestock, vehicles, plant and machinery, and other dairy-related assets, is relatively similar across farm sizes. As a result, there are no significant economies of scale in pasture-based dairying.

What are the disadvantages of smaller farms?
Farms with fewer than 150 cows are disadvantaged because of the proportion of fixed expenses unrelated to land area or cow numbers, and the cost of having at least one capable manager. In addition, the comparatively high value of capital infrastructure – housing and the dairy in particular – per hectare disadvantages these businesses.
However, there are advantages. The most significant contributor to cost per cow is feed. Cows on smaller farms are likely to have lower feed requirements given the smaller walking distances and lower stress levels in smaller herds.

What opportunities are there for gaining economies of scale on large farms?
The rotary dairy offers an opportunity for higher labour efficiency. Labour costs can be lowered by using a higher proportion of less experienced staff in the rotary dairy. All other significant infrastructure is likely to be proportionately sized to the number of cows or hectares being farmed.

There is certainly some opportunity for larger farms to benefit from negotiating higher prices for bulk milk and lower prices for bulk commodities. This has been a driver in forming co-ops or buying groups.

If there is no imperative to grow the size of the dairy business to gain from economies of scale, why are farms getting bigger?
Dairy farmers must harness productive improvements over time or their business viability will decrease because of the continual increase in input costs. If 200 cows produced, say, R500 000 for personal expenses in 2005, it might take 230 cows in 2010 to produce the same R500 000 due to margin erosion.

As costs increase, farmers must develop more efficient management practices  or grow their herds to keep up – or both. We should expect farms to get bigger regardless of the apparent lack in benefits from economies of scale.

Can you give examples of more efficient management practices?
These could involve running more cows per full-time staff member; getting higher pregnancy rates from the same number of inseminations; delivering feed to cows using less fuel; or harvesting more pasture from the same amount of applied nutrients.

These improvements in efficiency can be harnessed to manage a larger business without an increase in input costs.

What are the top farmers doing differently to less profitable farmers?

The top performers usually stand out in a number of areas. Their pasture harvest per hectare is high compared with that of other dairymen, as is their labour productivity. Their combination of stocking rate and milk produced per cow results in high milk production per hectare. And in many other areas, excluding feed costs and nitrogen use, their cost structure is lower.

How can farmers improve profitability?
It’s essential for farmers to reduce costs as much as possible in areas such as animal health, breeding, dairy expenses, repairs and maintenance, vehicle expenses and administration fees. The focus needs to be on continual improvements in productivity. This requires annual increases in output (milk and livestock), as well as offsetting increases in input costs by more efficient management.

Phone David Beca on +61 418 535 715 or email
[email protected]. Visit www.redskyagri.com.

This article was originally published in the 25 October 2013 issue of Farmer’s Weekly.