Diversification: an essential approach in a tough economy

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Don’t put all your eggs in one basket; if you fall, you run the risk of not having breakfast. Farmers should spread their risk by adding a second component to an existing farming operation, or even by investing in industries unrelated to agriculture, says Dawie Maree, head of information and marketing at FNB Agriculture.

Diversification: an essential approach in a tough economy

Successful farming businesses in South Africa today are often well-diversified, with interests both on-farm and off-farm, and frequently operating in two or more regions.

Not long ago, diversification was a buzzword thrown around at almost every agricultural conference or meeting. But what exactly is diversification?

In short, it is a technique that reduces risk by allocating investments among various financial instruments (in this case, agricultural products), industries or other categories. It aims to maximise returns by investing in a number of areas, each of which would react differently to the same event.

Agricultural economists preach diversification to farmers to help them spread risk, and most farmers diversify within a category; for example, they might produce maize, soya bean and sunflower, or peaches, apricots and plums.

But it seems as if South African farmers are not as genuinely diversified as they once were. I remember more herds of cattle and sheep foraging on lands after the harvest in the maize triangle than what I see nowadays. I realise, however, that livestock theft has made a massive dent in the country’s sheep flock.

Monocropping is becoming a thing of the past, but one still sees farmers planting maize year after year on the same lands. The practice is not sustainable in the long term, and we will see more and more farms advertised in the yellow pages.

Why diversify?
There are probably three reasons for farmers to diversify, and perhaps even more, depending on the situation.

The most important is that diversification is a tool to mitigate risk. This includes climatic, financial and market-related risk. There are other ways, such as insurance, to mitigate risk, but diversification is the best option in the long run.

A second reason to implement diversification is tied to an old friend (or foe) in agriculture: economies of scale. Farms have become bigger over time, while smaller-scale farms struggle to survive, unless they can establish a niche market or become more productive.

Through diversification, farmers can achieve a certain scale in production and be sustainable, while continually striving to improve productivity.

A third reason that farmers might consider diversifying is because of the demands of a family business. When, say, two sons or daughters return to the farm after their studies, it can quickly become too small to support all their families.

Buying new farms spreads the risk and allows everyone to do what he or she loves to do. Some people are more inclined to agronomy, while others prefer the husbandry side
of agriculture. In a family business, this type of diversification can be beneficial for everyone.

Investing in a different industry
On-farm diversification can be done by adding another component to an existing operation, for example introducing (or reintroducing) a livestock component to the current grain operation, or adding a long-term tree crop such as pecan nuts or macadamias.

More and more farmers, however, are going even further by diversifying outside the farm gate; such as a livestock farmer who buys a butchery (vertical integration).

While this is good, investing in industries not related to agriculture is even better, as the risk is spread among different industries, preferably those not closely correlated.

Investing in off-farm enterprises or assets does not imply that a farmer has lost confidence in, or passion for, agriculture; it only confirms that he or she has done research and understands the risk of being exposed to a single asset.

There is sometimes a perception that you need a large sum of money to invest off-farm. This is not true; even a small amount can make a huge difference over time. The sooner you start, the better!

It is also prudent to diversify geographically. This does not mean that you have to buy a farm in another province or country; it might be possible within the same district. Soil conditions and rainfall might differ to such an extent that it is possible to spread risk over a number of farms relatively close to one another.

Nonetheless, if you have different commodities in your business, consider diversifying geographically across the country to take advantage of the different growing seasons.

Challenges
Every farmer’s situation is different and there is no easy road to diversification. When embarking on this journey, make sure that the reason you are diversifying is the correct one.

Also, avoid the temptation to choose a particular crop or livestock type merely because it seems to be in vogue. It may be unsuitable for your farming environment or climatic conditions.

When you diversify, do it sensibly. Have a strategy and long-term plan when venturing into either on- or off-farm diversification. The plan, and the result, needs to fit your business strategy in terms of your structure and management capabilities.

When you diversify geographically, for example, there will be challenges with regard to management that have to be considered in advance.

Affordability will always be key to diversification. When you add another commodity or component to your current operation, it is important to assess the specific component on its own merits.

Farmers tend to throw everything in one pot and cross-subsidise commodities, only to realise that there was a bad apple that dragged the entire business down. Good financial practice involves assessing each commodity on its own, and if it doesn’t contribute positively to the enterprise, changing it, or getting rid of it.

This is equally important for off-farm investments. If it is not profitable on its own, cut it loose. It is a matter of priorities; your farm cannot support an unprofitable business in town in the long run.

In addition, don’t venture into a business where you lack knowledge without the backing of a good manager or partner with the necessary skill set. The hospitality industry is not farming, neither are restaurants, retail or construction.

In the end, it is easy to preach diversification, but not that easy to implement, especially in the case of off-farm and geographical diversification, and unfortunately there is no one-size-fits-all approach.

It is important to have a thorough discussion with qualified advisers and specialists to assist and guide you with a solution that will suit your management skill set, business structure and specific strategy.

Having said all this, the value of diversification in principle is beyond dispute. To have your breakfast, you need to put those eggs into several baskets!

The views expressed in our weekly opinion piece do not necessarily reflect those of Farmer’s Weekly.

Email Dawie Maree at [email protected].