According to the latest agriculture department figures, the price of farm inputs increased by 12,9% from 2010 to 2011 and by an average rate of 13% from 2005 to 2011. However, the price of farm products increased only 6,7% from 2010 and by an average of 8,9% from 2005.
The ratio between agricultural inputs and product prices is weakening worldwide. The “terms of trade” of agriculture deteriorates over time. Farmers are therefore under continuous pressure to farm more efficiently and save money, but there are right and wrong ways of doing so.
Wrong way 1: Limit variable cost
A well-known Afrikaans proverb warns that “‘n Boer moet oppas dat hy hom nie bankrot spaar nie” (a farmer must watch out or he may save himself into insolvency). When costs are rising, farmers are tempted to cut costs ruthlessly, usually with disastrous results.
When input prices increase as sharply as they did in the last year, a farmer’s natural tendency is to save on total cost. As it is easier to save on direct cost, the farmer spends less on fuel, fertiliser, feed, herbicides and pesticides, usually with very negative effects on farm profitability.
Basic agricultural economic theory tells us farmers will maximise profit if they produce at a level where the marginal cost – that is, the cost of producing an extra unit – is equal to the marginal income. In practice, this means that as long as you can spend less than the price per unit to produce more units, it’s more profitable to do so.
This is especially true in intensive livestock production, but also applies to crops, although external factors such as climate play a major role. It usually isn’t possible to increase profit by producing less.
The real goal is not to limit cost but to increase the gross margin. In most cases the farmer with the highest yield also makes the highest profit.
Wrong way 2: Cut out less productive resources
I recently visited a livestock farmer who followed a consultant’s advice and culled the low-production cows from his herd. The nett result is that he saved some money on feed, but his total income decreased so much that he now battles to make ends meet.
While the lower-producing cows didn’t make a nett profit, the income from their milk was still more than the marginal cost of producing that income. Every year when the summer grain season approaches, farmers are told to plant less maize and only plant maize at all if they can produce it at a profit.
While this advice is correct on a long-term basis, it isn’t correct on a short-term (one year) basis. Total cost consists of fixed and variable costs. Farmers who plant fewer hectares to maize will save on variable cost, but their total fixed cost will usually remain practically the same. This means they’ll have the same fixed expenses and lower total income.
Right way 1: Gross margin up
Technical efficiency is a prerequisite for farm profitability. The correct mix of inputs is important. South African farmers can still access a lot of very good advice free-of-charge, and save a lot of money if they follow it. But watch out: there’s also bad advice out there, and it’s often hard to tell the difference.
Farmers can save on input costs if they follow the principles of biological farming as far as possible. However, blind adherence to no-till and organic farming methods can cause problems. Use biological farming methods as far as practically possible but also be prepared to use conventional practices if necessary.
Right way 2: Fixed cost down
There’s often little evidence that economy of scale works if you compare larger and smaller farms. There are many reasons for this – a major one is that it’s easier for the larger farm to spend money on nice-to-have things such as a beautiful new compressor than it is for a smaller farm. The test of whether you should buy something is not whether you need it but whether you can do without it.
I once asked a very successful farmer friend why he didn’t buy a specific adjacent farm. His answer was that when he visited the farm there were three labourers working in the garden and that he can’t afford to spend so much money on the upkeep of a garden. Limiting fixed cost is very difficult, but every rand saved is a rand added to the bottom line.
When times are difficult, ensure you don’t “save” yourself into serious problems. The slogan “Gross margin up, fixed cost down” is usually true.
Dr Koos Coetzee is an agricultural economist at the MPO. All opinions expressed are his own and don’t reflect MPO policy.