Blogs / 23. Dec 2012

People and the dairy economic equation

People and the dairy economic equation

It’s definitely time for a more positive article on the dairy industry. This article was prompted by Ian Zandstra, the DFMC Chairman, and I quote:

“When we invest in farms - it is hard assets, calculable, and other dollar inputs. But the intangible investment is people, attitude and skills and often the unmeasurable, our expectation of them.”

The ingenuity, skill and persistence of people is a powerful force. Uncontrollable environmental and economic forces might batter the dairy industry but farms are started, survive and prosper because people make it so. Let’s explore how this intangible, off balance sheet item shows itself in farm economics.

Lining up cows and people

You would all be disappointed if I didn’t put some numbers into the equation and so again I have gone to the Victorian DPI farm monitoring data to see what is happening on farms in the southeast of Australia.

Starting with the number of people employed on dairy farms, Figure 1 shows staff numbers vs cow numbers. This is an interesting plot because it shows that staff numbers are roughly proportional to the number of cows. In other words there are little or no economies of scale in terms of staff numbers per cow. The average for the 11/12 year was 98 cows per person and this has changed very little over the past 5 years.

Figure 1 Dairy farm staff numbers vs number of cows

fig1-staff-num-vs-cow-num

Staff numbers employed on Victorian dairy farms based on the DPI Farm Monitoring Project data for 07/08 and 11/12. This includes the farm owners if they are working on the farm.

A second outcome from this data is that the variation in staff numbers is quite independent of farm size. What that means is that (roughly) 1 - 3 people are employed on a 200 cow farm and 5 - 7 people are employed on a 600 cow farm. The implication is that the economics of operation of smaller farms is much more sensitive to labour numbers and labour cost management. That is seen more clearly in Figure 2.

Figure 2 shows the total labour cost per kilogram of milk solids produced vs cow numbers. It is possible but very difficult to run a farm with less than 2 people. The traditional family unit of a husband and wife, plus a son or daughter, apprentice, or part time worker quickly takes the farm to 2 - 3 people. With an industry standard for staff numbers equivalent to about 100 cows per person, it should be no surprise that the this coincides with the average industry farm size of 200 - 300 cows. This in turn generates an industry standard for labour cost at or about $1.00 / kg MS.

Figure 2 Farm labour cost per kilogram of milk solids produced vs cow numbers

fig2-labour-cost-vs-num-cows

DPI data for the cost per kilogram of milk solids including the owners imputed labour cost. There is a rise in cost for smaller farms because it is very difficult to operate a farm with less than 2 people. Small farms are spreading the labour cost over less milk and rapidly fall behind the industry benchmark as cow numbers reduce below ~ 200.

Dairy labour costs rising rapidly

Apart from staff numbers, the second dimension of labour cost that is important to the economics is the level of staff salaries or the price of the labour. The DPI data reveals quite surprising results for this issue.

Figure 3 provides data for the cost of labour vs farm size. This chart shows that the price of labour is only weakly correlated with farm size. That in itself is an interesting outcome - again, there are no apparent economies of scale. What is more surprising is the rise in cost from 07/08 to 11/12. This effect is also shown in Table 1.

Figure 3 Staff cost per person vs farm size

fig3-staff-cost-vs-num-cows

This chart shows the DPI data for the total cost of labour per person. This includes the imputed cost attributed to the farm owner. Total cost includes on-costs such as workcover, holiday pay and superannuation.

Table 1. Key labour statistics from the DPI data for 07/08 and 11/12

07/08 11/12 % Change
Cows / Person 99.2 97.7 - 1.6 %
Cost / Person 44,294 58,019 + 31.0 %
Employed Labour / Kg MS 0.32 0.41 + 31.0 %
Imputed Labour / Kg MS 0.70 0.88 + 26.4 %
Total Cost / Kg MS 1.01 1.29 + 27.8 %
% Imputed Labour cost 67% 64% - 3.9 %
CPI + 9.6 %

 

The data reveals a very significant rise in dairy farm labour costs from 07/08 to 11/12. Whilst staff numbers per cow has remained relatively static, the price of labour has risen by almost 30%. This compares with a 9.6% increase in the Australian consumer price index across the same period.After allowing for on-costs, the current salary average on southeast Australian dairy farms is about $50,000 per annum. This is a good wage for a farm worker but is far too low for the complex and arduous task that the farm owner or manager undertakes. My advice to farmers is to ignore this issue and pay what you and your workers agree is a fair value wage. Like many businesses, the price of labour is important but not as important as the skill and performance of the person employed. The old saying about monkeys and peanuts is as true in this industry as anywhere.

monkeys milking a cow
Opportunity for cost reduction in dairy farms

Whilst I wouldn’t for a moment suggest that the salaries currently paid on dairy farms are unreasonable.This data does go some way to explaining why margins and investment returns remain modest in the industry despite a very significant lift in farmgate milk price since the 2006 / 2007 financial year

Labour cost and investment return

In my recent articles I have noted the importance of achieving an acceptable commercial return on capital for the owners, investors and bankers of dairy farms. This to me is a fundamental requirement if we expect a turnaround from a decade of milk production decline in Australia.

Figure 4 Return on Assets vs labour cost per kg of milk solids

fig4-roa-labour-per-kgms

This chart shows how ROA is correlated with labour cost in the 11/12 DPI data. Farms that have a labour cost below $1.00 / kg MS perform better than their peers. This probably reflects good cost control and asset utilisation across a whole range of areas including labour. Note that a low cost / kg MS is generally a reflection of more cows and milk per person rather than setting a lower salary for employees. The wages cost per person is not correlated with ROA.

The easy place to start with this is to show how Return on Assets (ROA) is correlated with labour cost. Figure 4 is something of a mirror to Figure 2. ROA tends to be higher for those farms that have a labour costs at or below $1.00 / kg MS and then falls away sharply as the cost increases. Unfortunately it is again the small farms that struggle to generate a positive commercial return. This is not just a consequence of high labour costs. Many other fixed and variable costs tend to be higher on small farms (per kg milk solids).

Intangible Assets

Discussions on farm performance often cite the importance of both skill and commercial commitment to the business. There is a consistent belief that a better result is obtained when the farm manager is an owner or share farmer. The Victorian DPI data cannot answer this question directly but it is possible to show the ROA relative to the proportion of labour cost that is attributable to the owners - the imputed labour cost.

The evidence is not conclusive but Figure 5 suggests that there is no relationship between the % of labour cost that is paid to the owner and ROA. Note that is necessary to discount from this analysis the small farms have a lower asset return because of their scale. In these cases a low ROA is function of a range of economic factors and is not a reflection of the management and capability of the owner. When the problems of scale are taken into account, comparable performance is being achieved across the full spectrum of owner involvement in the farm activity.

Figure 5 Return on assets vs the proportion of owner labour

fig5-roa-vs-owner-labour

This chart shows the 11/12 DPI data for ROA vs the % of labour cost that is attributable to the farm owner as imputed labour. At 0% the farm owner does not work on the farm and at 100% there are no employees. The chart also shows how farms with less than 200 cows fare in comparison to average - large farms.

The last word for small farms

This analysis shows that small farms are struggling to compete in strict economic terms. They tend to have more people per cow plus other handicaps in cost and income. The low ROA suggests that owners have essentially bought themselves a job. That said, this is not such a bad thing. If the business is structured carefully there will be little or no tax to pay and a reasonable cash income is possible in most years. It is however important for the owners to understand that the underlying asset value of the farm is unlikely to grow very quickly. More importantly the business will not support a high proportion of debt. High owner equity, or alternatively a second off-farm income, are almost essential ingredients for sustainable small farms.

And finally if you want to ignore all these numbers then please do. What the balance sheet and income statement doesn’t show is the value of a lifestyle for the farming family and self determination in your life. The spiritual value of the farm environment is priceless.