Profiting from Low Milk Prices (New Zealand)

By David Beca, RED SKY Agricultural

With lower milk prices, a rising New Zealand dollar, and a stagnant world economy, the usual challenges are being directed at farmers, consultants and accountants alike.  How can we improve our profit in these conditions?

For ALL farmers, it is essential to maintain a low cost structure for most standard areas such as animal health, breeding, dairy expenses, repairs and maintenance, vehicle expenses and administration fees.  But what about the big variable costs?  What price can you afford to pay for supplements?  What is a sustainable level of expenses as a percentage of revenue?  What is a sustainable level of expenses per kilogram of milksolids?

Some of you will be tired of hearing the same questions being asked year after year just as some of you may be frustrated by not receiving a simple and clear answer.  Unfortunately the answer to each of these questions is different for each farmer and can only be answered by some thorough financial analysis.  There is no doubt that some farmers can pay 25-30 cents/kgDM for high quality silages and still make a profit from this while other farmers cannot make a profit from the purchase of 10-15 cents/kgDM silages.

Sustainable levels of expenses as a percentage of revenue or expenses per kilogram of milksolids (‘expense ratios’) depend on the farming system being run.  An all grass farming system would typically need to run a lower level of expenses as a percentage of revenue to generate the same profit as a supplemented farming system.  Expense ratios primarily tell us about the risk profile of a farm and not the likely level of profit.  In almost every case we increase the expense ratios when we add supplement to pasture based farming as pasture is usually our lowest cost feed.  Although the intent is to increase profit, it also increases risk.

Some average all-pasture farmers will focus on improving pasture harvest to improve profit.  Some top all-pasture farmers will include some cost effective supplements to improve per cow performance and farm productivity.  Some average supplement feeding farmers will focus on improving pasture harvest and/or reducing their cost of supplements to improve profit.

The key to answering all these questions is to know how you are performing at present, what level of progress you have made in recent years, what factors have driven that progress, and how you compare to your peers as this may provide a guide to future improvements.

If there are no absolute answers to the questions regarding affordable supplement purchase price or expense ratios, there are some general principles that can be sustained.  When forage supplements exceed 25 cents/kgDM and concentrates exceed 35 cents/kg it becomes very difficult to maintain a profitable margin.  When expenses exceed 75% of revenue or exceed $3 per kilogram of milksolids (at a $3.50-$4.00 payout) it is difficult to make a sustainable profit.  If the level of expenses drops while maintaining the same level of productivity, or supplements of the same quality are purchased for a lower price, then profit must improve.

Tim Montgomerie had some useful advice in his speech at the Intelact Nutrition conference in Rotorua.  “It is critical that we keep the cost of feed as low as possible and ensure there is a healthy margin left.  This has nothing to do with the often heard quote that you ‘can’t pay more than 20 cents/kgDM for feed.’  That is a complete nonsense but the lower the feed cost or bigger the margin between milk price and feed cost then the more money is left in my pocket at the end of the day.  Or to put it another way, the further that milk price can fall before my high productivity farming system becomes less profitable than the all-grass alternative.”

Tim farms near Cambridge on very high value land and has found that the only way he could produce a reasonable return on assets was through large increases to per hectare and per cow performance.  However it would not have been sufficient for him to simply produce 430-440 kgsMS/cow and over 1900 kgsMS/ha.  The key has been that his cost of feed is well beneath most of his peers and his labour productivity is well above most of his peers.  For instance his maize silage is being sourced from leased land and due to good yields this is costing him around 13 cents/kgDM (including lease costs) while his labour productivity remains well above the top 10% for his district despite the extra supplement being fed.  Most of the balance of Tim’s costs are similar to the best of his peers, which ensures a healthy profit at milk prices beneath $3.50/kgMS.

Many others who are feeding increasing amounts of supplement have considerably higher costs.  Some will be able to make a sound profit at milk prices between $3.50 and $4.00 while others may need to receive $4.50 or more to produce a sound profit.  If you require over $4.00/kgMS then your only choices may be to substantially reduce your cost of feed and/or increase your productivity from this feed OR move back to a lower supplement system.

On the other hand, for those who are not feeding any purchased supplement there will still be a considerable variation in cost structure that due to cow performance, stocking rate, pasture harvest, and a range of other factors will determine the level of profit.  Again there are no simple answers as to what this group should do to improve profit.  There may be some clear opportunities to reduce costs and these are best determined by financial analysis that tracks these costs over time and/or compares these to other farmers.  For others it will be essential to increase revenue through improvements to pasture harvest, changes in cow numbers or adding new feed sources.

The key message is: beware of anyone who has simple one-line answers to the complex question of what drives profit on dairy farms.  The question over what is an affordable price to pay for supplements effectively has no answer as it is specific to each farm (although lower is better).  Target expense ratios (as a percentage of revenue or per kgMS) will be different for each farming system.  Every farmer who has pursued higher productivity through feeding supplements has increased these risk ratios in the pursuit of higher profit.

So if you want to take the shortest road to an improved profit, this demands you undertake a comprehensive analysis of your present level of performance.  And then the answers to all these questions should become crystal clear.  And if they don’t then find an accountant or consultant who can help “clear the fog”.

One software tool to help with farm financial analysis is Red Sky.  It is specially designed for dairy business analysis.  Farmers with a keen interest in financial analysis use it independently.  Others use it in collaboration with their consultant or accountant.  For more information on Red Sky contact Howard Wright ph 0274-723 3491 or Evelien Baas ph 025-682 0308.

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