Controlling dairy farm cost of production

The key dairy priority at the moment, which stands above all else, is to minimise the number of New Zealand dairy farmers who will succumb to the current downturn. In particular, we all need to try and limit the damage to the latest generation of younger farmers who are often the most indebted.

It is all about getting the cost of production under control.

I have previously written about survival strategies and the need for each farm and farmer to chart his or her own path. I have also tried to caution against panicking and making big system changes when in a crisis. More particularly, I have tried to emphasise that hungry cows always kick their owners in the back pocket. Also, I regularly try and remind people that cost of production has both a numerator (which is cost) and a denominator (which is production).

Factoring in El Nino
We have been fortunate this year that drought predictions were wrong. The El Nino has been real, with high water temperatures throughout the tropics and a strongly negative Southern Oscillation index (SOI). But the dominant mantra, that this would cause drought here in New Zealand, was always overworked. The reality is that both climate and climate change remain full of puzzles.

Fortunately, the false predictions of drought have done little damage to most farmers. And being ready for a drought that does not come is much better than the reverse.

One of the current positives is that cows on most farms are going into the autumn in good condition. Given the dairy farm economics, this is a huge plus, and I have no doubt it has prevented many farmers making some bad decisions around the need to keep the feed up to the cows.

Right now, we are still not free of the El Nino. The tropical sea temperatures appear to be in decline and it is likely that this decline will gain momentum in coming weeks. But the SOI is still strongly negative – indeed it has been plummeting further in recent weeks – and so the outlook for late autumn rains remains uncertain. Either way, there are big decisions ahead.

Targeting $3.50 for farm working expenses
In the last two weeks I have been fortunate to talk with many farmers, most of whom have their budgets under control for the coming year. I have spoken to farmers from Northland to Southland, and from low input to high input.

Independent of either geography or farming system, there is a lead group of farmers who have their farm working expenses down at about $3.50 per kg milksolids. And this is the basis for confidence going forwards. However, this lead group is apparently in a minority.

Farm working expenses of about $3.50 per kg milksolids is a good target for everyone. Anything over $4 needs particularly close scrutiny, unless it is buttressed by winter milking or other price premiums.

Interest rate margins
These same lead farmers who have their working expenses under control also have their banks ‘on side’, and they are paying interest rates of typically between 4.5% and 4.75%. A few of them are paying slightly more than this, but only a little, and their costs will come down as they come to the end of longer term loans.

And there lies the first point. Any farmers currently paying an interest rate of much more than 5% needs to realise that they are paying considerable risk margins to their bank. It might be time for a little talk with the bank.

That talk may or may not lead to a shaving of margins, but at the very least it will confirm where the bank has positioned the farmer within its dairy risk profile. If the interest rate is high, then the bank is nervous.

DairyNZ exemplar farms
While pondering on the challenges of getting farm working expenses down to about $3.50 per kg milksolids, I came across an excellent DairyNZ website (http://www.dairynz.co.nz/farm/financial/budgets/budget-case-studies/) where they are documenting the income and expenses of nine New Zealand dairy farms, with a particular focus on farm working expenses. As with the farmers that I have been talking to, these farms range from Northland to Southland, and from System 2 (low intensity) to System 5 (high intensity).

The DairyNZ exemplar farm budgets have been updated in February, and all except possibly one, which has faced difficult seasonal conditions, remain on target to keep their farm working expenses under $3.50.

First some clarification for those who are not used to monitoring farm finances. The farm working expenses (FWE) include all cash outlays associated with running the farm. That includes feed, labour, animal health, repairs and maintenance, plus all the fixed costs such as rates and insurances. It does not include depreciation, which is important in the long term, but largely irrelevant when facing a cash crisis.

I wanted to see whether I could see any relationship between cash cost of production and the system of farming. More specifically, I wanted to see if there was evidence that the farms with low feed costs ended up with a lower cost of production.

The simple answer was that amongst these exemplar farms there was no evidence that low input farms end up with lower costs of production. The Bay of Plenty System 2 farm had, on paper, the lowest farm working expenses, but this was because of minimal labour expenses, with farm drawings for the living of the owners not included. The Taranaki System 2 farm came out at the higher end relative to other exemplar farms once drawings were included. Most of the other farms already had these drawings included as salaries.

The South Waikato System 5 farm had the highest feed costs at $1.95 per kg milksolids but still came out with only $3.30 per kg milksolids for overall farm working expenses. This was primarily because the high production diluted all the other costs, including labour. Also, with 40% of feed being purchased, there was minimal need for fertiliser.

Once figures were converted to a cash operating surplus per hectare, the System 3 and 4 farms came to the fore, followed by the System 5. These farms had considerably greater capacity to pay interest on their debt than the lower input farms. However, all of the farms appear to have enough debt paying capacity over the next year to keep their bankers comfortable.

Per cow production
All but one of these exemplar farms has above average production per cow relative to the region and system. The Bay of Plenty and Taranaki farms were each producing 385kg per cow. The Northland farm was over 400kg. The  System 3, 4 and 5 farms were all well above 400 kg, with most in the high 400s and through to mid 500s. Production was typically more than 90% of liveweight, which is an important measure of efficiency on these more intensive farms.

High production per cow, relative to district and farming system averages, was something I noticed time and again over the years when judging the best performing farms for the Redsky and Intelact Farm Business of the Year competitions. These same top-performing businesses, measured primarily by return on capital, were also characterised by a low cost of production as a direct outcome of the denominator effect.

My point in bringing out these issues is not to argue for any specific system. I have seen plenty of evidence over the years that a low cost of production is achievable within all systems. It is what one does within the system that is important. Good use of pasture is always important. Also, good per cow production is achieved by many factors in addition to feed.

Getting ready for next year
In general, these DairyNZ exemplar farms plan little change next year. Quite simply, they don’t need to change. However, looking more broadly across New Zealand dairy farms, it is clear that many farmers are reducing cow numbers for next season. My best guess is that numbers will be down at least 6% on this year, which in turn are some 6% to 10% down on last year.

If less cows leads to better production per cow, then I have no argument with that. Also, with beef prices high, those culls cows do bring in ready cash. But farmers need to be careful of the denominator effect. If production declines, it is not only the fixed costs within the working expenses that have to be spread over less production. There is also the same debt to service with less kg of milksolids.

All of the DairyNZ exemplar farmers deserve praise for being willing to put their numbers in the public domain. It is not easy in these times to be so forthcoming. Regardless of farming system and region, they are setting targets for others to aspire to.

In trying to emulate these lead farmers, there is no one big decision that will make the difference. Rather, it is lots of little things that all add up to give cost efficiency. And that is what makes it so challenging.

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About Keith Woodford

Keith Woodford is an independent consultant, based in New Zealand, who works internationally on agri-food systems and rural development projects. He holds honorary positions as Professor of Agri-Food Systems at Lincoln University, New Zealand, and as Senior Research Fellow at the Contemporary China Research Centre at Victoria University, Wellington.
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3 Responses to Controlling dairy farm cost of production

  1. Pingback: Rural round-up | Homepaddock

  2. Wurst Fratzer says:

    Where do you factor in reducing N-leaching rates by (for argument’s sake 20%) across the industry? Throughout your posts I see very little reference to this need which is now regulated in many parts of NZ. It appears as if the attitude is “let’s hope people will get over their healthy environment aspirations” and we will be able to make our decisions purely based returns.
    Surely the way to dot his is to decrease stocking rates and thus urine patches and the need to use high amounts of urea.
    If this requirement was factored into analyses of low-input low SR systems would this improve their returns?
    I am not an expert in the economics of dairy farming but it does appear to be a gap which shouldn’t be left unfilled in your analyses.

    • Keith Woodford says:

      Wurst,
      Reducing N leaching will be a major driver of future dairy systems in NZ.
      But whether reducing stocking rates by 20% is the way to do this is debatable.
      On most farms, reducing sticking rates by 20% will have a series of ‘consequentials’ to the system and the net benefits may be well under 20%.
      In any case, 20% reduction in N leaching is not enough.
      The solutions vary according to soil type and climate, but in most cases the long term solutions lie with off-paddock wintering. But it is going to be along journey as that is a whole new paradigm here in NZ.
      Keith Woodford

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