Wells Fargo Economics

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Wells Fargo Economics Michael Swanson
Ph.D., Agricultural Economist December 2003
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Optimal Farm Size

• Where to aim your business
• Its better to steer than to skid

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No Magic Number

• Economies of scale end
• Crop mixture
• Technology
• Labor and capital costs
• Broken markets
• Input costs loosely predict output
• Land costs not tied to land quality

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What are Economies of Scale?
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Total Costs Fixed Variable Costs Some
fixed costs are opportunity costs.
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ATC FC / Output VC / Output
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Economies of Scale Exist If

• ATC falls as you get bigger
• Typically, FC / Output gets smaller
• VC / Output is nearly constant
• Everything is variable with enough time

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Farming Profitability Analysis

• Advantages to being big enough
• Going from 200 to 1,000 tillable acres captures
  all cost advantages
• Yield differential overwhelms economies of scale
• Before and after growing to 1000 acres, yield
  differences (primarily quality of land) is
  everything

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So Why If ?

• So why if ATC bottoms out at 1,200 acres are
  farms getting bigger than 1,200 acres?
• If AR / acre gt ATC / acre farms keep expanding
• Is 1,200 acres a magic number? No.
• Depends on crop mix and weather zone.
• Depends on time intensity constraints.
• Technology
• Risk levels from weather variation
• Labor organization and resource sharing

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So how are producers getting bigger?Most rely
on renting alliances rather than on land
ownership for expansion.
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Being big enough drops costs by 100 per acre.
However, some of these are not cash costs.
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Source University of Illinois Extension
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What are the possible cost curves and their
implications?
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Source University of Illinois Extension
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Two Factors Where Size Matters

• Machinery Utilization
• Avoiding idle equipment
• Average repair costs
• Labor costs (not necessarily cash cost)
• Hired help
• Your own labor (revenue versus acres)

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Source University of Illinois Extension
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Source University of Illinois Extension
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Factors Where Size Doesnt Matter

• Crop costs
• What buying power?
• Building costs
• Land Costs
• Slight advantage
• Overhead
• Only the smallest operations are at a disadvantage

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Source University of Illinois Extension
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Source University of Illinois Extension
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Source University of Illinois Extension
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Source University of Illinois Extension
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Yield Unaffected by Size

• Yield remained nearly constant by size
• Yield is the biggest determinant of profit
• Avoiding marginal
• Regions/areas
• Land

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Source University of Illinois Extension
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Farm Profitability Analysis

• Yield overwhelms size cost differences
• Gains from getting bigger fall off fast after
  critical size
• Yield, Revenue and Margin they are not all the
  same thing

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No clear pattern showing bigger more profitable
2002 MN Farm Mgmt data
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Better yielding operations clearly more profitable
2002 MN Farm Mgmt data
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The Land Markets Are Just a Little Pregnant.

• Yield potential does not predict sales price
• Yield potential does not follow rental value

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Source University of Minnesota Extension Svc
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Arent there laws banning the display of
obscenities?
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What does this all mean to me
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Portfolio Of OperationsCash Rent Corn
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Portfolio Of OperationsCash Rent Soybeans
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Margin Contribution - Cash Rent AcresFrom Best
to Worst Units
Best corn and soybeans
Worst corn and soybeans
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Getting to a Wealth Maximizing Strategy

• Marginal cost strategies only apply if
• One time opportunities
• No alternative for your time and skills
• Know each units margin contribution
• Dont subsidize the bad with the good
• The first loss is always the cheapest loss
• Change your capital structure
• Land
• Equipment
• Your innovation
• Off the shelf technology is not advantage
• Continuous incremental change

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Wells Fargo Economics Michael Swanson
Ph.D., Agricultural Economist December 2003