Optimum Resource Allocation on New Zealand Dairy Farms

By B J Ridler Consultant

(a) The Alternative to Physical or Financial Planning for Best Return.

A previous article in UK Vet (Ridler: 2007) discussed the development of agriculture in New Zealand and the use of production targets. These targets were summarised as measures such as production per cow or per hectare and used to compare farms and the (supposed) ability of managers. Such measures however rarely accounted for the very different resource mix between farms.

As easy improvements in the productive capacity of land were exhausted (application of fertiliser, encouraging better pastures and animal production through more enlightened animal management) increasingly complex financial and production benchmarks were used as the means to control farm systems.

New Zealand agricultural debt (Riden 2009) rose rapidly as demand (spurred on by tax-free capital gain) pushed land prices higher. Costs for developing and maintaining farms also increased. With the reduction in net income, lenders required borrowers to prepare detailed month-by-month production and cash flow forecast budgets for the year in advance to control farm finance.

The present “credit crisis” has strengthened their resolve in this regard. There is an assumption that production and net farm income1 targets can be driven by data which is dislocated from the reality of actual real-time climatic and market variations.

[ 1 Net farm income per farm is assumed to be gross cash income plus change in value of inventory minus costs of production].

These budgets mix physical and financial measures ($ cost/kg Milksolids (MS) produced; Margin over Feed Costs – MOFC) in a belief that using such estimates is the criterion for success despite changes in consumer preference, climatic conditions, cost or availability of feed and opportunities for substitution of inputs or enterprises.

So, farm business planning and lending now concentrates on achieving particular mixtures of physical and financial benchmarks as the means of measuring success or “efficiency” of the business. Additionally, the semi-detached supervision required by corporate owners has led to detailed monitoring (which may be good) but also overly complex reporting structures and administrative

pathways. These have created barriers between staff, management and administration and further dislocated the management decision-making and implementation functions.

Computer-driven analysis of each operation is now seen as the means to control management rather than to provide data with which to inform management on available resources and how best to allocate (manage) them to maximise and sustain profitability.

This new ideology of the business of the firm has subsumed the importance of the economics of the production of the firm.

The proliferation of measures and benchmarks has obscured the fact that farm systems are based on biological principles which must be met. If the objective of the farm is to be a sustainable business, economic and biological factors must be integrated to ensure the objective is met successfully.

This means that maximising production from each animal or area of land must be tempered with the need to achieve a residual monetary surplus.
As has been shown in previous articles (Ridler: 2008), there is a point where additional resources result in higher costs per unit of additional input than the additional income received.

Financial and physical statements, or combinations of these in the form of generalised benchmarks, cannot compare how well “representative” farm types will perform as they use averaged, rather than incremental data. Averaged data spread each additional input cost across all previous outputs rather than comparing the last input to the output it generates.

It may also (as in the case of “MOFC” – margin over feed costs) assume that certain resources are already committed, and account only for the change that is then made. But there are limited specific circumstances where MOFC will be relevant (at the point around which marginal cost and return are equal) but provides no alternative options for the resources involved.

Benchmarking disguises erosion of profit and an increasingly inefficient allocation of resources by assuming that the criteria and conditions that established the benchmark remain constant and are the same as those applying to other farms.

Each business, whether farm or commercial venture, has a unique set of resources in the form of land, capital (fixed assets, stock, plant and machinery) management, including financial expertise, labour, inputs and time. Such resources are always in a state of change either from natural (climatic) or applied (management) effects. Any management analysis must be capable of rapid re- allocation of variable (and at times, fixed) resources as conditions vary, sometimes within short periods of time.

There is an increasing tendency to assume that production and financially based plans should achieve predetermined results. This has resulted in on-farm decisions being delayed when specific financial and production targets were required to be met despite changing circumstances.

Conversely, optimal resource allocation methodology makes timely use of monitoring data. As a consequence, management is able to retain flexible control and learn from comparing actual with expected outcomes. This alters the perception of how the farm system integrates resources over time and that striving for 100% efficiency of use of one component may ultimately be counterproductive. The process is also able to adjust for specific managerial objectives and associated risk.

Optimisation allows any constraint to be evaluated on its marginal cost (MC) and marginal return (MR) and allows the effect of any change to be calculated as part of an integrated farm system.

Optimal allocation of available resources makes financial budgets a
consequence of the allocation process rather than a device to artificially drive the system. Furthermore, management and staff are aware of the quality and
quantity of resources to use and the risk or variations possible.

Prudent managers will discuss plans so derived with their bankers, as bankers may consider cash flow requirements more important than the advantages of efficient resource allocation.

The process is a move back to production economics being applied in an (optimising) analytical framework. It allows integrative analysis rather than partial or component analysis where the effects of diminishing returns and substitution are unable to be included directly.

References:

Riden, C.P. 2009 http://www.agprodecon.org/node/29  Ag Debt Monthly Update

Ridler, B.J.; Production and profit Part 1: A New Zealand example. UK Vet –

Vol12 No 12 May 2007 pp38-40.

Ridler, B.J.; Comparing high-input and low-input dairy systems. UK Vet – Vol 13
No 7 November 2008 pp 47-49.

22 June 2009


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