Understanding maximizing profit, minimizing loss
Today's column is more about economics than law, but the two topics are inseparable in my world. On the legal side, several businesses are exploring "debtor/creditor law" in order to collect from farmers who owe them money. Bankruptcy filings are up, and bankruptcy attorneys are busy.
The Sunday newspaper has plenty of summer auction sales, both for land and for equipment and farm liquidation. Farmers are forming business entities in order to protect themselves from personal liability should they go out of business.
During my college days at North Dakota State University, my advisor was Professor Thor Hertsgaard. Many NDSU graduates, particularly those who studied agricultural economics, recognize the name. Thor was a wonderful educator and an even better man. He passed away several years ago, but the lessons he taught to his students live on.
Thor taught both beginning and advanced level ag economics courses. There were several common themes that he taught throughout each of his courses. One of those themes was that "farmers are price takers," and another was "over a lifetime, the only farmers who survive the business are those who understand not just how to maximize profit but also how to minimize loss."
Farmers are price takers. In a perfect business model, a "non-farm" proprietor develops a product and sets a price. For example, an inventor may develop a computer, and the inventor will say "I will sell this computer for X amount of dollars." If a buyer doesn't produce the sales price, the inventor chooses not to sell the computer, and then moves on to a different prospective buyer.
But farmers are different. Farmers grow a commodity or raise livestock, then go to the elevator or auction. Instead of saying "I will sell this to you for X amount of dollars," the farmer asks, "What will you give me for this commodity or livestock?" The farmer does this largely without any meaningful negotiating leverage.
The big board at the local elevator today says that hard red spring wheat is selling for $5.35 per bushel for harvest delivery. Soybeans are at $8.50. Corn is at $3.25. What does that mean for farmers?
It means that margins are thin; making a profit in 2017 will be challenging.
Thor's second theme is truer than it ever was; successful farmers have limited profit potential, so maximizing profit alone will not cut it. Farmers will also need to minimize loss.
How do they do that? Well, creative marketing helps. Incrementally pricing commodities throughout the year at an "acceptable" price is a far better strategy than waiting for the perfect price. Reducing risk with hedge to arrive pricing or forward contracting is rarely a bad idea.
But reducing expenses is really the only way to minimize loss. Choosing which expenses to reduce, though, is like choosing your favorite child.
Land rent, or the cost of land, is a fixed cost. That's hard to adjust. Fuel is not controllable, as well. Farmers can reduce cost of seed by decreasing plant population, and several did so this spring. Reducing fertilizer cost is dicey, but it has to be considered.
Crop insurance is one area where farmers often "cut costs." Fortunately, there is such a thing as "revenue insurance," where farmers can set a "floor" on the amount of revenue they will generate with their operation. At a bare minimum, producers need to insure a level that covers their fixed annual costs.
Although it is counterintuitive, now — post planting and pre harvest — is the time when farmers should sit down and examine their annual budget. It may seem early, but it is never too early to examine expenses and make some hard decisions. It is easier to do it now than it is in the spring when your loan officer is wondering why you spent so much the year before.