Cost of Production

ATrinity

ofCost / Value / Worth

ACORN 2016Ironwood Organics

Overview• Consider a constrained traditional view of Cost

of Production (CoP)• Look and a broader of ‘farm’ costs (Scope + n)• Look at the ‘pit falls’ of CoP• Consider Benefits of Production (BoP)• CoP and BoP as it relates to sustainability and

climate resiliency

Why Record and Calculate• CoP is a derived measure• Record ‘raw data’ first

– This is where things can start to go wrong– Humans tend to fudge input to max output

• How many inputs measures over what time frame?• The more the input measures, the longer the time frame,

the greater the complexity, the greater the ‘truth’• Calculating CoP is a cost• Volatile climate may reduce the effectiveness of CoP

calculations (reflects climate more then you practices)• CoP is most relevant from the revenue side

Organic CoP• Required to calculate• Very specific to each farm• Tends to have higher labour costs and less inputs• Very scale dependant (multiple sweet spots)• In a competitive market place

– Should the consumer pay more because your costs are higher (less efficient / less automated /more sustainable)

– Perhaps the ‘competition’ is not fully calculating CoP?– Regional ‘weather’ drives some aspects of CoP

CoP - Follow-on Decisions• Is it worth growing?• Is my scale efficient?• What price to sell it for?• Who to compare your CoP to?• Where to sell it?• Grow more, or less, or stop growing it?• Maybe you are in the wrong market place?• Bigger equipment?• Less debt?

• Climate change will add a variable to results making it more difficult to determine the success of your process improvements

Traditional CoP Records• Direct variable costs

– Costs directly tied to specific product• Indirect variable costs

– Costs in operating farm in general ( labour, fuel, utilities)• Fixed costs

– Costs independent of level of production, do not vary with output (rent, insurance, accounting, certification, depreciation, legal, interest, lease, land taxes… etc)

• Revenue– Gross revenue before any costs

• Net Profit/Loss– Revenue minus all fixed and variable costs

• Increase profit by either– Increase revenue– Reduce CoP

http://www.economicsonline.co.uk/

Traditional Analysis• Breakeven ‘price’ to cover variable costs• Breakeven ‘price’ to cover total cost• Breakeven yield• Investment decisions

• CoP is most relevant in relation to revenue• If you consider ‘field to consumer’ as CoP, you

must also consider cost of storage, cost of processing and cost of sale….

Where Cost Are Measured• Fixed Costs – accounting system• Variable costs

– Every time you step foot in field, record what activity it is, person hrs, tractor hrs, implement tractor tools etc

• This will account for;– Tillage– Seeding– Management– Harvest costs

• Post harvest costs are transactional or incremental records and include– Storage costs – Packaging costs– Sales costs

Improve Ratio of CoP to Revenue?

• Cost Side– Find markets for ‘waste’– Select crops that share

equipment ‘out of season’thereby reducing capital investment

– Reduce cost of sales– Declining fixed costs – 1st

acre is the most expensive – double the land ½ the fixed overhead

• Revenue Side– Cut out middle men– Consider stepping down

the value chain– Niche specialization– Season extension– Elasticity of demand

Beyond Fixed Annual Scope• Difficult to assess multi-year initiatives

– Costs are incurred incrementally, returns lag– Preventative maintenance program (1-6 years)– Soil rebuilding (3-50 years)– Hedgerow restoration (10-30 years)

• Activities are not directly related to crop production

• Contribute to farm overhead (blend of indirect variable costs and fixed costs)

• Returns will not be realized until some future date

How for Factor in Sweat Equity• When do ‘investment’ costs get realized?• Ex A) Hazel nuts

– 6 years, $900 cash + approx $4500 labour, irrigation, straw mulching. 1st 5 hazel nuts cost $1080 each –were they ever good;)

• Ex B) Bulk up of landrace grains. – Approx 5 years to get to an acre – 1st 500 kg (worth

about @ $6K). • Build market for how many years at premium

cost before opportunity costs are recouped?

Competitive market place vs.. Doing the right thing?

• If you compete in the market place, then your CoP is being measures against others (as an indirect function of revenue).

• Competing on price is a low denominator driver.

• If your CoP is high because of ‘gentle’ land practices, or crop varieties, who should ‘pay’.

Pit Falls of CoP

• Usually annual cycle• There is an argument that it should be

decades or generations• When considering CoP in context of

revenue, the instinct is to reduce CoP not to increase revenue

• Driving down CoP is sometimes bad for the land / environment

CoP as a Measure of Performance and Sustainability

• Efficiency measurement– Food per land area– Food per hour worked– Food per input costs– Food pre capital dollar

• Sustainability measurement– Biodiversity index– Organic soil matter– Retention of soil moisture– Invasive species presence– Species at risk inventory (actually habitat at risk)

CoP Time Line• 1 growing season (traditional)• 2-5 year time frame

– Realize effects of soil organic building, and seed selection

• 10-25 year time frame– Realize early benefits of hedge rows management

• 25-50 year time frame– Realize benefit gap between other degraded lands

• 50-250 years– Last man standing?

CoP as an Investment• How do you factor in ‘leave behinds’: costs that

do not generate immediate revenue.– Bury straw – avoid revenue, increase cost of

production, retain nutrients, improves soil and moisture retention, better returns on future years

– Rock picking – capital improvement, reduce implement wear and tear, possible increase cultivation speed, avoid catastrophic failure (rock in combine), source of building materials, piles provide snake hibernacula, makes the picker more fit and therefore more efficient

Capital to Revenue• Cheating the System• Ecological Goods and Services \ Ecosystem

Services• Sustainable implies a certain reserve: soil,

nutrients, moisture, biology, biodiversity• Easy to create an annual ecological deficit• Perhaps too much capital already converted• Need to reinvest some revenue to replenish

capital to make sustainable

Fossil Fuels and CoP• 1 barrel equates to 6.1 Gigajoules• 5.8 million BTUs• An average person would take 11 1/3 years to

replace a barrel of oil (equivalent to 1700 kwh)• A top athlete would take about 5 2/3 years.• Take a midpoint of 10,000 man hours per barrel• At $15 per hour average payroll compensation• That is $150,000 of work per barrel that costs

$45• Oil is good, but lets use is judiciously!

Other ‘hidden’ CoP

• Carrying costs, especially for new farmers• Development costs; germplasm and breeding• Fixed costs are different for each farm but

contribute to CoP ( e.g. higher fixed costs makes you less competitive)

• Depreciation costs (The newer your equipment the greater you loss)

• Social costs• Your age, health

Market Separation

• Making a better product most often drives up CoP.

• How do you inform marketplace that your ‘product’ is of greater value than what is commercially available?

Case studyValue vs. Cost of Production

• Heritage Organic Grain• Small scale• No Fungicides• Air Dry (10 days)• No desiccant• Low yield .5 tonne/Acre• Low to no inputs• Taller straw – more carbon• Shorter gliadin chains• Stone ground• Milled in the last 10 days• $6/kg

• Conventional Grain• Large scale• Fungicide spray• Propane Dry ( 2 hrs)• Possible desiccant• High yield 4-5 tonne/ acre• High Inputs• Shorter straw – less carbon• Longer gliadin chains• High speed mill• Unknown mill date• $0.72/kg

Benefits of Production• Important to asses the benefits of your

production practices• BoP relates to improvement of:

– Food quality– Sustainability– Carbon capture– Soil building ( glomalim)– Biodiversity– Species / Habitat at risk (esp. note of Passenger Pigeons)

• Over time, CoP will drop because nature is more productive

Cost / Benefit• Usually costs and benefits are considered

together.• Not reasonable to look at CoP out of context –

may have led to drive for profit at a cost of reduced sustainability

• If you marginally increase CoP, can you significantly increase Benefit of Production?

• Play with numerators / denominators • Gives insight to efficiency and sustainability

Resiliency• A changed climate is already contributing

to ‘data anomalies’ in the long term CoP measurement – esp. yield

• Assuming it is permanent for the foreseeable future, how do we:– Maintain reasonable farm revenue– Maintain affordable food supply – Dampen volatile price swings in food– Pay for on-farm climate mitigation activities

Climate Risk• Can you afford climate risks?• Unstable environment results in unstable

‘measures’– Easter Ontario -average per plant Potato Yield

• 2014 – 267 g• 2015 – 990 g• 2016 – 407 g

• 2016 ( e.g. hulless oats) triple cost of production ( e.g. 1/3 yield) will the market pay triple price –over how many years can you afford to amortize a singular climate failure event?

• How many failure events can you sustain?

Soil Risk• FAO says we have about 60 plow cycles

left• If each harvest decreases organic matter,

how do we attribute that ‘cost’ into CoP?• If we loose soil each crop cycle, will our

CoP go up because our yield goes down or our inputs go up or….?

• Soil is technically a renewable resource, is it therefore a not-for-sale product?

Water Risk Too Much and Not Enough

• 1% organic matter in soil ‘stores’ 160,000L per hectare

• Severe rain events erode soil and leach nutrients

• If rain events are more infrequent, we need to retain soil moisture.

• Should the annual CoP fluctuate with last seasons climate?

Conclusion

• There is no right way calculate.• Still important to measure as part of ‘farm

intellectual capital’• Over the long term it will provide insights –

if only statistical