March 4, 2022
What can we learn about increasing farm profitability from the University of Nebraska-Lincoln Testing Agricultural Performance Solutions program?
TAPS is a farm systems management education program, consisting of a series of real-life, real-time farm simulation contests. This past year’s profitability winner for the Sprinkler Irrigated Corn contest was Farm 2, which was a typical example of a profitable team.
Farm 2 did not have the highest yield or lowest cost (using either per-acre or per-bushel measures), nor did this team achieve the highest average market price. This farm won because individual components of cost, yield and revenue synergistically worked together. Careful study of Table 1, which shows a comparison of the top four most profitable competitors in SIC, provides insight into how and why Farm 2 won.
TABLE 1: Top four most profitable competitors of the SIC contest held in North Platte, Neb. Revenue, costs and profit are listed by dollars per bushel ($/bu.) and dollars per acre ($/ac.), along with contest maximum and minimum values for each category.
Table 1 shows the minimum costs at $655.23 per acre, on Farm 4. Farm 4 has a profit of $384.81 per acre, versus Farm 2 with $736.01 per acre, almost double that of Farm 4.
Farm 4 used $655.23 per acre ($3.45 per bushel) and produced 192.6 bushels per acre of corn, while Farm 7 used $752.16 per acre ($2.81 per bushel) and produced 273.8 bushels per acre of corn grain.
For Farm 7 to be as ineffective in using dollars to produce bushels as Farm 4, a cost of $945.16 per acre would have been necessary, about $180 per acre more than the listed cost. Among the top four, costs ranged from a low of $2.79 per bushel (Farm 7) to $2.95 per bushel (Farm 13).
Notice that the team with the lowest cost was not the most profitable. So, why was Farm 7 not the most profitable farm? Or, for that matter, why didn’t either Farms 13 or 7 with the highest yields earn greatest profitability? Answering these questions requires a clear understanding of the factors that create profit.
Profitability depends on interrelationships of costs, revenue and yield. First, while the cost per bushel is important in determining profit per bushel, it fails to recognize revenue’s role in determining profit, aka the revenue effect. By definition, total profit (TP) equals total revenue (TR) minus total costs (TC).
Therefore, revenue is clearly an active component of profitability. Second, it is important to recognize the yield effect, which affects both revenue and costs. If TC was constant, any gain in yield reduces cost per bushel. On the other hand, if yield was static, increasing TC would result in higher cost per bushel.
This seems simple enough and, idealistically, it is. The more effectively inputs are used to increase productivity, the smaller the cost per bushel. Successful operators know how to combine technical skills with economic knowledge to optimize their input use. Like TC, TR is dependent on yield, but unlike TC, TR is also dependent on market price received. Increasing yield decreases per-unit cost, while increasing overall revenue.
Let’s first consider the revenue effect. Two SIC farms with 1,000 acres each have identical costs of $3 per bushel with yields of 200 bushels per acre. Farm A averages a market value of $5 per bushel, while Farm B averages $4.90 per bushel. Farm A has a $0.10-per-bushel or $2-per-acre profit advantage over Farm B. Farm A’s TP is $2,000 more than Farm B. This is the primary reason why Farm 2, even with the lowest yields of the four most profitable teams, outperformed the other three farms; it had the most revenue.
The yield effect is also very powerful. If corn price was constant at $5 per bushel, two farms with identical $3-per-bushel costs would have a profit of $2 per bushel.
In this scenario, Farm A produced 100 bushels per acre, and Farm B mustered 200 bushels per acre, resulting in Farm A with a $200-per-acre profit and Farm B with a $400-per-acre profit. If both farms had the same number of acres, B would accrue twice as much TP as A. But, if Farm B had a cost of $4 per bushel, both farms would have the same TP. This is a simple concept, but not an insignificant point, and supports the idea that profit maximization trumps cost minimization, alone.
Overall profit impact
In Table 1, listed in order of profitability, are Farms 2, 7, 5 and 13. Farm 7’s higher yield and lower cost per bushel were enough to outweigh the impact of Farm 5’s higher market price. As shown, Farm 2 outperforms Farm 7 in profitability, because of its positive revenue effect created by its higher market price, despite lower yield.
Farm 13 had the greatest overall yield of any farm in the contest. This farm had two factors that held it back, however: high cost per bushel and lower market price. If Farm 13 would have had Farm 7’s cost per bushel, its profit would have increased by $38.94 per acre.
Farm 13 spent $42.96 more in fertilizer and irrigation than Farm 7, with about a 0.1 bushel-per-acre increase in yield. With this savings, Farm 13 would have made $115,959.60 more TP. Had Farm 13 secured a market price equal to Farm 2, then 13’s revenue would have increased to $1,598.95 per acre, an added $150.88 per acre, making that farm the most profitable.
If you consider the effect of cost reduction by $150.88 per acre for Farm 13, the market price of $5.69 per bushel would tie it with Farm 2, $5.45 per bushel to tie with second-place Farm 7, and $5.42 per bushel to tie with third-ranked Farm 5.
An increase in market price of $0.24 per bushel could have tied Farm 7 for first place. Realistically, any one of these four teams could have won with some small adjustments in cost, marketing and productivity.
Putting it together
This brief analysis has some very powerful implications. First, yields must be plentiful, but not necessarily the highest to win the profit game. Secondly, yields must be cost-effectively produced, as illustrated by the difference in costs between Farms 7 and 13.
In this case, the difference was easily seen in fertilizer and water use and resulted in Farm 13 having costly high production reducing overall profit. Third, while yield increases revenue, so does higher market price(s). This is seen in both Farms 2 and 7, where both were more profitable than higher-yielding farms.
Farm 2, of the four ranked farms, had the lowest yield, the highest market price, and the second-lowest cost per bushel. TAPS profitability winners are observed as effectively using inputs to create above-average yields that result in low cost-per-unit production and a high degree of efficiency, while they marketed production at an above-average price. In a single word, this describes the winners as balanced.
Stockton is a Nebraska Extension agriculture economist. Data is courtesy of the TAPS team (Daran Rudnick, Matt Stockton and Chuck Burr) and was collected from the 2021 TAPS contests.
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