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Cover Story: Where Farm Diversification Fits Best

Cover Story: Where Farm Diversification Fits Best
A leading financial consultant spells out the pros and cons of diversification

Farm Futures Contributing Editor Dick Wittman wears many hats. He's a farm financial consultant and also manages a large family farming business that is equally diverse. He discussed diversification with Senior Editor Bryce Knorr.

FF: Dick, you're eminently qualified to comment on the topic of diversification, given your involvement in grain, cattle, timber and consulting. Am I missing anything?

Wittman: We are "involuntary investors" in several rental houses. That transpired when we acquired farms with homesteads on them. These are a pain in the rear, but we can show the return on investment from these assets often exceeds our returns from farm assets. These homesteads have provided good versatility for housing employees on the farm, when the situation fits. But it is important to document what your true labor costs are by imputing a reasonable "rent" for these facilities and recognizing that as a return on the rental house enterprise and a labor cost to the farm to get accurate costs of production.

We also are developing our hunting and farm recreation enterprise. This will likely take on larger resources and more management time, but will allow us to manage the farm's value as a recreation as well as a commodity production resource. It also provides another avenue to attract family members interested in succession who are not necessarily passionate about the farm commodity production side.

FF: Is diversification still a good idea?

Wittman: I think diversification fits for many producers, but it can come in more ways than most think. We need to expand our creativity in how we think about ways to diversify. A partial list would include diversification by:

-Enterprise -- within agriculture as well as outside of agriculture;

-Location -- this can be just up the road, in another county or on another continent;

-Market outlets -- selling to different end users;

-Non-farm investments -- retirement plans can reduce pressure for liquidation or "cannibalizing the farm" to fund retirement needs;

-Creating value added products -- this is not really diversification, it's more like extending the marketing chain or vertically integrating.

FF: Is there an advantage to developing new on-farm income streams, as opposed to developing off-farm business ventures?

Wittman: Investing in off-farm businesses can be an advantage as long as you develop the skills and experience to manage these ventures. One of the biggest advantages is the one I stated above: reducing dependence on the farm to fund retirement needs.

Many off farm diversifications have started with best of intentions, but they failed because it took the farmer outside his or her core competencies. You have to have the ability to strategically know where and when to invest, how to oversee or monitor performance, and when or how to exit. Many farmers admit diversifying outside agriculture makes sense, but they have persistently told me they can do better staying in agriculture, growing wealth by doing something they know and understand well, rather than trying to jump into competition with others who have already perfected competing in alternate investment worlds.

FF: What's the downside? What are the pitfalls of diversification?

Wittman: Here are just a few of them:

-Getting outside the core competencies needed to effectively decide where to invest, monitor performance, and exit.

-Creating conflict among business principals because of different levels of interest or support in diversification ventures. This is a classic where grain and livestock diversification is not fully supported by all on the team.

-Failing to use good cost accounting (or managerial accounting) to monitor performance in diversified profit centers and adjust investments or strategies accordingly.

-Diluting your attention from your core businesses by trying to manage too many diversification avenues; the consequence is that you start performing at a mediocre level in multiple disciplines, especially your main business, versus striving for excellence in each.

-Not understanding the internal conflicts or drains that diversification can have on human resource use; production strategies; capital and financial needs; and marketing expertise.

-Staying with an enterprise too long and not knowing when its performance warrants exit from the business. This is often tied in with the 3rd point, not having a good measurement system to tell you when the enterprise is performing poorly.

FF: Is there a dollar threshold needed to make diversification worthwhile?

Wittman: A dollar amount doesn't seem relevant. More importantly, I advise farmers to have a diversification goal, strategy and action plan to get there.

A goal might be to have 25% of your net worth tied to non-farm assets at retirement age. A potential strategy would be to build a portfolio that includes cash value insurance, retirement plans, stock investments and off-farm commercial real estate in some balance to achieve the goal. The action plan would include an annual provision in the operating plan to fund and manage investments in each of these non-farm categories working toward the goal. Having a spouse with a good job, pension and medical benefits can be a good idea, too!

A critical part of the action plan would be an annual review, ideally with the coaching of an outside investment advisor or advisory team to assess progress in reaching the goal and plans to alter future investments to maximize the balances in the off-farm investment portfolio.

The payoff from having a goal, strategy, and action plan is that at retirement, the farmer can achieve financial security to retire with good cash flow. He can gift or will assets to heirs and/or charity. Or, he can retire but stay active as an investor in the farm. The last point, continuing to remain as an investor, is likely going to become more important as the capital needs to sustain a viable farm grow to more enormous levels and heirs or successors are less often in a capacity to "buy you out" to execute a farm retirement or succession plan.

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