Economies of Scale are not everything they seem!

Posted by Brendon Walsh on 18 October 2016

Up until now, many sheep and beef farmers have been under the illusion that to make more profit you need to get a bigger farm/land area, increase production, run more animals, increase stocking rates, inject more capital and/or renew X% of your pasture every year. It all seems to be justified by the reason of “Economies of Scale.” But does that thinking really deliver the desired results?

From my observations (and those of many in the industry as reported in our farming newspapers) the answer would have to be No! At least No unless you were coming from a really low base of production, debt and utilisation of resources. Some are in this position but most aren’t, especially after three decades of being given the above advice.

Farmers have grown production – well done! But despite this, their profits and other business results aren’t generally improving, let alone keeping ahead of business and industry changes. To many this is an anomaly but when you think about it, logic would say it is expected. How? Let me explain.

Economies of Scale rationale says the way to get a bigger gap between income and expenses is to put the same amount of expenses over larger sales – hence greater profit. This sounds great at first but it is really only an assumption. There is no actual system that governs this as a foregone conclusion. Sometimes it works out and sometimes it doesn’t. I am not sure if it is 50:50 or not (possibly close to that, perhaps worse) but either way those are crap odds to bet your future on and to go into larger debt for. Besides, expenses often increase in the push to lift production. Something is wrong with this picture!

This thinking doesn’t measure how well income is actually generated from those expenses, as the expenses are allocated. It is usually measured annually by accounting profit (tax) figures or by using gross margins for shorter or longer terms. That is very unhelpful to farmers – the ones taking the biggest risk and who have the most to lose. Confusion easily reigns. Overall, it is a mindset that is really not delivering.

To improve the gap between income and expenses animals must gain the most value change (income) for the farm working expenses (FWE) that are allocated to those animals. In other words, the value change generated from eating Dry Matter (DM) has to be greater than the cost of that DM, for a profit to be made.

This is where the 6 Profit Principles come into it. Click here if you are not familiar with them. They are a logical system that generates profit if they are followed. If they aren’t followed, you don’t generate profit! There are times when profit can be available (profit periods) because the value change is greater than the expenses. There are also times when profit is not available (non-profit periods) because the value change is less than the expenses. This can be due to poor timing for the season or markets, or poor feeding causing poor live-weight gains, hence the low animal value changes. Why waste lots of DM down animal’s throats for a loss? You can’t get it back again.

True profit thinking is not just a tweak on Economies of Scale, or on a different branch of the tree, it is up a completely different tree! That is why farmers who try and tweak what they are doing using the same old advice or thinking will not get sustained and consistent profits. In fact, those that recommend the Economies of Scale method as THE way forward to better results don’t understand how to generate profit from a farm business in the first place. If they did then the farm business results from 30 years of advice would be far different, wouldn’t they?

Advice is recommended to others because there is benefit in it, and most of us measure the major benefit to our businesses on the bottom line as profit. Just make sure you know who is receiving the benefit of that advice. Historic results show that it is not necessarily the farmers!

If you are curious about how the GrowFARM® System can help sheep and beef farmers generate the profits they really want, contact me here.