Profitability is a key measure analyzed in the Dairy Farm Summary (DFS), published by four Northeast Farm Credit associations. Celebrating its 30th anniversary in 2009, the DFS has presented individual herd data averaged in a benchmark since 1979. The 2009 report is a healthy 48-page summary that explores various aspects of financial results for 540 dairy farms across eight Northeastern states.

This article highlights three aspects of profitability that were touched on in the report. Those are the earnings gap between the top 25 percent and the bottom 25 percent profitable businesses, business strategies that the most profitable dairies in the study employ and the question of whether bigger dairies are better. The profit gap Over the past several years, we have found the “profit gap” (or the difference in net margin) between our top 25 percent of farms in our study with the bottom 25 percent to be widening.

To illustrate, in 1983, net earnings per cow was $237 per cow for the top 25 and -$315 per cow for the bottom – a difference of $552. In 2008, the difference has more than doubled to $1,220 per cow. What does this disparity mean? From a financial standpoint, it translates into sharp differences in progress made by the two groups. The most profitable group earned 12 percent return on their investment in 2008, while the least profitable group lost 3.9 percent, even with high milk prices by historical standards.

Where does the disparity lie? As milk prices are similar between the two profit groups, the difference in profitability lies in the cost of producing milk. In 2008, while costs increased for both groups, the difference in the cost of producing milk between the two groups widened to $5.45 per hundredweight from $4.71 in 2007 (see Figure 1*).

Over the years, this study has determined that there is no simple explanation as to why some farms do better than others. There are, however, two consistent conclusions about differences in farm profitability:
1. The interaction of factors, rather than any single factor, explains why one dairy farm is more profitable than another.
2. No unique combination of factors is common to highly profitable farms.

Many combinations appear to work well, which provides dairy farmers with the opportunity to create their own formula for success. Certainly, high milk production per cow influences profitability. However, Figure 2* illustrates that by itself, high production per cow does not guarantee superior profitability, as a significant number of high- production farms fall in the lower-profit groups. However, very few low production farms fall in the top-profit group. The importance of balancing production with total costs to achieve profitability is much more obvious in Figure 3*.

As net cost of production decreases, the possibility of higher profits increases on nearly a straight line. Cost control, production ability, buying savvy, labor management and wise capital spending determine the cost of production. The ability of dairy producers and their management teams to consistently stay on top of these challenges determines profitability. Successful management strategies Above-average management is critical to profits, but “above-average” is difficult to quantify.

Successful managers have been able to identify and leverage their individual management strengths on which they build profitable dairy businesses. In short, these managers have developed a management strategy that fits their personalities and resources. They recognize that all parts of the farm operation are interrelated and important.

We are able to look at different key financial measures that relate a producer or group of producers’ management styles. We break the top 25 percent profitable into different groups that focus on cow output, labor efficiency, milk price received and cost control. In addition, several farms typically display a good balance of these measures in a positive way.

• Cow output
Farmers who focus on cow productivity typically spend more time and money to achieve more milk per cow. For 2008, this group, on average, had 25,588 pounds per cow. This allowed them to ship the second-highest amount of milk per worker – second to the group that focused on labor efficiency.

• Labor efficiency
The group that concentrated on superior labor management had the highest herd size in 2008 and sold 1.33 million pounds of milk per worker. Additionally, this group excelled in cow efficiency with the second-highest level of milk per cow. Consisting of larger farms, this management style typically gains labor efficiencies from economies of scale.

• Milk price received
The group that focused on attaining a higher milk price received $21.17 per hundredweight for their milk in 2008. This is $1.49 more than average for the entire top 25 percent profit group. Higher milk prices could be the result of high milk fat or protein content or negotiated premiums for quality, volume or specialty markets. Although cost of production is also higher, these producers have struck a balance that earned above-average profits.

• Cost control
Those dairy farm businesses that focused on cost control had a cost of production at $14.59 per hundredweight in 2008. This is nearly 20 percent lower than the overall benchmark. While milk per cow and milk per worker are below the top-profit group average, the rewards of managing costs are easily seen in the highest earnings per cow.

• Balanced
The “balanced” group is comprised of good, all-around managers with no one leading financial measurement. Profits may be less than the other styles, but these farmers are able to respond quickly to adversity affecting their business.

The common theme among top- profit farmers is that they reached a balance between milk production per cow and costs. Numerous variations of management styles have proven successful for individual farmers. However, management on all farms will continue to be held to a higher standard of performance as time goes on.

Dairy size does not guarantee financial success
“Is bigger better?” is a topic of frequent discussion as the U.S. average herd size continues to increase annually. In our 1983 Summary entitled “Do More Cows Mean More Profit?” we concluded that a wide range of profits indicated that farms in all size groups could significantly increase their earnings through improved management. The same holds true today. Profitability has more to do with successful management than any other factor, including size.

Certainly compared to other size groups in our study, the largest farms were more profitable than others, which has been true for several years. Their increased labor efficiency, reflected by a greater amount of milk sold per worker, is key to their advantage. As a result of labor-saving technologies, the largest farms can milk more cows and spread fixed expenses over more hundredweights of milk, thereby having an easier time increasing the farm’s whole-farm profitability.

Larger farms also achieve substantially greater capital efficiency on average than do small farms. With much less invested per cow in land, buildings, machinery and equipment than smaller farms, larger farms increase the rate of asset turnover, which contributes to a higher return on assets.

However, it takes a dedicated and effective management team to make a large farm a success, not simply more cows. That size of the dairy does not guarantee financial success may unfortunately be most painfully obvious in the current dairy environment. While the potential for whole-farm (versus per cow or per hundredweight) profitability is greater, so is the exposure for greater loss. Indeed, poorly managed large farms have the opportunity to lose money on a much larger scale.

Small- farm operators that manage for strict cost control, high cow productivity, lower debt and high reliance on family labor can be profitable. While there are issues of lifestyle, working conditions and monetary reward that go along with this, the fact remains that effectively managed small farms can do well. As always, to succeed, dairy producers need to be able to work through down cycles.

Management strategies will be as different as the individual characteristics of the farms and farm managers in our study. Finding the strategy for success that best positions your farm is critical to meeting the challenges of a changing and increasingly volatile industry. PD

*Figures omitted but are available upon request to editor@progressivedairy.com

Joanna Samuelson
Knowledge Exchange
First Pioneer Farm Credit
joanna.samuelson@firstpioneer.com