The 5 Percent Difference

By: Danny Klinefelter

I worked in the Farm Credit System from 1982- 1987. As bad as times were for agriculture, one of the things that struck me was that a lot of farmers remained profitable. Their market value net worth may have declined with land values falling by half, but their earned net worth kept increasing.

After I came back to Texas A&M, I conducted a study of the factors contributing to the changes in earned net worth between the top 25 percent and the bottom 25 percent of producers in a major ag lender’s portfolio over the six years between 1982 and 1987. The portfolio was separated into six farm types: corn-soybeans, wheat, cotton, farrow to finish hogs, dairy and cow-calf in order to compare like type firms. I looked at production per unit, net price received per unit, cost per unit, asset turnover and leverage. It was interesting that leverage appeared to be as much a result of, as it was a cause of problems. If the rate of return on equity (ROE) was higher than the rate of return on assets (ROA) greater leverage, it required better risk management, but it also resulted in greater profitability. If ROE was less than ROA, being highly leveraged took the business down faster. Essentially, leverage was the straw that broke the back of farms who were unprofitable, had poorly structured debt or lacked sufficient liquidity.

The results that surprised me most were the differences in production, prices received and cost of production. The top 25 percent were only about 5 percent above average, while the bottom 25 percent were about 5 percent below average. Obviously, the really low performers weren’t included in the study because they didn’t remain in the database throughout the period.

Later studies by the University of Illinois, Kansas State University and the University of Minnesota using their farm business records found similar results. Although they didn’t break out the factors the same way, all three found about $100 per acre differences in net farm income between the top and bottom groups. One of Kansas State’s studies by Terry Kastens found 53 percent of the difference was revenue (price and yield) and 47 percent resulted from lower costs. Last year, Dave Kohl was quoted in Crop News Weekly on net income information from Minnesota’s FINBIN financial database, “The biggest surprise is the widening gap in net farm income from the top 20 percent to the low 20 percent of producers in the database. In 2008, the average net farm income was $426,476 for the top 20 percent compared to - $33,206 for the low 20 percent. When analyzing the data since 2003, the financial extremes have become greater each year.”

The important point is that the top producers tend to sustain their advantage over time and the gains compound themselves in the form of accumulated equity. Remember the multimillionaire, future hall of fame baseball player with the .300 lifetime batting average only gets 1 more hit every 20 times at bat than the .250 hitter who just manages to hang on. The incremental differences may seem small, but they do it over and over again.

Consider the following example. Assume an average corn yield of 200 bushels per acre, an average price of $4.00 per bushel and per acre cost of $650.00, which would generate a net income of $150.00 pr acre. What would be the impact per acre net income beating the averages by 5 percent?

Some may question the ability to generate higher yields and at the same time have lower costs. However, it occurs frequently. Producers renting the same quality ground in the same area often pay significantly different rent. Sometimes it’s because of their relationship with the landlord, sometimes because of being better negotiators and sometimes because of their reputations for being better stewards or managers. Some achieve lower rents by providing additional services. Still others achieve lower costs through economies of scale, by sharing resources with other farmers or simply by making more efficient use of their resources. I see farmers all the time with the same equipment and labor force on 1500 acres that another producer uses to farm 2500 acres. Several TEPAP participants share equipment and even labor with producers in other parts of the country. Some joint purchase to achieve better input prices. The possibilities and the examples are endless; but, there are always ways to do better and it comes down to management and being willing to change.