By: Matt Stockton, TAPS Team Member & Ag Economics Specialist
Data contained in the following article is courtesy of the TAPS Team (Daran Rudnick, Matt Stockton, and Chuck Burr) and was collected from the 2021 TAPS contests; the accompanying analysis was completed by Matt Stockton.
What can we learn about increasing farm profitability from the Testing Ag Performance Solutions (TAPS) program? This year’s profitability winner for the Sprinkler Irrigated Corn (SIC) contest was Farm 2, which was a typical example of a profitable team. Farm 2 did not have the highest yield, lowest cost (using either per acre (/ac) or per bushel (/bu) 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 shows the minimum costs at $655.23/ac, Farm 4. Farm 4 has a profit of $384.81/ac versus Farm 2 with $736.01/ac, almost double that of Farm 4. Farm 4 used $655.23/ac ($3.45/bu) and produced 193 bu/ac corn, while Farm 7 used $752.16/ac ($2.81/bu) and produced 274 bu/ac of corn grain. For Farm 7 to be as ineffective in using dollars to produce bushels as Farm 4, a cost of $945.16/ac would have been necessary, about $180/ac more than the listed cost. Among the top four, costs ranged from a low of $2.79/bu (Farm 7) to $2.95/bu (Farm 13). Notice that the team with the lowest cost was not 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 $/bu cost is important in determining profit/bu, 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 $/bu cost. On the other hand, if yield was static, increasing TC would result in higher $/bu cost. This seems simple enough and, idealistically, it is. The more effectively inputs are used to increase productivity, the smaller the $/bu costs. 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/bu with yields of 200 bu/ac. Farm A averages a market value of $5/bu, Farm B averages $4.90/bu. Farm A has a $0.10/bu or $2/ac 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/bu, two farms with identical $3/bu costs would have a profit of $2/bu. In this scenario, Farm A produced 100 bu/ac and Farm B mustered 200 bu/ac, resulting in Farm A with $200/ac profit and Farm B with $400/ac 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/bu, 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.
In Table 1, listed in order of profitability, are Farms 2, 7, 5, and 13. Farm 7’s higher yield and lower $/bu costs were enough to outweigh the impact of Farm 5’s higher market price. As shown, Farm 2 outperforms Farm 7 in profitability, due to 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 $/bu cost and lower market price. If Farm 13 would have had Farm 7’s $/bu costs, its profit would have increased by $38.94/ac. 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/ac, an added $150.88/ac, making that farm the most profitable. If you consider the effect of cost reduction by $150.88/ac for Farm 13, the market price of $5.69/bu would tie it with Farm 2, $5.45/bu to tie with 2nd place Farm 7, and $5.42/bu to tie with 3rd ranked Farm 5. An increase in market price of $0.24/bu 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.
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 lowest yield, highest market price, and the second lowest $/bu costs. 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.