June 7, 2024

Improving Your Strategic Risk Plan

by Michael Langemeier, Brady Brewer, and James Mintert

In the third episode of the strategic risk series, the Purdue University Center for Commercial Agriculture’s team of ag economists, James Mintert, Michael Langemeier, and Brady Brewer discuss the tradeoff between improving efficiency and resilience of the farm business. This episode provides a series of questions you can use to help evaluate tradeoffs on your farm. The discussion concludes with five key managerial levers you can focus on when thinking about efficiency and resilience.

Slides and the transcript from the discussion are available below.

Audio Transcript

James Mintert: Thanks for joining us for the Purdue Commercial AgCast podcast. I’m Jim Mintert, Director of the Purdue Center for Commercial Agriculture. And joining me today on the podcast are Michael Langemeier, who’s Professor of Ag Economics here at Purdue and also the Associate Director of the Center for Commercial Agriculture, and Brady Brewer, who’s an Associate Professor of Ag Economics here at Purdue.

So we’re going to do a discussion of strategic risk, and this is a follow up to two prior podcasts where we talked about strategic risk, so this is the third in a, in a three part series. And we want to talk a little bit about, first of all, what is strategic risk, and then we’re going to talk about the relationship between managing for strategic risk and what that means in terms of how it might impact the efficiency of the operation of your farm.

So, Michael, let’s do a, just a quick review here and talk about what do we mean when we say strategic risk.

Michael Langemeier: Strategic risk is the risk of being out of strategic position, and usually when we think about strategic position, we’re thinking about a business plan or a strategic plan. And in that plan, we typically indicate, is our goal to be a low cost producer, to have lower per unit costs than other farms in the industry, or is our goal to add value to get a higher price for our products than other, other farms in the same industry that we’re in. And, and so that’s the danger, is you’ll have an external shock, like government policy change or geopolitical conflict, a war , Ukraine-Russia war for example, that causes a shock to the operation and causes you to rethink your strategy.

The shock can also be internally. And the classic example there is you lose a key member of the team, of the decision making team. You know, through retirement or, or leaving the farm or something like that. And so it can be internally or externally, but that’s what we’re talking about when we talk about strategic risk. How can we ensure that we just keep right on rolling with production, if we’re faced with these external or internal shocks.

James Mintert: Yeah. And just as maybe a follow up, Michael, where we’re not talking about forecasting necessarily what that strategic risk is. It’s an idea about managing your business in a way that you can weather strategic risk. And it could be a variety of different things. It’s useful to think about some of the possibilities that could happen, but it’s really not a forecasting exercise per se, right?

Michael Langemeier: It’s not forecasting and it’s not predicting. You can’t often, if ever, can you predict a strategic shock, uh, either externally, internally. And so, and so you’re right, Jim, you’re, you’re thinking about how, how would I respond to a shock? And in a previous podcast, we talked about scenarios. You have different scenarios and you talk about here’s how I’d respond to scenario A, here’s how I’d respond to scenario B and so on.

James Mintert: So related concept is what I want to talk about with you, Brady, and that is the idea of positioning your farm for long term success by being resilient to strategic risk. But there’s a related point, and that is how agile are you, right? So sometimes there’s a little bit of a tug of war here with respect to being agile and responding to change. And also being resilient.

Brady Brewer: Yeah. So we’re gonna get a lot more here later in this episode about the resiliency versus kind of efficiency on the financial side. But there’s also this tug of war between resiliency and agility, uh, of a farm. And, and I say there’s a tug of war sometimes they, they do go hand in hand and this is why it’s important to be very strategic on the farm.

So agility is a farm’s ability to quickly identify and capture business opportunity. So we talk about some of these risks. Sometimes there’s opportunities in this risk. We saw this, you know, when you think of these rare events that happen, you know, if a pandemic were to happen, we saw a lot of people capitalize on some of the the opportunity that was presented by the risks that were happening of the day. So agility is just the ability of a farm to quickly say, Hey, things are changing. How can I change my operations to meet the new needs that are before me? And then there’s this other concept, which is resiliency, which is the ability to just withstand these negative shocks that Michael was just talking about, right?

So we tend to think of that from, you know, we’ve talked in the previous two podcast episodes about redundancy. I think we’ve used that term a lot. Uh, typically redundancy means that you’re going to be more resilient and resilient is, it’s just quite simply the ability that you have to withstand these negative shocks.

James Mintert: So one of the things to think about with agility, and I think some of our listeners are probably thinking about, well now, what’s a good example that’s happened in agriculture? You know, one of the things that pops into my mind is, is the regime change that took place when all of a sudden ethanol became an important source of demand for corn. And that really shifted the corn soybean profit environment and in some cases made people maybe change their cropping patterns, etc. They responded to that external shock to the system and they were agile enough to take advantage of it. In some cases that meant going out and renting additional land, maybe purchasing additional land.

So that’s part of what we’re talking about with respect to agility. Is there some kind of regime change taking place? It’s you can maybe take advantage of.

Brady Brewer: Yeah. And I think with that example, Jim, you’re sitting there, you know, you may be listening to this and be like, well, that doesn’t seem that hard. But you think about the assets that are needed, whether it be land or equipment, also production knowledge as well. There’s there’s actually a lot that I think needs to be changed in in that particular example that would make a farm agile to respond quickly.

James Mintert: Yeah, good point. So let’s talk more about this trade off between efficiency and resilience, because most of the time when we think about managing our farm a little bit better, we think about improving efficiency.

Now Michael, I’ve heard you speak a lot of time and a lot of different programs over the course of the years and years, a tendency to talk about, you know, are you efficient and how do you measure that? And then there’s this relationship between that and resiliency, because if you’re very resilient I think you’re going to be a little less efficient. At least that’s a risk, right? So, Michael?

Michael Langemeier: Yeah, we often talk about cost efficiency indices, for example. We often, we talk about things like the profit margin. So we do talk about efficiency and financial performance a lot. We also should, at the same time, we don’t always do this, but we should, indicate that there’s this risk return trade off.

Yes, we can push performance higher and higher, but at what cost? So that’s what we’re talking about with this trade off between efficiency and resiliency. We don’t, we’re not saying you necessarily want to be, want to focus on just efficiency or just resiliency. You wanna think about the balance. What is the, what is the appropriate balance for your farm? And I know by looking at some of the survey data from from our strategic risk survey, that there is folks that are fairly efficient and adopting management practices, but also resilience. And that’s the balance that they’ve come up with.

James Mintert: So Brady, I think one of the challenges to figure out what, what kind of risk tolerance do you have and maybe, you know, what stage, what stage of the life cycle of your business and your career you’re at, right?

Brady Brewer: Yeah. Jim, part of the motivation for doing this third episode in kind of this series is if you’ve listened to the previous two podcasts on strategic risk, we’ve really mention redundancy a lot. If you are super risk averse, in other words, you don’t like risk at all, you’re going to build in all those redundancies. But I also don’t think that’s a very feasible position or logical position to take, right?

So if you think about the spectrum of being super risk averse, you don’t want, you want your farm to be prepared for any and all strategic risks that it could face here in the near future. As Michael just said, there’s this tradeoff between efficiency and resiliency, and that’s just going to erode profitability, right? Because that’s going to take a lot of assets to build in all that redundancy that you need to respond to some of those risks.

The other side of that coin is we’re not going to prepare for any of these strategic risks and say, Hey, we’re, we’re not going to build in any redundancy. We’re going to be super, not risk seeking, but risk neutral, right? We’re just going to be profit maximizers. And if one of these happens where we may not be prepared for it.

In reality, people are probably going to be somewhere in the middle, and you have got to understand your risk tolerance for some of these events that we’ve been talking about, right? And what is that level of resiliency that you want to build into your farm, and what are you willing to give up in terms of year to year profitability to build in that resiliency?

Uh, you know, the goal of any business is to maximize profits, but we’ve got to be in business in order to maximize profits. So we, you know, we know we’re gonna have to give up some efficiency to build in this resiliency. But how much you do is gonna be up to your particular risk tolerance.

Michael Langemeier: And one of the challenges in farms a lot of times is we’ve got a team, there’s several family members involved in the business. Everybody has different risk tolerances. The classic case is think about the difference in the, in the ability or the desire, uh, to, to add debt comparing an older generation to the younger generation. I talked to the people in my Ag Econ 524, my finance class about this issue. A lot of times the younger generation, uh, has, are fairly risk neutral. They want to grow. And so they’re willing to take on debt, whereas the older generation, they’ve, they’ve just got done paying off some loans, perhaps for some land. And they’re a little bit more leery about taking on, on debt.

You’ve got to come to an agreement. You know, you know, we know we have different risk tolerance, but we think this is, this is what the farm needs to do. And so, uh, coming together as a team and deciding what your strategy is going to be, uh, in this case, I’m talking about leverage.

James Mintert: And that’s a good point to raise, Michael, the difference between generations at a farm, because that comes up all the time.

One of the challenges there is to think about the risk tolerance of the business. Not the individuals within the business. And I think that’s a barrier for a lot of folks. They tend to forget that the idea is that that farm is going to succeed and exist beyond the lifespan of any individual on the farm. At least that’s the longterm goal. When you think of it that way, you come at it from a different perspective, but a lot of people have trouble making that transition.

Michael Langemeier: It’s getting the older generation to realize thinking about my retirement is different than thinking about what the business needs to do. Those are two separate issues, personal and business, and you’ve got to separate those when you’re thinking through these issues.

James Mintert: Yeah. So, um, the key point here is maybe to think about what is your level of risk tolerance and what are maybe some ways to look at that, Brady?

Brady Brewer: Yeah. So, I think Uh, it’s very similar to what you would do on the tactical side with thinking about what is your risk tolerance when you’re making crop insurance decisions, right? What are you willing to pay to get rid of some of this risk? Right. Now traditionally, we think of that as what are we willing to pay in terms of crop insurance premiums. But in this case, it’s what are you willing to pay to build in some of this resiliency into the farm, whether it be additional assets, additional labor. I know labor is also, uh, a really big item that you can build into your farm in case opportunities come about or or risk happen, right? So, the question I would always ask is, what am I willing to pay to be able to negate the risk that I could potentially face? And I think that’s a good way to frame your particular risk tolerance.

The more you’re willing to pay, the more risk averse you are.

James Mintert: Yeah, that’s a good point.

Michael Langemeier: But, but thinking about that slack, Brady, I wanna, I wanna, uh, pipe in there a little bit. Thinking about that slack, we also gotta realize that we’re building in slack. We have a, we have more labor than we need, or we have more assets than we need.

This also relates to agility. It’s, it’s, it’s for resilience, but it also relates to agility. If, if we have the labor in place and we have the machinery in place, it’s much easier, uh, to go out and, and, and take on quite a bit of rented ground or to, or to go ahead and purchase, uh, purchase another tract and not have to worry about, do I have enough labor, enough machinery to handle, handle this additional land? And so it really is both that agility and the resilience that we’re thinking about the slack of redundancy.

James Mintert: And I guess the other thing to conclude from that is there’s no single right answer, but the key here is to get these issues on the table and discuss them, which a lot of times in our experience, farms don’t have these discussions.

Maybe individuals think about it on their own without airing that and discussing it with the other partners in the business and the other folks that have a stake in the business. So let’s think about some key questions to ask. And we’ve got four questions we want you to kind of walk about, walk through and think about.

So, Michael, the first one is the efficiency of the production system. How do you tackle that?

Michael Langemeier: The only way to really know if you have an efficient production system is to benchmark your performance. And the way I would suggest that, do that at both the enterprise level and the whole farm level. So for example, what is your break even price for corn?

How does that compare to others in the industry? There’s data sets like University of Minnesota FinBIN, uh, that provides benchmark data for different enterprises. You can take a look at that, uh, compare your break even price for a particular year, uh, with that benchmark data. On a whole form level, uh, I, I, I, I, Let’s keep this fairly simple because we’ll probably delve into this into some future podcasts is you can think of something like the net farm income ratio, which is just simply the net farm income divided by gross farm income.

And long term, you want that to be 20 to 25%. You’re not going to be 20 percent in 2014. It’s highly unlikely you’re going to be 20 percent in 2024, excuse me, 2024, because this year is going to be a little challenging, uh, from, from a margin perspective. And so, and so when you’re talking about whole farm, you’re talking more long term. Long term, what does my ratio look like again, uh, compared to, to others in the industry?

James Mintert: So, you know, when you think about cost of production for, for example, corn, soybeans, you know, feeding cattle, uh, raising hogs, et cetera. One of the key points there is to think about how you’re doing your computations, how you’re doing your accounting, and to come up with a standardized format.

So that’s where some of the more formalized benchmarking systems like, uh, in Illinois, the Farm Business Management Association, Um, we’ve had a lot of experience over the years with the Kansas Farm Management Association. What those groups do is help you standardize your accounting so that when you’re making comparisons, you’re really comparing apples to apples. Because sometimes when I ask people about what their cost of production is, it’s obvious from the answer. That they’ve used their own unique approach to computing cost of production, which makes it very difficult, if not impossible, to make an accurate comparison with other folks in the industry.

Michael Langemeier: Yeah, that’s a very good point. And there’s a couple of excellent sources of information out there that would help you with that. For example, Gary Schnitke at the University of Illinois, puts together budgets and those budgets are very consistent with the way the Farm Business Farm Management Association, uh, computes cost of production.

We use very similar, uh, uh, uh, very similar techniques with the Purdue budgets. You can also look at the Purdue budgets and try to calculate your costs, uh, using the Purdue or the Illinois budgets and that, that, that would really help. Uh, make sure that you’re, you’re including all the costs, because what often happens, Jim, is, is, is if I own land or I own machinery, that’s not a cost to me. Well, it is, uh, from a break, you know, when you’re talking, you’re talking about cost of production, it’s full costing. You both, you got both the cash costs and the opportunity costs. I have money invested in that land, I could do something else with that money, and so we’re, we’re charging, we’re charging an opportunity cost for that own land, own machinery, uh, operator labor. Uh, in those kinds of items.

James Mintert: And so, I’m sure you’ve run into this many times, perhaps more than I have, but a lot of times I run into folks who look at, for example, the Purdue budget, and conclude their cost of production is lower than what you’re showing on the Purdue budget, and therefore conclude they’re efficient. But the reality is, they’ve failed to include those opportunity costs you just mentioned. Um, and the key is usually on owned land, right?

Michael Langemeier: Yes.

James Mintert: Uh, so make sure you’re using a standardized approach to doing that. You wanna think about whether or not you’re efficient, compare that to industry averages. Again, coming back to things like the Purdue budgets, the Illinois budgets, those farm business management associations in the various states can really be very helpful.

Um, then Brady come back to thinking about, the next question is, do we have sufficient equity and liquidity? To handle adversity in a cyclical downturn. And that’s a good point to talk about in 2024 because we’re in the early stages of a cyclical downturn.

Brady Brewer: Yeah. So, you know, the previous questions really got at how you operate as a business and that resiliency versus efficiency trade off.

And now we’re thinking about more the balance sheet of okay. If we have the assets in place, if we’re operating correctly and we’re executing our strategy, but at the same time, we know we’re going to need, I always call it a war chest, right? Uh, on, on your balance sheet. And what is, what does that war chest look like? Do you have sufficient equity to dip into, uh, to utilize if times do get tough, if this risk does actually negatively impact your operation and if a cyclical downturn comes, what is your burn rate? Which burn rate is just how much how long it would take you to burn through your working capital? Which is your current assets minus your current liabilities. So essentially your excess of liquid assets on the farm, uh, if you were to continue to operate like you do, how long would you last? Would it be one year, two year, three years, right? So asking that question, does your farm have sufficient equity to dip into or just working capital to burn through, uh, to last for a significant period of time is, is a super important question to, to understand for your farm’s resiliency question.

James Mintert: So burn rate is a key concept for a year, like 2024, when some farms are clearly gonna have, uh, an opportunity, so to speak, to burn some, some of their working capital. And that’s really a, a term that we don’t hear too much in agriculture. But if you follow the business press, it shows up a lot.

Recently, it showed up a lot with the EV industry, the electric vehicle industry, right? With some of these companies burn rate being so high that they wind up leaving the industry, right? There’s been a couple of big closures here just recently.

So it’s, it’s not something we tend to think about in agriculture, largely because when we do have a burn rate, it’s usually not that large. Is that

Brady Brewer: Correct. Yeah. So, I mean, in general, if you think about current ratios that we advise, we always say current ratio of two. We also know that unexpected expenses come up. So if you’re, if you’re sitting there with the current ratio of two, you’re probably not going to make it a full two years. You want a little bit more of, of a buffer.

Okay. And it’s just hard to get a burn rate more than more than two to three years. That’s a pretty large war chest that you have sitting there. Um, that would be what I would call the advisable. Uh, two years is what I would tend to advise. I mean, most downturns don’t last more than that, but that also means that you have time to adjust.

Right? So we’re talking about this agility, uh, from earlier in this episode. You know, if you think about having a burn rate of two years, that’s a pretty long time. That you can readjust your operation to, uh, adjust it to what is, I’m going to call the new normal if one of these strategic risks actually does happen.

James Mintert: So I’m going to disagree with you a little bit when you said we usually don’t have downturns that last more than a couple of years. I think we have evidence in production agriculture of downturns can last longer than that. But I think the key is it gives you some time to make some adjustments. Yes. So as we think about a burn rate and maybe it is initially at current rates, maybe it is only two or three years, which isn’t that long, but you’ve got to make some changes. It’s a signal. that you’ve got to start making some adjustments, right? And whether that turns out to be on the, for example, if you’re a crop farmer on the cash rent side, maybe that’s an opportunity your other production decisions, what you do with respect to replacing machinery. It’s a signal to not continue business as usual, right?

Brady Brewer: Yep. And maybe I should clarify there. So when I say we don’t have downturns longer than two years, yeah, I mean, credit cycles tend to last six or seven years, so we can have six or seven year cycles where we have what I would call depressed commodity prices or depressed incomes. We typically only see two to three years where it’s, it’s, uh, red all the way throughout agriculture, right?

James Mintert: Yeah, yeah, good point.

Brady Brewer: Which I think highlights the need to be agile and resilient. Cause that means as long as you can change within that one or two year period, you’re probably going to be okay. Right. Cause we can adjust to something that while you may not be making a lot of money, It’s going to get you to the next year.

James Mintert: Yeah, good, good point. So Michael, the last question is, do we really have an adequate system for obtaining the management information to monitor the business performance? And you like to start off with the first one, which is on the people side, right?

Michael Langemeier: Yeah, the first thing I always ask a farm is do you, is there, do you have a designated person, uh, that that’s responsible for keeping up to date records? And notice they said up to date records, uh, because you want to have a record keeping system that you can use. If I want to, if I want to buy a, a piece of machinery, for example, you should be able to pull from that record system and see exactly what the cash flow situation looks like for the rest of the year, for example, you should be able to tell immediately what the balance sheet looks like, not just not just, if you’re sitting in September, you shouldn’t have to go back to the January balance sheet. You should have you should have an up to date balance sheet to see where you’re at. She can use that information to make decisions. But I like, once you’ve got that in place, I encourage people to go one step further and really start thinking about developing financial statements. A lot of farms have a balance sheet and a cash flow, but do not necessarily have an income statement, and of course, my favorite statement, Jim, uh, the sources and uses of funds statement.

And so that’s kind of a goal. Uh, you know, once you have a, a system in place, you’ve got somebody that’s doing this. Uh, uh, you know, try to start developing some financial statements because that’ll, that’ll really help you, uh, monitor business performance. You really can’t calculate things like the operating profit margin, for example, uh, unless you have, uh, an income statement. And so, and so that’s kind of the, that’s kind of the end goal. So listeners

James Mintert: are probably wondering why Michael referred to the sources and uses of funds as his favorite statement. It’s because it’s one of the more heavily downloaded items on our website. We’re not completely certain who’s downloading it, but we do know it gets downloaded quite a bit.

So, um, Brady, let’s think a little bit about what we’re going to call the DuPont profitability model, which is widely used in the finance world, but maybe not talked about quite so much in agriculture. But it’s really got a good application here, and it’s a really good way to think about Managing your business. So talk us through that a little bit.

Brady Brewer: Yeah, so let’s think about so the DuPont’s gonna be a tool we’ve talked a little bit about this trade off between resiliency and efficiency, and the DuPont profitability model which all it says is that a firm’s return on equity, which return on equity, I think, uh, we were talking a little bit before we started recording. I think it’s one of the most underutilized, uh, ratios in agriculture. I love the interpretation of it. So the return on equity, uh, interpretation is if I put a dollar of my equity or capital into my business, what does that return me? Okay? Uh, it’s a pretty strategic ratio in terms of we’re not analyzing one thing. We’re not analyzing. Do I have money like working capital to get to the next year? or a operating expense ratio where I’m analyzing something on the income statement. It’s just do I, if I invest another dollar in my farm, what, what can I expect as a, as a long term return?

James Mintert: So let’s pause for just a second there, because I think some of the listeners right now might be confusing this with another term that gets used a lot, which is return on investment.

Return on equity and return on investment are related, but they’re not the same thing. So you might maybe define the distinction between those two.

Brady Brewer: Yeah. So return on investment, if you think about, well, It has the term investment in there. So if you think about investing in, uh, a particular stock or something for the, the New York stock exchange, right? Uh, when I think about return on invested capital, uh, that’s, you know, specific investment that we’re making equity is looking at all of the equity capital in in the particular business.

James Mintert: So, so the difference is return on investment can include return on borrowed capital.

Brady Brewer: Yes.

James Mintert: As well as our own capital. Whereas return on equity is looking at the return on the capital that we own that we provided,

Brady Brewer: Yep.

James Mintert: Not the borrowed capital.

Brady Brewer: Yeah. And I think that’s a super distinction to make right now because, you know, again, we’ve talked about redundancy a lot over these past couple episodes on strategic risk. So at the end of the day, when you make money on your farm, one of the decisions you’re gonna have to make is where do I deploy this capital?

One of the options is take it out of the farm. Uh, one of the options is put it back in the farm. And if so, where do I deploy it across? So it really gets down to the interpretation of if I’m deploying my hard earned equity back into the farm. What, what can I expect as a return back to me?

Um, and what the DuPont model does is it breaks down return on equity into several, uh, key areas. So the first is going to be the margins you get from, from your farm. So margins is, uh, you, you mentioned the net farm income ratio, right? Very related concept. It’s at the end of the day, our farm grossed X amount. What do we keep at the end of it? So it’s really a cost efficiency measure. So we’re starting to see this trade off between resiliency and efficiency come through.

Then the second bucket that it decomposes return on equity into is asset turnover. An asset turnover is how much throughput do you get on your farm relative to the amount of assets. So I think of this as a what you do with what you have. How much product and value do we generate on our farm relative to the amount of assets that you have?

Now, we want to make a key distinction here when you are looking at asset turnover, it’s going to be highly dependent on your capital structure of your farm. So if you rent a lot of lands, obviously, that asset number is going to be smaller, so your asset turnover is going to be a lot higher.

It’s also going to be very dependent on the type of farm that you are. For instance, dairies tend to be very asset heavy, relative to other types of farms. Your asset turnover is just going to be a little bit lower. So, we got When you’re benchmarking some of these ratios that I’m talking about, you got to be very careful to benchmark against like farms or to take into account. Here is how my balance sheet may differ from other farms and understand, okay, I, I’m going to be higher on this because I rent a lot of land relative to owning my land. Okay.

And then the third thing it decomposes it is your capital structure. How do I deploy my balance sheet in terms of that, uh, trade off between debt and equity. Uh, and we call this the leverage factor because we can think about it as we add debt. We’re leveraging up the asset and margin efficiency of the farm. So, why we’re, uh, bringing this into the discussion here in a strategic risk framework is that asset efficiency and margins tend to be a little bit at odds at each other, right?

So we’ve again bringing up this concept of redundancy when you add redundancy on your farm you’re typically adding more assets, right? You’re becoming more agile to respond to these strategic risks, but that’s going to decrease, you know Your throughput of your farm may not increase but you’ve now increased the assets. So we’re now producing the same amount of with more assets, which it’s going to decrease your your return on equity that you see. So in other words, your investment, your equity capital in your farm is now less efficient, but you’re now more resilient.

James Mintert: Yeah, so you made your farm a little less efficient. And that’s the trade off to get a little more resiliency, right? And perhaps some agility. Right. Depending on the situation. So there’s a kind of a trade off there. Michael, what

Michael Langemeier: It also come. The leverage is also important to what we’re talking about. We’re talking about strategic risk because we talk about absorption capacity resilience. We often talk about strong balance sheet. Well, if you have a strong balance sheet, that that’s a that’s a That, that, that may also be related to your risk tolerance. Uh, people that have less risk tolerance tend to have a really strong balance sheet because they’re not as willing, uh, to borrow money. And so that’s how this all ties together. Uh, you’ve got risk tolerance, you’ve got, you’ve got efficiency, and you’ve got asset turnover all tying together, uh, to, to come up with this return on equity.

James Mintert: And so the challenge for farmers listening to this podcast is to figure out, first of all, what their risk tolerance level is. And then the related point is to think about, you know, if you, if you err too high on the resilience side, you’re really giving up some profitability opportunities, right? Uh, and conversely, if you err on the side of not having enough resilience, You run the risk of getting into trouble, right?

Michael Langemeier: Yeah. And again, we can’t predict how, how, how these opportunities that we may be pursuing are going to turn out. And so sometimes leverage works against you. That’s the way I usually put it, Brady. And that’s usually not the right words. We borrow money thinking that this is going to make us more money and it turns out that the, that, that, that opportunity wasn’t as good as we thought it was going to be, uh, and so, and so it actually brought in less money, uh, and so, and so that’s why you got to be really careful with leverage. That’s why it’s got to be really tied to that, uh, that risk tolerance.

James Mintert: And I think for listeners that remember the 1980s, they can appreciate the idea that leverage can work against you, right, because that was clearly one of the key problems in the 80s. So, Brady, let’s think about the five managerial levers a farmer can pull to actually improve the management of their farm operation.

Brady Brewer: Yeah, so we kind of want to end here thinking about, okay, where are some opportunities in that you have on your farm where this trade off comes into play this? Resiliency versus efficiency trade off and and this is all of these are going to directly impact the DuPont profitability model. Because it’s either going to impact the margins, the asset efficiency or the how you structure your balance sheet.

So first, let’s start with people. Right? I think this is a pretty straightforward lever you can pull. So what these levers are, as I go through these, I’m going to start here with people. Any decision you make on the farm, broadly speaking, is are going to fit into one of these five levers, and in some cases, they’re going to impact several of these levers that we’re going to talk about.

So the first one is people. I think this is a pretty straightforward one. The more people you have, the more resilient you’re going to be and the more agile you’re going to be. Michael talked about those opportunities for growth, growth tends to be a very stair step, uh, happening on a farm. And what I mean by that is, you know, we tend to say farms grow at eight or 10 percent every year, but it’s not a linear. What happens is you get an opportunity, you buy more land and you have 30 percent growth one year, and then you have 0 percent growth the next year. And you’ve got to be able to, uh, be able to capture that upside when it comes. So people is a pretty straightforward, more people is more resilient. But as we know, you have to pay, uh, farm workers, that’s going to make you less efficient from a cost perspective.

The second lever, assets. We’ve talked a little bit at length here, so I’m not going to belabor this point too much. The more assets you have, the more resilient you’re going to be, but that then decreases your efficiency, uh, your asset efficiency because we’re not improving or not increasing throughput even though we’re increasing the amount of assets we have.

Costs. This goes right to efficiency, right? If we decrease costs, uh, and become more efficient, right? We’re then decreasing some of the resiliency we may see on the farm.

Okay, yield. Uh, thinking about the yield lever that you can pull on the farm. If you try to do everything to increase the, the throughput, the output, okay, that’s going to make you more efficient. Uh, that by nature means you may take out some of those redundancies you see on the farm. Okay.

And then the fifth lever is output price. This is probably the one that Impacts this resiliency versus efficiency argument, um, probably the least, um, just because if, if you’re maximizing your output price, um, well, there may be assets you can do that you can deploy, um, thinking about timing of when you can get grain to the market. Maybe, uh, you can buy some assets that help you be more agile, uh, in terms of delivery to market, uh, and that can help on the output price. But for the most part, I think this is the one that it works. In terms of the resiliency versus efficiency market is probably, uh, one that I would say spend the least amount of time on spend the most amount of time on the yield, cost, asset, and people levers.

James Mintert: So Michael, I know you like to talk a lot about the people aspect because that’s one that a lot of folks overlook. One of the challenges. Particularly with respect to integrating the next generation on a farm is how do you bring in that next generation when maybe the farm today isn’t quite large enough. What are some strategies that you’ve seen people use that might help out there?

Michael Langemeier: I want to talk about this and from a couple different angles. First of all, yes, we have to have have to have people to run the business and we have to have people on our bus. But you people probably hear is People listening to this have probably heard this analogy before, but once you get those people on the bus, they need to be in the right seats. And so that’s what, that’s what, that’s, this goes back to what, which the question you were asking Jim. And so, and so when someone’s coming back to the farm, one of the questions that should be asked, uh, before that person comes back is what is, what are our gaps in knowledge? What are our gaps in skills? Are there certain things that we’re not getting done that we would like to get done in a more timely fashion? If some, if, if we hired someone that was responsible for that task. Uh, a classic example is technology. You know, checking out the, uh, the, the latest and greatest technology and seeing if, uh, we’re, we’re using the technology, you know, using, uh, using this, this technology wisely and prudently. And so once you’ve done that, then you can talk to the people that are coming back and, and see whether they can help fill that, fill that gaps in knowledge and add to the business.

James Mintert: So that’s one aspect of it. What about just from an income standpoint, integrating that new family member, that returning a family member to a family farm?

Michael Langemeier: There’s several things you can think about there. One of the things that happens all the time in agriculture is it’s a transition. Uh, you know, in, in, in the Eastern Corn Belt, this is easier to do than in the Western Corn Belt, where I grew up. There’s a lot of off farm opportunities in the Eastern Corn Belt, and so maybe you come back to the farm half time, uh, for, for a few years, and, and, and that’s, that’s, that’s important for a couple reasons.

First of all, the farm might not be big enough to employ you full time, but it also will convince you that that’s what you want to do. Sometimes people, uh, growing up says, Well, I would like to come back to the farm. And then they get into that situation. Well, maybe this isn’t for me. And so it gives everybody a test, if you will, a testing stage there, uh, to see if that’s really what they want to do.

James Mintert: Yeah, good point.

So I think we’re going to wrap it up with that. So that wraps up the third part of our three part series on strategic risk. If you haven’t had a chance to listen to the first two podcasts on this topic, you can find those at our website, purdue.edu/commercialag. And of course, it’s also on any of the major podcast providers, uh, that we post the website or So with that, I’m going to thank my colleagues, uh, Dr. Brady Brewer and Dr. Michael Langemeier for joining me today. And on behalf of the Center for Commercial Agriculture, I’m Jim Mintert. Thanks for joining us.

TEAM LINKS:

PART OF A SERIES:

RELATED RESOURCES

Conventional & Organic Enterprise Net Returns, FINBIN data from 2019 to 2023

July 12, 2024

This article summarizes net returns for conventional and organic crop enterprises using FINBIN data from 2019 to 2023. Organic corn and soybean enterprises had lower crop yields, higher crop prices and gross revenue, and higher net returns. However, there was a much wider difference in enterprise net returns among organic corn and soybean enterprises than there was among conventional corn and soybean enterprises.

READ MORE

Corn & Soybean Basis Strengthen Through June & July

July 12, 2024

Depending on where you are located, Indiana corn and soybean basis have seen large swings in the last six weeks. For example, SE Indiana corn basis was -$0.13/bu. in the first week of June but was $0.03/bu. on July 10th. Unlike history suggests, the movement has generally been a strengthening in basis for both corn and soybeans.

READ MORE

Corn Was King: The Transition to Soy in U.S. Production Agriculture

July 11, 2024

Margaret Lippsmeyer presented during agri benchmark’s 2024 annual conference in mid June, which was hosted by the Spanish Ministry of Agriculture in Valladolid, Spain. An increase in soybean acreage may come from either (a) shifting away from continuous corn rotations to corn-soy and (b) shifting corn-soy rotations toward corn-soy-soy. Based on agri benchmark¬†data, Margaret showed that option (a) would require an increase in soybean prices of 6% and option (b) of 8% to make these rotations preferable over existing ones.

READ MORE

UPCOMING EVENTS

We are taking a short break, but please plan to join us at one of our future programs that is a little farther in the future.

2024 Crop Cost and Return Guide

November 22, 2023

The Purdue Crop Cost and Return Guide offers farmers a resource to project financials for the coming cropping year. These are the March 2024 crop budget estimations for 2024.

READ MORE

(Part 2) Indiana Farmland Cash Rental Rates 2023 Update

August 7, 2023

Purdue ag economists Todd Kuethe, James Mintert and Michael Langemeier discuss cash rental rates for Indiana farmland in this, the second of two AgCast episodes discussing the 2023 Purdue Farmland Values and Cash Rents Survey results.

READ MORE

(Part 1) Indiana Farmland Values 2023 Update

August 6, 2023

Purdue ag economists Todd Kuethe, James Mintert and Michael Langemeier discuss Indiana farmland values on this, the first of two AgCast episodes discussing the 2023 Purdue Farmland Values and Cash Rents Survey results. Each June, the department of agricultural economics surveys knowledgeable professionals regarding Indiana’s farmland and cash rental market.

READ MORE