Agricultural Trends

March 31, 2023

What Got You Here Will Not Get You There!

By: Dr. David M. Kohl

At a recent creamery board meeting, our entrepreneurial partner, who founded the business, had an interesting quote to kick off our 23rd year of business. “What got you here will not get you there!” This quote prompted us to think of the past and also develop a vision for the future.  

Moving toward the quarter century mark of business, we have endured the trials and tribulations of a startup, the Great Recession, and, of course, the pandemic as the business has grown from under $1 million in sales to over $13 million. Now as we peer into the future, changes in consumer trends and environmental, social and governance (ESG) framework, along with a myriad of changing regulations and an economy of higher interest rates, inflated costs and increased competition impact our strategic planning and actions.

What got us here?

When applied to the agriculture industry or your business, this quote can provide some introspection. When considering the agriculture industry in the post-farm crisis era of the 1980s, there were many factors that got us “here.” In some years, government payments amounted to over 50% of net income for some commodities and enterprises. Next, paper wealth gains or the appreciation of assets, specifically land, have boosted the net worth on many balance sheets. In the broader economy, stocks and residential real estate have increased personal and household net worth in a similar fashion. The advent of technology applied to seed and livestock genetics and equipment have boosted productivity of many farms and ranches. In many cases, increased production was the variable for profits. At the macro-economic level, the expansion of global markets that created the commodity super cycle from 2007 to 2012 accelerated profits and net worth after the turn of the century, along with a combination of other events.

As more baby boomer farmers and ranchers transition out of ag businesses, opportunities arise for the generations that follow to transition into business management. Proactive ag producers are implementing new business, financial, marketing, risk and human resource practices. This has led them to garnish a greater share of the profit pie. Others have been satisfied with operations dependent on non-farm revenue and the steady gains of paper wealth.  

What will get us there?

The economic environment needed to get us “there” will pose both challenges and opportunities to the agricultural industry and individual producers. Navigating and managing in the triple play environment of price volatility, inflated costs and higher interest rates will be in the headlights of the future. One could see in the near future a macroeconomic environment in which prices come down faster than costs and interest rates, resulting in slim or negative margins. This will require a backup strategy of working capital reserves.

With regional and international bank failures and issues that may be interconnected throughout the country and globe, a cycle of credit tightening may occur. This may result in the equivalent of a 1% to 1.5% increase in interest rates which will slow inflation in the economy. The good news here is the rate of interest rate increases by the Federal Reserve may possibly be reduced or abated, particularly if the U.S. economy goes into an economic slowdown.

The importance of export markets and international competition will be on the radar screen of agriculture moving forward. Along with a focus on major trading partners such as Canada and Mexico, close attention to China’s economic health and geopolitical strategies with other authoritarian economies will be critical in future plans. Chinese citizens have saved over $2.4 trillion over their three-year COVID-19 lockdown. Their spending habits will have a ripple effect on energy prices, which are critical to the agricultural industry as well as export markets. China’s Belt and Road Initiative tied with agricultural producers in the Southern Hemisphere in South America, Africa and other regions will create more intense competition. The ongoing war in Ukraine, a major breadbasket, and European economic health will be critical in plans moving forward. Of course, weather, climate change and the transition from fossil fuels to green energy will require attention in strategic planning.

The Five Percenters

Now, let's ponder the future of the agriculture industry and the players that will carry out the strategies and actions. First, an emphasis on a management mindset for profits and overall success will be front and center as we approach the quarter-century mark. A management mindset needs to be incorporated into the business vision, mission and core values. The opportunity for business and personal prosperity will not be dependent on size, enterprise or the “next big thing.” Success will be about the “five percenters” being a little bit better in many components of production, marketing, risk management, finance, operational efficiency and human resources as producers focus on their values and goals.

In this winter’s speaking tours, examples of the actions of many “five percenters” have come to light. Through conversation and engagement, I mentioned our creamery utilizing weekly cash flows as a tool for intense monitoring of revenue and cost strategies and actions. I was surprised when seven young producers out of a group of fifty were using the same practice to their benefit!

Some were increasing operational efficiency as a demonstrated “five percenter” practice. This included conducting budgeting and enterprise analysis often down to the field level. Others are simplifying operations to align with labor or operational challenges.

Other agricultural producers were reevaluating processes and procedures to reduce overlap and increase efficiency. Some were making tough calls in the human resource area by terminating employees who are toxic to the work culture. In some instances, this involved family members who lack the maturity, skill set or mindset needed for high performance. One producer indicated that his family member needed to be exposed to other work environments that could enhance his abilities to operate the family business in the future. A fast-growing trend has been creating advisory groups, some with individuals outside the ag industry, to provide both introspective and outside-the-box thinking.

Success will be about leveraging the institutional memory and talents of the vintage generation while also harnessing the talents and energy of youth and the next generation. Innovation, technology, leveraging talents and resources, and aligning with the rapidly changing marketplace will be a focus of the future. The future will be about soil and water health and regenerative agriculture that aligns with the demands of consumers and society. Consumers will demand transparency from production, processing and distribution to the marketplace.

Expect a new generation of producers with a one-size will not fit all mentality. Some will mesh into family businesses while others will start up new businesses. Some producers will be boomerangers seeking to return to the agriculture industry to mesh their talents into business while seeking an agricultural lifestyle. Intensive management with an executive mindset, regardless of size or enterprise, will be critical. Key performance indicators (KPIs), benchmarking, collaboration with others and human relations skill sets will bode well in “getting us there.”

Nuts and bolts

Will the 2023 to 2026 era be similar to the recent past? Many strategies learned during the “grinder years” from 2013 to 2019 following the super cycle from 2007 to 2012 will be applicable in the era ahead of us. This new era will require juggling the triple play, that is extreme price volatility, sticky inflated costs and elevated interest rates.

One must focus on fine-tuning risk management plans. Cost of production and breakeven points need to be in the management mindset mentality. For those who operate multiple enterprises, the cost of production for specific commodities needs to be refined. Some managers are drilling down to the field level as a tool for land and lease negotiations.

Developing input and output marketing plans will move up in importance. Moving from “just in time” to “just in case” inventory management will be critical in the era ahead. Crop insurance and other insurance coverage levels and as well as other risk management programs will need more intensive evaluation.

The cash flow plan with cash budgets that are developed and monitored throughout the year with the lender and advisory team will enhance the needed communications with partners and spouses. Financial sensitivity testing of revenue, costs and interest rates will provide the guardrails of business possibilities in an era of rapidly changing events.

Family living budgets separate from business budgets will be imperative for calculating true living costs. Consider the number of families living out of the business and budget busters such as miscellaneous expenses. Do not forget inflation in your analysis when assessing living expenses. Remember, living costs are often paid out of operating lines of credit so full transparency of the flow of money needs to be considered.

Finally, while equity gains were substantial in the past due to inflated asset values, “current equity” or working capital will be a metric of the future. Aspire to maintain working capital at a level of 25% of total annual expenses or three times annual debt service payments. Operators’ ability to quickly convert current assets into cash and match them with current obligations will be a part of the triple play juggling act.

Whether it is our creamery or your agribusiness take time to do this exercise on paper. It will be an invaluable reflection of the past that can launch your business journey going toward the quarter-century mark.

Dr. Kohl is Professor Emeritus of Agricultural Finance and Small Business Management and Entrepreneurship in the Department of Agricultural and Applied Economics at Virginia Polytechnic Institute and State University. Dr. Kohl has traveled over 10 million miles throughout his professional career and has conducted more than 7,000 workshops and seminars for agricultural groups such as bankers, Farm Credit, FSA and regulators, as well as producer and agribusiness groups. He has published five books and over 2,500 articles on financial and business-related topics in journals, extension and other popular publications.