Examining the relationship between production costs and managerial ability

1. Examining the relationship between production costs and managerial ability P. Smyth1, 2, L. Harte2 and T. Hennessy1 1Rural Economy Research Centre, Teagasc, Athenry, Co. Galway, 2UCD School of Agriculture, Food Science and Veterinary Medicine, University College Dublin

2. Overview • Previous Work • Background • Methodology • Data • Results • Conclusions

3. Previous Work • Policy reform led to an erosion in world stocks of dairy products • This led to increased price volatility • 2007 saw the benefits of market exposure and late 2008 and 2009 saw the disadvantages of it. • Cost Volatility • Oil and Grain Price fluctuations • Cost efficiency crucial to future viability

4. Methodology • Sectoral cost efficiency measured using cumulative cost curve • Individual farm cost efficiency explored • Quintile analysis illustrates variability across farms • Average cost curve • Capacity to improve costs (Survival and Hazard analysis)

5. Cumulative Cost Curve

6. Cumulative Cost Curve

7. Cumulative Cost Curve

8. Average Cost Curve Economies of scale up until this point (99 cows) C.P.L 20 40 60 80 100 120 140 160 180 200 220

9. Conclusions • Cost efficiency increased from 1998-2003 but declined marginally from 2003-2006 • Large cost variability exists • Persistence of very high cost producers • Ability to cope with price risk? • Larger herds more efficient at a declining rate (optimal herd size 99 cows) • Current average herd size is 50 (constrained by quota) • Economies of scale exist and quota removal may be beneficial • Cost mobility is low and no obvious drivers.

10. Methodology • Seasonality of Milk production • Comparison of Manufacturing and Liquid milk producers • Determining cost differences according to calving date. • Calving date is used as a proxy to represent the seasonality of production. • Compare the costs of predominately spring calving herds to all others

11. Conclusions • The NFS data revealed that costs of production on average are higher on liquid milk farms. • The model demonstrated that when size, efficiency and unobserved individual effects were accounted for, calving date had no significant effect on production costs. • However low numbers in other calving season sample • Time-invariant characteristics of an individual or farm, known as the individual effect were controlled for in the model. • An example of these characteristics is managerial ability.

12. Background to Present Research • Most research looking at the costs of production look at scale and efficiency • But individual effect of farmer may be a factor • Previous studies on managerial ability have looked at looked farm management factors affecting profitability and costs of production • Determined that financial, herd and forage management important • No such individual variable exists • Such studied haven’t been conducted on Irish dairy data.

13. Background • Research Objective • Explore the costs associated with milk production and farmers different managerial ability

14. Material and Methods • National Farm Survey (NFS) data (Connolly et al 1994-2008) • Full sample of all 6572 dairy farms • An unbalanced panel dataset for 15 years is used. • All specialist and non-specialist dairy herds included.

15. Material and Methods • Fixed Effects (FE) and random effects model (RE) are used. • FE model can control for all time-invariant characteristics of an individual or farm. • RE model can control for characteristics that may be time-invariant between farms and also characteristics that fixed between farms but vary over time.

16. Material and Methods • The FE and RE model allows the panel data to examine the effect different variables on total costs of production per litre. • Scale factors such herd size and efficiency factors such as yield and forage acres per cow are accounted for in the regression. • Pasture and Forage ability ranks each farm on a weighted scale from zero to one on a farmers ability to grow fodder crops as well as forage crops.

17. Material and Methods • Financial ability ranks each farm on a weighted scale from zero to one on a farmers ability to cope with the financial management of the farm. • Variables included in the financial index include • Debt per cow • Interest paid per cow • Net Margin per cow • Equity asset ratio • Return on Equity • Return on Investment

18. Material and Methods • Herd management ranks each farm on a weighted scale from zero to one on a farmers ability manage herd welfare • Variables included in the herd management index include • Milk sold per cow, Calves to cow ratio and Maiden heifers in calf • Vet & Medicine per cow, butterfat and protein per cow • The model in full is • Total cost of production per litre= f(Cows, Cows², Yield per cow, Yield per cow², Stocking rate, Stocking rate², Concentrates per cow, Concentrates per cow², Pasture & Crops ability, Financial ability, Herd Management ability.)

19. FE Results

20. RE Results

21. Results • The FE model showed that economies of scale were present, when herd size increased, the per unit cost of production decreased but at a declining rate. • However the RE model did not. • The two models also demonstrated efficiencies such yield and stocking rate are important in the reduction of costs

22. Results • Results show the three levels of managerial ability have a significant effect on the reduction of costs • Shows that higher the index the lower the production cost • Suggests that farms have reduced costs through better management

23. Conclusions • Better herd, financial and forage management leads to the reduction of costs. • Update training in the three managerial pillars • Encouraging better management skills could be key to survival in dairy industry

24. Further Work • Recent 2008 data from NFS • Shows yield per cow increased with use of diet feeder, milk recording and earlier release of cows to first grass. Discussion group has no significant effect. • However total cost per litre were significantly increased from use of diet feeder and milk recording • Discussion group participation and release of cows to grass had no significant effect on total costs per litre

25. And Finally • Questions • Comments • Suggestions • Thank you