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You are here: Home > Current Topics > Mind your Business > 25 October 2004 |
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A recent report by the accounting and consultancy firm Deloitte Touche, highlighted the problems facing those in agriculture. The report, an annual survey of farm prices, pointed to significant fluctuations in the incomes of farms caused by various conditions - weather, good and bad, and world market conditions. The report suggests that farm incomes will rise during 2004 from £43 per hectare to £200 per hectare. Much of this rise was due to the excellent weather conditions experienced in 2003. However, weather conditions in 2004 have been poor, rain and less than average temperatures have affected yields and caused damage to crops and this has not been helped by lower prices. Deloitte predict that this will mean that incomes for the coming year (2005) will be around £84 per hectare. Mark Hill, head of the Deloitte Food and Agriculture Group, points out that a 400 hectare farm would have seen its income fluctuate from £17,000 to £80,000 and back to £33,600 in three years! Remember that these figures represent income and not profit. 
Image: Crops can be affected by the weather and through fluctuations in world prices. Can this be explained by the cobweb theorem? Copyright: Stephen Whitehead, stock.xchng. Deloitte also refer to the changes in the nature of many farming businesses. The lack of stability in incomes and the problems experienced by farmers in recent years - the BSE (Bovine Spongiform Encephalopathy) crisis and foot and mouth as well as the changes imposed by reform of the Common Agricultural Policy (CAP) - has led many farmers to look to utilising their assets to develop other sources of income. The diversification of farms has become an important part of the rural economy for many. Deloitte predict that there will be three types of farmer in the coming years:
The reform of the CAP has also brought about a new scheme that aims to simplify how farmers are paid for the work that they do. In the past, farmers received subsidies under the scheme related to the type of crops, etc grown. The form filling meant that subsidies were linked to actual production levels for each crop. The new payment scheme, called the Single Farm Payment Scheme, aims to enable farmers to make a single claim based not only on the work of the farm but also on their record of the effects of their work on the environment and how they manage the countryside. 
For example, farmers applying for the scheme have to ensure that they take care to meet strict guidelines when cultivating and spraying crops to ensure that they do not damage hedgerows. Deloitte suggest that a key part of many farmers' activities in the future may well be stewardship of the countryside. For farmers, the problems facing them are not new. The CAP did, for some time provide farmers with a degree of certainty and for many the opportunity to invest, almost risk free. Those times have long since gone and whilst the rules and regulations still exist; the exposure to the cold winds of the market has been problematic for many. Image: Traditional farming landscapes may have to be sacrificed to cope with the demands of the market and to enable farmers to continue living on the land. Many farming families have lived on the same land for generations but what future is there for the next generation of farming sons and daughters? Copyright: Jeff Osborn, stock.xchng. |
Farming is one of the few industries that has a number of the characteristics of perfect competition - or at least comes close to them. These characteristics are:
Farming, as an industry, meets many of the characteristics above pretty closely. The products are all fairly similar with farmers having difficulty in differentiating their crops. There may be different varieties of barley, for example, but barley from one farm will be, to all intents and purposes, identical to that of another.
Image: Milk - an homogenous product? It may be difficult for a dairy farmer to differentiate their products to gain any sort of market power. Copyright: Matthew Maaskant, stock.xchng.
Farmers tend to be part of a world market and as such, their output represents only a fraction of the total market supply. Wheat farmers in the UK, for example, are tiny compared to their counterparts in the United States and the plains of Canada. However, they are all, in effect, part of the world market in wheat. Farmers, therefore, are at the mercy of the market price for the product they are producing.
If conditions are good and supply increases world wide, then price will be driven down and if times are hard and their supply and the world supply is limited, then prices will rise. However, the impact on their revenue is going to depend on the level of output they produce and the price. If prices rise, farmers could still be worse off if their output has fallen by a larger percentage than the rise in price and vice versa.
Information is not perfect but farmers do get indications of current prices through trade journals and are in contact with local agricultural markets. In addition they get information from the EU about prices and the state of markets and can use the Department for the Environment, Food and Rural Affairs (DEFRA) to gain information.
Being part of a relatively competitive market, farmers have certain limits to what they can do to increase their competitiveness. They have to rely, to a large extent, on their ability to be able to control costs and increase productivity. Both these areas may require significant investment to be able to get the desired returns and in uncertain markets that is not easy to plan for.
The nature of the uncertain markets that farmers operate in has been explained through the concept of the Cobweb Theorem. The cobweb theory seeks to explain how a market may (or may not) move back towards equilibrium when there are time lags involved.
The basic principle is this. Supply of agricultural products involves a time lag from the decision to allocate a field to a particular use and the time when the farmer receives a price for the output produced as a result. Demand, however, responds to prices existing in the market at the current time. At the time of planting, farmers can only estimate what the demand conditions will be like when the supply becomes available. Let's use an example to illustrate this that is vaguely topical given the time of year!
Consider the case of a turkey farmer. The decision to rear turkeys will be dependent on the cost involved and the expected return. Farmers do have alternative uses for resources, for example, instead of rearing turkeys for the Christmas market, a farmer might decide to rear geese.
That decision may depend on the price that exists at the beginning of the planning period. Let's assume that rearing a turkey ready for the table at Christmas takes 10 months. A farmer will have to decide whether to allocate resources for that use in February of the relevant year (call this year 1). If prices for the previous season's flock have been healthy, a farmer may decide to increase the resources devoted to turkey production. By the end of the production period, all sorts of things might have happened to affect demand.
Delia Smith, Gordon Ramsay or any of the TV chefs may have released a series of programmes that included cooking duck for Christmas rather that the 'boring old turkey' or there may have been some sort of food scare related to fowl. If demand, in December of year 1 proves to be much less than anticipated then there will be a surplus of turkeys and the price will fall.
Image: The fate of the turkey depends on the vagaries of demand and supply and cobwebs! Copyright: Joseph Zlomek, stock.xchng.
In February of year 2, farmers will be taking stock of their position and making decisions about the next year of production. The lower than anticipated prices may lead to farmers switching resources to geese rather than turkeys. By December of year 2, all the fuss about turkeys the year before has been forgotten and demand is more healthy. However, the decisions of farmers back in February means that supply will be less than the year before and there is likely to be a shortage of turkeys - the price will subsequently rise.
This process continues until a stable equilibrium position is reached. The equilibrium will be reached but only after some years of fluctuating prices. Such a situation would be known as a 'convergent cobweb'. In a convergent cobweb, the fluctuations in prices and the extent of the shortages and surpluses gets less each year.
In a divergent cobweb the opposite may occur - prices fluctuate more and more wildly each year and the price actually moves away from the equilibrium. For a market to be a convergent cobweb, the price elasticity of supply (over the length of the curve) has to be greater than that of the average for the price elasticity of demand over the whole curve.
The cobweb theory does have some limitations. It assumes that farmers do not take account of past history or estimates of trends in demand in planning output. It assumes that they will plan production only depending on the price level at the time - in reality this is unlikely to be the case.
The accompanying PowerPoint Presentation highlights the operation of the cobweb theorem.
Diversification involves branching out into other activities and business enterprises either related to farming or entirely different from farming but making use of the assets that a farm typically might possess.
Diversification has become more important in recent years because of the uncertainties surrounding traditional farming practices (mainly associated with food production). Such uncertainties have included the fall in incomes partly because of the behaviour of markets and partly due to the reforms of the Common Agricultural Policy (CAP), which have removed or reduced many of the price guarantees that farmers once enjoyed.
Image: Diversification may mean looking for new and different products. Ostrich meat is becoming increasingly popular. Copyright: Wojciech Sadlej, stock.xchng.
Diversification can take many forms. A recent survey by the Scottish Agricultural College (SAC) identified 630 different projects. Some of these projects attract some EU funding as the EU seeks to help farmers to move from a reliance of the CAP to a more market led system. For many farmers, moving into such projects can involve considerable upheaval and often a steep learning curve.
For farmers, one of the biggest challenges is how to diversify their businesses. © Photolibrary Group
Diversification projects might include using farm buildings for bed and breakfast accommodation, using the land for recreation and leisure pursuits like fishing, shooting, riding, quad biking, off road driving, paint balling and using land to develop into golf courses or 'theme' parks - often based around a farming theme. Other projects might involve moving away from traditional crops and livestock to other more 'exotic' products - ostrich farms, llamas, hemp and crops that can be used for producing energy like certain types of grasses or willows.
The Deloitte report suggested that income from these non-food activities is rising, up by £35 per hectare, but that the expected windfall from diversification may be illusory. Invariably, moving into a different business area creates significant problems; the sorts of skills needed to deal with the bureaucracy, marketing and face-to-face customer service may be very different to the sorts of skills many farmers already have. Many of the activities farms could provide take away precious time from the main farming activities.
So diversification in farming may be one way in which modern farms can help to make a living but it is not a magic solution that is without problems. Simply converting a farm building to a cottage for let requires investment in both financial terms and in learning how to manage a different business area, and the very existence of the cottage does not automatically mean that tourists are going to flock to the area and pay good money!
