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January 2008

New Realities of Cost of Production

With the costs of fertilizer, fuel, and other essentials for dairy farming rising, it is more important than ever to know what it costs to produce milk. This article details some of the changing expenses dairy producers are experiencing and then provides valuable resources to assist dairy producers in determining their own cost of production. Knowing exactly what the costs of production are in their farms allows producers to plan ahead and maximize their likelihood of survival.

G. William Robb
Extension Dairy Educator
Western Michigan

Dr. Craig Thomas
Extension Dairy Educator
Eastern Michigan

Production costs for nearly all commodities are higher this year. Fertilizer, feed, fuel, pesticides, land rental rates and labor are all examples of rising input costs on farms. Petroleum prices have set new highs, inflating transportation costs for nearly all products. Domestic and international demand for grains and livestock products also has resulted in dramatic swings in planted acres and production of feed grains. Higher prices for many livestock feed commodities such as corn, soybean meal, and hay also are contributing to higher input costs on livestock farms. If you have not sharpened your pencil or cranked up your computer lately, you may be surprised at the new economic realities on the cost side of the profit formula.

Changing Costs of Production

Let’s take corn for example. The old rule of thumb was that it cost about $150 per acre in variable cash costs to grow an acre of corn. It also was assumed that fixed production costs like real estate taxes, building and machinery depreciation, insurance and interest were roughly equal to variable cash costs. So $300 of total costs per acre with a yield of 150 bushels would result in a total cost per bushel of about $2.00. But now fertilizer prices have nearly doubled versus just 6 years ago, so many farms estimate total cost of corn production at almost $400 per acre, or about $2.67/bu at 150 bu/acre yield. Minnesota reports 2006 average direct and overhead production costs at $397 per acre, compared to 5 years ago that is over a 23% ($75/acre) increase. Livestock farms save $24 per acre on fertilizer from manure and another $4.50 per acre on drying fuel likely due to high moisture corn storage, but the other production costs continue to climb. This year’s drought kept many crop yields below normal, further increasing the production cost per bushel for many Michigan grain and livestock farms.

If you purchase corn for your herd, then in 2006-07 you paid $3.00-plus per bushel or 50% more than the $2.00 per bushel prices paid in many previous years. (US season average farm price 1998-99 through 2005-06 averaged $2.04 versus a $3.03 estimate for 2006-07). Purchased corn booked for 2008 needs also is likely in the $4.00-plus range.
Production of milk also is experiencing greater costs compared with recent years. For many dairy farms, total input costs were greater than milk income in 2006 and continue to cut into profit margins during early 2007. The USDA reports an estimate of Michigan milk production costs. If one includes fixed costs in addition to cash costs, their estimate rose to $20 per hundredweight by the end of 2006 and above $20 for the first nine months in 2007. The report is provided in Table 1. You can see the updated report at <http://www.ers.usda.gov/data/> by searching for “monthly cost of production”. Dairy farmers recently have received record milk prices after suffering through terribly low milk prices in 2006. At this time (early November, 2007), 2008 Class III futures prices are still above long term averages, but are about $1.70/cwt below the 2007 average. Will farm level milk pay prices in this lower range be enough to keep farmers profitable with these new higher cost realities? That is the question all dairy producers need to ask as they begin the 2008 budgeting process.

Maybe your farm’s costs are not as high as those reported by USDA. For example, many will argue that the USDA’s opportunity costs of unpaid labor at $2/cwt is larger than they will experience on their farm. Others may think the general farm overhead at another $0.80+ cents per cwt is also too high. These charges may be overstated, but they cannot be dismissed entirely. There are real costs for unpaid labor and general overhead that many accountants or farmers do not, but should, include in cost of production estimates.

Analysis of Cost of Production in Michigan

The MSU Extension risk management project Market Plan$ collected 2006 business analysis data from 20 Michigan dairy farms. On average, these were well-managed farms with average milk sold of nearly 24,300 lbs/cow in 2006. In 2006 the average total cost to produce milk in these herds was $16.17/cwt, which was over $3.00 higher than the average pay price for milk sold ($13.06). This did not mean all these farms lost money, because the cost to produce milk was quite variable with a low of $11.96/cwt and a high of $22.05/cwt. The wide range of costs to produce milk on these farms also demonstrates the need for you to work with a professional to determine your exact cost. Extrapolating average data from other farms, or using figures you hurriedly scribble on the back of a napkin, could lead to disaster. That is why we highly encourage each farm to track its own cost of production.
Michigan dairy farm business analysis summaries and budget estimates can be obtained from the local Extension office or online at the MSU extension Dairy Team web site <http://dairyteam.msu.edu/>. Again, one should be careful estimating the cost of producing milk for your farm from these summaries because of unpaid factors including labor, management and capital that are not accounted for in the expense items. However, individual expense items can be compared to your farm expense categories. For instance, in 2005 average cost of purchased feed was $4.06 per cwt or $833 per cow for the 156 farms in the summary. For the five-year period of 2001- 2005 variable and fixed cost of production for all the reported items went up 12.66%.

Finding More Information

A good place to start an online search for financial information is the MSU Extension Dairy Team web site at <http://dairyteam.msu.edu/> with its many reports and links. Online Microsoft Excel budgets for crops and dairy enterprises are available to download from MSU Extension Farm Management Educators web sites at <http://www.msu.edu/user/betz/> and <http://www.msu.edu/user/steind/>. Work sheets are available to estimate costs and compare these to your farm records to prepare for 2008 or help in developing market plans. Cost of production budgets of other upper Midwest states are available from the University of Minnesota Finpack Fin Bin summaries at <http://www.finbin.umn.edu/CropEnterpriseAnalysis/Default.aspx>.
The new economic realities of escalating input costs are challenging all agricultural producers. Thus, every producer must keep specific farm financial records where one can track the farm cost of production. These records allow a producer to plan ahead to maximize their likelihood for profit and survival. MSU Extension is dedicated to providing you with the resources you need to meet these challenges. Contact your MSU Extension district farm management or dairy educator for budgeting recourses or to complete a business analysis or financial long-range projection.

Resources

MSU Extension Dairy Team. Retrieved Dec. 13, 2007, from <http://dairyteam.msu.edu/>.
USDA 2005 Agricultural Resource Management Survey. Retrieved Nov 13, 2007 from <http://www.ers.usda.gov/data/>.
MSU Dairy Farm Business Analysis Summaries. Dept. Ag Econ. MSU Staff Paper 2006-27. Retrieved Dec 13 2007 from <http://web1.msue.msu.edu/firm/telfarmreports.html>.
University of Minnesota Finpack Fin Bin summaries. Retrieved Dec 13 2007 from <http://www.finbin.umn.edu/CropEnterpriseAnalysis/Default.aspx>.

 

 

 

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