LMC: Cost of Production Analysis

NORTHERN IRELAND, UK - In November the LMC Bulletin carried a brief article explaining the Red Meat Strategic Forum’s plans for developing a cost of production index for specific beef and sheep production systems.

17 January 2012

6 minute read

Europe

The Strategic Forum was formed in September 2010 from senior members of the organisations that participated in the Task Force. Its role is to work on the strategic development of a sustainable and profitable red meat industry in NI. Following some recent queries, LMC is now providing an update on the progress of that activity.

Background

The concept of a NI red meat cost of production index was spawned by the NI Red Meat Task Force which included theoretical models for a range of highly efficient production systems. The Task Force report was published in 2007 and included associated costs for each of these models with all variable, fixed and hidden (land, labour and working capital) costs provided. Since 2009, LMC updated these figures on a six monthly basis by applying an inflation index provided by Anglia Farmers (a large scale agricultural purchasing coop in the UK). Anglia Farmers calculate an overall inflation index for agriculture generally, an index for specific inputs and for different enterprises. In the past the generic beef and lamb inflation index figures produced by Anglia Farmers has been used to update the Task Force figures. The same approach is used in Table 1, below.

The Task Force and these subsequent updates essentially provided producers with an ongoing estimate of the full cost of beef and lamb production (for the most efficient farms) by considering all inputs, including those that producers normally ignored in their own rudimentary profit and loss analysis. These figures provided a benchmark for producers and generally highlighted the lack of profitability in the sector.

Updating the cost of production index

At the latest meeting of the Red Meat Strategic Forum in June 2011, it was agreed that a cost of production index was a valuable tool and that continued efforts should be made to provide these figures. However, it was also recognised that five years have elapsed since the original Task Force figures were published and that there have been ongoing developments in production methodologies since then. Best practice suggests that it is not appropriate to continue using an inflation index to update the original Task Force figures ad-infinitum, since any variance is compounded as time elapses.

With this in mind, the Red Meat Strategic Forum agreed that it was appropriate to undertake further research which would allow a re-baselining of these figures and the development of a more robust and sustainable method of calculating costs of production without always referring back to the original Task Force report.

A new approach

At face value this may seem to be a straightforward task. However, it is one that LMC cannot tackle by itself since it holds absolutely no data of its own on upon which we may calculate costs of production for the NI red meat industry. In this regard the industry is reliant on information being made available by other parties including DARD. Any new initiative to calculate production costs for the industry must clearly be a multilateral initiative led by the Red Meat Strategic Forum since it requires the input of a wide range of parties.

At present LMC is working in liaison with DARD Policy and Economics Division to calculate costs of production using Farm Business Survey data as the basis. This is a time-consuming exercise and one which will ultimately involve input from all members of the Red Meat Strategic Forum, who will be well-positioned to verify results as they emerge.

At the end of this process we should have a cost of production index which can be updated and rebaselined on an annual basis using a robust methodology with the same principles as were employed in the Task Force. Crucially, it will be based on recent and real farm business data from NI and not upon figures that were gathered more than five years ago.

Understanding your cost of production

It is important to note that it was never the purpose of the Task Force to provide individual producers with an indication of their own costs of production of beef and lamb. There is a wide range of efficiency in the NI red meat industry at farm level and analysis of this type gives no indication of the viability and efficiency of individual farms. It is a generic analysis of costs at farm level across the industry, based on the most efficient production systems.

In this regard it is important to note that producers ought to have a good understanding of their own costs. It makes no sense to rely on a generic cost of production figure for this purpose. Indeed, CAFRE provide a bench-marking service and are eager to sign up new members, so any producers or groups of producers that are keen to get a better indication of their own costs of production and efficiency should consider contacting the benchmarking team there.

Interim measure

It is clear however, that some producers are eagerly waiting for an update on costs of production. This is understandable. Prices have increased sharply in 2011, but with input costs also rising, it is difficult to evaluate whether the industry in general is any better or worse off than this time last year at farm level.

For those keen to have a generic reference to the Task Force we have provided an update in Table 1 below. It is important to bear in mind that the baseline data for this information is now five years old and this obviously creates some uncertainty. Notwithstanding any weaknesses of this approach however, we do believe that this information may be of some value for the purpose of comparison in the absence of any other figure.

Finally, it is also worth adding that none of the source data for this analysis belongs to LMC and all of the source data for these calculations is on the public record. The figures are derived from a combination of the published Task Force figures from 2007 and the Anglia Farmers Agricultural Inflation Index. These two entities are entirely independent of LMC. The next cost of production figure that LMC refers to will be based on a new methodology agreed by the Red Meat Strategic Forum. Given that this exercise will be led by the Red Meat Strategic Forum and requires input from a range of parties, it is not for LMC to give a definite timescale on the availability of this update at the present time. In this respect, we trust that this update may provide a useful reference for those that require it in the interim. While LMC does not intend to provide a further update to the figures outlined in Table 1 below, there is nothing to preclude others from doing so given that the source data is publicly available.