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Cost of Production and Break Even Price Analysis (2017/18)

The average budgeted unit Cost of Production (before interest), and Break Even Price (after interest), calculated from 2017/18 client budgets for the major commodities is shown below:

Both the Cost of Production (COP) and Break Even Prices (BEP) for wheat and canola are lower than those figures calculated for 2016/17.  However both the COP and BEP for wool have increased, while both costs for lambs have remained very similar to the previous year.

Caution is required in interpreting these figures, as no two businesses are the same and the sample size is relatively small for comparison purposes.  However, the figures do show what is achieved by some clients, plus the extent of their comparative advantage in a competitive market place, both locally and globally.

The costs for wheat and canola have dropped as a result of the rolling ten year Decile 5 yields, on which budgets are based, have increased.  Costs attributed to wool have risen in line with higher expenditure by clients.

The phenomenon of costs rising to meet income with wool occurs as a result of management becoming complacent about costs when incomes are better, or spending money on inputs like feed supplements of dubious benefit, to chase even higher returns.

The top 20% of producers continue to have both lower variable and fixed unit costs than the bottom 20%, due to higher productivity and better matching of variable costs to expected output.

The challenge to management is to achieve a Cost of Production which provides sufficient margin from expected commodity returns.  The suggested target margin is at least 25% of expected returns.

Therefore if the net ESR for wheat is $200/tonne, the desired Cost of Production is $150/tonne or less.  For lambs, if $100/head net is obtained, the Cost of Production needs to be $75/head or less to achieve a 25% margin on sales.

The unit cost of production for the top 20% of wheat and canola producers, continues to be just under 70% of that for the bottom 20% of producers, while the unit cost of production for the top 20% of wool and lamb producers, is about 55% and 40% respectively of that for the bottom 20% of these producers.

There is no pattern for the difference in the unitised interest cost of the top 20% of client producers compared with the bottom 20% of producers, based on Break Even Price.

An example of the differences in unitised variable, fixed and interest costs between the top 20% and bottom 20% of producers (ranked by total costs), is illustrated in the following table:

Components of Cost of Production and Break Even Price

The budgeted costs for the top 20% of clients ranked on a total costs per hectare basis are as follows:

The average total costs of $365/ha for the top 20% of clients ranked on total costs per hectare, is 77% of the overall average of $476/ha, despite this top 20% group operating an average effective total area 23% less than average.

This shows that while scale of operation is important, it in itself does not guarantee lower costs.  Not surprisingly, the average interest cost of $29/ha for the top 20% of clients ranked on total costs per hectare, is 53% of the overall average of $55/ha.  The average interest cost per hectare for the top 20% has risen by 12% over the last 12 months, while the average interest cost per hectare has dropped by 5%.  This is a reflection of the lowest cost producers taking on more debt to grow their business.

This top 20% group runs very lean operations, generally with lower gearing ratios and low inputs due to lower targeted output, but in line with environmental expectations.  They often reduce debt quickly from higher operating surpluses, then re-borrow to expand again through land purchases.

Unitised costs are a more reliable indicator of cost efficiency, as they take into account productivity as well as absolute costs.