Potato Economics: Potato Markets, Marketing &

Cost of Production

Potato Science PLSC 490/590Lecture 20

April 8, 2014

Paul E. Patterson Extension Agricultural Economist

pattersn@uidaho.eduhttp://web.cals.uidaho.edu/idahoagbiz/

2

• A short lesson in economics • Market-based economies: supply & demand

• Overview of potato markets & marketing• Overview of developing cost of production estimates

• Uses of cost of production• Example of Idaho cost of production

Objectives

3

• Economic systems answer 3 basic resource allocation questions:

1- What?2- How?3- For whom?Shall goods and services be produced

Economic Overview

• Economic systems:• Market-based economies (capitalist)• Centrally planned economies (socialist)• Mixed

4

$

Quantity

Demand

Supply

P1

Q1

Market-based economies: supply & demand set price

5

• What are things that you want to know before you produce a crop?

Economic Overview

• Market Analysis can provide answers to important questions:• Supply & Demand• Trends• Prices

• What to produce?• Where to sell?• When to sell?

6

• Demand Analysis : + & -

Economic Overview

• Diet fads (Atkins)• Health issues (obesity, fat, acrylamide)• Demographic shifts (age, ethnicity)• Income level• Where meals are consumed (home or away from home)• Form of meals consumed (processing and convenience)• Price of product and price of substitutes

• What factors influence consumer demand for food?

• Consumer tastes & preferences

8

• Supply Analysis : + & -

Economic Overview

• Commodity price and price expectations• Price of alternative crops• Input prices• Technology• Government policy & programs• Environmental factors

• Weather, disease, pests

• What factors influence supply?

• Producer preferences & expectations

10

• Potato Market Structure & Market Channels

Potato Market Overview

• What markets are available for potatoes and how are prices determined?

• Fresh: consignment, formula pricings• Process

• Frozen: mostly pre-season, collective bargaining contracts, some open-market purchases

• Dehydration: some pre-season contracts, mostly sale of washed processes grade from sheds

• Seed: some multi-year & formula prices

Source: USDA.

Source: Patterson, industry sources, USDA.

Source: USDA.

20

$

Quantity

Demand

Supply

P1

Q1

Market-based economies: supply & demand set price

$Cost of Production & Supply

Quantity

Supply

C2

Q2Q1

C1

Q2

C3

.

.

.

22

• Does cost of production matter?

Cost of Production Overview

• Does the market care how much it cost you to raise potatoes or any other crop?

23

Overview• Short run – cost of production does not matter

• Long run – cost of production does matter

“Cost of production would have not effect on competitive price if it could have none on supply.”

John Stuart Mill, 19th century economist

Although potato production practices may be similar among different growers, each farm has a unique set of resources with different levels of productivity, different

production problems, and therefore different costs.

How much does it cost to raise potatoes?

It Depends:Acre vs. Cwt

LocationVariety

Farm SizeStorage

Conventional vs. OrganicWater Source & Irrigation System

How much does it cost to raise potatoes in Idaho?

It Depends:

RegionUI CAR Estimates $/ac

Field-RunYield $/cwt

SWI RB w/ Fumigation $3,770 530 $7.11

SCI RB $2,892 410 $7.05

SCI RB w/Fumigation $3,289 455 $7.23

EI-S RB $2,563 375 $6.83

EI-S RB w/Fumigation $2,862 415 $6.90

EI-N RB $2,360 350 $6.74

Idaho 2013 RB Production Costs: no storage

Cost to grow, harvest, and sort .

Measuring Cost of Production• Traditional uses:

Farm-level decisions & analysisPolicy & government program analysisPerformance analysis

Overview of Costs & Returns • Enterprise budgets

Commonly used to characterize costs & returns• What is an enterprise

An enterprise is any coherent portion of the farm business that can be separated and analyzed as a distinct entity (profit center)

An enterprise uses inputs & incurs costs while producing either products or services

• Traditional production unitAcres (hectares) for cropsHead for livestock

30

• Because CAR estimates are typically structured for an enterprise, they are frequently referred to as enterprise budgets

• An enterprise may produce more than one product, making it difficult to focus only on a single commodity

• Examples: A wheat enterprise produces grain and straw A seed potato enterprise produces seed and tops A dairy enterprise produces milk, calves and cull cows

Overview of Costs and Returns Estimates

31

• An enterprise can be defined broadly or narrowly Broad classification: dairy, beef, crops Narrow classification: milk, calves, wheat, potato, barley,

sugarbeets, etc.

• An enterprise can be structured differently for different types of analysis

• Most frequently, an enterprise is defined on a commodity basis

Overview of Costs and Returns Estimates

32

• CAR estimates can also be categorized by the type of management system

• Management system combined with a commodity: Conventional tillage vs. No-till winter wheat Irrigated spring barley vs. rain fed spring barley Potato production with or without storage Roundup Ready Sugarbeets

• These designations are useful and help avoid confusion

Overview of Costs and Returns Estimates

33

• Time frame of CAR estimates: Can be based on historical data – looking back Can be projected data – looking forward

• Time Frame of CAR estimates: Typically 12 months, or a production cycle Can be longer or shorter

An orchard or a vineyard would require a longer time period

Overview of Costs and Returns Estimates

34

• Scope of CAR estimates: CAR estimates can represent a single farm, the average of a

group of farms in a region or nation, or a composite or model farm USDA often develops an average or composite CAR

estimates to evaluate policies Universities normally develop CAR estimates for a

model farm to evaluate alternative technologies and cropping systems, as well as market opportunities

Overview of Costs and Returns Estimates

Cost of Production• Revenue:

Price x YieldCorrespondence between price and yield

Field-run or paid

• Costs:• Operating (variable)• Ownership (fixed)

Cost of Production

• Operating costs typically vary directly with production and involve inputs consumed in one production cycle (typically one year):

• seed, fertilizer, chemicals, fuel, water, labor, etc.

Cost of Production

• Ownership costs typically don’t vary directly with production and involve inputs (depreciable assets) lasting more than one production cycle:

• machinery, irrigation system, breeding livestock, and sometimes management, owner/operator labor and land

38

• Two basic means of calculating cost of production

Cost of Production

1. Farmers allocate costs based on accounting records• Track, accumulate and then allocate costs• Structure of chart of accounts is critical• Some costs can easily be assigned to a given crop or

field, while other costs cannot• Allocation procedures are needed

• Machinery operating expense: fuel, repairs, etc.• Machinery ownership costs

39

• Two basic means of calculating cost of production

Cost of Production

2. Universities Generate Costs • Budget generator software “generates” cost for field

operations specific to a crop• Machinery operating expenses are generated for

each operation and accumulated for the enterprise• Labor, fuel, repairs and ownership costs• Difficult to calculate enterprise specific

“overhead” expenses, such as legal, accounting, utilities, etc.

40

U of I Cost of Production Estimates

• Historical not projected• Crop costs & returns estimates “published” biennially in

odd-numbered years• 75 - 80 crop enterprise budgets• 4 regional areas:

• Northern• Southwestern (Treasure Valley)• Southcentral (Magic Valley)• Eastern Idaho

• Dryland & Irrigated

41

U of I Procedures & Assumptions

• Typical or representative costs of production estimates, not average

• Based on grower surveys, sequence of operations, not cost data from growers

• Model farm for each region or sub region

42

U of I Procedures and Assumptions

• Economic costs, not accounting (cash) costs• Opportunity cost (market value)

• Machinery: 75% of replacement cost new• Management: 5% of total costs• Overhead: 2.5% of cash operating expenses• Land: crop specific 1-year cash rental value• Surface water, avg. price by region• Pressurization only, per acre-inch water applied

43

U of I Crop Budget Format

• Portable Document Files, or PDFs• 8 – 14 page format• Background & assumptions page• Cost per acre with detailed list of inputs, quantities &

prices• Cash flow and machinery summary• Sensitivity analysis• Ranging analysis• Monthly storage costs (potatoes only)

44

U of I Crop Budget Format

• Excel spreadsheets• Cost per acre with detailed listing of inputs• Sensitivity analysis• One crop per worksheet• One file per region or sub-region

• Crop Enterprise Budget Worksheet data files• Cost per acre with detailed listing of inputs• Sensitivity analysis• One crop per worksheet• One file per region or sub-region

45

U of I Crop Budgets Yields

• Generally based on above average management and are consistent with input use

• Based on farm surveys, USDA county or regional yields, as well as expert opinions from extension specialists, county extension educators, fieldmen, etc.

46

U of I Crop Budgets Input Prices

• Based on regional surveys conducted annually• Northern Idaho• Southwestern Idaho• Southcentral Idaho• Eastern Idaho

• Chemical fertilizer dealers, seed dealers, irrigation districts & canal companies, fuel distributors

• Published as AERS staff paper

47

Sequence of Field Operations

• Based on surveys of farmers• What they do, how they do it and when it is done

• Tillage, planting, cultivation, pesticide applications and harvesting

• Quantity of inputs applied, when and how applied• Seed, fertilizer, herbicides, insecticides,

fungicides, irrigation water

48

Understanding Operating Costs

• Fertilizer – typically pounds of element, not product• N, P2O5, K2O, Zn, micros• Dry nitrogen – priced as urea (46-0-0)• Liquid nitrogen – priced as solution 32 (32-0-0)• Dry phosphorous – price from 11-52-0 with nitrogen valued at

price of urea• Liquid phosphorous – price from 10-34-0 with nitrogen valued

at price of solution 32• Potash – valued at price of 0-0-60 (muriate not sulfate)

49

Understanding Operating Costs

• Pesticides (chemicals) • Herbicides, insecticides, fungicides, fumigants• Detailed list of products, quantity & price• Trade name, not common name

• Custom & consultants• Input application: fertilizer & some chemicals• Hand labor: onions• Consultant: potatoes, onions, sugarbeets

50

Understanding Operating Costs

• Irrigation• Water assessment (irrigation district, canal co.)• Irrigation system repairs:

• Center pivot - cost per acre-inch• Concrete ditch & siphon tube – cost per acre

• Irrigation power - costs to pressurize only• Cost per acre-inch

• Machinery• Fuel – gallons per acre• Lubricants – cost per acre• Repairs – cost per acre

51

Machinery Cost Calculations

• Based on engineering and economic equations built into the crop budget generator program

• Calculates machinery operating expenses• Fuel, oil, lubricants, and repairs• Machine time: hours per acre

• 8.25 ÷ (speed x width x field efficiency)• Labor hours based on machine time x 1.2

• Calculates machinery ownership costs• Depreciation, interest and insurance (taxes if

applicable)

52

Understanding Operating Costs

• Labor hours per acre• Machinery: tractor operators and truck drivers• Irrigation: specific to irrigation system• Other: unskilled labor used primarily at harvest

• Storage• Potatoes & onions

• Other• Crop insurance• Assessments

53

Understanding Operating Costs

• Operating interest• Charged from month of application to harvest month

• Total operating costs per acre• Total operating costs per unit of production

based on yield used to generate gross receipts

54

Understanding Ownership Costs

• Tractors & Equipment Depreciation, Interest and Insurance• Calculated only on equipment used• Capital recovery method of D & I over the useful life,

not the tax life• Based on 75% replacement cost new, adjusted using

NASS machinery index

55

Understanding Ownership Costs

• Land• 1-year crop-specific cash lease, or cash equivalent

based on crop share (northern Idaho)• Includes irrigation system ownership costs

• Overhead• 2.5% of cash expenses

• Management• 5% of gross receipts

Cost of Production• Uses of enterprise budgets:FinancingLease negotiationsEnterprise selectionCost control and analysisMarketing plansAppraisals – income approachAnalyzing alternatives

57

Potato Costs and Returns Estimates• Seven potato CAR estimates statewide • SWI-Fumigated: 1,600 acre farm, 500 acres potatoes• SCI Fumigated & Non-Fumigated:

• 2,200 acre farm, 550 acres potatoes• Eastern Idaho:

• Southern Fumigated & Non-Fumigated:• 2,400 acre farm, 800 acres potatoes

• Northern: 2,400 acre farm, 800 acres potatoes• Seed: 2,000 acre farm, 500 acres seed potatoes

58

Potato Costs and Returns Estimates• Base budget: Cost to grow, harvest & sort

• Detailed cost per acre with summary by major cost category

• Cost per cwt for operating, ownership and total cost based on field-run yield

• Storage: starts with base cost per cwt for both field-run and paid yield, • Adds cost per cwt storage ownership & repairs

for both field-run and paid-yield• Adds monthly storage operating costs

2013Production Costs, Storage Ownership & Repair Costs, & Monthly Storage Operating Costs

SWIField-Run

SWIPaid-Yield

SCIField-Run

SCIPaid-Yield

EI-SField-Run

EI-SPaid-Yield

Base COP: $7.11 $7.49 $7.05 $7.42 $6.83 $7.19

+ Storage Owner. $7.62 $8.02 $7.56 $7.93 $7.34 $7.73

+ Storage Repairs $7.66 $8.06 $7.60 $8.00 $7.38 $7.77

Oct $7.86 $8.28 $7.81 $8.22 $7.58 $7.98

Nov* $8.03 $8.45 $7.98 $8.40 $7.75 $8.16

Dec $8.12 $8.54 $8.07 $8.49 $7.84 $8.25

Jan $8.20 $8.63 $8.15 $8.58 $7.92 $8.34

Feb $8.28 $8.72 $8.24 $8.67 $8.00 $8.42

Mar $8.37 $8.81 $8.33 $8.76 $8.09 $8.51

Apr* $8.55 $9.00 $8.51 $8.96 $8.27 $8.71

May $8.66 $9.11 $8.62 $9.07 $8.38 $8.82

Jun $8.78 $9.24 $8.74 $9.20 $8.50 $8.94

Paid-Yield = 95% of Field-Run Yield*Sprout inhibitor appliedStorage Operating Costs: labor, power, chemicals, interest, shrink and insuranceSWI = Southwestern Idaho, SCI = Southcentral Idaho, EI = Eastern Idaho

67

• If cost of production doesn’t matter to the market, should it matter to you?

Summary

• How do you survive in a competitive commodity market?

• Are you losing money if you don’t cover your cost of production?

• Perhaps not. You may not, however, be getting a market rate of return on you labor, your management, and your equity.

68

• Become the low cost producer – forever.

Summary

• Focus on producing the highest quality crop for the lowest cost per cwt

• Manage your production costs

• You can only manage what you measure

• It’s not how many potatoes your produce per acre, it’s ultimately how many dollars you produce per acre!

69

$

Quantity

Demand

Supply

P1

Q1

Market-based economies: supply & demand set price

Questions?Comments

Internet Site• University of Idaho – AERS Idaho Ag Biz

http://web.cals.uidaho.edu/idahoagbiz/

Select Publications for potato reports-Includes annual cost of production comparison

Select Enterprise Budgets for crop and livestock costs and returns estimates- Specify one or more: Year, Region, Crop, Format