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Parsing apart the SCA report on farm profitability

2017-11-15 Comments

Following the recent Avance coffee sustainability conference held in Guatemala, the SCA released a report that analyzed existing public information about farm profitability and costs. The authors conducted a meta-analysis of reliable cost of production data available to them. Shockingly, the analysts only found nine studies and publications from around the world that they considered usable (For an industry built on 22 million farmers, this tells us that there is very little publicly available data on farm costs and profitability).  The main (and surprising) conclusion from the authors of the study is that farm yield is not correlated to farm income.  On the surface, this seems to be a somewhat paradoxical conclusion.  Why wouldn’t higher production lead to more income?

Harvest time at La Revancha, Nicaragua. Photo by Oscar Leiva.

Let’s take a quick look at how to calculate net income.  The simplest version is (yield x price) – (cost of production) = net income. In practice, this is much more complex, as there are multiple sales, prices and several fixed and variable costs that are involved in cost of production, but for the purposes of our discussion, let’s focus on the basics. The first two variables of this equation – yield and price – often come under the most scrutiny, yet we often forget that the three variables in the equation tend to have a correlation.  The key finding of the report states… “Increasing yield typically increases the cost per hectare to produce coffee, especially in the short term, and hence may decrease a farm’s profitability”. In other words, producing more coffee is expensive, costly and cuts into a farmer’s margin.

This seems like it follows a basic economic theory – the law of diminishing marginal returns.

This economic theory states that the when you attempt to increase production, the incremental output of each input decreases.  In other words, if you spent $100 on fertilizers, for each subsequent $100 that you spent, you would not get the same increase in output that you got on the initial $100.

To get a better understanding of how commercial farms balance the issue of yields and profitability, I went and talked to someone who knows and manages this dynamic on a daily basis.  Gustavo Cerna is the supply chain director of MACERCAFE, a family business in Nicaragua that currently operates 10 farms, each about 200 hectares in size.

I shared with Gustavo the findings of the SCA report and asked him what he felt about the negative relationship between productivity and net income. Gustavo enthusiastically agreed with the findings, since it mimics an approach that they have on their farms.

“We try to go for a medium level of productivity – trying to produce about 25 to 30 quintales per manzana[1] (3500 to 4200 lbs./hectare of green coffee).  That’s the sweet spot. We’ve tried producing 40-50 quintales and it’s just too expensive and we are exposed to too much risk.”

In other words, in many cases, it is very expensive and highly risky to be a highly productive farmer.  Gustavo is referring to the increased cost of production that increased productivity requires.  To get higher productivity, it requires some combination of the following management: higher plant densities, increased quantities and number of applications of fertilizers, higher frequencies of renovation.  You also need access to labor, as more person days are needed to apply these management techniques and more hands are required to harvest the coffee.  Ultimately, MACERCAFE’s economic analysis has shown them that the key to their profitability is to maximize efficiency, not yield. This is right in line with the findings of RD2 Vision in their report.

Gustavo laid out their economic analysis in more black and white terms. “We need a margin of about $50/QQ – that’s the goal.  That’s not our net profit, but that margin covers our long-term loans, depreciation and provides us with some profit. “

If we look at a per area basis a $50 net profit per QQ with an average productivity of 35 QQ per hectare, that’s a profit margin of $1785/ha.  At MACERCAFE’s average cost of production of $1.10-$1.20, a $0.50 profit per lb puts a target price at $1.60-$1.80.  These are prices that while still ABOVE the current global price of coffee yet are still within reach. The Technoserve study cited in the article put the cost of production at $1.66, which means that these farmers would need a price of $2.16 to reach MACERCAFE’s $0.50/lb margin.

Gustavo and MACERCAFE have the ability to analyze their costs and income, arriving at an understanding of how to maximize their economic efficiency.  So, what can a small farmer learn from this?  What are the keys for producing in an efficient manner?  I posed this question to Gustavo and he had these ideas:

  1. Understanding fixed costs and maximizing your productivity

“A farm needs to understand what their fixed costs are and how to maximize the productivity from these.  These costs don’t necessarily contribute to the farm’s productivity, but the (fixed) costs add up.”

The SCA report said that fixed costs for farmers are nearly 0, but this is an oversimplification of the issue. Household expenses could be considered as fixed costs, as they are necessary for the farm to function. And as the report mentioned, the depreciation of trees need to be included in these fixed costs.

  1. Minimizing risks through medium levels of productivity

“It’s too expensive to produce a lot of coffee.  You may generate a lot of cash flow with higher yields, but your costs will increase and you’ll have a lot of cash coming out.  It also puts you at risk for the next disaster – coffee leaf rust, the weather, a bad crop year – you’ll have the costs, but none of the income.”

  1. “Radio de control”

“A smaller farmer has a greater level of control than on a larger farm on all aspects – the productivity of labor, quality control.  This is an advantage they should try to maximize.”

 

For small farmers, they often lack access to capital in order to make investments into productivity.  They don’t have the ability to absorb the initial decrease in profitability needed to have higher yields later on.  For small farmer, they are looking for the highest margins possible.  Which means you invest less into your farm.  Or not at all.

But this is an uncomfortable answer for the coffee sector, especially when we consider the future needs of coffee consumers and the 22 million farming families involved in coffee production globally. Given this situation we need to reframe the narrative and think about farmer return on investment rather than absolute increases in productivity.

In the report, the authors criticized the promotion of “Good Agricultural Practices” because while they may increase yields, they may not necessarily improve profitability.  Therefore, the question we must be asking is  “What practices provide the biggest ROI?”  It is our job to ensure that we measure the returns not only in purely economic terms, but also considering natural resources and social aspects.  Coffee farmers produce more than just a commodity that is the driver of an industry that contributes 1.6% of the GDP of the United States.  They produce drinking water for local communities.  They are sequestering carbon (unfortunately at rates slower than humans produce it) and are providing jobs to locals and migrants in need of cash for work.  We need to find ways to value all of these contributions in order to fully compensate coffee farmers.

[1] A manzana is a Central American unit of area equivalent to approximately .70 of a hectare. Quintales are 100 pound units.

-Kraig Kraft

7 Comments

  • P Baker says:

    Maybe worth pointing out that for most farmers, a “medium level of productivity” of 3500 to 4200 pounds per hectare of green coffee (= 2.3 to 2.7t/ha) is actually very high for most farmers.

    The annual GAIN coffee report for NIC states national average is 11 bags/ha (=0.66t/ha) – but then gives a table at the end which contradicts this (19 bags = 1.14 t/ha).

    Global estimates of coffee production, land use, yield etc. are a mess, and a disgrace for a US$200 bn/yr industry.

    • P Baker says:

      Sorry – correction: 3500 to 4200 lb/mz = 1.6 to 1.9 t/ha … but that’s still pretty high.

      Compare to RA cert. yields from Colombia which averaged 1.2t/ha from around 2014.

      • Kraig Kraft says:

        Hi Dr. Baker.

        Thanks for your reply. I agree that the yields for MACERCAFE are quite high compared to that of a smallholder. Here in Nicaragua, the average yield is purported to be half of their yields, approximately 12 QQ. There are other commercial ventures that report much higher yields than the 25QQ/mz, with the new technologies providing yields of 50+ QQ/mz. However, I think the greater point here is that even for MACERCAFE, who operate over 2000 mz of coffee farms, maximizing productivity does not maximize profitability. Gustavo had a quote that didn’t make it in the article. “Coffee isn’t like peanuts, or sugar cane or corn, where more productivity means more profit.”

  • Stephen Cox says:

    In the last paragraph, I have to take exception to the observation that the authors criticised the promotion of Good Agricultural Practice (GAP)as it may increase yields.
    GAP is focused on improving on-farm efficiency by rationalisation of inputs and education which may or may not produce yield increases. Examples would be ensuring usage of protective clothing for pesticide application, implementation of pest thresholds, selection of disease resistant varietals to reduce fungicide applications, efficient application of fertilisers to minimise ground water impacts, etc, etc. Good practices lead to increased efficiency in all industries and as such, the coffee producer also has the right to progress in this area.

    • Kraig Kraft says:

      Hi Stephen.

      Thanks for your comment. The SCA report said that the impacts of GAPs did not always increase yields, yet implied increase costs. In the examples you give, there are many that would increase costs (protective clothing, resistant varietals) that may not have an impact on yields. In nearly 100% of CRS’ projects we have promoted some set of GAPs, at times not fully understanding the potential impact on cost of production or yields. Much like your suggestions, we also prioritize impacts on farmers’ health and on natural resources in addition to impacts on profitability.

  • P Baker says:

    A problem is that GAP is often poorly-defined and means different things in different places and times.

    In the old days (before broca and roya) when prices dived, a quite reasonable tactic for farmers would be to hunker down, work off-farm and do nothing to the crop – just turn up at harvest time and pick.

    These days the farmer has to be much more on top of things, but margins are so tight that s/he may often have to cut corners. Under such circumstances the concept of GAP starts to break down – farmers try to control their risks the best they can. We try to help them with that, but it’s not easy and turning up with a list of ‘quehaceres’ won’t help.

    • Kraig Kraft says:

      Hi Dr. Baker.

      I agree completely. There are so many different tasks/management that get bundled into GAP, that it becomes difficult to pull apart their impact. This is an emerging topic for CRS – understanding the economic and environmental impacts of different practices.

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