How to hold on to your milk cheque

Milk price volatility has increased significantly in recent years and while we hope prices will continue to firm, it is clear longer term there will inevitably be a cycle of peaks and troughs in the milk market.

The key question is, how do we maintain profitability through the troughs, but also maximise our returns during the peaks?

There is no doubt there have been milk price increases at times, but this has all too often been eroded by inflation in major input costs (especially feed, fuel and fertilisers, many of which are also affected by the same factors that drive milk price variation and therefore correlated to some degree). So, how do we ensure we hold on to our milk cheque, or indeed any price increase?

The first key point is to budget in advance. Do this by firstly calculating the profit you need to make in order to ensure an appropriate return for all family labour, a rental value (for owned land) and a return on capital, as outlined in the first of these series of articles (February 2012). Then put this profit figure into your budget plan and lock the value (so it is not negotiable) and do the rest of the budget.

If your budget does not meet or exceed the profit, you need to work out why not and how it can be achieved, either for that period or how the system can be changed so it will be achieved in the near future. Be realistic and cautious in the budget in terms of input and output variables and work on the basis of a worst-case scenario.

Use sensitivity analysis to show the effects of variation (for example, milk price +/- 1p, 2p; feed price +/- £/t). If the business can deliver the required profit then it should survive the troughs and thrive during the peaks.

But when the budget is unable to meet the required profit target within a sensible time frame, you must examine alternative options. Use imagination, creativity and enthusiasm. By setting the bar high and thinking outside the box, you will find possibilities you may not have considered previously. This may not come easily and may well require major change, so harness the ability of others. It may be family members or close friends, but often those without a close connection with your business may bring more objectivity and open-mindedness.

Discussion groups are an excellent resource. Use them to arrange visits to other farmers and get them to visit you, bringing ideas with them. Seek out and learn from top operators – those who achieve demonstrable goals of real financial return, business growth, as well as job satisfaction and lifestyle.

Never be afraid to ask. No matter how radical your proposal, there will always be a dairy farmer somewhere in the world who has already done it.

The next key point is to stick to it. If it’s not in the budget, don’t spend it. This will often be dependent on the person at the helm. If you know you are partial to the odd shopping spree, pass the cheque book to someone else first and then try to justify your desire to part with your hard-earned milk cheque before you spend it.

If you are tempted to spend on capital investment, make sure it will deliver a minimum of 10% return after a depreciation charge.

Even when all the above points are taken care of, there will inevitably be some factors that are considered beyond the control of milk producers, along with some differences between systems in the exposure to cost inflation.

This issue is clearly examined in the latest Milkbench+ report, which has shown a 12% increase in milk price on average between 2010/11 and 2011/12. However, it has also shown an increase in costs across the board, mainly as a result of increases in input prices. As a result, farms in the Milkbench+ sample were not able to retain all of the milk price increase as extra profit (see table).

Clearly there is a difference between systems in their ability to withstand cost inflation and hold on to their milk cheque. But the range in total cost and profitability was much larger within systems – between the best and the worst – than across systems. These results clearly reiterate the points outlined and show profitability is not just about a system or a milk price, it is down to the manager.

Tony Evans is head of dairy business consultancy at the Andersons Centre.