Economic Review of a Superdairy

Dec 2010

This economic review of the superdairy concept is an attempt to put some economic information into the public arena in the hope that everyone with an interest in the future of the dairy sector and the British countryside can have an informed debate.

Some farming leaders and economists are giving their support to the superdairy concept, in the belief that the superdairy will deliver the economies of scale required for the business to survive in these challenging times, but without having access to economic analysis that supports their belief.

And that’s not surprising, there is little published information on the economic viability of a superdairy in the UK to back up the assertion that the superdairy concept is “the only way forward for the dairy sector”.

The planning application by Nocton Dairy for a unit of 8000 cows in Lincolnshire has created a great deal of debate amongst environmentalists, animal welfare organisations, local residents and traditional dairy farmers.

Based on the superdairy model that has been developed in the USA, the Nocton Dairy proposal is seen by many within the dairy sector as a logical response to the financial pressures faced by the dairy farmer – but we have to ask are these pressures real and are they justified?

Economic Analysis of a Superdairy.

The costs of operating a superdairy in the UK are not known because there are no working examples of superdairies to make valid comparisons. Using economic analysis from the land based Universities in the USA, where superdairies are more common, it is possible to make comparison between the major methods of dairy production.

Direct comparison is made more challenging because the superdairies in the USA experience a different economic situation to here in the UK – not least the fact that most of the superdairies in the USA are in very low rainfall areas requiring different infrastructure and different cropping.

The numbers

Working from publically available information from dairy consultants and practising dairy farmers, along with figures adapted from the Nocton Dairy application in 2009, I estimate that:

  1. The total capital cost of an 8000 cow herd in Lincolnshire (capital cost less land purchase divided by output in litres) I estimate at 54ppl.
  2. If we assume that investors are looking for a 10% return on their investment then the annual cost of capital is 5.4ppl
  3. I estimate the production cost at 19.5ppl.
  4. Adding the production cost of 19.5ppl to the capital cost of 5.4ppl gives a breakeven cost of 24.9ppl

Looking at the production cost it is obvious that a superdairy does demonstrate efficiencies over traditional dairy farms. These efficiencies are achieved through 24/7 operations and its efficiencies of scale giving lower variable costs.

How does that compare with traditional family farms?

  1. Industry consultants Promar and Kingshay [1] benchmarked herds achieve 19ppl over purchased feed
  2. Breakeven cost for a well-managed traditional dairy farm would be around 26.5ppl.

So the superdairy is more efficient?

On first glance the efficiencies achieved by the superdairy of nearly 1.5ppl look attractive but closer examination of the market reveals the superdairy’s vulnerability.

  1. The world market price of milk is around 23ppl – that’s below the 24.9ppl breakeven cost of the superdairy.
  2. That 24.4ppl is significant because, with milk going into the genetic processing markets at 23ppl, it means the superdairy has to gain a milk contract with a reasonable premium to give a 10% return on investor capital.
  3. The premium can only come from supplying the liquid milk market or supplying the branded dairy product market. The superdairy will have to muscle into these fully subscribed premium markets and will therefore displace between 60 and 100 existing traditional family farms from the market.
  4.  More worryingly the superdairy’s lower costs will have the effect of driving down the industry ‘benchmark’ cost analyis that underpin many premium milk contracts and thus putting the majority of financially viable dairy farms into financial jeopardy.
  5. Nocton is vulnerable to increases in land charges. Based in an intensive arable farming area the increasing gross returns from combinable crops will have the effect of driving up annual rental prices. Therefore where annual rents for fodder production might have been in the region of £120/acre I would expect annual rents to reflect the increasing profitability of arable farming and increase to £225/acre if the wheat price remains in the £165/ton region

Will the superdairy need public investment?

If the superdairy is unable to secure premium contracts and the milk has to go for processing at world market prices the superdairy will need to attract public money through development grants in order to increase the investor’s return and to achieve financial security. Somewhere in the order of 27% of the total capital cost (£11m) will be needed to achieve a cost of production that allows the superdairy to survive at world market price.

The economic conclusion is that an 8100 cow herd is not big enough

8000 cows does not give the efficiencies needed to survive at world market prices whilst operating in a first world economy with all the additional costs that entails and therefore an 8000 cow herd will be just as vulnerable to fluctuations in the market and supermarket bullying as every other dairy farm in the UK (and EU)

Co-existence is not possible.

The NFU, DairyUK and others seem to believe that co-existence between traditional family dairy farms and superdairies is possible. However these figures demonstrate that the superdairy will be competing for the same contracts as the traditional dairy farm.

In competing for these premium markets the superdairy will use its lower production costs to secure contracts at prices that are not viable to traditional dairy farmers therefore pricing the majority of producers out of the market place.

Perversely, because the superdairy can’t survive at world market prices, it is far more damaging to the traditional family dairy farm than if the superdairy really could achieve the economies of scale to survive at world market prices.

Can the market support a superdairy?

We are told that the UK is not self-sufficient in dairy products – but that is only partially true. The UK is self-sufficient in the premium markets for liquid and branded products. Most of the imports are for imported branded products (brie etc) or for generic products (skimmed milk powder, generic cheddar etc) for the food processing industry that can be supplied by the lowest cost producers in the world.

It’s naïve and damaging to think that UK producers, operating in a first world economy with all the additional costs involved, could or should compete with the world’s low-cost producers.

What are the alternatives?

The US experience

Looking at the analysis of dairy herds in the US is also instructive. In the Economic Comparison of Some US Dairy Systems and States [2] Prof Tom Kriegl makes the point that the lowest cost producers in the US are grass-fed herds below 100 cows.

The primary measure employed by the University of Wisconsin in comparative analysis is the Net Farm Income From Operations (NFIFO)[2] and is expressed as ‘NFIFO as a % of revenue’.

Using this method the traditional Wisconsin grazing herd of below 100 cows achieves around 27% whilst large confinement herds (typically in California or New Mexico) achieve just 12% – around half the NFIFO of a traditional grass fed herd.

The problem is that whilst small grass-fed herds have a higher NFIFO as a % of revenue they don’t have the scale to provide the farmer with a living wage.

It’s only when considering the measure of Income per Owner that the superdairy concept looks an attractive option to investors.

Is that the case in the UK?

We are told that superdairies are the only way forward but these figures demonstrate the vulnerability of a superdairy concept to supermarket bullying and fluctuations in the market place.

As in the USA there are extensive dairy herds operating today in the UK that can match, or even surpass, the superdairy on breakeven price. Analysis supplied by existing extensive dairy herds taking best advantage of the natural resources available to them (home produced forage, breed type, etc) demonstrate that the extensive systems can match the breakeven cost of the superdairy[3]

Milk Price

Ultimately the advent of the superdairy concept can be seen as a response to retailers squeezing the market beyond economic sense.

Many studies, including the Environment Food and Rural Affairs committee [4], demonstrate that there is no linkage between the retail price and the farmgate price. The DairyCo Supply Chain Margins report 2010  highlights the distribution of power within the milk chain with the retailer increasing their margins through increasing the retail price whilst driving down the farmgate price.

It’s not just the dairy farmer who is suffering – the retail price is inflated above a reasonable mark-up on the farmgate price and the consumer is consistently being overcharged.

Who benefits?

Certainly not the consumer, nor the cows, nor the countryside, nor the image of UK dairy farming – and importantly this economic analysis brings into question whether the investor will be a beneficiary if considerable public funding is unavailable. 

[1] Promar www.promar-international.com and Kingshay www.kingshay.com

[2] Center for Dairy Profitability, College of Agricultural and Life Sciences and Cooperative Extension, University of Wisconsin – Madison. http://cdp.wisc.edu.

 [3] The primary measure used here to compare financial performance of these dairy systems from several states is net farm income from operations (NFIFO) per dollar of income or as a percent of income based on accrual adjusted income and expenses. This is a measure commonly used in the non-agricultural business world and provides a much better apples-to-apples comparison than cost per cow or per CWT sold. It is quite similar to the CWT EQ measure used in Wisconsin. In fact, the cost per dollar of income and cost/CWT EQ measures applied to the same data will provide the same relative results. The higher the NFIFO/$ income, the lower the cost of production

[4]  Neil Darwent, Farms Director, Lordswood Farms Ltd, Walk Farm, Witham Friary, Frome, Somerset BA11 5EX

[5] Parliamentary Environment, Food and Rural Affairs Committee (EFRA) report “Milk Pricing in the UK”

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