Volume 16, Issue 7
Managing Your Business in an Inflationary Environment
Look at any news website today, and you’re likely to see an article on inflation and its impact on the U.S. economy. With inflation, as measured by the Consumer Price Index, running in the 8% range, prices are rising at a rate we haven’t seen since the early 1980s. Inflation is broad-based, with prices rising across the board, but not everything has been increasing at the same rate. As of May 2022, while overall inflation was 8.6% (measured against May 2021), consumer food prices increased by 10.1% and energy costs increased by a staggering 34.6%.
Figure 1: U.S. Consumer Price Index, percent change year-over-year
While energy costs are leading the way, for agriculture, virtually everything is more expensive today compared to one year ago. The causes are complex and range from the impact of the COVID-19 shutdown to the Russian invasion of Ukraine and supply chain disruptions around the globe. For this article, we’ll set the causes of inflation aside and consider strategies producers can employ to manage through the current inflationary environment.
We interviewed seven Farm Credit East business consultants to get their take on what business owners can do to cope with rising prices and snarled supply chains. Here’s what they had to say:
Mark Mapstone, Cortland NY
I mainly deal with dairy producers, so my comments are dairy-focused, but many of these ideas apply more broadly as well: First off, while input costs have risen significantly, particularly fertilizers, be careful about cutting back too much and hurting yourself later. Keep your revenues and margins in mind and think about your return.
Remember that while input costs have risen, so too have output prices, whether for milk or for crops. So, while that fertilizer bill may be shocking, think about your output and your gross margin. Don’t skimp up front and hurt your revenue in the end.
Having said that, there is always a point of “diminishing returns” – whether you’re fertilizing crops or feeding cows – a point where the cost of that additional input doesn’t pay for itself anymore. Know where that is for your farm.
Farmers with good protocols can track their return-on-investment much better than those without them and use their inputs wisely. Ultimately, your system drives your costs. Know what inputs you’re using and how much, and avoid waste where you can. Know what amount of cutting back will start to hurt your productivity or quality.
Ultimately, it comes back to basics, and doing the kinds of things you should be doing all along – it’s just that the stakes are higher now with rising costs.
Think about hedging, forward contracting and prepayment. It’s probably too late now for a lot of things, but farms that engaged in forward contracting for inputs are seeing significant benefits from that. If you’re going to go into hedging or forward contracting, be informed, deliberate and consistent.
With the rising cost of labor, efficiency is more important that ever. Invest in technology, facilities, and people. Give them the training and the tools they need to work effectively and efficiently.
Denise Russo, Williston VT
I agree with Mark – whether you’re running a dairy farm, producing crops, or doing something else entirely, try to really know your costs-of-production for whatever your main products are, and your break-even points. Keep in mind that cost of production will vary by farm and your individual circumstances.
Manage and project cash flow – plan for increases – look at scenarios and think about what to do if various inputs rise.
Test your soil! Don’t pay for fertilizer that’s not needed. Prioritize better fields – your inputs will be most effective on your best ground. Engage with agronomists or crop consultants. More than ever, it’s worth paying for some good advice.
The most profitable farms right now are the ones that were – and are – forward looking. Hindsight is always 20/20, but it shows the importance of long-term planning.
Budgeting and cash flow projections are very important in this environment.
Talk with your loan officer about your interest rates. It might make sense to lock in a fixed rate on some of your debt if you have variable rate debt. Note that this is more of a risk-management strategy at this point than a way to save money – expected increases are already “baked into” fixed rates, but you’ll be guarding against unexpected further increases.
Buying groups and coops can be worth looking into.
Managing inventory is especially tricky right now. It can make sense to order way ahead and store nonperishable inventory, but know the cost of storage (and cost of financing it if you have to borrow to do it). We will likely continue to see more price increases before we’re out of this cycle.
Don’t cut back on the wrong things. Spending money on efficiency might make more sense now than ever.
Jon Jaffe, Dayville CT
I deal with a lot of farm retailers, so here’s my thoughts for direct-to-consumer farm businesses: Now can be an opportunity to re-set your prices and enhance your margins where possible. Customers expect price increases now. Raise prices where you have to, so you don’t fall behind on your margins and have to jump more later.
Know who your primary and most profitable customers are. Think about where they may be sensitive to price increases, and where you can get away with them. Your customers will be more understanding if you are increasing prices alongside and proportional to, other increases in the economy. Avoid increasing too much or too little.
Know your costs – and know your numbers! Look at the true inflation of your own costs. It’s likely not everything is increasing at the same rate. Your variable costs will typically rise faster than your fixed costs.
Within challenge lies opportunity. This can be a chance to push towards new clients and new business. Inflationary periods have historically not lasted long, and the fed is acting aggressively, so take the opportunity to adjust your pricing now. Look at other businesses to see what they are doing – both your peers, and perhaps others outside your sector.
Gregg McConnell, Geneva NY
These are certainly interesting times, and we’re still learning how to cope – many of us haven’t see this in our careers.
For all businesses: Rising interest rates make higher debt levels more difficult to manage. You may want to speak with your loan officer about fixed rate opportunities and whether they make sense for your business. Fixed rates are definitely less attractive than they were a year ago, but it’s hard to tell how high rates will go. Get “back to the basics” – these times make the things we should be doing all along even more important. Keep a tight leash on costs. Pick up the phone more often and check prices. Negotiate where you can – and this might be in more areas than you initially think of. Don’t lose your labor pool in the midst of rising wages. Keep up with wage rates. Your employees won’t like feeling left behind.
For production agriculture: Most farms in this category buy commodities and sell a commodity. As a result, they can feel like they are between a rock and a hard place. In fact, sometimes at the leading edge of inflationary times, traditional agriculture can enjoy very good profit margins depending on certain factors. This is due to using last year’s input costs to produce a product that will be sold in a higher price environment. During these times: consider buying inputs in advance of need. Prepaying might improve your negotiating position, as well as allow you to lock in costs. Prepayment can also be used for tax management. In addition, you can seek to contract input costs rather than prepayment and this can work well also.
The price risk can also switch directions quickly. As input costs rise there is no guarantee of a higher price to offset those costs. This is often the case later in an inflationary cycle. At some point, you may end up buying in advance and find out later you could have saved money by delaying a purchase in a declining market. You need to stay in tune with markets and do the best you can and try not to judge yourself too hard. One approach is to start to risk manage your sales price at some point in the cycle. Crop or dairy farms can use CME trades to do this or deal with a local grain market that is willing to contract. The point is, at some point your costs will be high and the crop price will begin to drop. To review: early in the cycle focus on locking in input costs and further on in the cycle consider locking in or protecting the price of what you sell. In dairy and crop, the crop insurance products can provide a government subsidized program that will provide the ability manage the risk of crop prices/milk prices with less downside risk and I much prefer these programs to forward contracts.
For retail business: Don’t be afraid to make price increases where they are justified. People expect it now. But be careful and think about how you are creating value with your offerings (retail). Be sure to still offer “deals” and value to customers who may be experiencing inflation shocks themselves (i.e. gas). This might mean getting creative!
Ethan Robertson, Auburn ME
Farmers often want to grow and expand, but depending on your operation’s risk profile, now might not be the right time – debt, inputs, and construction are expensive right now, and real estate seems to be at a peak. Try to optimize your current situation and facilities first.
Financial management is crucial – optimize your liquidity and try to keep your debt manageable. Keep room on your lines of credit and debt capacity. It’s already been said, but locking in rates can help manage risk.
With rising interest rates and costs, look closely at the return-on-investment in taking on additional debt.
No one really knows exactly when it will happen, or to what degree, but we’re likely to see a slowdown in the economy or a recession. Position yourself now to withstand a downturn.
As with any stressful time, it’s important to keep things in perspective. Be sure to take care of your health – physical and mental. Find a way to avoid getting too focused on the downside, know who you need to talk to when you are feeling the pressure of all the things in this article. We all have that one friend/family member/colleague that is ALWAYS negative and finds the worm hole in a perfectly good apple; identify the person (or people) you can talk to that will help see the good in situations too, this could be a consultant, loan officer, extension professional, family member or mentor.
Finally, we’re living through a period of great uncertainty. Between rising prices, supply shortages, and everything else, its hard to know what we’ll face next. But don’t get paralyzed, or put off important decisions. Remember that to NOT act on something is a decision as well.
Keith Dickinson, Bridgeton NJ
So much has already been said, but here are a few thoughts: Inflation has always been there, it’s just worse now. So, if you haven’t been accounting for it on a regular basis, now is the time to catch up.
How you respond may depend to some extent on your type of business. For commodity producers, your prices are largely set by the market. It’s imperative to understand your costs of production and know what the impact is, say, in cents per bushel (or whatever metric you’re using) of an increase in inputs.
Hedging and crop insurance are especially important – greater volatility and bigger dollars.
For businesses with more pricing power, i.e., retailers, horticulture, knowing your costs of production are still important – know how much more you need to get for your products. Consider what the market will bear. Overall, customers are expecting price increases now, so seize the opportunity. Don’t wait till this blows over to raise your prices.
For wholesale specialty crop growers, like vegetables and fruits, we’re not seeing the same increases on the sales side as we are on the input side – so it might make sense to stop producing some varieties or packages at certain points if the price that the market is offering is below the per-unit cost of production. The key to those decisions is understanding what it costs you to grow each crop on a per-unit basis.
Erin Pirro, Enfield CT
I mainly work with retailers, so that’s the focus of my comments. I’d echo what Keith said in large part.
For retail businesses, it’s time to strategically adjust your selling prices to maintain your margins, but try to think about continuing to offer value to the customer where you can.
Above all, your business needs to be financially sustainable, so don’t shy away from doing what you have to in order to maintain earnings.
Use the tools that you’ve invested in – leverage your point-of-sale system to manage your inventory and customers. Use the management reporting features – POS systems can generate reams of data, but it’s only valuable if you can use it.
Strive to maintain adequate working capital.
Managing inventory in a time of shortages can be challenging. Prioritize your inventory – work on “must-haves,” make the plan and work the plan.
At the same time, don’t be afraid to “sell out” sometimes, especially with items that are perishable or seasonal.
COVID-19 brought a lot of new consumers out of the woodwork for ag retailers and local farms. Seize this opportunity! Try to maintain those relationships and keep them engaged.
Finally, manage from a place of abundance rather than scarcity! Realize that there are always challenges, but there is opportunity as well. Build on your business’s strengths, and remember to feel excitement, positivity, and possibility, rather than dwelling on limitations, setbacks, and hardships.
Farm Credit East employs financial service professionals throughout their territory including the consultants above. Reach out to your relationship manager if you would like to find out what Farm Credit East’s consulting services have to offer.
Editor: Chris Laughton
Contributors: Tom Cosgrove and Chris Laughton
View previous editions of the KEP
cost of production,