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Farm diversification decision-making

This guide aims to help new landholders make decisions about diversifying their property. These five steps can guide you to making a decision that will help you avoid failure and disappointment.

Step 1: Compatibility

It is easiest to act upon an idea that is highly compatible with what is already being done. It is harder to diversify into a completely new opportunity.

It is important to clarify the purpose of buying a farm before plunging into any enterprise. For example, if you don’t live on the property or cannot be there every day, then you are not well placed to graze animals or grow crops that need constant care.

Some useful questions to ask yourself before diversifying:

  • Are we living on a farm primarily to enjoy the environment or to focus on some agricultural activity?
  • Will we be away from the property for extended periods of time?
  • How much do we know our proposed venture?
  • Have we got the time to do the work, especially during the peak seasons for harvesting?
  • Am I physically able to do the work? What about in 15 years’ time?
  • Will we enjoy doing this type of work?
  • How much will it cost to do this properly?
  • Do markets exist for the amount I will produce? How far away is the market?
  • Do I have to spend half my time trying to sell the product?
  • Are there other things that I would rather be doing?

Lease, share farm and agistment agreements

You can enjoy living on your rural property without taking part in farm activities. Leasing, share farming and agistment agreements allow another farmer to use your land for agricultural purposes. For leasing, share farming and agistment, an agreement should be prepared that defines the terms, conditions and payment. These agreements can be helpful when you have just purchased a property and before you commit to a particular activity.

Contracting out labour requirements

If you are involved in an agricultural activity that has regular demands for skilled labour or for heavy workloads you may be able to contract out the work. Specialised contractors for jobs associated with land and enterprise management operate in most regional areas.

Bushland conservation and revegetation

For many new landholders, the primary attraction of rural living is getting closer to nature. Many properties have significant areas of native vegetation or are close to the bush. Native bush has a low stock carrying capacity and requires careful management to prevent degradation.

The development of wood lots for fire wood or timber plantations can turn re-vegetation into a commercial enterprise in the medium to long term. Using local species of plants will provide both biodiversity benefits and wood production benefits.

Step 2: Observing

By observing an activity you can see if you like the idea and want to learn more and also assess its complexity. Being able to see and talk to someone else who has already successfully undertaken an idea improves confidence.

The easier a product is to observe, the more knowledge and understanding you can obtain and this will increase your ability to make good decisions. A new industry will be less observable and there will be more risks.

Product cycles

Agricultural products, like many other products have life cycles. Some life cycles occur over many years and others may collapse in a relatively short period.

Decisions to invest are improved if people consider the life cycle stage of the product and market. A mature industry that has been developing for many years is highly observable and much information is available. Investment is easiest the further into the product and market life cycles one starts the new activity.

Learning from others’ mistakes

One of the biggest advantages of observing an industry before taking an active part is that you can see what works and ask why. You might even have ideas about how to do things better. Research your interest area from a wide range of sources. Contact industry organisations, local government agencies, community groups and local landholders for valuable advice.

Questions and issues that may arise

Observing a potential investment may raise further questions to be considered in the decision-making process.

  • Look to see if the activities are compatible with your lifestyle, values and interests. Will you be happy carrying out the activities you see? Will you have the time?
  • Look for practical demonstrations and trials of the industry. The more trials you can visit the more you will learn. Attending field days, open days and exhibitions is strongly recommended. Do not hurry your decision.
  • Understand how complex the activities involved with a particular industry will be during a typical year and during a difficult year. What happens during dry conditions? How do current participants overcome difficulties and complexities?
  • During your observations try to identify any resource advantages you might have.

Step 3: Trialling

Trying something out on a small scale to test it reduces the financial risk and helps you plan how to move into full scale production and learn the production and marketing process.

An important aspect of trialling is to gain constructive feedback from your customers. This feedback is valuable information and helps improve your product and grow your business.

Reducing your risk

In any venture, business planning reduces risk. There is less risk involved if an agricultural idea can be tested or trialled on a small scale first. When you are considering an idea, see if it can be divided into smaller components or steps rather than testing the whole. This allows testing for suitability while minimising risk.

Examples of trialling

New animal—The landholder purchases 100 non-breeding Angora goats and learns how goats behave before deciding to purchase more. By choosing non-breeding animals the management is kept simple as there are no males to keep in a separate paddock, and there is no breeding and kidding management. The trial is big enough to learn about mohair production and understand the complexity of managing a breeding herd.

New product—A small flock owner has their wool spun into yarn. The yarn is knitted up on one machine in their house. As confidence grows the business expands. A full business plan is prepared. They lease a larger building and buy modern equipment.

New crop – If inexperienced, it is essential for a landholder to learn how to grow a crop, manage it and market the produce on a scale that does not involve significant cost and allows the production pitfalls and issues to be learnt without high risk.  If growing a horticultural crop, try a small area for a season or two first, such as half an acre of vegetables or a quarter of an acre of berries.

Economies of scale

When a diversification activity is trialled on a small scale it will have high average costs of production. As production increases average costs should begin to fall and can potentially reach a minimum efficient scale where in the long run, average costs can be minimised. This is likely to occur more often when an industry reaches maturity and businesses have reached a minimum efficient scale. Hence if a trial remains a ‘trial’ then cost disadvantages will affect profitability.

For example, people who buy in small quantities usually pay higher prices for their inputs thus affecting their profit. At the other end of the supply chain purchasers often want to be able to buy certain quantities of product on a regular basis and suppliers will favour those who can do this and penalise those who cannot.

Table 1. The relationship between the size of a trial, the planning behind the trial and risk.

Planning and thinking involved with trial Size of trial
Small scale       Medium scale Commercial scale
Low level, little planning Poorly planned small scale trial HIGHER RISK Poorly planned large commercial venture
Medium level LOWER RISK Arrows pointing up, down, left and right HIGHER RISK
High level, lots of planning Highly planned small scale trial LOWER RISK Highly planned commercial enterprise from first day

Step 4: Complexity

The more complex the idea the greater the changes needed to fit the idea into an existing system. As complexity increases, the risk of failure increases. As complexity increases, the need for, and the costs of gaining additional knowledge increases.

Technical complexity

To overcome complex problems requires information, and organisational and analytical skills. Some questions you may need to ask are:

  • Are you prepared to learn how to operate new systems?
  • What knowledge do you have of soil fertility needs, irrigation needs, harvesting requirements, storage needs and/or spoilage risks?

Financial complexity

The costs of entry into enterprises on a commercial scale, the cost of equipment and the length of the payback period all increase the financial complexity of diversifying in agriculture. Financial risks, including drought, exchange rates and imports are often overlooked, and can seriously undermine financial returns.

Marketing complexity

Quality assurance programs and export and safety regulations increase the degree of expertise and specialised production systems required to be part of a market supply chain.  Quality assurance programs involve costs but if planning to supply a major retailer will be essential.

Frequent monitoring of storage conditions, management of records and the maintenance of certification for equipment are all activities that increase the complexity of producing or selling new products. Plant variety rights, licensed production systems and controlled marketing increase the complexity of marketing a product.

Marketing requirements keep changing. In every industry you need to keep asking your old and new customers what they want, how they want it and when they want it.

Complex industries

For established industries, the systems in place have been developed over many years. These systems can be explained by existing producers and agents. This is not always the situation for new industries. For some new industries the systems are very complex or have not even been established. Some examples are given here.

Wine production system:

  • Technically demanding requirements to set up efficient production and irrigation systems.
  • Demanding spraying schedules for herbicides, insecticides, fungicides and for pruning.
  • Delayed income.
  • Labour intensive.
  • Demanding financial needs.
  • Marketing may be complex.

Olives:

  • Fruit needs specialist harvesting equipment and processing.
  • Processing batches need to be large or costs become prohibitive.

Alpaca production system:

  • Alpacas are mated individually.
  • Birthing can be spread throughout the year.
  • Both issues need effective time management and may impact on harvesting activities.

Farm forestry systems:

  • Demanding soil and water requirements and planting, management and harvesting schedules.
  • Unclear market signals.
  • Little income for many years.

The level of complexity can be reduced by specific resource advantages you may have. For example, wine production is made less complex with access to irrigation water and existing equipment for spraying. Olive production is made less complex by access to a large area of land, close to processors.

Table 1 summarises the relationships between different levels of complexity, different types of complexity and barriers to entry into different activities.

Degree of complexity Technical complexity Market complexity Financial complexity Barrier to entry
Low Easy to learn and do. Lots of information and training available. Simple to sell. Many buyers. Commodity product Affordable for many people. Low cost to start. Easy to sell if want to retire. Low
High Difficult to learn. Needs a high level of expertise to do well. Information lacking or not accessible. Specialist production system. Needs special equipment. Controlled marketing systems. Exclusive distribution system. No clear market system. Need license, trademarks or special knowledge. Expensive for most people. High cost to start. Hard to sell if retiring. Low cash flow for many years at the start. High

Table 1. The relationship between different levels of complexity, different types of complexity and barriers to entry to an industry.

Step 5: Resource advantage

Resource advantages can give your idea a better chance of succeeding. If you have a resource advantage for an idea then it will be cheaper, faster or more efficient to adopt that idea compared with another idea.

Resource advantages may occur at the farm, district or regional level or at the industry level. For example, a resource does not have to be on-farm to provide advantage. Being close to a market, a transport company providing refrigerated transportation direct to market, a highly competent supplier or a government research station are resources that other localities or people may not have.

Financial resources

  • Access to cheap finance
  • Disposable income and cash reserves
  • Off-farm income
  • Access to competitively priced inputs
  • Financial model of the current and new enterprise applied to the business

Physical resources

  • Soil type, water, temperature, altitude, vegetation
  • Machinery and equipment
  • Access to quality roads
  • Access to power
  • Proximity to other businesses providing support services such as cool stores, packing sheds, abattoirs
  • Proximity to markets
  • Physical resources that create real or perceived advantage particularly in the minds of customers, e.g. proximity to wilderness areas

Human resources

  • Skills associated with the business
  • Access to people with specialist skills and knowledge
  • Disposition to risk
  • Access to labour
  • Ability to plan
  • Predisposition to continuous improvement
  • Ability to learn from experience and innovate
  • Competency to harness & develop the existing resources base to deliver value
  • Strong industry leadership or champion

Organisation resources

  • Style of operation or modus operandi
  • Strategic long-term approach
  • Business reputation
  • Culture of quality management
  • Basic assumptions that underpin the farm (business)
  • Industry structure, e.g. many small producers, few large producers, cooperatives or corporate farms

Information resources

  • Knowledge of the supply chain customers and consumers
  • Knowledge of the market forces
  • Knowledge of competitors strengths and weaknesses
  • Systems to make best use of information, e.g. IT systems
  • Access to, cost of, and ability to analyse information

Relational resources

  • Degree of integration of production, processing and marketing
  • Vertical relationships with suppliers and customers
  • Horizontal relationships with other producers
  • Geographic concentration (or dispersion) of producers, input suppliers, buyers
  • Relationships with advisory services

Legal resources

  • Trademarks, licences, copyright
  • Proprietary information, intellectual property
  • Ability to brand the product and be recognised by customers and consumers
  • Exclusive marketing arrangements
  • Regional branding activities
  • Legal structure associated with organisation
  • Degree and usefulness of government regulation, trade policy, tax incentives, subsidies, etc.

Ability to use resource advantages

Resources that are hard to imitate or substitute provide the basis of a sustained competitive advantage.

Having a resource advantage is one thing but means nothing if you are unable or unwilling to exploit the advantage. The trap is to use resource advantages in your planning and budgets but be unable to competently harness them to deliver value. If this happens you will not reach your financial targets.

In evaluating any new idea or investment diversification it is easy to see that everyone has different resource advantages. The increasing move to corporate farming provides the corporations with large financial advantages and the ability to access resources from other parts of the company. Often companies are better able to use resources to advantage compared with small farms.

Table 1. Summary of the main resource advantages

Resource Description
Financial Cash reserves, access to financial markets
Physical Machinery, equipment, soil, water, temperature, vegetation
Human Skills, knowledge of people in the business or associated with the business
Organisational Competencies, controls, policies, culture
Information Knowledge of consumer, competitor, access to information, cost of information
Relational Relationships with suppliers, buyers and other stakeholders, other producers, advisory services, other service providers
Legal Trademarks, licences, copyright propriety information, intellectual property

(Source – http://agriculture.vic.gov.au/agriculture/farm-management/new-landholders/land-management-tips/farm-diversification-decision-making)

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