Farming: Beware the siren call of economies of scale

Farm businesses have long viewed expansion as the main route towards increasing profitability – but the industry should “beware the siren call” of economies of scale and be sure that farming more hectares will genuinely add to the bottom line, a leading firm of consultants has warned.

In their most recent Business Matters report, farm business consultants Andersons cautioned that for the majority of farming businesses economies of scale were more often a myth than reality.

Stating that while the aim of such expansion was often to spread overhead costs, the report highlighted the fact that the evidence indicated that in many cases the anticipated additional profit either failed to materialise or was much less than expected.

“In some cases business expansion actually leads to reduced profits – and additional costs exceed the additional income,” it warned.

Growing the business was unlikely to offer any major opportunities to reduce variable costs such as seed, fertiliser, sprays and feed, concluded the report (Photo: Leon Neal/Getty Images)

And the report flagged up the fact that if expansion involved farming additional land at a distance from the main holdings (a situation which was not uncommon in UK agriculture) the additional travelling would generate higher fuel costs than those incurred on existing land.

“Our experience suggests that this is one of the least understood and most under-estimated costs associated with economies of scale,” said Andersons director, David Siddle.

Additionally machinery would also be subject to higher depreciation rates due to the higher levels of “wear and tear” associated not only with travelling to and from the distant land but also from working the extra hectares.

Labour costs were an area where the report concluded some savings could be made – but this was only where salaried employees had spare time on their hands to be better utilised.

For those paid on hourly rates, additional work will directly increase expenditure (sometimes at higher average wage rates if the new tasks are paid as overtime).

And while there were some opportunities for true economy of scale savings on overall administration costs, these tended to be relatively minor.

However rent and finance were areas unlikely to yield any major savings through expansion, with rent and working capital finance directly related to the area farmed.

“In fact, this is a category where unit costs may increase, with paying of above average rents (or rent equivalents for contract farming) for additional land,” said the report.

It was also pointed out in the report that growing the business was unlikely to offer any major opportunities to reduce variable costs such as seed, fertiliser, sprays and feed on a per unit basis beyond the possibility of being able to negotiate better terms for larger orders.

The report concluded that the real issue for farms was not economies of scale but instead, “scale matching” – whereby business overhead costs were designed to leave as little spare capacity as possible: “This may be achieved in a range of ways and, importantly, includes collaboration between businesses – quite frequently a feature of those with the lowest costs of production.”