Farm Credit of Western New York: Notebook: Feature Stories

Can outsourcing sharpen your competitive edge?

Competitive edge is all about profit potential. And profit potential is all about how you use resources in your business.

Do you use your resources effectively? Or could someone else do a better job in certain areas, allowing you to focus where the real money is?

With these questions in mind, you might consider outsourcing, a practical alternative to business as usual and a trend in agribusiness today.

The concept is simple. You “outsource” your nonincome-producing enterprises to custom operators in order to focus resources on income-producing assets.

For example, a dairy farmer might outsource the cropping operation in order to concentrate on milk production. Or a wholesale greenhouse operator might outsource distribution to a trucking company while maintaining primary focus on plant production. Or a timber land-owner might hire a contractor to cut, skid and haul logs while investing his or her energy in land management, where the profit potential is greater.

This article explores the outsourcing alternative and suggests ways in which Farm Credit can support the decision-making process.

Specialization: a natural progression

A real-life example

Van Perry tells a story of a customer who owns 10,000 acres of timberland and his own timber harvesting equipment. “This customer was concerned that the harvesting equipment tied up huge sums of capital that he might be able to use more cost-effectively in another area of his business.
“By segmenting his monthly expenses, he learned that his harvesting equipment actually cost him more to own (loan payments, maintenance, labor, fuel, oil, insurance, etc.) than the income it generated. His solution was to sell the equipment and pay off his loan with the proceeds from the sale. He hired logging contractors to harvest his timberland. And he reallocated his resources by opening his equipment repair garage to outside businesses. “In this case, an already successful business owner learned that he could turn an expense (harvesting equipment and staff to run and maintain it) into an income generator.”

According to Gary Snider, a farm business consultant with Farm Credit of Western New York, “Agriculture has developed into more of a business and less of a way of life. Specialization of agricultural production is a natural progression in this evolution.

“In the past, sole proprietors performed every farming function — from operating equipment to assembling product for market — and they also maintained one set of financial records for their entire operation.”

Van Perry, a loan officer with Farm Credit of Maine, adds, “As competition intensifies, growers need to analyze their costs more closely.” Perry suggests that producers allocate income and expenses by enterprise or business segment, rather than just for their entire business. By “enterprise,” he means separating a business’s discrete operations into separate entities for financial analysis.

“By separating enterprise-specific information from overall business data, producers can pinpoint where they make money and where they lose it. This level of information also provides more accurate, detailed guidelines for future decisions.” Van adds, “You may be making money overall, but you need to be aware of areas that are a drain on your profits.”

It is precisely these profit-draining areas that make excellent targets for outsourcing.

WHY hire a custom operator

Agribusinesses outsource services for as many different reasons as there are agribusinesses. Here are some of the issues that might prompt a business owner to consider outsourcing:

Profitability. With today’s interest in business expansion, some agribusinesses prefer to focus on income-producing assets, rather than managing multiple enterprises (including money-losers) and diluting their management efforts.
Time constraints. Dairy farmers who outsource their heifer raising operations may find that, with fewer distractions, they have the time and resources to milk more cows.
Reduced bureaucratic requirements. A vegetable operation can outsource its spraying operation, thus allowing a spraying specialist to deal with government regulations.
Quality of life. Many successful business owners opt for spending more time with their families when they are comfortable with their current income.
Limited resources. A dairy farmer with limited land or facilities may pay a specialist to raise his heifers, and use his forage to feed an expanded milk herd.
Crop quality. Harvest time has a narrow window for delivering peak freshness to market or peak nutrients for forage. That’s why farmers may opt to hire a custom harvester with the capacity to harvest at peak.
Economies of scale. Some owners find hiring a contractor is more cost-effective than owning and maintaining expensive equipment with limited use. (Larger operations may have enough acreage to justify the expense of owning a big-ticket item, however.)
Workers’ compensation expenses. A logging contractor, for example, may separate his business into trucking, land and logging enterprises to reduce his workers’ compensation insurance costs. That’s because workers’ compensation insurance is expensive for individuals employed in more dangerous work. Therefore, a logger is more expensive to insure than a trucker is, so it might make sense to outsource the logging enterprise.
Borrowing capacity. Outsourcing a nonincome producing enterprise might enhance your borrowing position. Talk to your loan officer about the advantages of allocating your loan capacity to your income-producing assets.

WHEN to hire a custom operator

In his own words Gary Snider says, “Remember that after you hire a custom operator, you must also reconsider other costs. If a vegetable grower, for example, continues to own harvesting equipment after hiring a custom harvester, he continues to pay the associated expenses and, therefore, gains little or no benefit from hiring the custom operator! By selling the equipment, he will lower his out-of-pocket expenses and eliminate maintenance costs, loan payments, insurance premiums and perhaps labor costs at the same time.”	According to business consultant Gary Snider, the decision to hire a custom operator is a two-step process. He suggests that if you are considering outsourcing then you should first ask yourself the following questions: 1. *When should I outsource a function?* The answer is: When a custom operator can lower your production costs so your primary business can be more competitive. Custom
operators are often more efficient because they can afford better technology and they are experts in a niche business. If they can do a job better, faster, more thoroughly and for less cost than you can, “Hire them,” says Gary. 2. What business adjustments must I make as a result of outsourcing? Deciding to hire a custom operator is only part of the decision. You also need to consider how the change will affect your business’s big picture, and what adjustments you must make so you don’t lose profit. Gary suggests that you may need to adjust costs to offset the out-of-pocket expense of hiring custom operators. These costs may be associated with the purchase of new resources, increasing milk production, increased vegetable harvest, buying more timberland or selling equipment.
WHAT about the risks
Consider the quality of service you’ll receive and the reputation of the custom operator before outsourcing a segment of your business. Also ask yourself if you are ready to surrender total control over a particular enterprise. You want to be sure that you hire someone who can do a job as well as you can — preferably even better. First Pioneer farm	A real-life example Dan Brogdon tells a story about a dairy farmer who shipped his heifers to a custom grower, expecting to get them back ready to calf at 24 months. Unfortunately the custom operator didn’t feed the calves aggressively enough or breed them early enough, which delayed their return two additional months. That error translated into two more months of unnecessary expense for the farmer.
business consultant Dan Brogdon, of Cortland, N.Y., suggests that you get to know your custom operator, either personally or through references, and consider requiring a clearly written contract of services. You should also learn about the contractor’s experience, equipment or facilities. “Perhaps you may want to visit the operation or check back periodically,” Dan says, and then adds, “Or ask for value-added services, such as monthly reports on height and weight of animals.”

HOW to make a decision

For a discussion of how a decision is made — click here.

Contact us at info@farmcreditwny.com for more information.

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