Decomposing variation in dairy profitability: the impact of output, inputs, prices, labour and management

The UK dairy sector has undergone considerable structural change in recent years, with a decrease in the number of producers accompanied by an increased average herd size and increased concentrate use and milk yields. One of the key drivers to producers remaining in the industry is the profitability of their herds. The current paper adopts a holistic approach to decomposing the variation in dairy profitability through an analysis of net margin data explained by physical input-output measures, milk price variation, labour utilization and managerial behaviours and characteristics. Data are drawn from the Farm Business Survey (FBS) for England in 2007/08 for 228 dairy enterprises. Average yields are 7100 litres/cow/yr, from a herd size of 110 cows that use 0·56 forage ha/cow/yr and 43·2 labour h/cow/yr. An average milk price of 22·57 pence per litre (ppl) produced milk output of £1602/cow/yr, which after accounting for calf sales, herd replacements and quota leasing costs, gave an average dairy output of £1516/cow/yr. After total costs of £1464/cow/yr this left an economic return of £52/cow/yr (0·73 ppl) net margin profit. There is wide variation in performance, with the most profitable (as measured by net margin per cow) quartile of producers achieving 2000 litres/cow/yr more than the least profitable quartile, returning a net margin of £335/cow/yr compared to a loss of £361/cow/yr for the least profitable. The most profitable producers operate larger, higher yielding herds and achieve a greater milk price for their output. In addition, a significantly greater number of the most profitable producers undertake financial benchmarking within their businesses and operate specialist dairy farms. When examining the full data set, the most profitable enterprises included significantly greater numbers of organic producers. The most profitable tend to have a greater reliance on independent technical advice, but this finding is not statistically significant. Decomposing the variation in net margin performance between the most and least profitable groups, an approximate ratio of 65:23:12 is observed for higher yields: lower costs: higher milk price. This result indicates that yield differentials are the key performance driver in dairy profitability. Lower costs per cow are dominated by the significantly lower cost of farmer and spouse labour per cow of the most profitable group, flowing directly from the upper quartile expending 37·7 labour h/cow/yr in comparison with 58·8 h/cow/yr for the lower quartile. The upper quartile's greater milk price is argued to be achieved through contract negotiations and higher milk quality, and this accounts for 0·12 of the variation in net margin performance. The average economic return to the sample of dairy enterprises in this survey year was less than £6000/farm/yr. However, the most profitable quartile returned an average economic return of approximately £50 000 per farm/yr. Structural change in the UK dairy sector is likely to continue with the least profitable and typically smaller dairy enterprises being replaced by a smaller number of expanding dairy production units.