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Swanson: Dairy must embrace, adapt to volatility

Progressive Dairyman Editor Dave Natzke Published on 02 January 2018

The dairy industry is volatile and unpredictable, and that isn’t likely to change. Dairy managers must embrace and adapt to that mentality to be successful, Michael Swanson, ag economist with Wells Fargo, told dairy producers attending the 2017 Vita Plus Dairy Summit, Dec. 6-7, in Madison, Wisconsin.

“Dairy is an industry with volatility,” Swanson said. “If that’s not part of your business model, than I don’t think you’re preparing yourself for success.”

Swanson described the dairy industry as a “closed-loop” system, with multiple individual components such as population and economic growth impacting demand, and technology and productivity impacting supply.

“In a system, everything is related, and there’s a feedback loop,” he said. “If you change A, you change B, but B comes back to change A. When you have a closed loop in a system, it becomes inherently unpredictable.”

On a macroeconomic level, there are constants within the loop. Technological and management advances boost milk production at a fairly consistent rate. Increasing population and economic growth yield fairly consistent growth in demand. However, supply growth and demand growth are not parallel, creating a tug and pull that leads to price cycles. As a result, every 1 percent change in milk production results in a 10 percent change in price.

“It’s the head-butting of these two feedback loops that give you crazy price volatility,” Swanson said. “In inelastic supply and inelastic demand, you should expect radical price changes all the time.”

Hoping for a flat, stable dairy market is unrealistic, he said.

“We have 30 years of proof of volatility,” Swanson continued. “You have to build a business model to deal with that. You are impacted by price volatility no matter how good of a manager you are; nobody can escape volatility.”

Long-term bullishness

Long term, Swanson is bullish on agriculture, and especially dairy.

Despite more than a century of predictions the world will fall short of food supplies to feed the world’s population, the growth in productivity continuously outpaces population growth.

He noted global grain acreage has remained fairly stable since the 1960s, but grain yields have increased about 1.9 percent annually, outpacing a 1.1 percent annual increase in population growth.

“We have more grain per person today than we’ve ever had,” Swanson said. “It’s not well-distributed, and not everyone has equal access to it, but we’re not falling behind in grain production.”

What has changed is the acreage devoted to oilseed crops, which have been growing about 1.9 percent annually, resulting in oilseed production that is growing about 2.5 times the pace of population growth.

“Oilseeds are about protein – fed to livestock,” Swanson said. “People want more meat, not more carbohydrates. Dairy is especially well-suited for the future due to global demand for protein. As population and economies grow, we’re going to see continued growth in demand for dairy products.”

Despite the growth in protein demand, Swanson tempers a forecast for higher global milk prices due to the potential for productivity gains elsewhere.

Among global competitors, U.S. milk producers are world leaders in milk output per cow. Swanson said average annual production per cow in the U.S. is about 10.2 metric tons (MT). Among other countries, Denmark averages about 9.2 MT per cow per year, while Canada averages at 8.8 MT. That’s in contrast to Mexico (4.6 MT); New Zealand (4.1 MT); Brazil (1.5 MT) and India (1.4 MT), with the world average about 2.4 MT per cow per year.

For the low-end producers, technology to boost production is readily available. Therefore, low-end producers will find it easier to catch up than it is for the U.S. and other production leaders to forge ahead.

Increased dependence on export market

In the U.S., management and technology changes – including genetics, dietary improvements, robotics, and information and/or technology – have resulted in about 1.6 percent growth in milk yield per cow per year, outpacing population growth of 0.7 to 0.8 percent.

That puts heavier reliance on finding markets outside the U.S. Without growing the export market, the U.S. would have to remove about 1.3 million cows from production, Swanson estimated. He expects the percentage of U.S. production to grow to more than 20 percent of domestic production over the next decade.

“Exports are a necessary component of the U.S. dairy industry, but they will mean inherently more volatility,” he said.

In a globally competitive business, absence of change and the challenges it creates – with everyone on the same plane – will always benefit those who can do it the cheapest.

“The more that we have a changing market, and the more you can adapt, the better you can differentiate yourself from the competition,” he said. “Don’t be bearish about dairy; just understand it’s all about your management skillset that makes the difference.”

Measuring success

Swanson urged producers to look at long-term return on assets (ROA) to benchmark themselves against competitors. Financial analysis showed the top producers averaged 8.2 percent ROA, while “average” producers saw a 3.3 percent ROA.

He forecast a change in the agricultural debt and equity picture. In the past, low interest rates made debt cheap. As the cost of debt moves higher to provide a truer reflection of risk, Swanson expects a contraction in return on equity ahead. “It’s not about the dairy market; it’s about the cost of debt,” he said.

Finally, Swanson urged producers to be “sailors, not rowers.” Rowing, he said, equates to working harder, while sailing equates to management.

“Let the wind do the work, but you have to sail the boat,” he concluded.  end mark

Dave Natzke
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