Factors affecting profitability of organic farms (OF0155)

Summary

Financial Factors
The importance of price premiums for profitability has been clearly established for cropping farms. The lack of availability of price premiums for livestock products means that the importance of price premiums in livestock systems to overall financial success has not been established.
There is some indication that the success of organic farms is likely to depend on the successful management of internal resources; the diversity of the farming business might aid this, but no studies have established any clear indicators or relationships. The total variable costs might give some indication and would be expected to be low where the internal utilisation of non-marketable goods, such as fertility, nutrients and forage, is efficient.
There is evidence that organic farms of a particular type (cropping, mixed and horticultural units) require more labour than comparable conventional farms and that the inclusion of labour intensive enterprises might lead to higher labour requirements, particularly during conversion. Organic farmers appear more likely to employ labour, and it can therefore be concluded that labour requirements, as well as the use of paid labour, are likely to represent an important profit factor on organic farms.
There is some indication that organic farms also have higher other fixed costs than conventional farms but few studies examine this in detail. The issue of fixed costs is likely to be of greater importance for the profitability of organic farms as more emphasis is placed on the management of internal resources than of purchased inputs.
It is likely that organic farms, in line with all farming activities, benefit from the economics of scale. Questions remain whether the importance of diversity applies differently to farms of different size, with large farms benefiting from economics of specialisation. There is no clear assessment in the literature with regards to the risk associated with organic production.
Managerial Factors
Organic producers have a variety of financial and non-financial objectives, which are likely to contribute to their managerial decisions and hence to the profitability of their farms.
In some studies the time under organic management has been identified as having an influence on farm sucess that might be attributed to greater level of experience as well as soil biological conditions.
In addition, their managerial ability and experience, farm workers' motivatio and the marketing ability, are likely to contribute towards the sucess of the farm but none of these issues have been studies on organic farms.
It is, however, likely that organic farmers vary in their personal and business related objectives and in management ability, and that the variation is an important factor of success.
Farm Profitability Measures
To analyse the factorss influencing profitability on any farm it is important to select measures of profitability that reflect the financial situation of the farm and are reresentative of the influences on the farmers' decision-making process. Profit, in this report, is used as an economic term, although other potential meanings are acknowledged.
Arguably, cash income reflects best the financial, decision-making as influenced by liquidity and bank statements. However, depreciation is recognised as a real cost to most farmers aiming to maintain their investment. Despite the value of increased comparability between farms of different tenure and indebtedness in standard FBS income measures (NFI and MII), the inclusion of the notional charges for labour and rent implies that farms are associated with expenses that will have no bearing on their financial decision-making. As the analysis is based on data of organic farms in the FBS format, ONI was selected as the most appropriate measure of farm profitability for much of the analysis, but NFI and cash income have been included for the factor analysis.
Despite the limitations of gross margins in general (designed for the comparison of enterprises with similar resource requirements) and for organic farms in particular (replacement of external inputs through management of internal resources) they often represent the only available data on physical and production aspects of organic farms. Gross margin data are therefore used in this study to illustrate the effect of price, variable costs and yield factors on the outputs for arable crops and milk.