Farm business models—why is there interest in the alternatives?

Ag Production Newsletter – Article by Andrew Rice (ORM, Parkes), September 2016

Key points

• The family farm business model, where the land is owned and operated by the family, has generally served Australian agriculture well.  However it does have some limitations.
• Alternative farm business models can enhance farm business profitability, provide more effective risk management and assist with business succession and access to capital.
• It is important to recognise that the financial performance of farm business models differs in terms of profitability, return on assets owned, working capital requirements and exposure to risk.

The family farm business model, where farm assets and farming operations, including management and labour, are usually provided as a whole by the family, has generally served Australian agriculture well. However, there are situations where ‘internal’ contribution of the farm’s assets and operations will not deliver the best outcome for the business or the people involved.

Business model v structure?

A farm business model is commonly mistaken to mean ‘business structure’, or the combination of legal entities for business operation and asset ownership, such as a partnership, trust or company.

While legal entities are important, they are only part of the puzzle and may not take into consideration the foundations for a successful farm business. The business entity is best addressed in the later stages of setting up or restructuring a farm business model, matching the entity to the needs of the business and people.

What is a farm business model?

A farm business model involves arrangements for:

• business ownership and access to resources
• business management
• sources of capital for the business.

Basic principles of farm business models

The following principles are critical to the design and operation of farm business models:

• Farm business can be broken down into business resources (assets and operations);
• Resources help define the relative contributions of different parties to the farm business; and
• Contributions of each party to the farm business can be valued and rewarded.

Within the categories of assets and operations, farm business resources can be broken down into:

• land
• irrigation water, where applicable
• livestock, where applicable
• management
• labour and machinery
• capital.

Land is the most common example of a resource that is valued and rewarded.  Lease payments made under lease agreements are a ‘reward’ for the contribution to a farm business.

The evolution of alternative farm business models

Corporate farming is based on the separation of farm business resources, with a clear delineation of farm asset ownership, business management and reliance on employed labour for farming operations[1].

Within this model, farm assets and operations are commonly separated in the business structure to protect assets from operational risks by breaking down the farm business into distinct business resources.

An increasing number of family farms are evolving towards this corporate model, by changing the mix of business resources. Sometimes referred to as ‘family corporates’, many of these enterprises operate with formal board and administrative structures, as well as employed staff[2].

Benefits of alternative models

Modifying the family farm model, or developing an alternative model to include some external contribution of assets and/or operations, can deliver greater flexibility and rewards. It may be as simple as ‘tweaking’ the traditional family farm model to include some contracting services.

Alternative farm business models can assist ‘farm business operators’ achieve:

• Enhanced profitability by improving cost structures and access to resources.
• More effective risk management through sharing risk with other parties.
• Business succession.
• Increased access to capital for growth and operation, reducing the reliance on debt funding.

While adopting an appropriate farm business model can help address the above ‘drivers’, business success also depends on the ability to ‘manage and operate the business well’.

What are the alternative business models?

Due to the range of personal and business needs, and differing requirements for resources, most farms operate using a mix of business models. For example, family farms now typically operate with some leasing, some share farming and/or some contracting. The level of asset ownership and contribution to farming operations within each model vary significantly depending on the business circumstances.

These variations mean it is not possible to define discrete business models; rather it is more appropriate to consider model ‘types’.  The primary farm business model ‘types’ include:

• family farming
• leasing land
• share farming
• contracting, including machinery, labour and/or management
• joint ventures.

Within the model types, the ownership and access arrangements for farm resources can range from completely ‘internal’ (business owners/operators) to completely ‘external’ (other parties). Mix of ownership and access arrangements for resources defines the model.

Which farm business model?

Alternative farm business models cannot be selected ‘off the shelf’ and implemented. They need to be developed to suit personal and business needs, focusing on people, finances and resources.

When considering the suitability of alternative farm business models for your business, it is essential to understand:

What are the drivers for considering an alternative business model?

Understanding what the drivers are provides essential background about what aspects of performance are most important.  It is important to recognise that the financial performance of models differs in terms of profitability, return on assets owned, working capital requirements and exposure to risk.

What are the perspectives of the different parties within each model?

Parties within an agreement may include; business operator, contractor, land owner and investor (joint venture partner). While there may be alignment, commonly the different parties will have differing requirements reflecting their personal, business and financial situation.

Other considerations

It is common for the financial performance of farm business models to be considered in isolation, making the potential financial outcomes the primary focus. However, non-financial considerations should not be dismissed when assessing the potential suitability to personal and business circumstances.

Farm business management is based on decision making; choosing a path for your business that has acceptable reward, both financial and non-financial, for acceptable effort with an acceptable level of risk[3].  What is ‘acceptable’ will vary from business to business and person to person.  It is essential that farm decision making includes all key people in the farm business.

More Information

Andrew Rice, Agribusiness Consultant - ORM (Parkes, NSW)

0427 965 469

andrew@orm.com.au

www.orm.com.au

Acknowledgements

Material for this article has been drawn from the Grains Research & Development (GRDC) project undertaken by ORM: ‘Farm business models: options for building your future’ (ORM00016). Full project outcomes will be published in a GRDC ‘GrowNote’ later this year (https://grdc.com.au/Resources/GrowNotes).

References