10 questions to ask before expanding the farm

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Growth lets farm businesses increase revenue and earnings, take advantage of economies of size, and better use the skills of current and future employees.  But the Center for Commercial Agriculture at Purdue University encourages producers to ask these 10 questions first.

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1Why grow?
Before growing, think about the strategic direction: Is the operation interested in a commodity-based strategy or a differentiated product strategy? A commodity product strategy focuses on cost control and a differentiated product strategy focuses on value-added production or receiving an above-average price for the farm’s products.

2What are my options?
There are at least six growth alternatives available to farms: focusing or specializing in one activity, intensify or modernize current production, expanding, diversifying, replicating the business into multiple sites, and integrating.

3What influences growth?
Conduct an internal and external analysis of your farm business. An internal analysis identifies key resources, capabilities, and core competencies. Ask yourself whether your operation has unique resources that lead to a competitive advantage.

It’s also important to examine the external environment or scan the horizon. What’s the social environment and industry the farm faces? Think about key drivers facing the markets for the products you produce.

4Evaluating growth
The following eight criteria can be used in making the choice: strategic fit, expected returns, risk, capital required, the cost and ease of entry and exit, value creation, managerial requirements, and portfolio fit.

5What skills do I need?
Analyze the skills of current employees. How strong or weak are the workforce’s production management skills, procurement and selling skills, financial management skills, personnel management skills, strategic positioning skills, relationship management skills, leadership skills, and risk management skills?

6How do I finance growth?
Besides using debt and equity (retained earnings), growth can be financed through leasing assets or joint ventures. It is also important to examine working capital funding.

7What business model do I use?
There are numerous business models that can be used to implement a growth strategy: organic or internal growth, merger or acquisition, franchise, joint venture or strategic alliance, service provider, asset or service outsourcer, agricultural entrepreneur, or investor. Traditionally, most farms use the organic or internal growth model.

8How will expansion impact my operation?
Use pro forma statements or projections to gauge how each option will impact the farm’s balance sheet and income statement. Use at least three scenarios (worst case scenario, most likely scenario, best case scenario) when evaluating each growth option.

Particular focus should be given to how each growth option impacts the profit margin, the asset turnover ratio, and returns on investment and equity under each scenario.

9Start-up challenges
Start-up challenges can include construction delays, cash flow shortages, depleted working capital, and short-term operational inefficiencies and management bottlenecks. Cash flow and working capital requirements can vary substantially between growth options.

10What is my sustainable growth rate?
The sustainable growth rate is the maximum rate of growth that a farm can sustain without having to increase financial leverage or look for outside financing. The sustainable growth rate can be computed using information on earnings, retained earnings or savings, and business withdrawals.

Sources: Farm Growth: Challenges and Opportunities, Michael Boehlje and Michael Langemeier, Center for Commercial Agriculture, Purdue University.

Next week: 9 options for expanding the farm business.

(Farm and Dairy is featuring a series of “101” columns throughout the year to help young and beginning farmers master farm living. From finances to management to machinery repair and animal care, farmers do it all.)

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