March 30th, 2016
Mr. Bill Vanderspek
General Manager
BC Chicken Marketing Board
101 - 32450 Simon Avenue
Abbotsford, British Columbia
V2T 4J2
Mr. Ravi Bathe
President
BC Chicken Growers Association
Dear Mr. Vanderspek & Mr. Bathe:
RE: COMPARISON OF BCCMB COP UPDATE WITH ONTARIO COSTING MODEL - DRAFT
At the meeting in the BCCMB offices on February 26th, 2016 you requested that I provide you additional analysis and
commentary related to the revised Cost of Production (COP) that I outlined at that time. You made specific reference
to the interpretation of the COP process itself as well as how the results compared with the new model being used in
Ontario. I have compiled the following for this purpose.
Context
It is important to clarify that while I am familiar with the results of the new costing model being used in Ontario I am
not aware of many of the specific costing elements that have been used in the calculation. Some of the key questions
that I do not know the answers to include:
•
How many producers were used in estimating costs;
•
•
•
•
•
•
•
The demographic profile of the sample itself – does it reflect the total population or a selected sub-segment;
The rates of return that were applied to capital;
The period of time over which capital assets were depreciated;
The way that labour was addressed in the calculation;
How feed costs from on-farm feed manufacture were treated;
How and if discounts and premiums for pre-payment and/or large purchase volumes were addressed; and
How normalizations were made to address the various “efficiency” adjustments that were made.
It is within this context that I provide the following comments.
Cost of Production (COP) Defined
Valuation literature is clear that a COP refers to the total sum of money needed for the production of a particular
quantity of output – in this case a kg of chicken. As defined by Gulhrie and Wallace, “In Economics, cost of production
features a special meaning. It is all about the payments or expenditures essential to get the factors of production of
land, labor, capital and management needed to produce a commodity. It signifies the money costs which are to be
incurred for acquisition of the factors of production.” In the words of Campbell, “Production Costs are the costs which
should be essentially received by resource owners so as to presume that they will continue to supply them in a
specific period of time.”
Mr. Bill Vanderspek
Mr. Ravi Bathe
March 31, 2016
2
It is critical to note that the definition refers to the money cost vs the cash expended. This is important since it moves
the analysis from a cash basis to an accrual basis. Essentially the estimated costs must reflect the fair market value of
the capital and labour used at the time it is consumed vs. when cash is actually transferred. This reflects a fairly simple
concept in valuation – money has value regardless of who is supplying it.
As a result of this principle a proper COP does not strictly rely on accounting statements prepared for tax purposes.
Instead the COP requires the valuator to apply basic valuation principles to determine the actual cost independent of
how the costs were financed – in this case the COP is agnostic to how a farmer pays for inputs (cash or credit) since
he/she either owes the bank or themselves. To calculate costs any other way would suggest that the only way that a
cost would be included in a COP is if the farmer borrowed money since their own cash would have no value.
As a result, by definition a COP involves the use of judgement in its development. This judgement must be based on
sound valuation principles, be replicable and subject to review by stakeholders. There is no reason why expert opinion
and/or models cannot be used as part of a COP. As long as the process is being used to calculate the total sum of
money needed for the production of a particular quantity of output it is a COP.
OPINION
You have requested that I provide an opinion on two questions:
1.
2.
Does the process reflect an accurate cost of producing chicken in BC – a BC COP; and
How do the results compare with the model developed in Ontario – the Cost of Production Formula (COPF)?
1: The BC COP Question
To be clear, in my opinion as both a professional valuator and economist the new cost provided to you is
based on a valid COP for chicken produced in BC during as of A-135.
•
•
The process used to develop the COP is consistent with the principles of COP development as outlined
above. In addition, the sampling process resulted in a covariance of .08 in the cost per kg. With a sample of
42 this indicates that the estimated weighted average cost per kg calculated for BC producers is statistically
accurate at a 95% level of confidence at 2.5% Margin of Error.
There are a number of assumptions made in developing the COP however I am confident that they fall within
what a reasonable person would use when estimating the “costs which should be essentially received by
resource owners so as to presume that they will continue to supply them in a specific period of time.”
The Issue of a Weighted Average COP vs a COP for an Individual Farm
It is important to note that these costs reflect a weighted average cost of production for the province as a whole. As a
result, not achieving the weighted average COP does not immediately drive individual producers into shutting their
operation down. This industry COP assumes that the average producer will require a specified return on equity and
assets based on what they could get for substantially equivalent activities in the market. The fact that they sometimes
have to accept less does not imply that their costs are actually lower, only that the operating reality dictates that they
do not receive what they perceive to be market rates for their equity and labour for that period of time – essentially
they are having to farm the amortization.
To be clear, the purpose of any COP is essentially to measure the recovery of sufficient production cost and returns on
investment “by resource owners so as to presume that they will continue to supply them in a specific period of time.”
The fact that farmers may decide to produce when prices are below the calculated weighted average COP is not
Mr. Bill Vanderspek
Mr. Ravi Bathe
March 31, 2016
3
inconsistent with economic theory – in the short run all producers will continue to produce as long as they recover
their variable costs. However, the extent of the “short run” will vary based on three main factors:
1.
2.
3.
Where the individual farmers’ costs are relative to the weighted average cost of production –
remember that by definition, 50% of farmers are actually more efficient than the “weighted average” COP so
can withstand a lower price and still recover the calculated fair market return on investment and labour;
The return to capital and labour/management that an individual farmer is willing to accept to operate
their farm – some farmers may be willing to take less than the values attributed in a fair market for noneconomic reasons as they don’t view their opportunity in other markets to be either available to them or
interesting to them; and
The age of the farmer and the amount of equity they have built – older farmers tend to be more likely to
be able to accept lower returns since they have more discretionary expenses meaning that their
interpretation of the short run is different than that of a younger farmer who has less discretion in how they
operate.
Ultimately the COP can only suggest what an average farm would require in a fair market under an average cost
situation. Individual farm results vary significantly and as a result their decision framework will also vary significantly.
This is why farm ownership is always in transition in any market – supply managed or not. This is also why we have
seen significant consolidation in agriculture as farmers strive to gain efficiencies of scale in order to be able to achieve
the target returns to assets and management. Integrated farms are also naturally more willing to accept a lower cost
recovery on farm assets as they use transfer pricing arrangements to recover this economic disadvantage in other
areas of their supply chain – their profitability is typically measured on an enterprise basis and not all areas of the
business are profit centers.
The fact that the industry may continue to operate at a price that is lower than a statistically valid weighted average
COP does not suggest that the COP is not reflective of the true cost of production. In my opinion it is more likely to
reflect either that the non-integrated farming operations are in fact subsidizing other elements of the supply chain or
that the general public buying chicken is not willing to pay what the true cost of production really is – remember that
cost does not necessarily equal price. Costs are what they are, and calculating them is really just arithmetic.
2: Comparison to the Ontario Cost of Production Formula (COPF)
As previously outlined, I cannot provide an opinion on how closely the formula in Ontario actually reflects the cost of
producing chicken in that province. All that I do know is that the “price” has been mandated and is now being used
for payment – price and cost are not necessarily equal.
The following table outlines the non-normalized differences by cost category between Ontario and BC.
Mr. Bill Vanderspek
Mr. Ravi Bathe
March 31, 2016
4
Ontario versus BC - cost of production formulae comparison
Component
CFO
0.0618
0.0240
0.0151
0.0266
0.0851
0.1441
0.0011
0.0080
0.0204
$
$
$
$
$
$
$
$
$
BC
Diff ON versus BC
0.0522
0.0359
0.0212
0.0302
0.0450
0.0688
0.0252
0.0091
0.0290
$
$
$
$
$
$
$
$
$
Energy
R&M
taxes and ins
Office and overhead
Contract services
All labour
Working capital interest
Farm Vehicles
Levies and licences
$
$
$
$
$
$
$
$
$
0.010
(0.012)
(0.006)
(0.004)
0.040
0.075
(0.024)
(0.001)
(0.009)
Total operating costs
$ 0.3862 $ 0.3166 $
0.070
Return on capital
Depreciation
$ 0.0763 $ 0.1238 $
$ 0.0694 $ 0.0854 $
(0.048)
(0.016)
Total capital costs
$ 0.1457 $ 0.2092 $
(0.064)
Feed
Chick
$ 0.6952 $ 0.7908 $
$ 0.3370 $ 0.3729 $
(0.096)
(0.036)
Total feed and chick costs
$ 1.0322 $ 1.1637 $
(0.132)
TOTAL COST
$ 1.5641 $ 1.6895 $
(0.125)
In absolute terms the difference is 12.5 cents/kg as of A-135 – higher in BC than in Ontario. There are essentially four
items that make the difference:
•
Labour – 7 cents higher in Ontario than BC;
•
Capital – 6.4 cents higher in BC;
•
Feed – 9.6 cents higher in BC; and
•
Chick – 3.6 cents higher in BC.
Mr. Bill Vanderspek
Mr. Ravi Bathe
March 31, 2016
5
Capital and Labour
Given that we don’t know how the Ontario labour or capital numbers were estimated and how accurately they reflect
the weighted average situation of the province it is very difficult to speculate on the difference. However, given the
fact that capital investment in many cases is a trade-off for labour it is not totally surprising that they essentially offset each other.
On the other hand it is very important to understand three additional factors relating to the cost of capital:
1. The stocking density between the two provinces- as provided under separate cover, the fact that Ontario
production can exceed BC in terms of kg/ft2 has a significant impact on cost per kg. Our estimates suggest
that this could result in up to 1.69 cents per kg (of the 6.4 cent differential).
2. The actual cost of building in the two regions – as a professional valuator I have access to the Douglas
Agricultural Cost Guide. This Guide estimate the cost of building across Canada and in 2016 the difference
between building a broiler barn in BC and Ontario is 9% (higher in BC). When this differential is considered it
results in a potential adjustment of 1.4 cents (of the 6.4 cent differential). It is also important to note that
while we are dealing with a weighted average in BC, the divergence in capital costs between the island,
mainland and interior are likely far more variable than found in Ontario.
3. In developing the COPF the documentation has made specific reference to the fact that various “efficiency
adjustments” are included. If these adjustments involved only using a portion of the results – those with
relatively lower costs of production – then this also may account for the difference in the capital costs.
Regardless of how the capital elements of the Ontario COPF were calculated, the first two differences alone account
for a variance of up to 3.1 cents per kg – 48% of the difference in capital costs. Given the potential for additional
efficiency adjustments and the obvious labour for capital trade-off being made, the actual difference does not appear
material.
Feed & Chick Costs
Feed costs alone account for 77% of the absolute difference – 9.6 cents per kg higher in BC. This only includes the
feed at the broiler end and does not include the difference that would be evident in the chick. When the feed
component is adjusted at the chick level this brings the BC chick price down by 2.4 cents per kg – 67% of the
difference in chick price.
As a result the difference in feed costs combined is 12 cents per kg – virtually all of the difference between the two.
Mr. Bill Vanderspek
Mr. Ravi Bathe
March 31, 2016
6
Summary
As outlined, it is very difficult to compare costs without full information. However, if you consider the differences that
we have identified, discussed and provided estimates for you see that the normalized difference between the COP in
BC and the COPF in Ontario is actually 2.59 cents in favor of BC production – all other things being equal, if BC
producers could produce with Ontario density, building costs, and feed costs they would be lower cost producers
than the COPF currently suggests that Ontario producers are.
What I can say with confidence is that the COP presented for BC represents what I believe to be the true cost of
production for producing chicken on the province given the assumptions as stated.
I trust that this information will assist you in your discussions regarding costs in the industry. Please to not hesitate to
contact me if you have any questions or require further explanation.
Yours truly,
SERECON INC.
Robert Burden, MBA, CVA.
Edmonton Office