It’s fitting that Progressive Dairyman include a marketing article in the issue focused on peak milk production and quality. After all, these days, dairy producers need to have as much confidence in handling markets as they do handling their high-producing cows. To gain that confidence, it’s best to examine what success looks like. Much like dairy producers group cows to manage their care, we could group our clients according to the characteristics they have as marketers – from the high-confidence group that has been through many market cycles on through to the newest clients who are still learning.
Since producers learn best from what other producers are doing, it seems wise to examine the characteristics of those who, over time, have been the most satisfied with their marketing performance.
Here are the common characteristics of our high-confidence group:
• Consistency. Among our longest-standing clients, consistency is the number one characteristic. In fact, inconsistency is a primary reason for losses in marketing that lead the not-so-confident producers to give up.
Successful clients set their goals for marketing, then fully commit to them, not just for the next two or six months but for multiple price cycles. (Think three to six years.)
This is not to say we don’t evaluate how we are doing along the way. Actually, there is constant evaluation and communication going on. A consistent marketer is always looking at price possibilities, setting trigger points and discussing what will happen when a trigger point is hit.
When pre-determined trigger-points are hit, the producer takes immediate action with no hesitation or doubt.
• Perspective. One of the best ways to navigate volatility is to focus on building a strong weighted-average price long-term. What is meant by “weighted-average price?” It is the running average price received for milk when you take into account how much production was sold at any given price. For milk, strive to build your weighted average price – for feed, strive to lower it.
This is accomplished by making sales incrementally over time, much like dollar-cost averaging is done in investing. In an environment where commodities prices can swing 2 to 5 percent on a daily basis, the importance of an incremental approach is crucial, because the odds of being right on any one decision are very low.
Feed purchases or milk sales made in increments of 20 to 33 percent are ideal. An increment of 20 percent gives a producer five opportunities at the market before being 100 percent priced.
The focus on building a solid weighted-average price expands a producer’s thinking to the long-term results of what you are trying to accomplish. It helps lower the emotional toll that high volatility can have on your mindset in the short term.
Clients in our high-confidence marketing group have this perspective. These producers do not expend unnecessary energy on marketing, worrying about decisions that do not have a measurable impact on their overall price. They are more free to manage other areas of their business because they have perspective.
• Open to using multiple tools. A producer who is open to using a variety of tools will ultimately see better performance. For dairy producers, this question usually arises when we discuss whether to use futures contracts or forward contracts at the milk plant. Both methods of milk pricing ultimately accomplish the same goal and each has its advantages and disadvantages.
Among our high-confidence clients, there is evidence to suggest that futures contracts outperform milk plant forward contracts as we seek to incrementally build the best weighted-average price.
That’s because historically, milk plant contracts have not been flexible: If you contract 200,000 lbs of your milk to a plant, it is committed to that plant. There is no ability to get out of the contract price you locked in, no matter where the market price goes.
Fortunately, some milk plants are beginning to offer more flexibility in their contracts. This is the result of producers asking questions and understanding that flexibility and a variety of tools really helps in the quest to build a solid weighted-average price over time.
The tools and methods that work best for each producer depend on the operation size and goals. If neither futures nor forward contracts are preferable, options are another way to go. And options strategies can be layered with the use of futures for maximum flexibility.
Especially when considering feed inputs, options can provide both confidence and flexibility: confidence to buy the physical product and flexibility to bring down the price in the event that the physical product ends up being purchased too early and the price continues to trend lower.
• Communicate with their adviser. This seems like a no-brainer, yet we’ve had clients who don’t pick up the phone because they know a trigger has been hit and they are hesitant to act. Perhaps they did not fully understand or agree on a strategy and did not voice their opinion before the trigger was hit.
Then, when the moment arrives, they hesitate and that throws off progress toward the previously agreed-upon goals.
Sometimes a client hesitates because they fear a margin call. One way to remove that fear is to bring your lender on board with the marketing approach. When the lender fully understands what the marketing approach is designed to accomplish, he or she is usually supportive.
A hedge line of credit can be set up in advance to cover margin calls if needed. That way, decisions are not made based on cash flow at the moment.
• Reinvest on their timetable, not necessarily at the top of the market. Ultimately, when I look at our most successful clients, they have been able to maintain a strong enough equity position that they can reinvest in their facilities on their own schedule, not dependent upon milk prices.
For example, there were producers in 2010 who had enough equity to expand or reinvest when no one else was feeling optimistic. And because they had a consistent, disciplined approach to marketing in place, their lender supported their decisions despite the tight credit markets.
Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The information contained here is our opinion and believed to be accurate. There are no guarantees that a specific approach will translate into successful marketing. PD
“Of the farms in my portfolio, those who engage in a consistent approach to marketing have more stability in their cash flow. The swings from price highs to price lows are much more gradual. When the swings are great and cash flow is unpredictable, I’m kept busy trying to get a handle on cash flow and I have to structure and adjust our loan programs to match the inconsistencies.
“Consistent cash flow enables the farm to have a more focused perspective of where they are today and where they will be tomorrow, and allows me to be more resourceful as an adviser to the financial team.”
Tips for success
“The lender, the producer and the marketing adviser sitting down together is essential. We discuss where we want to be a year from now, what the markets might do and what we need to protect. Really, it’s a brainstorming, goal-forming exchange of ideas.
“I definitely recommend a hedge line of credit, so hedging doesn’t interfere with other things we track such as operating costs or capital purchases. We have to be able to measure progress in all areas and so keeping separate lines of credit is important. I also recommend the financial team establish a pay-down plan for the line of credit, so that expectations about how it will be maintained are set and met.
“The final goal is to get better. For your business to improve, your marketing has to be better than the average price. It is unrealistic to think you can obtain the top price, but you have succeeded if you are somewhere north of average.”
Assistant Vice President
Investors Community Bank
“There are fewer farms today that can draw on their cash reserves to get through market lows. A producer who is using risk management tools in a disciplined way to manage price risk we view as someone who is proactive about their business, who is looking ahead and making plans to deal with different scenarios the market is giving them. The objective is not to get the highest price but to maintain the best possible profit margin; lenders want their producers to avoid the lows so you avoid burning up equity when prices are low.
“The producers using risk management understand and actively manage the marketing part of their business, making them a better credit risk. Of course there are many things that go into factoring credit risk … If someone is highly leveraged, they would almost have to use some form of price risk management to deal with market volatility. If your strategy is to remain open to the market price, then you will need to have a strong equity position to weather market downturns and also maintain strong working capital in order to meet cash flow needs.”
Tips for success
“Establish good communication with your lender about what you are trying to accomplish, especially when using a hedge line of credit.
“We also recommend meeting with a market adviser about potential scenarios and have some strategies set up in advance. Educate yourself and think through those strategies so that when the time comes, you can just execute. Dairy producers get busy in the field or have other things going on and sometimes aren’t able to focus on marketing. If you have plans in place you can execute them quickly when the market presents an opportunity.”
Senior Vice President and
Director of Business Management Services
AgChoice Farm Credit