To frame today’s opportunities, I went back in the Farrell Growth Group archives to another time when commodity prices rose dramatically—the run-up and subsequent crash of fertilizer prices in 2008 and 2009. During that time period, Farrell Growth Group team members preached in many presentations to “remember the tail!” As ag retail enjoys another economic boom, it’s a good time to revisit that advice.
Due to a complicated mix of supply and demand issues, commodity prices started to rise during summer 2020 and have remained high. Inflationary pressure is a major factor not only in the U.S. but also worldwide. The war between Russia and Ukraine and extreme adverse weather in key production areas continue to limit supply. The elevated prices may continue for a while.
The cure for high prices is high prices.
Just like all other boom cycles, this one will come to an end. It is important to prepare for that eventuality now.
Most of ag retail is currently in the “higher profits” section of the cycle illustrated above. The current demand-driven market results in higher prices charged at the farm gate. Retail costs during a boom are slower to rise as they are averaged in with lower-cost product still in inventory. Due to improved market conditions in recent years, retailers both sold more and were able to charge more on those sales. In addition to the lower costs of products in inventory, the operating expenses to produce those additional margins generally remain steady at the beginning of a boom. The result is a period of nicely elevated profits.
Increased focus on fixed assets and people.
With increased profits, many retailers invest in their operations to take advantage of opportunities resulting from the economic boom. At the same time, retailers’ cost of products increases as the lower-cost product works its way through the system and retailers have to pay higher prices for replacement products. These higher costs cut into the retailers’ profits, but the retailers are still making more money than they did before prices started to rise. As a result, the investment in their businesses continues.
As the boom reaches its peak and market conditions change, prices and, therefore, revenue begin to fall. We then transition into a supply-driven market. Because costs rise at a slower pace during the upturn, there is a period of time when those retailers report higher-than-average profits. But as revenue declines from its peak, costs continue to rise. Eventually, retailers move into the “lower/no profits” section of the chart. Not only are their costs still rising, but the additional investments in people and fixed assets also have now increased the retail businesses’ expense structure. Volume and margin reductions generally follow the decline in commodity prices, so those retailers face the double whammy of reduced margins with a higher expense structure.
Prepare for the change in market dynamics.
Now is the time to look critically at your expenses and make sure your business is running efficiently. Focus on building a strong balance sheet and increasing working capital reserves. Also, keep in mind this same phenomenon will be happening in your grower-customers’ operations. Stay close with key customers, and remind them to “remember the tail.”
Written by Kelly Farrell who is a partner in Farrell Growth Group, which provides premier financial planning tools to ag retail.
