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9.3 Profitability, Sustainability and Efficiency: Who Does Best Across Size Groups?

9.3.1 Comparative Unit Profitability By Class of Farm

The results here, detailed in Chapter 6 and the country studies, are intriguing. In most cases smallholders made higher profits per unit than larger scale farms, if family labor is not costed for either group. The unit profit advantage of smallholders tended to disappear if family labor is costed at market rates. In the Philippines and Thailand, contract farmers for broilers did better than independents at comparable levels of scale, because their forward price guarantees served them well in the face of falling world prices. This was not the case in India, however, where different power structures and greater isolation from world markets (at least for broilers) may be the explanation. There was a remarkable similarity in returns to contractors at all levels of scale, except for Indian broilers, where large scale-contractors did significantly better.

In India, small-scale dairy producers have higher profits on average: 2.45 rupees per liter, without costing family labor, than large-scale farms, at 0.52 rupees per liter. Similar results with a small gap hold if family labor is costed at market rates. In Thailand, medium-scale dairy farms made more about 20 percent more profit, at 6.25 baht per liter, than either small or large-scale dairy farms. In Brazil, there was no significant difference in profit per unit of output between small and medium dairy farms, both of which just failed to cover costs; large dairy farms just broke even at 0.05 reals per liter positive profit.

Results on unit profitability of broiler farming are especially interesting for two reasons. First, broilers are traditionally thought of as the area of livestock farming with the largest inherent "economies of scale", in the sense that unit costs of production are supposed to be lower for quite a while beyond smallholder levels as scale rises. Second, broilers are the area where contract farming is most prevalent, and thus where there is the most information on the costs and benefits of the vertical integration of smallholders.

In India, independent small-scale broiler producers actually made a little more profit per unit than did large-scale independent broiler farms, without costing family labor, at 13.1 versus 10.9 rupees per bird, respectively. But small-scale contractors did much worse, at 1 rupee per bird, compared to large-scale contractors at 3.2 rupees per bird. In the Philippines, independent smallholders also had higher profits per kg than large-scale independents, at 1.6 pesos per kg versus 1.1 pesos. Contrary to India, small contract broiler farms in the Philippines had higher per unit profits than large contract farms, but interestingly there was virtually no difference between small and large contractors: 4.1 pesos versus 4.0 pesos per bird, respectively.

In Thailand, large independent broiler farms, at 2.5 baht per kg average profit, did better than medium-sized independent farms at 1.6 baht per kg. On the other hand, independent smallholders failed to cover costs, at 0.15 baht per kg average loss. If family labor is not costed, fee contract farmers in the Thai broiler sample had similar per unit profits for large and small-scale (1.6 versus 1.5 baht per kg, respectively), but the medium-scale contractors had only 1.1 baht per kg profit. The medium-scale farmers had to employ labor, which cut their unit profits relative to smallholders, but were not in the same cost structure as the larger farmers. In Brazil, small and large broiler farms have surprisingly similar, profits per unit: 0.05 reals per kg versus 0.06 reals; this may reflect that almost all broiler production in Brazil is integrated with the integrators supplying all the main inputs into production and that integrators passed on some of their cost savings in dealing with larger producers to them. Smallholders maintain their unit profits close to big farm rates by not costing family labor.

Among Indian layer farmers, smallholders had higher profits per unit than larger farms if family labor is not costed, at 0.23 rupees per egg versus 0.17 rupees. If family labor is costed at market rates, smallholders have net losses per egg, while large-scale farms continue to have positive profit. In Brazil, both large and small layer farms had net losses in the survey year, although the large-farms almost covered their costs at a net loss of 0.01 real per egg, compared to a net loss for smallholders of 0.04 reals per egg, not costing family labor.

In the Philippines, independent smallholder swine farmers had higher profits per kg than large-scale independents, at 26.6 pesos per kg liveweight versus 19.8 pesos. Most of the difference comes from not costing family labor, and medium and large-scale independents had essentially similar per kg profit rates. In Thailand, small-scale independents had average profits of 11.5 baht per kg, compared to 20.0 baht for medium-sized farms and 15.4 baht for the largest farms. In Brazil, smallholders lost on average 0.25 reals per kg of swine, compared to losses of 0.15 reals per kg for large farms.

Thus hypothesis one of Chapter 1 is not supported: there is no basis in the data to the view that smallholders make smaller per unit profits than do large farms, as long as their labor is not costed at market wage rates. The pattern of good performance for independent smallholders versus large-scale independents above is encouraging, but should be kept in perspective. In the Philippines for example, the total average annual income from swine raising for farms in the independent smallholder sample was US$309 per farm, whereas for the larger farm sample it was US$9,650 per farm. The latter does not include the profits of the largest farms, belonging directly to integrators and not surveyed here. Even more pronounced gaps could be observed between the incomes of large and small farms in Thailand and Brazil. Thus despite the better per unit profit of smallholders, large-farms might still drive them out if they are more efficient users of resources for production. Another uncertainty is whether large farms have an unfair cost advantage or disadvantage in terms of environmental externalities that they capture due to scale-sensitive differences in the enforcement of regulations (or at least in the amount of negative externalities that are internalized).

9.3.2 Comparative Capture of Environmental Externalities

Two approaches are used to get at scale-differences in the capture of environmental externalities (or, in other words, having someone else incur costs while one gets the benefits). The first is from calculations detailed in Chapter 7 of nutrient mass balances. The second is from a more indirect measure of environmental impact, as laid out in Chapter 4.

Mass balances. The utilization and disposal of animal manure and dead animals has become a more visible concern as the structure of the industry has shifted toward fewer but larger operations, and the percentage of animals raised in confinement has increased. Traditionally, farmers applied manure to agricultural land to promote plant growth, thereby recycling much of the nutrients. With fewer but larger operations relying on trucked-in fertilizers, manure use has become more localized in producing areas. When application rates exceed the carrying capacity of the land to assimilate nutrients, repeated applications can lead to a buildup of nutrients in the soil.

Following the first prong of our double approach to this issue, mass balance calculations were performed to get a rough estimate of on-farm nutrient balances. They serve to indicate systems with potential problem areas, as well as where further research and technology transfer may be the more productive for certain size households. They also to serve to indicate why some households have active involvement with manure markets. As explained in Chapters 4 and 7, a negative mass balance implies that excess nutrients are likely to accumulate in soil and water, leading to sustainability problems. These measures are approximations subject to many caveats as set out in Chapter 4, but are useful to get a broad picture of the scale-specificity of disposal issues.

The mass balance for swine production showed a range of excess nitrogen and phosphorous balances across countries. For each of the three countries in which the swine population was sampled, the larger producers show larger deficits, indicating a greater need to find more adequate disposal methods for manure. Each country has some households with sufficient land to assimilate nitrogen produced. Smaller producers are much more likely to have positive balances. Brazil, with its larger land availability, has households with positive balances in every size category. This may reflect the wide diversity of land and expansion into areas with large land areas associated with production. However most of the sampled large-scale producers in most of the study countries had inadequate land to dispose of the manure generated from their livestock operations. Conversely, the Philippines small-scale producers can assimilate much of the manure they produce, but whether they are properly handling manure disposal remains unclear.

Nutrient balances for poultry show wide variation between countries. Large producers are likely to have large nutrient absorption deficits, while smaller producers are more likely to have small deficits. However in some countries large and medium-scale producers may have small deficits, which may reflect the location and size of the farm. The Thailand sample has the largest number of households with positive mass balances in all size categories. Only India has small producers with nutrient balances at less than minus 10 metric tons. Also India shows no households with a positive balance. This is indicative of the higher degree of households producing on relatively small plots of land in India. For smaller production households with lower excess nutrient balances, informal mechanisms to dispose of manure may be sufficient as long as they meet environmental requirements. In all the countries surveyed, there appears to be an active market for poultry manure to aid this. Large producers may require systems that guarantee that excess manure is disposed of in a controlled manner.

Relative to other livestock production, the mass balances for dairy production are comparatively in balance. Dairy production by its nature requires land. Thus producers, may have sufficient land to properly dispose of manure, or may have access to nearby land. It is possible that small-scale producers in place like India or Thailand may not warrant sophisticated manure disposal mechanisms if they have adequate land.

Thus, the mass balance calculations show clearly and by a direct approach that smallholders are creating less of an environmental problem per unit of output than is the case for large farms. This result stems from the fact that in most cases smallholders have relatively more cropland available to them per animal to dispose of manure and dead animals. However, experience in Southern Luzon, the Philippines, suggests that if enough animals congregate in the same place, and that is close to cities, this relationship may change over time. For the time being, the mass balance approach indicates that smallholder production is more environmentally friendly.

Environmental mitigation effort per kilogram of output. A second approach yields a per farm-specific measure of environmental mitigation in money units of effort per unit of output. If one can assume that negative externalities within a country and commodity group are equal for each unit of output (a heroic assumption), then this approach gives an indirect alternative approach to estimating per farm differences in the amount of advantage gained from environmental externalities per unit of output. Farmers that make an effort, financial or otherwise, to prevent problems by spreading manure or otherwise cleaning up, or compensating their neighbors for problems created, are by definition internalizing a portion of the negative externalities created per unit of output. If externalities are the same per unit of output, then greater mitigation effort (measured in money terms per unit of output) means greater internalization, other things equal.

For broilers, smaller producers mitigate more per unit of output in each country. This difference in mitigation effort by size is striking. In each country except Brazil, smaller producers score on average over 5 times more in environmental mitigation effort per unit of output than large farms. In Brazil, the difference is a factor of 2. For layers, the relative difference is less. For Brazil and Thailand, the mitigation efforts per unit for layer households are higher than for broiler producing households. In Brazil, the opposite holds. In the Philippines, small contract producers make less effort than independents, but larger contactors make more effort.

Small-scale swine producers also make a larger effort per unit of output than larger producers, except in the Philippines, where larger independent producers expend more than medium-scale independent producers, but less than small-scale producers. Larger producers in Thailand expend considerably less per unit than smaller producers.

In India, dairy environmental effort per liter of milk output declines with increasing size. Efforts are relatively constant across scales in Brazilian dairy. Small producers expend very little on environmentally-related costs in Thailand, but medium producers expend five times more than large producers.

On the whole, the indirect approach to capture negative externalities through mitigation behavior is completely consistent with the mass balance approach. Smallholders make a significantly greater effort to mitigate negative environmental externalities than larger-scale farms. Thus, hypothesis 3 of Chapter 1 is supported by the data. However, the absolute orders of magnitude do not suggest that this is a major explainer of scaling-up, although it may be one factor.

9.3.3 Comparative Profit Efficiency

Unlike profit per unit, which is a descriptive variable, profit efficiency per farm is an analytical result from a modeling effort. Profit efficiency in the current context is a measure for each farm of the percentage that the actual unit profit performance of that farm is of the ideal computed for that farm, given that farm's resources and facing the same input and output prices as that farm. Typically farms in the overall sample may be at 60 to 80 percent of computed maximum obtainable profit per unit for that farm. Averages across farms are computed for classes of interest, such as independent smallholders. The approach and rationale for the efficiency computations are described in detail in Chapter 4, and results given in Chapter 8.

The overall results in Chapter 8 from comparing relative profit efficiency across countries, commodities, and degree of vertical integration are that small farms are not less efficient at securing profits per unit of output when family labor and environmental externalities are not costed. Hypothesis 2, that large-scale farms are more profit efficient, is therefore not supported by this study, with the possible exception of the largest producers of broilers and finished hogs. It is clearly not the case for dairy. Given higher unit profits and higher profit efficiency, smallholders at least have a chance in livestock farming.

Second, the efficiency advantage of smallholders increases when going from the backyard to the smallholder commercial model, but disappears fairly quickly with increasing size of operation, as the unit cost advantages of a "free" stock of family labor become less important. The smallholder commercial model, which is really an improved version of the backyard model, would seem to be a viable target for technology and institutional development.

Dairy production clearly is most efficient at small (not tiny) scales, consistent with 20 to 30 cow herds. Dairy clearly is a smallholder activity, and there is potential for keeping smallholders involved in poultry and swine, particularly with vertical coordination. All this abstracts from possible economies of scale in collection, processing and distribution of products such as milk and poultry, where transaction costs on the marketing (not production) side are major. The next section will look in detail at what factors explain why specific farms were more or less profit efficient.

Third, vertical coordination such as contract farming and dairy cooperatives clearly improve the relative profit efficiency of smallholder farmers, even if in some cases (e.g. India broilers in Chapter 6), unit profits were lower for contract farmers. Hypothesis 7 is supported by the results above, although there is more work to do in this area. Contract farming works to improve efficiency (and thus competitiveness) by reducing transaction costs. The next section gives insights on which transaction costs and other factors explain why specific farms are profit inefficient.

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