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Managing Risk in Fruit and Vegetable Production
By: Jayson K. Harper
Associate Professor of agricultural economics
Department of Agricultural Economics and Rural Sociology
The Pennsylvania State University
and
Gerald B. White
Professor of agricultural economics
Department of Agricultural, Resource, and Managerial Economics
Cornell University
When considering profitability, people are often seduced by the potential of fruit and vegetable production. Compared to most agronomic crops, these horticultural crops offer the opportunity to produce a fair amount of income on a small acreage. With this income potential, however, come sizable risks. These risks can be categorized as either those impacting receipts, or those relating to the cost of production.
Yield and Price Risk
Receipts are the gross returns (price times yield) from production. For perennial horticultural crops (tree fruits and nuts, small fruits), receipts may be zero for several years while the planting is in the preproductive stage. Variability in both yield and prices will affect receipts. The ability of the producer to deal with both types of variability will impact on the profitability of the enterprise. Large yields are not the important yardstick; having sufficient sales of high quality product is what is important to profitability.
Every year horticultural producers face yield risk in the form of adverse weather and pest damage. In a perennial crop, yield risk can take the form of year-to-year variability, or more serious damage which reduces the long-term production potential of the planting. Although yield risk is important, it usually has readily identifiable causes and remedies. In the Northeast, for example, average seasonal rainfall is somewhat less than is required for optimal performance of fruit and vegetable crops. Seasons in which moisture is a severe limiting factor affecting profitability occur perhaps two or three years in ten, for individual growers.
Producers can reduce the effects of yield risk through irrigation (see Cuykendall and White, 1998, Cuykendall, et al. 1999, and Jarrett et al. 1995), pest management practices, and site and cultivar selection. In addition, multi-peril crop insurance is available for many fruit and vegetable crops grown in the Northeast including apples, grapes, cabbage (pilot program in 1999), snap beans (canning and processing), cranberries, peaches, pears, peas, peppers, plums, potatoes, stone fruit, sweet corn (canning and processing, and fresh market), and tomatoes (canning and processing, and fresh market). While it is important to minimize the effect of yield risks and its impact on profitability, producers are usually much more equipped to deal with this type of risk than those associated with marketing.
Marketing Risk
Marketing plays a crucial role in horticultural crop production and should be planned well in advance of harvest. In fact, fruit and vegetable growers really should be thinking of marketing prior to planting. This is particularly important for perennial crops where decisions about which varieties to plant are made several years prior to the first crop.
Knowledge of what the market requires (in terms of form and quality) and when to market is the key to success. Why do "good" growers go out of business, while others in less ideal production circumstances thrive? Often the difference is marketing acumen. Developing a marketing strategy requires careful evaluation of the supply and demand for your product and investigation of market alternatives. The successful marketer must strive to produce products which satisfy basic customer needs and wants, rather than simply selling the products he/she produces. Strategic marketing planning requires specification of target markets, or the individuals or businesses identified as the most desirable customers. The selection of target markets in turn drives decisions about products (including varieties and packaging), promotion, pricing, location, and distribution strategies.
Seven traditional (distribution) alternatives are generally available to the horticultural crop growers: wholesale market, marketing cooperatives, local retail, roadside stands, farmers markets, pick-your-own, and processing. Other options such as rent-a-row/tree, community supported agriculture, and internet and/or mail order may be worth investigating depending on the nature of the farm operation and the crops grown.
Wholesale marketing is often done on a producer assignment basis, where shippers market and ship the fruit for a predetermined rate. Whether a shipper is used to take the crop to the wholesale market, or it is transported directly by the individual grower, this marketing alternative is subject to the greatest price fluctuations. Marketing cooperatives generally use a daily pooled cost and price, which spreads price fluctuations over all participating producers.
Local retail (selling directly to grocery stores) is another possibility, but considerable time must be spent in contacting produce managers and providing consistent quality when the store requires the produce. Roadside stands (either your own or another growers), pick-your-own operations, and farmers markets are other marketing options. They provide an opportunity for growers to receive higher than wholesale prices for their produce. In this situation, however, there may be significant expenses for advertising, building and maintaining a facility, and employing someone to service customers. In a pick-your-own (PYO) operation, harvest costs are saved, but growers must also be willing to accept some wastage. Furthermore, growers who market direct must be cognizant of the greater legal risk that is faced in dealing with consumers directly. The risk of food contamination, injuries (especially for PYO operations), and other potential liability claims significantly increase the cost of insurance for many direct marketers.
Depending on location, processing may or may not be a marketing option. Processing prices are often much more volatile than fresh-marketing prices. However, successful processing cooperatives, such as National Grape Cooperative (Welch’s) and Ocean Spray are examples of cooperatives in the Northeast whose marketing practices reduce variability of cash flow for their members as well as usually supplying a premium over cash market prices. For more information on markets and marketing alternatives, see Brewer, Harper, and Greaser (1994).
Price and quality are synonymous in horticultural crop production. Unfortunately, it is not always easy to know what is meant by "high quality" and quality judgment often varies from year to year. Federal grade standards do not exist for all horticultural crops and those that have them are often not very specific. Often there is only one recognized quality grade, U.S. No. 1, which means produce of "good average quality". Buyers, however, often have additional criteria by which they judge produce quality including flavor, ripeness, aroma, cleanliness, and the absence of pest damage and foreign material.
Proper disease management, harvest practices (including picker instruction and supervision), and post-harvest handling are critical to marketing success. Cooling produce to remove field heat and improve shelf life is especially important. Treatments to reduce decay may be another important consideration. Sorting and washing of some fruits and vegetables can also be done to help maintain quality and improve appearance. For certain crops like small fruits and other delicate produce, sorting and/or washing is not an option; harvest crews must be well-trained, and quality continuously monitored to assure a marketable crop.
Cost of Production
Horticultural crop production is not for the financially faint of heart. For certain vegetable crops, preharvest costs may amount to several thousand dollars per acre. For perennial crops, substantial initial investments are required and many years may go by before the first dollar returns to the operation. For most perennial crops, the preproductive costs for land preparation and establishment are often many times the cost of annual horticultural crops. This is the period where growers are most exposed to financial risk. Growers must realistically assess their ability to absorb losses during this period and not rely on single enterprises for current and future income. For more information on financing options and financial risk management see Hanson et al. (1995).
Naturally, growers complain when the costs of fertilizers and pesticides increase and they are often tempted to reduce these costs by cutting applications. In the whole scheme of things, however, these costs are minor. It makes little economic sense to jeopardize profitability by trying to save a few dollars here and there. Once the crop is established, the major cost by far in horticultural crops is for harvesting and marketing the crop. Labor management and costs are the primary concern. Investing in production practices which reduce yield and quality variability are rarely a waste of money.
Good labor management is a key to horticultural crop profitability. Because of the perishable nature of these products, hand picking is often the only alternative. Understanding the labor market and planning for adequate and experienced labor is critical to having a high-quality crop ready to market. Growers must understand the federal, state, and local laws which apply to the use of agricultural labor. These laws include those relating to migrant and seasonal workers, immigration, child labor, wages and hours, withholding taxes, unemployment compensation, family and medical leave, worker’s compensation, worker protection (pesticide exposure, safe workplace, field sanitation), and migrant housing. Communicating your firm’s personnel policies is a key element in effective human resource management. For information on how to write an employee handbook, see Maloney and Petracek (1994).
Horticultural crop budgeting
Understanding the magnitude of the financial risks and the nature of cash flows in horticultural crop production requires the preparation of enterprise budgets. Enterprise budgets represent estimates of the receipts (income), costs, and profitability associated with the production of agricultural products. Budgets are used to:
- enumerate the receipts (income) received for an enterprise,
- enumerate the inputs and production practices required by an enterprise,
- evaluate the efficiency of farm enterprises,
- estimate benefits and costs for major changes in production practices,
- provide the basis for a total farm plan,
- estimate break-even price and/or yield for market planning purposes, and,
- support applications for credit.
Enterprise budgets should contain receipts (income) for every product and by-product of the enterprise. Prices should be used which reflect the markets faced and the productivity of the enterprise, given the specific resource situation (land, labor, equipment, etc.).
Enterprise budgets contain several cost components. Determining the costs of various decisions can be difficult. Frequently, individuals disagree over which costs to include and how they should be measured. Understandably, these differences arise because production costs are unique to each individual resource situation.
One of the more common classifications divides costs into variable and fixed costs. Variable costs are those expenses that vary with output within a production period. Examples include marketing, fertilizer, chemicals, fuel, repairs, and hourly or seasonal labor. Other terms used to describe variable costs include cash costs (or expenses), direct costs, and out-of-pocket costs.
Fixed costs include depreciation, taxes, interest on investment, land charges, annual labor, and insurance. Sometimes, a management fee is also included as a fixed cost. These costs are considered to be "fixed" because they generally remain at the same level within a production period and do not vary with the level of output. Indirect, non-cash, and overhead costs are other terms used to describe fixed costs.
Total costs are the sum of variable and fixed costs. Although a grower’s aim is to earn a profit above total costs, this is not always possible. Because of yield or marketing conditions beyond the grower’s control, income received is sometimes less than the total costs of production. Should a grower continue to produce under these circumstances? The answer may be yes if: (1) returns are above variable costs and (2) it is a short-term condition. If fixed costs are not covered in the long run, however, reinvestment in capital items (like tractors, implements, buildings, and equipment) cannot be made and the result is a depletion of the existing capital stock.
Conclusions
Horticultural crop production has excellent profit potential and the ability to generate significant income on small acreages and limited resource farms. This profit potential, however, comes with a fair amount of risk. Producers must be prepared to not only produce a high quality crop, but also be an active and aggressive marketer. Initial investment is high and substantial annual cost of production requires growers to be able to financially weather annual cash flow demands (and the costs associated with preproductive years in fruit crops). For those who can balance the demands of production and marketing, the future of fresh market horticultural crop production in particular appears very favorable. Per capita fresh consumption of most fruits and vegetables are rising which bodes well for the continued strength of fresh market prices.
Sources of additional information on Fruit and Vegetable Production
Internet Directory to Horticultural Resources
Penn State College of Agricultural Sciences
http://www.cas.psu.edu/docs/cashome/agdir/Hort.html
Irrigation:
Cuykendall, C.H. and G.B. White. "Economics of Drip Irrigation for Apple Orchards in New York State". Research Bul. 98-07. Ithaca, NY: Dept. of Agric., Res., and Managerial Econ., Cornell Univ., September 1998.
Cuykendall, C.H., G.B. White, B.E. Shaffer, A.N. Lakso, and R.M. Dunst. "Economics of Drip Irrigation for Juice Grape Vineyards in New York State". Research Bul. 99-01. Ithaca, NY: Dept. of Agric., Res., and Managerial Econ., Cornell Univ., March 1999.
Jarrett, A.R., B.L. Goulart, G.L. Greaser, and J.K. Harper. "Irrigation for Fruit and Vegetable Production". Agricultural Alternatives Series. University Park, PA: Penn State Cooperative Extension, March 1995.
Markets and Marketing Alternatives:
Brewer, T.A., J.K. Harper, and G.L. Greaser. "Fruit and Vegetable Marketing for Small-scale and Part-time Growers". Agricultural Alternatives Series. University Park, PA: Penn State Cooperative Extension, July 1994.
Financing Options and Financial Risk:
Hanson, G.D., J.K. Harper, and G.L. Greaser. "Financing Small-scale and Part-time Farms". Agricultural Alternatives Series. University Park, PA: Penn State Cooperative Extension, June 1995.
Writing an Employee Handbook:
Maloney, T.R. and K. Petracek. "Writing an Employee Handbook – A Guide for Farm Managers". Ithaca, NY: Cornell Cooperative Extension Resource Center, 1994.
Crop Budgeting:
Greaser, G.L. and J.K. Harper. "Enterprise Budget Analysis". Agricultural Alternatives Series. University Park, PA: Penn State Cooperative Extension, June 1994.
Crane, L.M. "Using Budget Analysis to Identify and Manage Risk". Crop Insurance TODAY, Vol. 32, No. 2, May 1999, p:9-13. National Crop Insurance Services, Overland park, Kansas.
Budgets of Fruit Trees:
Harper, J.K., "Tree Fruit Production Budgets" in Pennsylvania Tree Fruit Production Guide, 1998-1999. University Park, PA: Penn State Cooperative Extension, January 1998. pp. 237-249.
Budgets on Small Fruits:
Harper, J.K. "Small Fruit Production Budgets" in Small Fruit Production and Pest Management Guide, 1996-98. University Park, PA: Penn State Cooperative Extension, March 1996. pp. 81-120.
Harper, J.K., B.L. Goulart, and G.L. Greaser. "Highbush Blueberry Production". Agricultural Alternative Series. University Park, PA: Penn State Cooperative Extension, August 1994.
Establishment and Production Costs For Grapes:
White, G.B., B. Shaffer, R.M. Pool, and A. Lalor. "The Economics of Replanting Generic Wine Grape Varieties in New York". Research Bul. 97-05. Ithaca, NY: Dept. of Agric., Res. and Managerial Econ., Cornell Univ., April 1997.
White, G.B., D. Peterson, and T.E. Martinson. "Cost of Establishment and Production of Vinifera Grapes in the Finger Lakes Region of New York – 1997". Ext. Bul. 99-04. Ithaca, NY: Dept. of Agric., Res. and Managerial Econ., Cornell Univ., March 1999.
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