[nafex] Nursery econ 101 (long, arcane)
the.fluffy.bunny at juno.com
Mon Mar 5 21:56:32 EST 2001
Joe wrote a whole lot of interesting stuff and basically saved me from
having to do it; something I am appreciative of. Joe, I am impressed by
your fundamental understanding of the economic process. A few comments
on the base material you presented.
An economist would tell you that a fair price is the variable cost
(rootstock, scion, labor, pesticides) + fixed cost (depreciation of
equipment, taxes, comparable wage for the manager, rent) plus 6% -to-
15% return on assets. It is doubtful that many nursery owners see that
kind of return.
Hmmm, sort of. The theoretical risk free rate is the T-bill rate.
However times have changed a bit since we were both probably in econ
school and though the financial markets have moved on the basic theory
has yet to catch up. Your return on assets is quite low. And a
fundamental shift has occurred in the financial markets which demands a
higher rate of return. That shift is due to the advent of Indexes that
can be purchased for a nominal transaction fee. This has the effect of
eliminating the company specific risk and leaving you with the return of
the market at a very nominal cost. In the past such a financial
instrument would prove to be illiquid, and expensive. Not any longer.
Considering the anomaly of the past few years that would account for a
nominal risk rate of 11.23% or 10.65 historically. As you deserve to be
compensated for company specific risk this would put the minimum rate of
return at something like 13-14% for a "safe" venture. I would consider
a nursery far more risky and discount my cash flows at a minimum of 18%.
In addition it must be considered that I can earn between 10.65 and
11.23 and while incurring only the systematic portion of market risk,
with what amounts no investment in time on my side, so I must consider my
opportunity cost. In this case what could I earn with the time I am
spending worrying about a nursery. Now my rate increases again. We
are probably looking at a minimum rate of return around 21%.
Reality does not seem to reflect theory. It seems as if the remaining
suppliers increase production to fill the gap and keep prices beaten
This is in large part because society does not demand an evaluation of
the energy cost per calorie produced. We are more efficient in terms of
land and manpower but certainly not from a resource perspective. Our
method of agriculture is certainly not sustainable.
We might as well be utilizing slash and burn technology. Come to think
of it we are : )
My observation is that there are many marginal producers who produce and
sell at their variable cost of production. Typically, it is some guy
who inherited money and land when Aunt Maude slipped her mortal coil.
He produces trees with little regard to replacing his tractor,
irrigation equipment etc. Essentially, he is "mining" his initial
investment (or Aunt Maude's) just like a miner depletes an ore body.
When it is gone, it is gone.
Else he subsidizes depreciation with a day job and congratulates himself
on how he is outsmarting the tax system. Eventually, he leaves the
business but is replaced by a guy 15 miles down the road who's Aunt
Sally just passed on.
The end result is that the market for nursery products are pretty much
pegged at the variable cost of production and the guy who is actually
trying to make a living and tries to treat the business as a going
concern takes a beating.
You are very astute. I commend you on your observation.
One is that the ground under the business is appreciating. Economists
are big on "opportunity costs." They contend that businesses should
liquidate and invest the money in bonds if they cannot make 6% on
assets. Economists also like to have a risk premium. So a risky (i.e.,
return bounces around from year-to-year) business like nurseries should
command 10% or more on assets. That means that the nursery owner should
be getting a *net* profit of $2000/acre on those parcels near the road
that he could sell for $20,000 per acre. That is profit over and above
the "fair market wage" is extracted to pay the owner/manager. Yeah,
right. And pigs fly.
I am not much of one for Government intervention, but a shell game is
always being played here. That shell game is a tax dodge that allows the
land to be taxed as AG when it should be taxed as developed when it is
being farmed simply to keep the taxes down. At present I believe there
is much merit in systems that would permanently assign land to AG and
forbid conversion at a latter date. This would tend to level the
playing field and not allow producers in the market who were financing
based on land appreciation.
I apologize for the extravagant consumption of bandwidth on a topic that
concerns such a narrow segment of the list. Sometimes, you just have to
get something off your chest.
Joe I was trolling with my comments to Ed. Ed knew it, but out of
consideration for me he responded. I am glad this turned in to a thread
with some relevance. I appreciate your commentary.
Live large my friends,
The fluffy one
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