Every business person should know what business they are in. That sounds easy, but it is not.
More than 50 years ago, Peter Drucker pointed out that if the railroads had decided they were in the transportation business instead of deciding they were in the railroad business, they would not have had problems adapting to competition from trucks and airplanes.
Last week I did a small presentation for the Eastern Ontario meeting of CAFA. The Canadian Association of Farm Advisers. My part was about transferring wealth but that is not the point of this article. One thing I learned is that there are ways to finance farms that recognize the importance of knowing what business you are in. The lesson is important to all business people.
It starts with noticing the part(s) of the activities that make the most money per unit of input. Efficient use of resources. For example, should a dairy farmer own the land they use? Traditionally yes, but not so much anymore.
Land ownership matters if speculating on the price of land over a long time is a profit center. Land ownership should be unimportant if the capital tied up there could earn more in some other activity. Assuming you can still use the land. Say more cattle, better feed handling equipment and more dairy quota. For some, the idea of not owning land is impossible and until recently was difficult to accomplish.
Now you can use land without owning it. One speaker at the conference was Marcus Mitchell of Bonnefield Financial. Bonnefield purchases and leases back farmland. A farmer sells land to them and uses the capital freed to be more productive. If the lease cost 2% of value annually and they give up 6% appreciation, there is a long term cost of 8% to do the deal. If the capital freed is invested to produce 15% immediately on the money, it is an attractive arrangement. There are many details and it certainly is not for everyone. Worth a look for a few.
Discover what part of the business assets are necessarily committed to earning a profit. If land is not as productive as other assets and not necessarily committed, explore alternatives.
Most large businesses have a hurdle rate for capital. It applies to new and existing investment. If they are already in some business, they may ask, “If we were not in this business, would we buy it for what it is worth?” If no, it is for sale. Same question for farmers and land.
Farmers need to ask the strategic question, “Do I need to own it or do I merely need to use it?”
The answer will lie in deciding which part(s) of their business earn the most for a given capital investment. For ones that decide to not be in the real estate speculation business, Bonnefield may have a way out.
For any business, discover the real business you are in. It will help you allocate resources.
Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: firstname.lastname@example.org