Is Size
Everything?
The Relationship between Size, Debt, Risk,
and Overheads
We know the saying “Get big or get out” but what is the everyday reality of this message.
Look at the diagram below of two businesses, one big, one small. Both get the same income at 10 units ($1/unit) and both have the same costs at 10 units ($0.60/unit). But notice the differences.
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The small business is characterised by low
overhead cost, those expenses that are paid
whether or not anything is produced, such as
electricity, telephone, rates and so
on. Compared to
big business it has higher variable costs, the
costs associated with each unit produced, i.e
drench, dipping, and shearing if running
sheep.
However, big business on the other hand
uses its size to shift variable costs into its
overheads because of greater
throughput. This
is the benefit of economies of scale and
therefore big business typically has higher
overheads and lower variable costs per unit of
production compared to small
business. So how
does scale influence the risk of a
business?
What you can now see is how the scale
of a business influences the breakeven point,
debt, and
risk.
Compare the breakeven points of both
businesses.
Because of higher overheads the bigger
business must produce more to break
even. This means
if the market becomes unstable, big business
has less flexibility to be
profitable. But
this is not where the risk of big business
lies.
The risk lies beyond the 10 units of
production because this is where big business
advances hand over fist in its profitability
because its variable costs are much lower (the
line is flatter).
This is why the emphasis is on maximising
production and shifting as many expenses as
possible into the overhead category all in the
name of increasing
efficiencies.
Therefore, when things go well big
business makes a lot of money, but when things
go poorly, big business is tied to higher
production costs.
In comparison, small business requires
less production to break even but does not
make as much profit after 10 units of
production. The
result is less risk and stress on the family.
As there are many
variables beyond the control of the farmer the
trick is to have a business with the lowest
overheads and variable
costs. Reliance on
technologies is often where farming business
can cut expenses and create greater
flexibility to be
profitable.