Cost-price thinking back again

Agricultural entrepreneurs have been keeping a close eye on their costs for centuries, because there is not much a farmer can do about market prices. It's really strange that cost prices of food have not been around for that long.

It was not until 1948 that drs. Jan Horring obtained his doctorate for the thesis 'Method of cost calculation in agriculture ', in which he explained how to calculate a cost. He solved a few problems with that. The first is how to cost the labor of farmers and family members and their equity. Horring proposed to separate family and business and to assume that the business must purchase those unpaid factors of production (for example, against collective bargaining wages or bank interest).

The second problem was that cost prices on small companies are much higher than on larger ones that operate more efficiently. You can take the average of this if you want to know the cost price of Dutch milk. But Horring, who had been the first director of the Agricultural Economics Institute (LEI) since 1940, couldn't handle it. His cost prices were to be used in Sicco Mansholt's Dutch agricultural policy to guarantee farmers a reasonable income. The liberal Horring saw it coming that this average would lead to an increase in production and milk urination.

To price out of the market
The PhD student, who had studied with the later Nobel Prize winner Jan Tinbergen in Rotterdam, consulted the competitors in Amsterdam for this. There were differing views between the two cities in business economics at the time. In Amsterdam in the 30s they had studied the question of how to calculate the cost price in the event of high inflation and unemployment.

Because of inflation, you should not take the costs paid in the past, but the current replacement value, otherwise you came out too low. But you could also end up too high if you divide all costs by the actual production (which didn't use the entire capacity of the factory). If this cost price was then used to determine the selling price, you price yourself out of the market, demand decreased further, and your cost price increased even further.

Base policy on efficient companies
So you had to calculate, they reasoned, with normal production and for the rest take your loss of understaffing. By analogy, Horring argued that you should base the cost of agricultural policy on the data of efficiently run farms, which could be designated by regional experts. By treating the average of a number of years as normal production, Horring solved the problem that yields fluctuated widely from year to year.

The methods from the thesis were the basis for agricultural policy for many years. It was inevitable that there was already a milk surplus in the 50s. Business economists later explained that cost prices also have only limited significance for management. The market determines the price, so it is primarily a business comparison tool. And not always for decision-making: if you are offered a contract for wheat at 105% of the cost price and for sugar beet at 95% of the cost price, it is better to grow sugar beet. The margin per hectare is just as important.

Don't pay too many fees
But in the meantime, cost-effectiveness is back. Now in the form of 'true cost accounting'. In agriculture we not only make use of unpaid family labour, but also of unpaid effects on the environment and nature. Like industry, we do not pay for CO2 emissions or for the emission of particulate matter. A new generation of economists is trying to express these costs in euros and include them in the 'actual' cost price.

I look forward to a good dissertation. As a consumer and farmer I hope that they will base the actual cost price on efficiently run companies, otherwise we will pay too many levies. And the true cost does not automatically become the true price that the consumer pays. That requires food policy.

Krijn J. Poppe

Krijn Poppe worked for almost 40 years as an economist at LEI and Wageningen UR and now holds a number of advisory and management positions. For Boerenbusiness he dives into his bookcase and discusses current developments on the basis of studies that have become classic.

© DCA Market Intelligence. This market information is subject to copyright. It is not permitted to reproduce, distribute, disseminate or make the content available to third parties for compensation, in any form, without the express written permission of DCA Market Intelligence.