Most people in leadership positions in business today have never experienced a truly high interest rate environment. Current mortgage rates, for example, are the highest in over over 20 years. It’s been over 40 years since rates hit their peak 16.63% in 1981, that’s more than double the current rate. I am 45 years old and have been in the industry for over 20 years and I’ve never seen anything like what we’re entering now.
While it’s unclear how high rates will go this time around, it seems clear that higher interest rates will be with us for some time. Economist Milton Friedman did some groundbreaking work back in the 1970’s to describe the lag time between monetary interventions and reductions in inflation. His work has been expanded upon and most experts now estimate that there is a lag time of 18 months to 3 years before changes in interest rates result in the economic slowdowns that policy makers intend. If that holds true, we’re in for an extended period of higher interest rates. Here are three ways this will affect your business:
Higher Cost of Working Capital
This may seem obvious, but I think we tend to underestimate the impact of these costs on borrowing whether for longer term capital expenditures or access to operating loans on which many businesses have become dependent during the era of cheap money. I’d like to focus on how interest rates can impact cost of production. According to SwineTex’s cost of production model, each 1% increase in interest rates result in approximately an increase of approximately 45 cents per pig in wean to finish cost of production.
The difference in 2% interest rates and 5% interest rates are almost $1.40 a pig which is significant given the tight margins our industry operates with. It’s worth pointing out that not only are interest rates going up, input costs have been extraordinarily high as well. So, not only are we paying a higher interest rate to access the capital we need, we need more capital than usual to pay for the higher input costs. Current wean to finish feed costs are around $117/head compared to $63/head two years ago. At a constant 4% interest, that’s .50/pig in increased cost just from interest.
Higher Cost of Equipment
It’s not just operating loans. Loans for necessary items like equipment are going up as well. According to Iowa State University’s Machinery Cost Calculator shows that the annual cost of ownership for a $160,000 tractor goes up by about $1200 for each 1% increase in interest rate.
A few hundred dollars a month may not sound like a lot, but when you multiply that over all the equipment needed to run a modern farming operation, it adds up fast and eats away at already tight margins. As we mentioned in reference to operating loans, we also have to keep in mind that the price of equipment has been rising dramatically.
Over the last few years, Covid-related supply chain disruptions and labor costs for manufacturers have driven high horsepower tractor prices increase in the double digits year over year. High prices, slow delivery times and poor availability in new equipment has driven up the prices of used equipment to sometimes absurd levels. It’s amazing what farmers will do to avoid paying taxes.
Much like feed costs, the rising prices are further complicating interest rate increases. Now, we’re not only paying a higher percentage of interest for the equipment, we’re paying that interest on ever higher prices meaning total interest costs are going up much more than the nominal rates would indicate. That $160,000 tractor referenced above would have probably only cost you $128,000 a year or two ago. Even if interest rates had stayed the same, your cost of ownership would have gone up $5,000/year.
Higher Cost of Talent Acquisition
This is not one you probably expected to see, but it is one of those stealthy, indirect ways that interest rates can impact your business. As I mentioned in the introduction to this article, mortgage rates are currently at highs we haven’t seen in quite some time. While remote work is a growing trend in our industry as it is most everywhere else, many of the positions we need to fill are tied to a physical asset and local team and can’t be easily fulfilled remotely.
I’ve spoken with several recruiters over the last several weeks and they have talked about labor shortages and the challenges in filling positions. The challenges of filling positions that require relocation are particularly daunting and one of the reasons is housing. As mortgage rates have skyrocketed in recent months, the following scenario has become common: you’re asking candidates to sell their house, on which they have a 3% mortgage and buy a new house where their rate will be 7%. That could mean a 40% increase in mortgage payments.
On a typical $400,000 mortgage, that would be about $1,000 a month and a nearly $350,000 increase in total interest cost over a 30 year mortgage. Attracting established talent to accept a new job typically requires a 10-20% pay increase anyway and with recent inflation, we’re looking at the upper end of that range. Now you have to add to that, maybe $12,000/year just to offset the increased mortgage costs (assuming cost of living is similar between the two locations). Let’s say your target candidate is making $80,000 and is in the mortgage situation described above. That means you’ll likely have to pay $108,000 to attract that person to come to work for you.
These are just a few of the many ways that interest rates are will continue to impact pork producer’s cost of production and ultimately, profitability. For a long time, interest rate has been a rather static number on cost of production spreadsheets, but as that number comes alive, producers will need to pay close attention to those costs.
Hidden costs are problematic because they’re costs, but they’re the most problematic when they remain hidden. As we develop business strategies to navigate the coming months and years, we’d be wise to not forget about interest and the cost of capital.
About the Author: Todd Thurman is an International Swine Management Consultant and Founder of SwineTex Consulting Services, LLC. SwineTex is a US-Based provider of consulting and training services to the global pork industry. To learn more about SwineTex Consulting Services, send an email to email@example.com or visit the website at www.swinetex.com.