Agroprosperis  11.09.2017

Michael Bertram, Head of the NCH Representative Office in Ukraine (Agroprosperis): We Grow Entrepreneurs, Not Grain

Our meeting took place during an Agroprosperis session at Saliutnaia street. In one of the exhibition pavilions, following the presentation and announcement of the company's plans,  employees were proposed to forecast profitability, yield, and productivity of different crops on different fields, and … to invest their own money into these activities, with a chance to earn an income and share the profit generated by the company. For Agroprosperis, these private investments are not significant, this was clear to me, but the session was already running for eight days. During these days, thousand employees had participated in it. Why? This is giants' life… These are puzzles…

A Few Facts of Life and Nuclear Physics

About Profitability of Crop Production

 

"So, do you think that crop production is a profitable business? As a matter of fact, profitability decreases continuously there, and costs increase."

 

"Presently, this business is very profitable in Ukraine, one of the most profitable legal businesses I know. But as an investor, I have to think a decade ahead. Will profitability change in the future?"

 

"Perhaps, this is a consequence of strong management rather than of profitability of crop production …"

 

"I can be an excellent manager, but if I work in the wrong sector of the economy, I won't succeed. Let's take global grain trading as an example. It has a low margin. One can trade in grain without generating a good profit. Competition is high, and the structure of this sector does not allow making good money. This means that we had to understand the crop production sector and its future. Another aspect is how to find your market niche. I look at the development of crop production in the following way. After the collapse of the Soviet Union, kolkhozes (collective farms) suffered for two reasons. First, they lost their supply chain, their access to resources. Moscow, Kiev, and the State Plan used to supply collective farms with everything which was necessary, and they took grain after harvest. That stopped over night. Second, farms lost access to capital. Investors are ready to invest money into a profitable business, and crop production is a profitable business in principle. However, collective farms could not attract capital for certain reasons. If an investor provides equity, he requires a governance structure which collective farms did not have. The alternative to equity is an investment in the form of debt. However, in this case the main obstacle was the collateral, not the interest rate. There are three types of collateral in crop production. The first type is land, but in Ukraine the moratorium on selling farmland did not allow pledging land. The second type is the future crop. However, there was no legislation at this time, and agrarian receipts are being used only now. The third type is real estate. But if a farmer wants to have one thousand hectares financed by a bank, he must pledge real estate worth half a million dollars, and the number of people able to do that was very limited. That was the time when agriholdings developed, because they made up for all these deficiencies."

 

"Don't you think that troubles faced by collective farms existed because they were not independent economically? They were pure production units which did not care about markets, did not have any sales departments and supply infrastructures. At the same time, agriholdings are true commercial entities."

 

"Look at farmers in America. Their farms average 200 hectares. They neither have a sales nor a procurement department, but they operate well. There are cooperatives, there is a supply chain."

 

How the Result Is Calculated

 

"Farming is an almost perfect model for Ukraine, if the owner of the farm manages the operations and makes all decisions himself. He does not have any bureaucracy and is given economic freedom. He can sell grain to anybody he wants. Or he decides not to sell his grain at all."

 

"Let’s look at an agriholding. There are scale effects almost everywhere, in procurement, sales, management, financial reporting, except if it comes to what happens on the field. There is no scale effect on the field. The EBITDA which can be generated on one field or on one thousand fields is the same if fertilizers and technologies are equally accessible. If you purchase 100 tractors, the price will be lower than if you buy one tractor. There is a scale effect. But growing crops on the field does not have such scale effect. Many people make one mistake – they look at higher crop yields and conclude that an agriholding is more productive than a small farm. It is not. An agriholding is more efficient in procurement, sales, management, but not in what happens on the field. Agriholdings set up efficient supply chains which are absent in Ukraine. And agriholdings have better access to capital. But if you look at any country which has an efficient capital market and an efficient relationship between the various market players, you will not find agriholdings. If Ukraine develops its capital market and creates efficient supply chains, agriholdings will disappear. They will simply not be needed anymore. They are less productive on the field. Production decisions need to be made on the field, not in the headquarters. A farmer needs to walk on his field, see the situation, and respond to it. I say it again: It is a mistake to believe that agriholdings are more productive because their crop yields exceed that of small farms. This is not productivity. Productivity is the ability of converting input dollars into output dollars. This is it. It is not important how many hectares are farmed. It is important how many dollars you earn having invested 500 dollars per hectare. Cooperating with our partners and clients on the market, we see that small farms, which use the same resources, are often more effective than a large agriholding."

 

"We see it among German and French farmers whom we are always expected to follow as an example as far as yield is concerned."

 

"Our crop yields at Agroprosperis are two times higher than the average yield in Ukraine, but not because we are smarter than the others. We simply buy good seeds, invest what is necessary in order to sow timely… However, if we give the same resources to a small farmer, he will produce a higher yield. As Ukraine develops, farmers will become more profitable, and agriholdings will lose their competitive advantages step by step. What about access to capital? Crop production is profitable, but it is lacking collateral. Therefore, banks refused lending to farmers, until agriholdings came to the market and produced their financial reports. These reports were compatible with banking technologies, showed a profit, and bankers were ready to lend. But later they understood that sometimes these financial reports are not worth the paper on which they are written. Defaults occurred, and as a result some agriholdings lost access to capital. In order to assess whether a farmer is able to repay a loan, it is necessary to look at his field, not at his financial report. Two years ago, we bought a bank. It belongs to our Agroprosperis Group and it has good borrowers, because we know that a good farmer will always repay his loan."

 

The only Solution Is to Increase Productivity

 

"How does the economics of crop production work presently, and how do you see the future?"

 

"Let's compare the production cost of a ton of corn in America and in Ukraine. Both countries are open markets and input costs are more or less the same. However, there is one significant difference which is the cost of farmland. Our EBITDA from corn this year is approximately 400 dollars per hectare. However, at current corn prices an American farmer earns no EBITDA on leased land. The reason is that we pay on average 125 dollars per hectare, while an American farmer pays up to 700 dollars. Would we pay similar leasing fees, our EBITDA would be zero as well."

 

"But the land leasing cost in our country is variable…"

 

"It increases. It's bad for us, because our margin decreases."

 

"It's bad for all."

 

"I'm not sure. Why should it be bad for the land owner?"

 

"Because a company which earns less money reduces its workforce, spends less on the development of the region, schools and roads, and in general, the company moves into negative territory, into survival mode rather than development. This impacts the company's purchases, equipment, seed, crop protection, fertilizers. Thousands of companies are active in this segment, and they all start earning less. There is energy in being successful. Perhaps, this concept is outside of the limits of physics. I believe though that it is within the limits of physics which are unknown to us for the time being. A prospering company generates positive sentiment."

 

"You're right. People want companies to implement social programs, and we participate in that. But in effect, we reconstitute the Soviet Union. Today a company must create jobs, pay legal salaries, and earn a profit in order to have stables jobs and pay taxes to the budget. In this way a private business earns the money which is used for improvement of the social domain. Look at Brazilian villages. You'll see how a village flourishes if a farmer makes money. Profitable farmers are the most effective social program."

 

"This is the case today. But how do you see the further development of crop production?"

 

"When we started farming, Ukraine had 35 million hectares of farmland of which about 5 million were not seeded. At that time, we created our land bank. Today there is no free farmland in Ukraine anymore. All land is seeded, especially in regions with good productivity. Today crop production is the most profitable sector of the economy which therefore attracts more capital. If there is more capital flowing into a limited resource – farmland – the cost of the resource increases."

 

"What do we see in villages? The main competitors for farmland are small farmers rather than agriholdings. Farmers are ready to pay more for the land because they earn more. Agriholdings have two options - either to increase their productivity faster than land cost increases, or to go out of business."

 

"As a matter of fact, you have only one solution. It is not a solution to go out of business."

 

"Yes," Bertram laughed. "If interest is not paid, capital disappears. If salaries are not paid, people leave. If the land lease payment is not made, the land is lost. Consequently, farming productivity needs to increase. We analyzed how the cost of farmland in Ukraine has increased during the last 10 years and saw interesting peculiarities. There is an exponential growth. As I see it, we will soon have to pay 200 dollars and more. We don't know how much we will earn in 2018 and further on, but we can make forecasts. We know our crop yields during the last years, and we can run a regression. Our crop yields increase linear, by approximately 5% per year. At the same time the cost of farmland increases exponentially. What factors do we take into consideration? We know that one hectare of leased land in Ukraine costs 125 dollars on average, and 700 dollars in the USA. We know that there is a large flow of capital, Ukrainian, not foreign money, looking to enter crop production. There is more money than land, which creates an upward trend in the cost of land. I'm afraid that the cost of land increases faster than we all expect."

 

One Hundred Million Tons of Grain Exports from Ukraine Is a Sure Thing

 

"Well, the attempts to open the land market are also dubious. Western markets are not moving. Prices are high, and deals are rare."

 

"It's true, and most farmers won't sell their land."

 

"Suppose millions of hectares of land are on the market. This would be similar to Ukraine producing 200 million tons of grain and causing world prices to tumble. And these millions of tons would cost 70 dollars each…"

 

"I believe that Ukraine will have these 200 million tons," Bertram said to my astonishment. "It will have them irrespective whether the moratorium is lifted. Even if Ukraine does not change. During the last 15 years, Ukraine has progressed from practically zero grain exports to exporting more than 40 million tons. And all this happened despite little foreign investment, the moratorium, corruption, two revolutions, a war. Ukraine has a lot of own money, and this capital looks for a place in crop production."

 

"Does one hectare cost you more than the others?"

 

"Yes, it does. Nevertheless, if we apply a modern and more expensive technology and incur higher costs, we still earn more income. Profitability increases. What does occur now? If land costs 125 dollars, I can earn money with a wheat yield of 4 tons per hectare. If the land lease payment increases to 300 dollars, 4 tons are not enough. I either produce 6 tons by paying more for inputs, or I go out of business. This automatically leads to an increase in crop output. Therefore, 100 million tons of grain exports from Ukraine are not a question to me. The question is how soon this will occur, in 5 or in 10 years. The soil produces such result, and there are people, farmers, and technologies. We are not talking about building spaceships, farming technologies are simple, and Ukraine has everything to achieve these results. In the future, small farmers will play a more important role in crop production. The supply chain and access to capital will improve - and we want to be in this business. Three years ago, we decided to develop this activity. We bought a bank in order to make capital available to farmers, and we accept their future harvest as collateral. We sell crop inputs and technologies as a "turnkey" package, we can guarantee a minimal EBITDA, and we guarantee to purchase the crops produced on the field."

 

"Don't you fear competition from small farmers? Because they could turn into a critical mass."

 

"This will happen anyway."

 

"What is your main idea? Do you want to move from competing with the farmer to cooperating with him?"

 

"Yes," Bertram said softly and calmly. "They are our partners. I see it in this way. Productivity in crop production is the production efficiency rather than the crop yield. It is how a dollar of inputs is converted into dollars of grain. The deciding factor of productivity depends on people rather than weather and other conditions. Conversion of inputs into outputs is driven by people; eighty percent of the result depends on them. In crop production, many investors made a mistake by paying too much attention to technologies and underestimating the role of people. At present, no crop production technology is able to replace the human factor. Perhaps it will appear in 50 years, but it does not exist today. If I give an expensive combine harvester to a fool, there won't be any harvest. If I give a seeder for tens of thousands of dollars to a tractor driver who will sow at a speed of 10 km per hour instead of 5 km per hour, there won't be any crop quality. We prove this with numbers when we rate our farm managers. The bottom line depends on the quality of team work, of just 20-30 people at the farm. Remember, crop production does not have a scale effect, and accordingly the farmer at the field should have the right to make decisions. However, there is a scale effect in procurement, and we want to give this effect to our partners, to small farmers, in order to allow them buying at the same conditions as large agriholdings."

 

"But this is the principle of a cooperative, for example, in France."

 

"Yes, exactly, this is the principle of a cooperative. Look at the farm teams which we have in the field. They make own production decisions and they decide how much they will eventually earn. In order to increase their motivation in making correct decisions and earning more money, I must give them part of our profits."

Employees Earning 80% Income on Money Invested by Them

 

"To some extent, you want to make them managers, entrepreneurs, and increase their responsibility for the result?"

 

"Seven years ago, we implemented a bonus system by proposing our teams the following. A conventional bank loan costs 20% interest. Therefore, our capital also costs 20%. We provide our teams with working capital, and if the return on working capital exceeds 20%, we will pay 10% of the exceeding part into a bonus pool. It doesn't matter if they did something right or wrong, or if crop prices are high or low. During the last seven years, we paid about 15 million dollars to our farm teams by sharing with them our profits."

 

"How many employees participate in this program?"

 

"Approximately one thousand. We developed these programs for our people so that they can earn a lot. Nevertheless, during the first three years, none of them took these programs seriously. People are being cheated all the time, and they hardly believe that somebody will fulfill his promises. We had to struggle for our people's trust. Today, all of them understand that there is a profit sharing formula which we do not change. Two years ago, when we had built sufficient trust, we proposed our employees to invest their own money into the farms. The idea was the same. If return on working capital is below 20%, nobody earns anything. If it exceeds 20%, we pay 2% for every percent of the exceeding profit on the money which our people invested. During the first year, we just watched. We had even doubts whether we did the right thing. In the first year only 35 people participated. They invested 250,000 dollars and earned 80% return on their investments.

 

"Sorry?"

 

"Eighty percent. The following year, we proposed the program again to everybody: 'You can take your money to a bank and get 2%, or you can invest it into your farm where you control the result.' This year have 945 participants. They invested 3 million dollars of their own money, and this is exactly what we want."

 

"You don't need their money actually, do you?"

 

"No, we don't need these three million; this is only 1.5% of our working capital. However, these three million are important to us, since they influence our people's work and the final result."

 

"Will your employees earn anything from these three million?"

 

"As I see our forecast, they will earn this year 2 million dollars in excess of the money they invested. By investing three million, they make five million. We'll see. There are farms in our group where employees gain more than 100% from their investments.

 

"What is the average yield of major crops in Agroprosperis?"

 

"Wheat yields 5.6 tons, rape yields 3.3 tons this year. Our forecast for corn is 9.2 tons, for soybean 2.6 tons, and for sunflower 3.1 tons. During the last ten years, our crop yields increased by 5% annually. This is how I make my forecast. If you ask me what will be our next year's wheat yield, I answer 5.6 tons plus 5%."

 

When Associates Become Farmers

 

"In 2013, you left Crimea…"

 

"Simply because productivity was too low there. In the south, crops can be grown efficiently only by using irrigation."

 

"Do you have any thoughts about irrigation?"

 

"As a matter of fact, I can get 9 tons of corn without irrigation and 12 tons with it. But the cost per hectare with irrigation doubles, while the yield doesn't double. This works in Southern Ukraine, but it requires long term investments. It is necessary to own land and water rights, and to produce more expensive crops than wheat."

 

"Are you actually aware of the significance of your activity for Ukraine as a whole?"

 

"Certainly. And let me tell you about our next step, which will affect the entire country. An increasing number of our employees wonder why they should work in Agroprosperis and earn 10% of the profit, while they can work independently and earn 100%. Today, we tell our employees: 'If you want, we are ready to help you. You'll have the same access to technologies and resources as in Agroprosperis.' We buy tractors, fertilizers for people who decide to run their business independently, support them technologically, buy grain from them, even help them with finding land. In some instances, people employed by us left, took 20 hectares, and earned a profit. Our people turned from being our employee into becoming our client. I don't see any principle difference between a person who is employed by us and earns part of the profit, and our client who earns all the profit while taking technologies and inputs from us. There is only a difference in terms of risks. A person employed by Agroprosperis receives a salary and cannot lose money. Being an entrepreneur, you can lose everything. However, by taking more risk, a person wants to have a larger share of the profit. This transition is gradual. We understand that our land bank will decrease at some point in the future, and part of it will move to small farmers. Nevertheless, we'll continue cooperating with them."

 

"In fact, I don't believe that a lot of people will take 100% risk. Not everyone can run a business. However, the creative and developmental role of this activity is indisputable. In this way, a field of cooperation and development is generated around a company and spreads far away."

 

"That's it. Not everyone will become owner of the land and the farm. However, the best employees will do so. Entrepreneurs are special people, not everyone is ready. I would say that we do not grow grain. We grow entrepreneurs. And if we do it correctly, we change Ukraine."

 

"Is this your credo?"

 

"Exactly. This makes sense to us because we earn more, and this makes sense for Ukraine because Ukraine needs entrepreneurs."

 

Vision of Market Changes in the Decade Ahead

 

"Don't you feel as if you create a nuclear power plant in your thoughts?"

 

"No, I don't," Bertram said cheerfully at last. "This structure is slightly different. There is a philosopher of science, Karl Raimund Popper. He wrote about philosophy of physics, and then used it to describe development of society. In his book “The Open Society and Its Enemies” he demonstrated that what we tried building in the Soviet Union can not work, and explained the reasons. There is no hidden law according to which society develops. In order to develop, society needs to be open to new ideas. Our future depends on us, on how we accept these ideas. This philosophy influences me. I know that I must make decisions and forecasts, but I must also respond to changes. Presently, we have a business model which earns money, but we must look five or ten years ahead, anticipate change in the market, and prepare for that. If I try to retain the current model, I will go the way of Kodak, a corporation which produced photographic films. Or I repeat the fate of Nokia which relied on its one-time leadership in cell phones. I must move with the market. If I see that crop production in Ukraine will be different in the future, I must participate in the development of this new market. If I fight with the market in order to protect my current business model, the market will get rid of me. Here even a nuclear power plant does not help."

 

"Somebody said that we live in times of opportunists, people who don't care about consequences, whose sole purpose is to make quick money. They say projects are created only to make profit and to be sold… But as I talk with you, I don't feel that your model is purely commercial. Although you follow the rules of business, I also see a significant impact of our activity on the economy, the society, and as a consequence on Ukraine. To put it precisely, I don't feel that your business looks solely at the financial result."

 

"Let me answer you in this way. An investor must increase the value of the invested capital by increasing the value of the business. Business value is a function of what it will earn in the future, rather than what it earns today. Value is the discounted cash flow of the future. Anybody who goes deeper into the issues of our conversation – the dynamics of crop production, its future development – will ask similar questions. Yes, we can say that it is an excellent business today, but the cost of farmland increases, and yield and productivity limits will be reached at some point. What should we do then? Here we need to come up with an answer. In order to set up a business which has value, it is necessary to develop it in such way that it has a strong competitive position in the future, bearing in mind that the market changes continuously. As an investor, I look at two factors. First, I need to generate a profit each year which covers the cost of my capital. At the same time, I must prepare this business for the future so that it will cover its cost of capital also in the future. This is the second task. If I do only one thing without the other, I don't do my job."

 

How can we achieve quality on large farms? Large farms seem to be a sort of condemnation. How do you find a balance, where is harmony?"

 

"The sole criterion in business, and farming does not differ from any other business, is return on invested capital. This is the rule which needs to be applied."

 

"That is, if 200 or 300 seeders produce a good result on large farms, they need to be bought, and if 45 seeders are more effective than 300, then one should use 45…"

 

"Yes, and this is important. This is our philosophy. What is the advantage of a market economy over a planned economy? A market economy allocates resources more efficiently. It allocates them on the basis of profitability. Those who think that it works differently in farming are wrong, it also applies to farming. Therefore, a decision on buying seeders depends on whether the capital invested into these seeders generates a return which justifies the investment. However, the difficulty in crop production is that such decisions have to be made on the field rather than in the headquarters. Hence, our management system involves our employees in the business – we want them to think like an investor. In general, the crop yield is not a deciding factor. What matters is how many dollars one invested dollar generates, not the crop yield. In order to allow our people to make these decisions, we provide them with tools. In our case, our farmers can tell me what profit every field and every crop generates. And they analyze these questions all the time themselves, because we pay them bonuses only when the return on working capital exceeds 20%. Thus, our farmers don't want to grow a crop unless they are sure that it would yield a profit above 20%."

 

Fascinated Investors

 

Like any German, Michael Bertram is scrupulous and exact, rational and punctilious. He even dresses as a Bavarian. His key traits are calm and prudence. Physics appears to enable him to handle volumes. It seems to me, he detaches himself from emotional perception of thousands of hectares and thousands of people, millions of tons and millions of dollars. He interprets these notions as arrays of figures, drawings showing structures and movement of physical values. Financiers, entrepreneurs, investors are special types. Physicists are the same. Nonetheless, he is not a man without emotions, he isn't ironclad. He has something which I saw in many western and some domestic entrepreneurs. Westerners call it "passion". We name it "glitter in the eye".

 

"Concerning the company of which you are the father … What do you think, how many years will it exist in Ukraine?"

 

"I hope that Agroprosperis will exist for 100 years, forever by and large. I hope it is a business which is well positioned on the market. We formed a team which understands the dynamics and changes of the market, and which is capable of changing itself. I think the company will focus in the future on servicing small farmers, which will be its next development stage. I've lived in Ukraine for 18 years, and I hope that I still have time. It is an interesting country. It is easy to make a positive impression on an investor who is visiting Ukraine. Any investor leaves the country thinking that it is better than expected. The reason is that expectations are very low. The reputation of Ukraine is worse than the real situation. Therefore, it seems that everything what we show is better than what investors had expected. Last year, we had for the first time the annual meeting with our investors in Ukraine. Usually, we do this in the US, but this time we invited them to Ukraine. If they just see me, my presentation slides, the numbers, they get a good but unemotional impression. However, when we showed them the fields and the team, young educated, dynamic, English speaking Ukrainians, our investors saw that there is much more behind us. They were excited about a 70 year old woman, one of our agronomists, who demonstrated like an expert the return on capital for different fields on her tablet computer. Not many people can do this, even in America. It is difficult to persuade an investor to come to Ukraine. But anybody who does ends up investing."

 

What We Leave After Us

 

"We all live at the same times in the same country, under the same conditions. We have a common policy, roads… Are you a happy man?"

 

"Yes, I am. To do something which makes sense for society is a source of happiness. When I look back I see that I achieved something which will remain for long."

 

"Yet you probably dream about building a small nuclear power plant for Agroprosperis sometime."

 

"Nuclear energy is a complex thing," Michael said as soon as he ceased laughing. "Attitude to it changed after Chernobyl. There is opposition to nuclear energy, there are sentiments against it in the society, and you cannot do anything against it. On the one hand, you must learn a lot, work a lot in order to become a nuclear expert, but on the other hand you see that society doesn't accept this idea. At one point I said: 'This is not what I want.' The collapse of the Berlin wall gave me the opportunity to do something else. I love nuclear physics, Popper, but I do not want to practice it as a profession."

 

"Even this doesn't matter. What matters is that you developed a taste for crop production."

 

"Yes, I did. At some day, everyone becomes a farmer. This is a basic activity, and ultimately we all return to it."

 

Thus, Agroprosperis won't have any nuclear power plant. Perhaps, it isn't needed. In fact, Agroprosperis is an inexhaustible source of energy which widely spreads waves of advance over the country. They entrain farmers and medium agricultural companies, they create workplaces and projects. Intelligence and expertise grow in them.

 

This source of energy is designed for at least 100 years, according to a short-range forecast. A long-term plan is to exist forever.

 

 

 

By Yurii Goncharenko