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Saleem Shaik, NDSU Agribusiness and Applied Economics Department, Published August 06 2013

Spotlight on Economics: A need for holistic efficiency benchmarking

Rankings of individual firms in the public (educational institutions and

government) and private (agriculture, agribusiness, food or manufacturing,

health care or insurance) sectors are published in newspapers, magazines and journals using the concept of benchmarking.

Traditionally, variations in performance benchmarks are measured by using income statements (revenues, costs and profits) and balance sheets (assets, liabilities and equity). These then are analyzed for specific revenues, costs or profits. Also monitored are specific indicators such as farm size or financial ratios.

However, performance benchmarks can change depending on what indicators are

used. For example, certain farms or enterprises are ranked based on farm size, but the ranking could change if financial ratios are used.

Even then, depending upon need, bankers and insurance companies have used

different financial ratios to evaluate performance. This is a great tool to

evaluate performance, but it is considered a partial benchmarking measure

because we only are looking at one slice of an apple.

This is appropriate for short-term or immediate needs but is not a good measure or indicator of long-term growth or sustainable profit margins.

What is needed is a broader (holistic) concept of benchmarking. One such effort is called the concept of efficiency analysis. Think of it as looking at the whole apple, not just one slice.

Efficiency benchmarking uses complete information from income statements

(quantities and prices of inputs and outputs) or balance sheets (assets, debt and equity) to estimate production, cost and profit functions.

The production function allows us to estimate technical and scale efficiency benchmarks. Cost function estimates are efficiency benchmarks identified with costs, while the profit function estimates efficiency benchmarks from costs and revenues.

Efficiency benchmarking is the distance between the observed revenues (or output produced) of a farm relative to a given set of costs (input resources used to produce output). The benchmark is a farm or enterprise with the highest production (revenue produced if it were 100 percent efficient).

For a producer, the efficiency benchmark measures by how much a producer's costs can be expanded or contracted to achieve the same level of revenues as the benchmark.

Once efficiency benchmarks are estimated within each year or through time,

attention should be paid to the sources and causes of differences in efficiency. Traditionally, variations in efficiency benchmarks have been identified with risks associated with production, price or marketing, financial, institutional or policy and household.

My research at NDSU involves working with instructors in the state to develop technical efficiency benchmarks for a U.S. Department of Agriculture project. I am pursing this research to develop interaction among NDSU faculty, educational instructors and, ultimately, producers.

An instructor or producer can check the performance of an enterprise to compare it with a similar group or comparisons can be made through time.

These measures would be useful to producers, Extension agents, bankers and

public policymakers. Because the efficiency measures are on a scale, the extent of inefficiency associated with costs can be computed easily, which would be useful for producers in particular.