Country Guide’s editor asked whether we see a trend in the machinery strategy of the farmers who take CTEAM, our management course. Behind this is the idea that their experiences may be of value to others.
The reality is that many strategies exist, ranging from turning over the complement of equipment every year, to squeezing out every penny by holding machinery as long as possible and doing your own repairs and maintenance. In many cases, different strategies have been well researched and justified by analysis. In others, not so much: there’s no question there was a tendency for some people to be “metal petters” especially during and after 2008 to 2013 when grain prices peaked.
Interestingly, different strategies can be justified, and a host of factors can affect strategy choice, like these three examples:
- Your access to people who can repair and maintain machinery. Having this availability substantially reduces the cost of maintaining older equipment, making it potentially more attractive than new for a longer period.
- The farther north you are, the more equipment you need. Planting and harvesting windows are limited, and if you have substantial acreage, you need lots of equipment to plant as soon as you can in the spring so the crop is mature in the short harvest window, as we have seen with early snowfall the past two years.
- Your relationship with your dealer may give you deals that are just too good to pass up, deals that are good for both of you. After one year of use during which the new technology doesn’t break down, in part because you take great care of it, the trade-in value is tops and a flip doesn’t cost much for that year of use. It’s good for both because the dealer gets two sales margins in two years.
Appreciating the variety of these factors is in fact what led us to develop our machinery investment course. Listening to CTEAM participants discuss the range of factors, it became evident that there could be value in determining whether the factors are true or whether they are rationalizations for new pets or for keeping the old ones around.
The arguments spawned two aspects of the course that are fascinating. The first question that a number of alumni and others asked was, how do I decide how much equipment I should have, and whether I’m over-capitalized?
Am I over-capitalized?
This question is often addressed by looking at the average value of equipment available on grain farms with different soil types. This may be a good indicator, but it has two limitations. First is the obvious: it may be useful for grain farms, but what about others? Second is that no study shows a relationship between machinery investment or operating cost per acre and profitability.
These issues led to an aspect of the work AME has been doing with BDO suggesting that the most profitable farms have machinery capital costs just under nine percent of revenue, compared to just over 15 per cent of revenue for the least profitable.
This is an annual difference of $60,000 per $1 million of revenue, a significant impact on the bottom line. It offers a good start toward a substantive answer to gauging over-capitalization.
The next phase of the BDO work to be completed later this year, with a much larger number of farm records, will give a much better idea whether it is an appropriate measure and how it might vary by farm type.
Should I buy, lease, rent or keep what I have?
This is the second major question. It’s where individual circumstances come into play. These can include location (i.e. how much time is available for planting and harvest), availability and cost of labour, what products are produced, the specifics of the deal, whether new machinery improves productivity, how long you may keep it, its likely salvage value, your perception of risk, your financial position, interest rate… the list can be long.
These decisions include time and the time value of money because they deal with long-lived assets. So, evaluation needs to be done in a capital budgeting framework. Using that framework with consideration of an individual’s specific circumstances often leads to two conclusions about machinery strategy.
The first is that including individual circumstances means that there is no “best” machinery strategy. Individual circumstances drive what’s best.
The second and related outcome is that what often seems to be an obvious answer frequently isn’t when the circumstances are included. For example, machinery leases may make sense even when the surface suggests they don’t.
As another example, as part of the course one farmer asked us to evaluate a proposal to build a shop. Many of us expected the shop was actually a pet project the farmer wanted to justify.
An analysis based on the individual’s circumstances, however, showed a 19 per cent internal rate of return.
These considerations partially account for why there is no clear trend in the machinery strategies of the farmers with whom we work. Some still need to do the analysis to make sure they haven’t invested in pets that make them over-capitalized. But there is never a guarantee that, without the analysis, the right strategy can be forecast.
Larry Martin is a principal in Agri-Food Management Excellence, a management training company and Dr. Larry Martin and Associates. He teaches and coaches managers of farms, agribusiness and food companies in Canada and the U.S.