Grains Research and Development

Date: 29.06.2015

Machinery economics a question of scale

Author: ORM Communications

Key messages for growers

  • Machinery costs are significant and in your control.
  • Know how much your business can afford.
  • Know your key costs and cost:income ratios and improve them.
  • Benefits should be quantified and outweigh the additional cost.
  • Consider alternative options and flow-on effects of investment.
  • Plan and budget for machinery replacement to match your system. 
Image of harvesters

Harvesters at a dealership in Wagga Wagga, New South Wales.

PHOTO: Nicole Baxter

Machinery costs make up about 27 per cent of the total cost per hectare for grain growers, and that does not include equipment finance. According to Department of Agriculture and Food, Western Australia (DAFWA), senior economist Tamara Alexander, machinery costs are as high as, if not higher than, direct crop input costs such as seed, chemicals and fertiliser.

“Machinery costs are substantial and they are in your control,” Ms Alexander told growers at the recent GRDC Farm Business Updates in WA.

Identifying ways to manage or reduce these costs is important to ongoing profitability.

Consider a new Class 10 header boasting 653 horsepower, averaging about 100 tonnes per hour, with an auger that can unload its 14.5t load at 143 litres per second.

Do you invest in this piece of machinery?

Do you look at whether an investment such as this will make or cost money? Or is the decision driven by other motivating factors?

Ms Alexander works through an example of what it costs to own a piece of machinery, such as a new header, that retails for $750,000, and the impact of scale and alternative investment options.

Machinery cost = cost of capital (owning) + cost of operating

Capital costs

A stacked bar chart graphic

Figure 1 Example annual capital costs of owning a header valued at $750,000.

Capital costs are the fixed costs incurred annually, regardless of how much the
machinery is used.

Capital costs = change in capital value + insurance + registration + shedding + the opportunity cost of capital/finance

The annual change in capital value is the annual cost of the machine over its intended life on the farm (Figure 1). In this example, the change in capital over three years would be about $75,000 per year, assuming a 30 per cent loss in value over three years.

Other annual capital costs include:

  • insurance and registration at one per cent of $750,000 = $7500;
  • cost of shedding at $50,000 over 25 years = $2000; and
  • opportunity cost of bank interest at three per cent = $22,500.

The total annual capital cost is $107,000.

Operating costs

While operating costs increase with usage, they remain constant per hectare or per hour.

Operating costs = all consumables, fuel, labour, general repairs and maintenance

This analysis uses: a harvest rate of 12ha/hour; wage cost of $30/hour (plus 35 per cent for superannuation, workers’ compensation costs and downtime coming to $3.50/ha); fuel at $7/ha, using 6 to 7L/ha; and repairs and maintenance of $8/ha. These figures will vary for different regions.

Figure 2 highlights the sheer size of capital costs and how economies of scale work to drive that cost down,” Ms Alexander said. While the investment in a new header is significant and can cost more than $107,000 per annum in capital costs, operating costs are relatively minor on new equipment.

It is important to run alternative options or scenarios. “By comparison, contractor rates of $50 to $60ha can look quite attractive for growers with less than 3000ha. There is also the option of purchasing second-hand to reduce the capital costs, but the additional risk of higher operating costs would need to be considered,” Ms Alexander said.

A comparative stacked bar chart graphic

Figure 2 The cost breakdown of owning and operating a header by cropped hectares (harvesting at 12 hectares per hour).

 

Expansion

An assessment of the likelihood of a range of seasons needs to be considered. For example, expanding machinery capacity to match a one-in-10-year event may lead to an over-investment of capital that may generate higher returns if invested in another part of the business.

Every farm business has different risk exposure, enterprise mix, market options and harvest arrangements that also need to form part of the analysis. Variations include distance to port, distance to domestic buyers, area cropped, livestock mix, economics of storage, risk of quality downgrades, experience of labour, agreements with local contractors, scale of operation, weather conditions and so on.

Often a new purchase cannot be justified for smaller cropping programs or a farm business that has expanded its cropping area but not enough to require purchasing another header. If this is the case, options with lower capital costs are available, such as:

  • buying second-hand;
  • buying a chaser bin;
  • equipment hire;
  • share farming;
  • contracting; or
  • contracting out the header, particularly if larger machinery is purchased.

Each option has advantages and costs. Investors need to consider more than just the capital costs when it comes to machinery: seasons, risk of delays and the associated penalties, and the financial impact of each option on the business must be considered.

“Beware of the high fixed costs and match them to the enterprise and what your business can afford,” Ms Alexander said.

Growers should also consider the opportunity cost of alternative uses of capital.

With machinery, bigger is not necessarily better financially, but it must be fit for purpose. Ms Alexander reminded growers to think about the job, not the tool, because there are multiple ways of doing the job. The most important element is whether the business can afford it.

More information:

Tamara Alexander,
08 9881 0225,

tamara.alexander@agric.wa.gov.au;

James Hagan,
08 9956 8520,
james.hagan@agric.wa.gov.au;

Ground Cover Supplement November–December 2013 (#107): Farm business management

See Ground Cover Direct for related resources.

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