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Corn+Soybean Digest

High-Profit Farms Keep Machinery Costs In Check

The five most important characteristics that set high-profit crop farms apart from mid- and low-profit ones are “Costs, costs, costs, costs and costs,” says Kansas State University's (K-State) Kevin Dhuyvetter. The ag economist's only some-what tongue-in-cheek response is based on his analysis of profitability among farms participating in the Kansas Farm Management Association 2002-2006 project.

Using profit/acre as the common denominator for comparison, farms were grouped into high-, middle- and low-one-third profit.

If there's any single factor that stands out between high-profit and low-profit crop farms over the long term, it's cost control, says Dhuyvetter. “If we are looking at longer term (five-year averages or longer), I contend it is almost all cost differences.”

Prices and yields may be more important in the short term (one-to two-year profit comparisons), Dhuyvetter says. But long term, farmers have more control over costs than they do over prices and yields, he maintains. “We have little evidence that farmers can consistently beat the market,” he says. And, he adds, yields are heavily influenced by weather.

In the long term, even revenue differences take a back seat to cost control among factors that separate high-profit farms from those in the mid- and low-profit groups, he concludes.

Among all costs, machinery cost stands out as the biggest difference-maker, he's found.

His analysis of non-irrigated corn enterprises in the Kansas Farm Management Association showed that the low-profit farms actually had higher gross incomes than mid- and high-profit farms (see chart, p. 12). But those low-profit farms had, on average, $89.80/acre more costs than mid-profit farms and $93.54/acre more costs than high-profit farms from 2002 to 2006.

HIGH-PROFIT FARMS' average machinery costs were $31.53/acre less than those of the low-profit ones. Those costs accounted for about 33% of the total cost difference between high-profit and low-profit farms, according to Dhuyvetter.

He found similar relationships for irrigated corn and soybean enterprises participating in the Kansas Farm Management Association.

Ag Economist Gary Schnitkey at the University of Illinois (U of I) believes controlling costs is the major factor separating high-profit farms from low-profit ones, long term.

“Where we see most of the difference is in machinery and overhead costs,” Schnitkey says, referring to long-term profitability comparisons of farms in the Illinois Farm Business Association.

Iowa State University (ISU) Ag Economist William Edwards says machinery costs are probably second only to land cost as a factor separating the high-profit farms from the low-profit ones in the Iowa Farm Business Association.

Volatility in cash rent in recent years — ranging from $200/acre to $300/acre — is showing up as the single most important cost factor affecting differences in profit per acre between high-profit and low-profit farms, says Edwards.

These ag economists say many cost factors are interrelated with other factors. One is farm size, where large-volume purchasing power may allow slightly lower input costs and a little earlier adoption of cost-saving technologies.

It's not costs alone. “We do find that high-profit farms get slightly better yields,” says Schnitkey.

Edwards says higher-yielding farms tend to be more profitable. Selling price can also be a factor between high- and low-profit farms. However, that “may not be as much (of a factor) as people think,” he adds. “The high-one-third farms received an average of 24¢/bu. more for their corn, but their average production cost per bushel was 79¢ lower than the low-one-third group.”

All three of these ag economists, of course, see other important characteristics that set high-profit farms apart from the low-profit ones.

“If I had to give a list ranking what I think are important factors explaining differences between high- vs. low-profit farms over time,” Dhuyvetter says, “it would be: 1. cost advantage, 2. farm size, 3. technology adoption, 4. yields and 5. prices.”

That's the long-term view. Short term, it can be a different story, these economists say. In any given year, a farm may happen to time a purchase or sale favorably or unfavorably enough to put it in a short-term profit group that's different from its long-term profit ranking, they say.

One example is timing of fertilizer purchases for the 2008 crop year, when fertilizer prices reached record levels before dropping off significantly. The timing of a farm's fertilizer purchase had a major impact on profit per acre short term, Dhuyvetter and Schnitkey say.

ON THE REVENUE side, as Dhuyvetter pointed out earlier, random year-to-year factors such as prices and yields can affect profit per acre enough in the short term to mask cost-control management that separates high-profit farms from low-profit ones over the long term. That's why it's important to look at farm-profit comparisons on a long-term basis.

“Machinery investment accounts for most of the difference,” says Edwards at ISU. “And, that depends on both the size and age of the equipment owned.”

U of I's Schnitkey says, “A lot of it is sizing of equipment. Most of machinery cost is related to harvesting.” That means owning a combine properly sized for the farm. Having as few tractors as possible is also important, he says, referring to primary tractors (planting and tillage).

“When you look at depreciation and interest that's more than what you can custom hire it done for, you're overinvested,” Schnitkey says. Custom hiring or joint ownership and labor sharing for harvesting may lower machinery cost, according to Schnitkey.

Number of acres isn't necessarily a determinate of cost efficiency, Schnitkey says. “We find that you can be a small farm and be pretty efficient on a cost-per-acre basis.”

Typically in Illinois and Iowa, economies of scale tend to max out at around 1,000-1,200 crop acres, he and Edwards say. Beyond that size, you're in the next size cycle of additional machinery investment and labor, he adds.

“We don't see a lot of difference (in machinery cost) between new and used equipment,” he adds. Generally, it's a tradeoff between high depreciation-low repairs for new equipment and low depreciation-high repairs for used equipment, he says.

“For some people, the convenience and less risk of down time make it worth having higher cost of newer machinery,” says Schnitkey. For others who have the tools, skill and a place to make repairs, used equipment may be the preference.

“Profit maximization may not always be a farmer's motive,” Dhuyvetter says. “Even though used equipment may be more appropriate in some cases, they might say, ‘Hey, I want to have a nice piece of equipment to operate.’ That's their choice.”

Schnitkey says from farms in the Illinois Farm Management Association that there doesn't seem to be a high correlation between machinery cost efficiency and tillage systems. For example, he notes, the difference between minimum tillage and no-till may be only one field pass.

“If you are keeping other tillage options open, you probably can't reduce tillage equipment inventory very much,” he points out.

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