Ownership vs Custom Hire: Evaluating the Decision

1. Ownership vs Custom Hire:Evaluating the Decision Dr. Alex White Virginia Tech axwhite@vt.edu

2. Evaluating the Decision • Be objective • Get rid of “Paint Fever”! • Understand your objectives • Look at all associated costs • Consider “non-financial” factors • Advantages • Disadvantages • Other

3. Understand Your Objectives • Why do you want to own spray equipment? • Improved quality • Lowered expenses • What is your “profit center”? • What is your “opportunity cost”?

4. Custom Hire - Costs • Custom application rate • $6-10/acre for spraying • Cost of chemicals • Markup by applicator or purchase yourself? • Any labor costs? • Other?

5. Ownership - Costs • Investment in machinery & facilities (fixed & variable costs) • Cost of chemicals • Cleaning, storage, disposal, etc. • Labor • Liability insurance premiums • Recordkeeping

6. Who Cares about Fixed Costs? • Fixed Costs • Depreciation • Interest Foregone • Taxes & Insurance • Maintain constant productive value of assets • Estimate with 15-20% of purchase price

7. Evaluating the Profitability • Partial Budgets • Estimate the net change in profit due to a change in the operation • Breakeven Analysis • Estimate the minimum level of performance needed to cover costs

8. Partial Budgets • “Good Side” vs “Bad Side” • Good = Added Revenues & Reduced Exp. • Bad = Reduced Revenues & Added Exp. • Look only at the factors that change! • Quick, simple, powerful

9. Partial Budget Example • Current Situation • 400 acres of cropland • Custom spray rate = $7/acre • Cost of chemicals = $60/acre • 1-pass program

10. Partial Budget Example • New System • 400 acres of cropland • 120 HP MFWD + 60’ boom sprayer • Cost of chemicals = $60/acre • Other costs of $1,000/year

11. Assumptions • Chemical handling facilities already in place • Storage, cleaning, rinsate disposal, etc. • Labor is available when needed • No change in chemical costs

12. Reduced Expenses • Custom spray • 400 A x $7/A $2,800

13. Added Expenses • Operating Costs: • Tractor & Sprayer • $4.09/A x 400 A $1,636 • Fixed Costs – total $2,154 • Other Costs $1,000 • Total Added Costs $4,790

14. Partial Budget Bad Side Reduced Rev $0 Added Exp $4,790 B. Total $4,790 Good Side Added Rev $0 Reduced Exp $2,800 A. Total $2,800 Net Change in Profit = ($1,990)/year (Line A – B)

15. Results • Under the assumptions • Net Change in Profit = ($1,990)/year • Reducing your profitability by $1,990/year by owning the spray equipment

16. Breakeven Acreage • FC of Equipment / (Margin/Acre) • FC = Depreciation, Interest, Taxes, Insurance • Margin = Custom Rate/A – VC/A • $2,154 / ($7 - $4.09) = 740 Acres/Year • Becomes profitable over 740 acres/yr

17. Breakeven Chart

18. Breakeven Custom Spray Rate • Fixed Costs / (Rate – VC) = Acreage • $2,154 / (Rate - $4.09) = 400 acres • Rate = $9.48/Acre

19. Adding More Realism • But I can buy the chemicals in bulk • Cheaper than what applicator charges • Oh yeah, I need facilities • FC and VC • Might need a nurse tank • FC and VC • Impact on other enterprises • Increased or decreased production?

20. Custom Hire - Advantages • No machinery investment (fixed costs) • No rinsate handling • “quick and easy”

21. Custom Hire - Disadvantages • Timing of application • Cost of chemicals • Dependability, availability

22. Ownership - Advantages • Better control of timing of application • Customized to your operation • Possibility of custom work

23. Ownership - Disadvantages • Cleaning, calibrating, repairing • Liability, liability, liability • Insurance premiums • Recordkeeping • Cost, time involved • Finding the time to spray

24. Other Factors to Consider?

25. So What? • Think about your goals • And your profit centers! • Evaluate the financial aspect • Partial budget & breakeven analysis • Consider the “other factors” • Choose the option that moves you closest to your goals.