A Better Understanding Of The Purchase Decision

Deere 4930 sprayer

Changes in agriculture are making headlines. It’s because of bio and mechanical technologies, import/export issues, and the biofuels boom, as well as the impact on a host of areas including commodity prices, farmland values, operating costs, and more. Growers are weighing the benefits of increased capital investments that will help them prosper during this period. Because of these new developments, many in the industry are projecting brighter days ahead.

Despite rising costs in fuel, the sub-prime home mortgage fiasco, and the continued war in Iraq, retail sales in the agriculture/grower sector are up. According to the Association of Equipment Manufacturers monthly “Flash Report,” the sale of all tractors in the U.S. for August 2007 was up slightly compared to the same month last year. For eight months in 2007, a total of 155,541 tractors were sold, compared to 154,730 sold the first eight months of 2006.

As we can see, the number of buyers is up slightly. However, it is still apparent that capital purchase decisions can hinge on hope and are possibly inhibited by fear.

As your grower-customers evaluate what to buy and when, they may face nagging doubts. How long will the good times in agriculture last? Will things continue to get better? Just what are the particular immediate and potential long term effects of this period? Will this current cycle end with disappointment, like the one experienced in the 1980s?

In this environment of shifting expectations, there is much to be gained by understanding how your customers should evaluate capital investments. While customers have their own hopes and fears, you can play a helpful role in exploring more measurable costs and benefits that your products carry into the marketplace. As you gain a better understanding of how customers should properly evaluate purchase decisions with you, you might gain some valuable insights about them and cement your role as a trusted business partner. These insights may also uncover other opportunities to expand your own product and service offerings.

The Best Approach

So how should one approach a capital purchase? Let’s take a look at how America’s corporate community does it. Within the financial control structure of most firms, there is a formal procedure for budgeting and evaluating proposed capital spending. Corporate managers recommending investment in capital goods must demonstrate that the investment will build value for shareholders. There are many analytical approaches ranging from a simple break-even calculation to more robust methods. One of the most widely used and respected techniques is Net Present Value (NPV).

Managers argue that the proposed equipment or machine addition will produce a positive NPV. To arrive at the figure, managers must model (a fancy word for estimate) anticipated cash flows associated with the purchase. These expected revenues are sometimes referred to as incremental cash flows. These flows include incremental revenue brought in by the equipment itself, as well as incremental cost reductions associated with its operation. Examples of cost reduction include reduced labor, savings from fuel use, lower maintenance costs, and many other factors.

When both the positive and negative incremental cash flow have been identified, the impact of the purchase can be tallied. The sum of these future cash flows associated with the life of the equipment is discounted back to its present value. This discounting is done using a discount rate, generally considered to be a firm’s cost of capital. Discount rates vary by business. In the very simplistic example in the accompanying table, we used 10%. Remember, the project cash flows do not depend on where you get the money. Financing costs are reflected in the discount rate.

Being Positive

If the NPV of the project is positive, then it is generally considered worthwhile. If it is negative, the project is usually rejected. In our accompanying example, there was a negative NPV, in spite of some fairly substantial annual cash flows.

Making Right Decisions

The point of this exercise isn’t to turn you into a finance guru or turn your grower-customers into corporate middle managers. Making good capital purchase decisions rides on an understanding of opportunities to increase revenues or reduce costs. These decisions must also recognize the cost of capital. Assumptions need to be grounded in reality. Generating assumptions requires serious thought and analysis. Penciling in $4 per bushel of corn as far as the eye can see probably isn’t a reasonable assumption.

These techniques can be used to enhance learning and evaluation and to overcome fear and uncertainty about the true value of your product offerings. The wrong piece of equipment can put a strain on the business. But working with your customer through a process that critically evaluates the true costs and benefits of a purchase can make you a hero. 

Leave a Reply

Management Stories

Young Corn Plants
ManagementTimac Agro USA Acquires Michigan Ag Retailer
January 20, 2017
Timac Agro USA, an agriculture supply company specializing in high-efficiency plant and animal nutrition products, has acquired St. Louis,MI-based A&E Ag, Read More
Sonny Perdue
LegislationTrump Formally Picks Perdue As Agriculture Secretary
January 19, 2017
U.S. President-elect Donald Trump officially announced Sonny Perdue as his choice for secretary of agriculture on Thursday, selecting a former Read More
ManagementPresident Trump, Wisconsin Review, and a Dow-DuPont Update
January 18, 2017
Editors Paul Schrimpf and Eric Sfiligoj reflect on a new administration, a recent winter show, and crop protection company mergers. Read More
Werner Baumann, Bayer AG, and Hugh Grant, Monsanto
Industry NewsReport: Monsanto, Bayer CEOs Among Latest to Make Trump Tower Pilgrimage
January 18, 2017
The chief executive officers of German chemical giant Bayer AG and U.S. seed behemoth Monsanto, Werner Baumann and Hugh Grant, Read More
Trending Articles
AgriSync
Matt Hopkins17 Agriculture Apps That Will Help You Farm Smarter In 2017
December 9, 2016
Ag professionals are working smarter, not harder, than ever before. Smart farming technologies have enabled them to reduce costs, maximize Read More
R4023 Sprayer, John Deere
CropLife 100Ag Retail Equipment Report: The Green Party Continues
December 7, 2016
In the annual race for sales in the ag retail equipment marketplace, the color schemes for participants are a little Read More
Mike Stern
Precision AgClimate Corp. CEO Talks Retailer Support For Digital Ag
December 1, 2016
CropLife Magazine’s sister publication, AgriBusiness Global, recently sat down with Mike Stern, CEO of The Climate Corp., following the Monsanto subsidiary’s Read More
Precision AgTrimble Debuts End-to-End FMIS Platform
November 28, 2016
October’s inaugural PrecisionAg Vision Conference left this author with many thoughts and things to ponder in the coming months. Probably Read More
CHS Primeland
CropLife 100The 2016 CropLife 100 Report: Reviewing The Many Bulls And Bears Impacting This Year’s Marketplace
November 28, 2016
For virtually all of 2016, the nation was wholly focused on the big Presidential election. Some folks aligned themselves with Read More
Monsanto sign
Crop InputsMissouri Governor Meets With Bayer CEO To Discuss Monsanto Merger
November 21, 2016
Missouri Gov. Jay Nixon visited Bayer AG global headquarters in Leverkusen, Germany, on November 18 to discuss the proposed Bayer-Monsanto Read More
Latest News
Eric SfiligojNo Alternative Facts: Dicamba Cropping System Applicato…
January 23, 2017
During President Donald Trump’s inauguration, much fuss was made over the use of the term “alternative facts” vs. some of Read More
Young Corn Plants
ManagementTimac Agro USA Acquires Michigan Ag Retailer
January 20, 2017
Timac Agro USA, an agriculture supply company specializing in high-efficiency plant and animal nutrition products, has acquired St. Louis,MI-based A&E Ag, Read More
Soybean field
Crop InputsNufarm Teams Up With John Deere Financial
January 19, 2017
Nufarm and John Deere Financial have teamed up to help farmers grow a better tomorrow. This program helps make purchases Read More
Sonny Perdue
LegislationTrump Formally Picks Perdue As Agriculture Secretary
January 19, 2017
U.S. President-elect Donald Trump officially announced Sonny Perdue as his choice for secretary of agriculture on Thursday, selecting a former Read More
ManagementPresident Trump, Wisconsin Review, and a Dow-DuPont Upd…
January 18, 2017
Editors Paul Schrimpf and Eric Sfiligoj reflect on a new administration, a recent winter show, and crop protection company mergers. Read More
Industry NewsBayer, MS Technologies Get China Approval For Balance G…
January 18, 2017
MS Technologies and Bayer have received import approval from China for Balance GT soybeans. The new Balance GT Soybean Performance Read More
Werner Baumann, Bayer AG, and Hugh Grant, Monsanto
Industry NewsReport: Monsanto, Bayer CEOs Among Latest to Make Trump…
January 18, 2017
The chief executive officers of German chemical giant Bayer AG and U.S. seed behemoth Monsanto, Werner Baumann and Hugh Grant, Read More
Giant Ragweed
HerbicidesStudy: Focusing On Weed Seedbank Can Help Manage Herbic…
January 18, 2017
Researchers writing in the latest issue of the journal Weed Science provide important insights on the control of herbicide-resistant giant Read More
Management3 Financial Trends To Watch In Agriculture
January 17, 2017
I recently had the opportunity to attend a meeting of credit managers for Midwest ag supply and input companies, in part Read More
Andersons Retail Store
CropLife 100The Andersons To Close All Retail Stores; Shutdown Does…
January 16, 2017
In a stunning announcement to the Toledo area, The Andersons Inc. said on Sunday that it would close its two Read More
Trimble TMX-2050 In-Cab Display
Eric SfiligojPrecision To Lead Agriculture In 2017?
January 16, 2017
Another new year is upon us! And I’m certain I speak for many in the agricultural world when I say Read More
Corn
Eric SfiligojThe Mood From Madison? In A Holding Pattern
January 16, 2017
Last week, I had the chance to attend the annual Wisconsin AgriBusiness Classic show in Madison, WI. It’s been a Read More
Syngenta Sign
Crop InputsAccenture Helps Syngenta Transform Its Global Logistics
January 13, 2017
Syngenta, a leading agriculture company, has collaborated with Accenture to design and implement a new digital logistics operating model across Read More
Fall Creek Seth Harden The Nature Conservancy
StewardshipLocal Farmers’ Watershed Initiative: Continuous Improve…
January 13, 2017
The goal in the Big Pine Watershed Project is to more intentionally do what local farmers and responsible ag retailers Read More
HerbicidesEPA Expands Enlist Duo Herbicide Registration To 34 Sta…
January 13, 2017
The U.S. EPA has expanded the geography for application of Enlist Duo herbicide from 15 to 34 states. This means Read More
Olson Ag Enterprise
CropLife 100Wilbur-Ellis Acquires Nebraska Seed Retailer
January 13, 2017
Wilbur-Ellis’ Agribusiness, a recognized leader in precision agriculture technology and the distribution and marketing of plant protection, seed and nutritional Read More
ManagementDeere-Precision Planting Update and the Ag Secretary Wa…
January 12, 2017
Editors Paul Schrimpf and Eric Sfiligoj provide the latest on the court date for John Deere/Precision Planting and the quest Read More
Monsanto sign
Seed/BiotechMonsanto, NRGene Form Agreement For Big Data Genomic An…
January 12, 2017
Monsanto Co. and NRGene have announced that the companies have reached a non-exclusive, multi-year global licensing agreement on NRGene’s genome-analysis Read More