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
ManagementMACA 2014: The State Of The Agricultural Industry, And Then Some
October 9, 2014
The trade association’s annual gathering featured speakers from across agriculture and beyond. Read More
StewardshipA Multi-Layered Approach To Water Quality
October 6, 2014
Illinois event highlights research and technology designed to better monitor and improve water quality — and the benefits of cooperative, coordinated effort. Read More
StewardshipMichigan Agriculture Leaders On Toledo Water Ban: We Want To Be Part Of The Conversation
August 8, 2014
Leaders of Michigan agricultural organizations said Thursday that the government should not have a “knee-jerk reaction” based on last weekend’s water ban in Toledo due to fertilizer run-off in Lake Erie. Read More
ManagementRussia Bans U.S. And EU Ag Product Imports In Ukraine Sanctions Battle
August 7, 2014
Russian President Vladimir Putin has banned the import of agricultural goods from countries that have imposed sanctions on Russia. Read More
Top 100 Articles
CropLife 100Pinnacle Agriculture Acquires Minnesota Retailer
April 14, 2015
Pinnacle Agriculture Holdings, LLC, ranked No. 6 on the CropLife 100,  has successfully acquired Liebl Ag, LLC in Ada, MN.  Read More
CropLife 100CHS, Aurora Cooperative Complete Fertilizer Storage, Grain Shuttle Loading Facility
April 13, 2015
CHS Inc., the nation’s leading cooperative and ranked No. 5 on the CropLife 100, and Aurora Cooperative (ranked No. 21) Read More
CropLife 100GROWMARK Acquires Missouri Refined Fuels Terminal
April 2, 2015
Bloomington, IL-based GROWMARK and Magellan Pipeline Co. have entered into an agreement in which GROWMARK will acquire the refined fuels Read More
CropLife 100Wilbur-Ellis Acquires South Dakota Retailer
April 2, 2015
Wilbur-Ellis Co.’s Agribusiness Division, a recognized leader in precision agriculture technology and the distribution and marketing of plant protection, seed Read More
CropLife 100The McGregor Co. Closes Smith-Kem Acquisition
April 2, 2015
The McGregor Co. — ranked No. 16 on the CropLife 100 list of largest U.S. ag retailers — has completed Read More
CropLife 100BRANDT Commemorates National Ag Day
March 20, 2015
The Illinois agriculture community gathered at BRANDT global headquarters on March 18 to celebrate National Ag Day behind this year's theme Sustaining Future Generations. Read More
Latest News
Syngenta
Eric SfiligojWill Monsanto And Syngenta Combine This Time?
May 4, 2015
Under the heading of “never say never,” it sounds as if crop protection/seed giants Monsanto Co. and Syngenta are once Read More
Dr. Bryan Young, Southern Illinois University, shows tour attendees a female Palmer amaranth plant.
Crop InputsPurdue Weed Scientist Publishes Weed Resistance White P…
May 4, 2015
Resistant weeds, the appropriate use of herbicides and integrated weed management strategies are highlighted topics in the new white paper, Read More
Industry NewsMonsanto-Syngenta Mega-Merger Would Drive More Deals
May 4, 2015
A combination of Monsanto Co. and Syngenta AG would set the stage for even more mergers and acquisitions, reports Brooke Read More
InsecticidesAgrian Announces New California Feature
May 4, 2015
Agrian announced today that it has developed a feature within its recommendation writing program that will support the California Department Read More
Storage Tanks at Nachurs
FertilizerNachurs Alpine Solutions: Liquid Fertilizer With Precis…
May 4, 2015
When it comes to fertilizer options in 2015 and beyond, ag retailers are taking a long, hard look at liquid. Read More
West Central Sac City growers
StewardshipIowa Lawsuit Challenges Ag’s Water Quality Efforts
May 3, 2015
Nutrient problems in west-central Iowa’s water supply made national headlines in March when the Des Moines Water Works (DMWW) filed Read More
Tim Hassinger Dow AgroSciences President and CEO
Crop InputsDow AgroSciences: Always About Agriculture
May 2, 2015
When you consider their respective backgrounds, it’s little wonder why Dow AgroSciences and new President/CEO Tim Hassinger ended up together. Read More
Nozzle spray close-up
AdjuvantsSpray Drift Enters More Complex Era
May 1, 2015
Off-target movement of crop protection products has been a problem for decades. The issue got more contentious when glyphosate-tolerant crops Read More
Crop InputsTop 10 Twitter Pics For #Plant15
April 30, 2015
Growers and ag retailers are working feverishly to plant this year’s crop. Fortunately, many of them still have time to Read More
ManagementIowa Retailer Sticks Up For Agriculture and New Spray D…
April 30, 2015
Paul Schrimpf and Eric Sfiligoj talk about how one Iowa ag retailer is working to defend agricultural practices and an Read More
Dow AgroSciences Logo wall
Seed/BiotechNew Soybean Trait Agreement To Use Dow AgroSciencesR…
April 30, 2015
Dow AgroSciences LLC, a wholly owned subsidiary of The Dow Chemical Co., Arcadia Biosciences, Inc. and Bioceres, S.A. have formed an agreement Read More
Confluence of St. Croix and Mississippi Rivers in Minnesota
StewardshipAgricultural Runoff Among Causes Of Water Quality Issue…
April 30, 2015
A new report released April 29 by the Minnesota Pollution Control Agency provides additional evidence that agricultural and urban runoff Read More
EquipmentTop 30 IRON WORKS Cartoons Of All Time
April 29, 2015
When CropLife IRON first started publishing more than a decade ago, long-time Publisher Al Strohmaier decided to start a cartoon Read More
StewardshipCPS-Hillsboro Becomes First ResponsibleAg Certified Fac…
April 29, 2015
Unlike a race where the first finisher takes home a medal or blue ribbon, safety and regulatory compliance doesn’t often Read More
HerbicidesWeed Scientists Offer New Definition For ‘Superwe…
April 28, 2015
The Weed Science Society of America (WSSA) has joined with six sister organizations to recommend a new definition for superweed Read More
Crop InputsValent Announces “Relentless As You’ Contes…
April 28, 2015
Valent U.S.A. Corporation today announced the winners of its national “Relentless As You” contest, which recognized the relentless spirit of Read More
HerbicidesSyngenta’s Acuron Secures EPA Federal Approval
April 28, 2015
Growers looking to control difficult weeds like waterhemp, giant ragweed and Palmer amaranth will have access to Acuron corn herbicide Read More
FertilizerSimplot’s Gal-XeONE Technology Moves West
April 27, 2015
The J.R. Simplot Co. remains committed to creating customer value through technology. In 2013, Simplot purchased the Gal-XeONE controlled release Read More