Equipment Replacement

Reasons to Replace Machinery

The decision to replace an item of farm machinery can be made for several reasons.

Cost Minimization

The standard rule for minimizing the long-run cost of equipment is to make a change when the annualized total cost of owning and operating the machine begins to increase. In the example shown in Figure 1, this happens in about the 10th year of ownership. At this point repair costs begin to increase faster than depreciation and interest costs decrease. However, the rate at which total costs rise is often very gradual. In this case, the total cost in year 10 is estimated to be R29,846 while the cost by the time the tractor is 15 years old is only R30,450.

Thus, while the rule of increasing total cost can give a general picture of when to replace a particular machine, it cannot give a precise answer. Note that the estimates for repair costs project them to increase gradually over time. In reality, though, repair costs tend to be quite variable from year to year, ranging from only routine maintenance items to a complete overhaul. Being able to anticipate when large repair costs will be needed is a key consideration in deciding when to replace a machine.

Reliability

Besides the standard machinery costs, most operators also consider timeliness costs in their replacement decisions. Timeliness costs occur when crops are not planted or harvested at the optimal time. They can be attributed to losses in yield, such as when corn or soybeans are planted too late to enjoy a full growing season, or a loss of quality, such as when hay or silage is not harvested at its peak nutritional value. If a machine breaks down at a critical time, timeliness costs can be quite high. Timeliness costs are very hard to measure, however, and their importance depends on the weather in any given year. Nevertheless, they should not be ignored, especially in climates where the optimal planting or harvesting period is rather short, and for crops that are particularly sensitive to the effects of weather. Owning machinery that has a high probability of breaking down increases the risk of crop losses.

Pride of Ownership

Many farmers take pride in owning and operating new, modern machinery. They may be willing to accept higher long-run costs in return. If the farm business is financially able to bear this cost, there is nothing wrong with “new paint.” However, the operators should have a clear idea of how their own machinery costs compare with those of other operations and the scope of their opportunity cost from not having capital invested in other assets.

New Technology

In some cases, a machine may be in perfectly good working order, but the introduction of new technology has made it obsolete. Newer models may do a better job of harvesting or planting or operate more efficiently. Care should be taken to distinguish new technology that can increase profits from changes that simply provide more convenience and comfort.

Need for Capacity

When the number of acres of crops being produced increases significantly, operators may need to replace machinery with models that have higher capacity to complete planting and harvesting without serious timeliness losses. Likewise, when farm size is reduced, it may be possible to cut costs by downsizing the machinery set.

The Farm Machinery Market

The market for farm machinery is subject to changes in supply and demand, just as for any other product. In particular, the demand for both new and used machinery is strongly affected by ups and downs in the farm economy. The operator who maintains a good capital reserve or borrowing capacity may be able to reduce long-run ownership costs by replacing machinery when dealers have excess inventory and are willing to offer deep discounts to make a sale. When the farm economy is below average, there may be bargains available in used machinery.

General Replacement Strategies

There are at least four general strategies that farmers can follow for replacing machinery.

Replace Frequently

This approach minimizes the risk of breakdowns and costly repairs by trading key machinery items every few years. Even when repairs occur, they often will be covered by the original warranty. Operators who cover a large number of acres each year and would be severely inconvenienced by extended down time are most likely to follow this strategy. Although this is probably a more expensive approach over the long run, some of the extra costs are offset by fewer timeliness losses, the ability to farm more acres, and less need to invest in repair and maintenance tools and facilities.

Operators who trade machinery frequently may find that leasing or rollover ownership plans are more feasible for them than conventional purchase plans. These options are discussed later.

Replace Something Every Year

A second approach is to try to replace one or two pieces of machinery every year. The goal is to spend about the same amount on new equipment each year. This avoids having to make a very large cash outlay in any one year. However, it also could result in replacing machinery before it is really necessary.

This strategy often is used by operators who prefer to finance machinery purchases out of their annual cash flow rather than with borrowed money. It works best when the net cash income of the operation is fairly constant from year to year or when significant cash reserves are available.

Replace when cash is available. A third approach is to postpone major machinery purchases until a year when cash income is higher than average. This keeps the machinery purchase from cutting into funds needed for other purposes such as family living and debt servicing. It also helps to level out income for income tax purposes, although the flatter federal tax rates and the ability to use income averaging have made this less of a consideration than in previous years. The biggest disadvantage of this strategy is that it is very hard to predict when extra cash will be available. Furthermore, a machine may become seriously unreliable before the business has sufficient funds to replace it.

Keep it Forever

Finally, some operators simply hang on to machinery until it reaches the point where it can no longer perform its intended function and is not worth renovating. This may be the least cost approach in the long run, but it runs the risk of a machine failing at a crucial time or having to arrange financing on short notice. The operator also must be willing to use less than the latest technology. Some older items can be relegated to less critical uses, such as keeping a second planter for a backup unit or using an older tractor for jobs such as powering an auger or moving wagons. This strategy works best for operators who have considerable flexibility in when they complete key field operations, and who have the skill, patience, and facilities to do their own repair and maintenance work.

It is clear to this point that recordkeeping with regards to equipment on a farm is of essential importance. To make sure that equipment is kept in good working condition and does not cost the farm more to maintenance than the value it adds, a replacement policy should be implemented. Steps to be followed when setting up the equipment replacement system on your farm:

• Keep a record of the total hours and kilometres your vehicle runs per day/week/month as well as an accumulative record.
• Compare this to the manufacturer’s guideline on optimum hours/kilometres your vehicle can travel to remain productive.
• When the vehicle reaches the maximum hours prescribed by the manufacturer, make the cost-benefit calculation, comparing the cost benefit of your existing vehicle with the cost/benefit of purchasing a new one.

Click here to download an example of a equipment replacement policy.