CUSTOM SERVICES OR DOING IT YOURSELF:
WHAT TO DO, WHAT TO DO?
Prepared by Bruce L Jones
UW-Madison
Department of Agricultural and Applied Economics
Through the years, most Wisconsin farmers have tended to
operate under the assumption that they were better off if they
did everything for themselves. As such they made sizable
investments in the machinery and equipment needed to raise
and harvest crops or the facilities needed to raise replacement
stock.
At first glance it is understandable that producers would want
to be able to perform all the tasks that need to be done on a
farm. Because this is the only way to insure that these tasks
will be controlled by the producers.
Benefits from control
1.
Tasks performed
a)
b)
2.
how producers want them done
when producers want them done
Raising one’s own feed or replacement
stock shields one from price risks in the
market place
Are these benefits from control really captured by producers?
Tasks performed as producers want them done
** only if producers can afford the technology to do them
Tasks performed when producers want them done
** only if producers do not have any other demands on their time
Raising one’s own feed or replacement stock shields one from price
risks in the market place
** the price or cost of raised feed and livestock vary from year to
year just as they do in the marketplace when supplies change as a
result of weather conditions and other factors.
In the last few years more and more producers are starting to question
whether in fact it is advantageous for them to engage in multiple farming
activities.
These producers are coming to the realization that in many cases they
could make better use of their limited capital and labor if they do not
spread these resources across multiple enterprises and instead commit
these resources to one or two enterprises and contract for other services
such as producing and harvesting crops or raising replacement stock.
These producers are correctly recognizing that it
makes little economic sense to commit labor and
capital to one activity when greater returns can be
gained from committing these resources to another
activity. It is encouraging that producers are starting
to grasp the simple economic principle.
One of the business arrangements that producers are
now starting to use in the operation of their dairy
farms is custom services. Under these arrangements
producers contract for such services as custom
harvesting or raising heifers so that they are no longer
required to commit labor and capital to these activities
that support a dairy herd operation.
Task today is to demonstrate how
one should go about deciding
whether it would be advantageous
to enter into a custom service
arrangement. Specifically we will
consider custom harvesting of
forage and raising replacement
heifers.
Decision on whether one should perform an activity
for oneself or hire someone else to do it hinges on
both costs and risks.
If it is less costly and/or risky to hire someone else to
perform a custom service, it follows that one will opt
for a custom service. The reverse is true if it is less
costly and/or risky to perform the task for one’s self.
The cost of a custom service is easily determined since it
is reflected in the charge quoted by the party that will be
providing the custom service.
The cost of performing the same activity that would be
available as a custom service is not as easily determined
since it has to be estimated on a case by case basis. This
specific challenge confronting the manager is
determining the value of the labor and capital that would
be used to perform a task such as harvesting forage or
raising replacement stock.
Costs of Labor and Capital
For labor, costs are determined by:
-
hours of labor to be used
hourly wage rate for labor
The hours of labor to be used can generally be found in enterprise
budgets from UWEX and others.
The challenge is discovering the appropriate hourly wage rate.
Going rate in local labor market wage being paid to hired labor or the
earnings expectation of operator.
For capital, costs are determined by:
1.
2.
value of capital being used
usage costs for capital
The value of capital being used is observable in the
market place
Usage costs are guesses at best
Depreciation
Interest
Repairs
Taxes
Insurance
Depreciation and interest are the major costs on capital
and they are the ones most likely to be overlooked by
producers because they do not trigger an outflow of cash.
However these are relevant costs because they are a drag
on equity.
Depreciation - expense which draws equity down over
time
Interest - the returns that could be earned if capital was
used elsewhere
Debt retirement
Dairy cows and related investment
Land
Stocks, Bonds, etc.
Forage Harvesting as Haylage
Machinery & Equipment
Purchase
Life in hours
Tractor 65 HP
Tractor 100 HP
Tractor 130 HP
Tractor 160 HD MFWD
28700
45000
56000
97900
6000
6000
6000
7200
Mower Cond. 12 FT
Forage Harv Base - Large
Blower, Forage - Large
Forage Wagon #1
#2
#3
Rake
15900
29000
5600
11200
9500
2000
4900
1000
1000
1000
2000
2000
4000
2000
Costs Per Acre
Energy
Repairs
Cash Costs
13.18
7.17
20.35
Labor (2.76 hrs)
Depreciation
Interest
Non-Cash
41.17
35.54
37.57
114.28
Energy, Capital, & Labor Costs
134.63
Energy, Capital, & Labor Costs
Input Costs
Land Costs
Prop. Taxes
Mang. Return
Total Costs
134.63
50.39
58.00
10.00
23.18
276.20
Benefit of utilizing machinery and equipment more
intensively.
Depreciation, repairs, energy costs, and labor are pretty
much unaffected by how intensively one uses
machinery and equipment because these costs are tied
to the hours of usage. This is not the case however
with interest charges.
Example interest costs on 130 HP tractor
Purchase Price
Salvage Value
56000
19320
Useful li fe i n:
Hours
Years
6000
12
Average Investment
5600 + 19320 = 37660
2
Interest over life of tractor
37660 x 10% x 12 = 45192
Interest per hour of use
45192  6000 = 7.53
Impact on cost if 6000 hours of useful life
used over 8 years versus 12 years
Interest over life of tractor
37660 x 10% x 8 = 30128
Interest per hour of use
30128  6000 = 5.02
Change in hourly cost of usage
$2.51 per hour
REPLACEMENT HEIFERS
INCENTIVES FOR RAISING REPLACEMENT
HEIFERS
Control
Certainty and continuity as to genetics of heifers
DRAWBACKS OF RAISING REPLACEMENT
HEIFERS
Risk of ownership - death
Commitment of Resources
Little or no choices
CUSTOM SERVICES
Retain ownership risks but shift cost and production risks
to party that is raising the replacement heifer.
CHARGES
$/Head
$/Head/Day
ADVANTAGES
Controls price risk on inputs
Access to capital and labor
CHALLENGES
Setting performance premiums and penalties
Age
Body Condition
Mortality Rates
Establishing charge
TOTAL COSTS NET OF HEIFER SALE
SALES VALUE OF HEIFER 1200
TOTAL 0 TO 24 MONTHS
TOTAL 0 TO 26 MONTHS
ADJ.
QUANTITY
DOLLAR
VALUE
ADJ.
QUANTITY
DOLLAR
VALUE
14677
21.90
286.63
69.63
49.77
50.98
587.10
32.85
24.36
15.32
3.48
25.49
168776
21.90
286.63
75.63
53.77
50.98
675.10
32.85
24.36
16.64
3.76
25.49
VARIABLE COSTS
FEED REQUIREMENTS
FORAGE
CORN EQUIVALENT
SOYBEAN MEAL
DICAL
MINERAL SALT
MILK REPLACER
lb
bu
lb
lb
lb
lb
TOTAL FEED COSTS
LIVESTOCK COSTS
BEDDING
VET & MEDICINE
BREEDING
POWER & FUEL
SUPPLIES
OVERHEAD
688.60
2560.59 lb
$
$
$
$
$
TOTAL LVSTK COSTS
LABOR
lb
bu
lb
lb
lb
lb
51.21
26.29
28.55
22.37
22.50
18.64
778.20
2740.59 lb
$
$
$
$
$
169.56
28.23
hr
282.30
54.81
27.49
28.55
24.97
22.90
18.64
177.36
29.83
hr
298.30
INTEREST
105.43
106.97
TOTAL VARIABLE COSTS
1245.90
1360.84
HFR. SALE for $1200
NET VARIABLE COSTS
.14
hd
163.64
1082.27
.14
hd
163.64
1197.21