Ownership or Custom Hire–Costs to Consider

When considering custom hire or purchasing equipment, farmers should factor in the pros and cons of each to make the best decision for their operation.

With custom hiring, farmers have no responsibility for operating and maintaining the equipment, repair costs, or any damages that would be incurred during the custom operation. 

The advantage of custom hiring is that the operator comes with the machine so that the hiring farmer can perform other tasks such as hauling or unloading, etc., although, these tasks can also be provided by the custom operator as well. This way the farmer is freed from any part of the harvest. It can also be a drawback as the farmer has no control over the quality of the work performed.

If the local labor market is limited, additional labor availability could be a significant reason for custom hire.

There is no long-term capital investment as the charge for the custom hire is paid out of the operating capital. It is paid only for the acreage that needs to be harvested. This can vary from year to year, so the effect on the farm cash flow will vary.

Small acreage farmers can find themselves at a disadvantage if they end up at the bottom of the custom harvester’s list. During bad weather or just simply because there are too many customers waiting, the custom operator can harvest their crops when there is ‘a window’ as opposed to during the optimum time. This could affect the quality of the crop harvested. If the harvested crop is fed for livestock, the lower quality would need to be offset by purchasing costly grain.

To decide whether to custom hire or purchase equipment, producers need to think of the costs associated with either option. Fixed (or overhead) and variable (or operating) costs associated with the ownership need to be weighed. For the custom hire the total costs of the custom hire are used.

The fixed costs of the equipment ownership would suggest that they do not change. However, they are fixed with the ownership, whether the equipment is used in the field throughout the year or just idling in the storage shed. The only time when the owner’s fixed costs are eliminated is when the equipment is sold. Fixed costs still can change over time. For example, repair costs would increase with use, or insurance costs could change with different rates or amounts of coverage.

The fixed cost of ownership includes depreciation, interest, repairs, taxes, and insurance.

Depreciation

Depreciation is a change in the value of equipment because of time, use, and obsolescence. Accumulated hours (or miles) and age are usual factors to determine the remaining or salvage value of the equipment at the end of its economic life.

Interest

Interest on borrowing money to purchase the equipment is determined by the lender. This is the cost of borrowed money for the purchase. If the farmer uses the farm’s cash reserves to purchase the equipment, an opportunity cost of the investment as opposed to other productive investment alternatives, needs to be reviewed.

Repairs

Repair costs in the ‘fixed cost’ category typically represent annual maintenance whether the equipment is used or not. However, it is sometimes difficult to separate annual maintenance costs and variable maintenance costs. These costs include the material (such as fuel, oil) and labor and they increase over time.  Operator’s skills, prices for lubricants in the area, etc. might affect the repair costs. Typically, repair costs are 5% of the purchase price of the equipment, but it pays off to check the farm's maintenance records from the past years’ expenses for better assessment.

Maintenance labor is an important consideration in comparing custom hire versus buying the equipment. It is estimated that the actual hour of labor exceeds field equipment time by 10 – 20%. This includes not only maintenance but also travel time (Edwards, W. 2015). Adding 10 – 20% to the equipment labor dollar value per hour would provide labor cost per our estimate (Edwards, W. 2015).

Taxes

Pennsylvania’s farmers have to pay a six percent tax on the purchase price. There is no property tax on equipment. In other states that collect separate taxes on farm equipment, 2-4% of the value of the equipment could be used to assess the tax.

Insurance

Insurance should be carried on farm machinery to allow for replacement in case of fire, theft, or physical damage. Pennsylvania’s farmers do not need to carry separate insurance if it is under the whole farm policy. If a vehicle is exempt, a minimum liability insurance is required. However, if the equipment is financed the lender might require full insurance coverage if it is used as collateral.

The insurance costs depend on rates or amounts of coverage. Typically, one percent of the average value of the machine often used is recommended to assess the insurance costs for planning purposes. But the actual insurance quote would be a more accurate value.

Another insurance that needs to be considered is worker's compensation insurance for hired/seasonal labor for more than 30 days of employment.

Housing

Housing is not typically included in the equipment fixed costs, but it is something that needs to be taken into account as well. Housing adds to the longevity of the equipment and thus lower long-term costs. It is estimated that 0.5% of the property's average value is sufficient for housing costs. However, a higher estimate would apply to states that heavily rely on property taxes and have higher-than-average property values.

Variable costs for owned equipment include fuel and lube, repair maintenance, and operator labor.

Fuel and Lubrication

A producer can estimate an average fuel consumption in gallons per hour of labor by using a quick method of converting the machine horsepower to gallons per hour. For example, a conversion factor of 0.044 for diesel engines, and 0.06 for gasoline engines is multiplied by the horsepower. A 100-horsepower tractor would use six gallons of gas per hour, multiplied by $4/gallon equal to the costs of $24 per hour (100 x 0.06 = 6 gallons x $3.50 = $24/hour).

Much more detailed and accurate to estimate the fuel costs is to use the Pennsylvania Field Operations Energy Calculator to get the estimates of annual energy use and cost from various field operations and to assess the energy implications of different field management choices. Lubrication comprises approximately 15 percent of the fuel costs.

Labor

Farm labor is another cost that needs to be thought of when considering ownership versus custom hire. There is no concern about incurring labor costs when the custom hire provides the whole amount of work. However, it needs to be considered when the producers need to hire someone outside the farm for any portion of operating the equipment or other tasks such as hauling or unloading. Hourly wages can vary region by region, overtime pay, health insurance, and other benefits mandated by labor laws influence labor costs.

Pennsylvania employers are required to pay workers compensation for agricultural workers who work more than 30 days or earn more than $1,200 in a calendar year from one employer (PA Dept of Labor).

On specialty crop farms when the crops are sold directly to customers, farmers can offset their increased labor cost by increasing the prices of their products. However, a dairy farmer doesn't have such an option in the short term and therefore it has a direct impact on the farm profitability.

When dairy farmers are considering buying equipment or using customer hire, weighing all the factors can help the farmer determine what would be the most advantageous for their operation and bottom line.

References:

Edwards W. Estimating Farm Machinery Costs, Iowa State University, 2015

Pennsylvania Workers' Compensation Act, Department of Labor and Industry.