With net farm income expected to fall 8.7% in 2017[i] marking the fourth straight year of decline, producers have significantly changed their equipment buying habits. In the past, it was common for large tractors and combines to be traded in after one or two years old, which worked well in an up market because first buyers enjoyed the latest equipment and there was strong demand for used equipment, ensuring high trade-in and resale values. However, following the decline in commodity prices starting in 2013, demand for used equipment has dampened and pricing has moved in tandem.
This pattern is compounded by the trends of farm consolidation and increasingly advanced technology. With larger farms and tighter margins, producers are putting more emphasis on controlling costs and improving efficiencies of operations through scale and technology. The result is fewer and larger farms using bigger, more expensive and more technologically advanced equipment, which in turn limits the pool of viable secondary buyers, as small to medium-sized farms simply can’t justify the size or cost. Furthermore, with emission regulations varying significantly from country to country, it’s difficult to move equipment around the world. Therefore, initial buyers of large, high-tech equipment in North America are forced by simple economics to keep and maintain equipment for a longer period stretching up to five or six years. Luke Smith, who grows corn and soybean in northern Indiana, describes the dilemma. “We want to stay in the latest technologies, but when the used market dried up, it stopped making sense to trade in every tractor each year.”
Not surprisingly, lease activity has ramped up during the last three to four years, as producers have eyed ways to keep their balance sheets healthy and free up capital needed for things such as land. As a result, original equipment manufacturers (OEM) and dealers are finding themselves left with more used equipment when leases expire. An April poll by “Farm Equipment” found 9 of 10 dealers concerned about the impact of the high number of lease returns on inventories and prices.[ii] Last year, Deere restructured its leases to reflect the lower residual value of used equipment.[iii] An executive in the equipment industry says, “There’s no doubt, the whole environment has changed, and it’s probably the new normal. Residuals on used equipment reached unsustainable levels during the boom.”
Beyond leasing solutions, forward-looking OEMs and dealers are beginning to explore other ways to meet the needs of customers keeping their equipment for longer. Servicing these customers and their older equipment will require a different mindset and different packages, such as extended service contracts or a guaranteed total cost of ownership agreements. Our industry might be wise to look to other sectors for ideas on making long-term ownership a viable alternative to leasing. Interestingly, some manufacturers in the construction equipment industry have already adapted their model to satisfy buyers who are keeping their equipment for longer periods and want assurance around cost management. Caterpillar’s Total Maintenance and Repair agreements, for example, allow equipment owners to pay a flat fee to cover all service, maintenance and repair costs during a period of time. The similar complexity and high-tech nature of large agricultural equipment lends itself to this model as well. Luke Smith of Smith Family Farms says, “Knowing your costs is such a big factor in farming because there are so many variables. A three-year service deal on equipment—where we can predict the exact cost—would make a huge difference.” Equipment industry executives confirm producers’ growing interest in extended warranties, maintenance contracts, and complete refurbishment to extend the life of their equipment assets. Some manufacturers are moving toward common architecture in their equipment to make it easier to offer seamless technology upgrades.
Another potential solution could include product-as-a-service or pay-as-you-go models. Avionics engine manufacturer Rolls-Royce first dubbed its performance-based contract as “power by the hour,” reflecting that compensation was tethered to actual product usage.[iv] Under this scenario in the ag equipment industry, producers would only pay for the time they used a tractor, combine or sprayer. In other words, could there be a role for an Uber of farm equipment? It’s already a reality in India, where Mahindra and Mahindra’s agricultural equipment division launched Trringo in 2016, a tractor-by-the-hour service, complete with surge pricing for peak periods, such as harvest time.[v] The construction equipment industry again offers a parallel. Recently, Caterpillar announced the acquisition of Yard Club, a service platform that allows contractors to easily rent machinery to one another for weeks at a time. The rentals in turn allow businesses to boost revenue in between jobs. An executive in the ag equipment industry notes that he’s watching this development closely. “Machinery Link has been trying to do same as Yard Club,” he says, “but farmers are resistant so far. Planting and harvest windows are so narrow, and farmers are tradition bound.”
Much of today’s ag equipment is large, expensive, and burdensome to transport, which has limited the success of equipment-sharing business models in the ag industry. However, as autonomous and semi-autonomous technology becomes market-ready, we are likely to see equipment size shrink, with smaller pieces of equipment working in tandem. An equipment industry executive says, “Instead of one large tractor, you might see ‘swarms’ of small planters that could be easily deployed in different combinations and different regions, depending on the planting window.” This scenario would improve the economics of equipment sharing over larger geographies with different non-overlapping working windows. Smaller equipment will be easier, cheaper, and faster to move from location to location.
Right-Fitting a Solution
Given the current business environment, manufacturers and dealers alike are wise get in front of the impacts by asking critical questions, such as:
- How are we adapting our selling or leasing process to meet this new and changing market, where customers will keep their equipment longer and will want assurances to lock in owning and operating costs?
- How will the change in types of ownership (i.e., more leases and rentals) impact our capital requirements?
- How is our technology replacement cycle synched up with customers’ lengthening equipment replacement cycle?
- How will our business model change as the used market shrinks and the new market demands larger and more technologically advanced equipment?
- Are we thinking out of the box to find unique solutions to customers’ needs? Are we ready to lead the way or are we at risk of being Ubered?
The Context Network has many years of experience in helping organizations in the equipment industry identify and execute go-to-market strategies that address customer needs in changing economic environments. Through our deep business knowledge and broad network of growers, dealers, and experts, we can glean current market information to gain an understanding of what expectations exist in the particular market cycle. For more information, contact Doug Griffin at email@example.com.
USDA Economic Research Service https://www.ers.usda.gov/topics/farm-economy/farm-sector-income-finances/highlights-from-the-farm-income-forecast