Setting custom rates isn't easy. “There's a fine line between the value your customers find in your service and what you need to charge,” says Dan Morgan, a corn and soybean grower who does custom strip-tillage for more than a dozen farmers near Morristown, MN.
Many farmers rely on custom-rate surveys from land-grant universities to figure out what to charge. These surveys are a good starting point, says Brad Carlson, University of Minnesota Extension educator, but state averages may not reflect your total machinery costs. “The real number that should be charged is a much more complicated thing to determine. Nevertheless, it is a calculation that I encourage everyone who does custom work to go through.”
Here are things to consider when setting your custom rates:
As a graduate student in ag economics, Scott City, KS, farmer Aaron Beaton looked at whether typical custom rates “truly covered all costs.” He and his family do quite a bit of custom farming, and he wanted to be sure “we were making money on it, rather than giving away our time and depreciation for free.”
His 2003 study found that average published custom rates in Kansas were actually about 30% lower than the full economic cost of owning and operating machinery. A 2001 study by University of Illinois Ag Economist Gary Schnitkey found similar results.
There are many reasons why average custom rates may be lower than farmers' actual machinery costs, says Kevin Dhuyvetter, Kansas State University Extension economist. For example, neighbor-to-neighbor work may be less timely, lowering its value. Farmers doing custom work on the side may charge only for time and fuel, considering their fixed costs to be sunk costs.
Custom farmers often use their machinery over more acres, thereby cutting their per-acre costs. Custom fertilizer and herbicide applicators may bundle prices, taking more markup on chemicals than on machinery operations.
A full accounting of crop machinery costs should include the following fixed and variable costs, Dhuyvetter says: machinery repairs; gas, fuel, oil; pickup expense allocated to crop production; machinery depreciation; machinery hire; machinery insurance; machinery shelter; opportunity interest on machinery investment; and machinery labor.
Many state Extension services offer online spreadsheets to help you calculate your machinery costs.
When calculating machinery ownership costs, use market depreciation rather than IRS depreciation. Aaron Beaton, the Kansas custom farmer, scours classified ads and auction results to estimate the market value of his machinery inventory. “I try to be fair and accurate, otherwise I'm just shooting myself in the foot. If I don't allow enough depreciation, I might not be coming out on my rates.”
Opportunity interest — the revenue foregone had your machinery capital been invested in the next best enterprise — is usually calculated as a percentage of machinery market value. Dhuyvetter suggests allowing 6-8% for opportunity interest.
Well maintained farm machinery “can last just about forever,” Minnesota's Carlson says, but there's usually a trade-off between equipment depreciation and repairs. So if you run older machinery, consider “your time spent keeping the machine repaired and maintained.” Often, “that may be about the same as depreciation on a newer machine,” he says.
You may love your work, but that doesn't make it worth less, Carlson says. Minnesota custom strip-tiller Dan Morgan values his labor at “close to $20/hr.” Despite tools like auto-steer, Carlson adds, “you still need an experienced operator with knowledge and skill.”
If you build a labor charge into your custom rates, as well as depreciation, opportunity interest and other non-cash costs, should you also build in profit?
“You need to decide that for yourself,” Carlson says, “but many would like to see at least a 5%return on investment.”
Another profit strategy is “to get your costs down so that you can charge the going rate,” Carlson says.
Per-acre machinery costs vary widely from farm to farm, Dhuyvetter notes, even among similar-sized operations. For example, about a quarter of farms enrolled in the Kansas Farm Business Management Program performed machinery operations for less than average custom rates, according to a 2003 report. So if you expect to offer competitive custom rates and still make a profit, “you'd better make sure your costs are in the bottom 25%,” he says.
When diesel fuel costs soared in 2008, Dhuyvetter received calls from farmers asking how much they should adjust their custom rates for higher fuel prices. “That told me they didn't know how much fuel they were burning per acre.” Fuel expense is one of the easier components of machinery cost to figure, so make it a point to do the math, he says. And if you don't have a good idea of your tractor's fuel economy, “you should consider measuring it,” Carlson adds.
Before you line up custom work, think about how many days you are likely to have available, Carlson says. In Minnesota, for example, you have about 10 working days to complete timely planting.
Dan Morgan, who does custom strip-tillage in southeast Minnesota, figures he gets about 20 fall days to strip-till and band nutrients. Last fall, he and his brother Dennis strip-tilled 3,000 acres. Because of the delayed harvest, they didn't get to another 500 acres they had lined up. Those fields will have to wait until spring, a less desirable time to strip-till.
If you are doing custom work as a sideline, ask yourself if timeliness on your own farm will suffer, Dhuyvetter says. If so, that cost must be factored into your rate. On the other hand, “don't expect to be able to charge top rates if you are coming a week late.”
The 2009 harvest had custom operators puzzling over what to charge for the “mud factor,” Dhuyvetter says. Harvesting in muddy conditions cuts productivity, raises fuel use and increases combine wear and tear. Dhuyvetter estimates that custom operators “probably need to increase rates by about 25% because of fighting mud,” although he adds that conditions will vary a lot from one situation to another.
Before Dan and Dennis Morgan set their rates for custom strip-tillage, they talked to experienced custom strip-tillers, lined up enough acres to cover their direct costs and bought a used strip-till machine to keep their expenses down.
The Morgan brothers, who farm about 700 acres near Morristown, MN, got into custom strip-tillage because they wanted to “band fertilizer in the fall for more fertilizer efficiency,” Dan Morgan says. The brothers have done custom application since 1990.
They started out with an older Ag Systems 12-row strip-till machine. “We figured out our costs and how many acres we could get done in the fall,” Dan says. To market their service, they put on a field demonstration for area farmers and hired a speaker to explain the benefits and cost-savings of strip-tillage and banding fertilizer. They also checked rates of veteran custom strip-tillers from South Dakota.
In 2007, their first fall doing custom strip-tillage, the Morgans set their rates on the low side, at $15/acre, in order to build their business, Dan says. They raised their rates by $1/acre the next fall to cover higher fuel prices.
In 2009, the Morgans invested in a more efficient, 16-row Case IH strip-tillage machine. “We were able to cover more acres, so we could keep our rates the same, even though we have a more expensive machine,” Dan says. Booking ground through their local co-op, they strip-tilled 3,000 acres in 2009.
“If you have the machinery capacity and are looking for extra work, there's opportunity,” Dan says. “You have to promote your service and line up your acres in advance. The key is getting enough acres to keep the cost per acre down.”