New harvest equipment can run into the hundreds of thousands of dollars. Genetic testing of breeding stock can be equal or even exceed a year’s average return on a per-head basis.

Further, the returns from adopting new technology are usually uncertain. For example, will buyers pay for genetic information?

What if a producer discovers through testing that his stock does not have genetics desired by the market?

While theoretical tools are available to analyze even the most complex decision problems, the information requirements or training needed to utilize these tools are often too onerous to be practical for most real-world decisions.

So, practitioners rely on alternative decision tools that have lower informational requirements. While economic theory and decision analysis are not likely to be favorite topics around the family dinner table, an understanding of what economic factors need to be considered is critical to achieving a farm’s financial goals.

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Here I discuss three criteria for analyzing complex agricultural investment decisions and some tools that producers can use to aid in investment decision-making.

Decision criteria

The three criteria are:

  • relative scale of the investment
  • perceived riskiness of the investment
  • the degree of reversibility of the investment

First is the relative scale of the investment. Relative scale might be in terms of percent of business being changed or in terms of dollars invested.

For example, think of a U.S. soybean producer considering changing 160 acres to a new variety.

For a 2,000-acre farm, this is probably a fairly minor change.In contrast, a 160-acre change for a 320-acre organic farm is a major change.

Second is perceived risk. In the previous U.S. farm example, a 160-acre change to a new variety is most likely a low-risk decision.

Producers routinely make these decisions, seed companies and land grant universities routinely publish varietal trial results, and markets likely exist for the new variety.

So this decision has a low level of perceived risk. While for the organic farmer, a 160-acre change might have very significant consequences.

Get the decision wrong and he could lose the farm. So the decision might have a high level of perceived risk.

Third is the degree of reversibility. Some decisions can be un-done at a low cost and in a short time period.

In the soybean example, the larger U.S. producer can switch back to the old variety in the next growing season, a low-cost and short-time reversal.

An example of a potential high-cost and long-time reversal is the decision to change hide color in a breeding herd. Individually and collectively, U.S. beef producers have selected for black-hided cattle in response to market premiums.

While a rational response to economic conditions, it would be costly and take several years to “undo” this decision.

Few producers have the financial ability to sell off existing breeding animals and replace them in a short time period, say one or two years.

Most U.S. producers would take eight to 10 years to either replace their existing breeding herd by buying new bulls and breeding in the desired hide color or buying replacement females over several years.

Before making an investment decision, producers should consider each of these criteria and weigh them relative to the expected returns from the investment.

Even if the scale is large, the risks are high and reversibility low, an investment might still be advisable if the expected returns are large enough to offset the negatives.

Applied decision tools

Extension specialists and farmers can utilize several decision-making tools or aids. As the complexity of decision-making increases, so do the informational requirements of the tools.

A number of these tools are available to producers. Most are variants of budgeting. Budgeting is used to test a production, marketing and/or investment plan on paper before real-world implementation.

These tools are used to identify bottlenecks to profitability, compare the profitability of alternative plans, and assess cashflow difficulties. These tools include:

  • Partial budgeting
  • Enterprise budgeting
  • Whole-farm budgeting
  • Cashflow budgeting
  • Capital budgeting

Resources available to producers

One of the roles of cooperative extension service faculty and staff is to develop decision tools to assist producers with decision-making.

Before investing in new high-priced technology, producers can visit with their local extension educator. They can help direct producers to appropriate decision tools.

Many land grant universities provide enterprise budgets for a wide range of crops, livestock, fruits, nuts and vegetables. And many of those budgets are available on the Internet.

For example, Oklahoma State University has enterprise budgets available online (http://agecon.okstate.edu/budgets/). The University of Minnesota maintains a farm management budget database with budgets from several states (http://www.agrisk.umn.edu/budgets/).

Also, some land grant universities have the ability to work with producers to generate budgets for specialized investments.

Again using OSU as an example, the Food and Agricultural Products Center (http://www.fapc.okstate.edu/index.html) provides services to individuals and companies considering investment in agricultural-related technology and businesses.

Producers can contact their local cooperative extension service office to find similar resources available in their home state.  end_mark

PHOTO

Producers should weigh the scale, risk and degree of reversibility of new technology before investing in it. Photo courtesy of Moly Manufacturing.

eric devuyst

Eric A. DeVuyst

Department of Agricultural Economics
Oklahoma State University
Eric.devuyst@okstate.edu