Economic considerations

From an economic perspective, identifying all costs and benefits of the technology results in a robust analysis to determine if the investment will be economically feasible. Direct costs of precision agriculture technologies include, but are not limited to, the initial investment cost (equipment cost, training, installation, etc.), annual subscription(s), maintenance costs and operating costs. Potential economic benefits of precision technologies include, but are not limited to, direct input savings through a reduction in inputs, yield increases, quality improvements, increase in production efficiency, an increase in machinery efficiency (e.g. fuel savings from reduced overlap), and the value of improved management/marketing decisions. When speaking in regards to nutrient management and precision agriculture technologies, the 4Rs typically drive the economic benefits listed above. Utilizing technologies to apply the right nutrient source, at the right rate, at the right time, and in the right place can be economically optimal compared to the uniform application of nutrients. Other benefits may not have a direct dollar figure attached to them, but are a benefit from using the technology. An example would be the ability of auto-guidance systems to allow an operator to conduct other activities while driving machinery and reduce operator fatigue.

When collecting data and information in Step 3, look deeper than the obvious economic cost and benefits stated above. The adoption of precision agriculture technologies can have impacts throughout an entire farming operation. Also, site-specific characteristics will determine the magnitude of benefits from adopting precision agriculture technologies. Investigating the following questions could bring to light additional costs and benefits that often go ignored.

1. ° Will the technology increase efficiency to complete other time-sensitive production practices? Competition for resources is especially critical when there are multiple enterprises in a cropping season competing for the same scarce resources (e.g. land, labor, and capital).

2. ° Can machinery size be reduced and still get the same job done in a timely and accurate manner due to an increase in machinery efficiency? Shockley et al. (Reference Shockley, Dillon and Stombaugh2012) illustrate that adopting auto-steer can allow for the purchase of smaller machinery while increasing net returns and lowering machinery costs.

3. ° Is land expansion viable with the current set of machinery due to an increase in machinery efficiency with precision technologies? Shockley et al. (Reference Shockley, Dillon and Stombaugh2012) and Griffin et al. (Reference Griffin, Lowenberg-DeBoer and Lambert2005) illustrate that auto-guidance systems can be purchased instead of larger machinery to support land expansion.

4. ° How does land topography influence the magnitude of precision technology benefits? Research indicates that automatic section control is more profitable on smaller fields and fields that are irregular in shape whereas auto-steer on a sprayer is more profitable on large square fields (Shockley et al., Reference Shockley, Dillon and Stombaugh2012; Smith et al., Reference Smith, Dhuyvetter, Kastens, Kastens and Smith2013; Smith and Dhuyvetter, Reference Smith and Dhuyvetter2016)

5. ° Will the precision technology be compatible with current technologies or will there be an incurred cost to make them compatible?

6. ° What is the learning curve associated with the new technology (e.g. cost for training and human capital development)? Time is valuable and learning a new technology can be costly to implement successfully.

7. ° If the precision technology is data intensive, is there a cost for storing data or putting data in a usable form? Is there a cost for management or analysis of the data? When initially evaluating a precision technology investment do not ignore the cost to produce quality data.

Tools for analyzing the economics of precision agriculture technologies

Organizing the costs and benefits identified is critical to analyzing the feasibility of the investment. However, economic feasibility and financial feasibility are two different concepts. A new investment is economical feasible if it generates sufficient income to meet the additional cash requirement over the life of the investment. A new investment is financially feasible if the operator is able to cash flow the investment given their financial structure. An investment can be economically feasible and financially infeasible. For example, an investment that requires a substantial capital outlay (e.g. vineyard, perineal crops, orchards, tile drainage, irrigation, etc.) without generating income in the first year of operation could be financially infeasible due to cash flow for the investor yet be economically feasible. A cash flow of an investment summarizes all the estimated cash inflows (additional economic benefits) and cash outflows (additional economic costs) for the economic life of the investment to determine the financial feasibility (Kay et al., Reference Kay, Edwards and Duffy2004). Cash flows for analyzing precision technologies are typically summarized for each year of the investment. Also, a cash flow outlines an investment so that the time value of money can be incorporated into the return on investment which is illustrated in the next section. Time value of money is the concept in which an individual would prefer a $1 today verses $1 five years from now. When an individual receives $1 today, he/she can invest that dollar and earn interest. Also, there is an element of risk attributed to $1 five years from now.

Once a cash flow is outlined, there are various tools for analyzing the economic feasibility of a precision agriculture technology. The most common suite of tools comes from investment analysis. Investment analysis includes such financial measures as simple rate of return, payback period, net present value (NPV), and internal rate of return (IRR). The simple rate of return used by industry to determine the return on investment (ROI) which is incorrect. Albeit simple, this measure ignores the time value of money resulting in an inflated ROI and is not recommended. Instead, use net present value (preferred method) or internal rate of return measures to determine the ROI. The net present value of a precision technology determines the value created by investing in the technology. It determines the difference between the present value of benefits and the cost of the technology. If the net present value is positive, it is a good investment. If the net present value were negative, one would reject the investment. To calculate the net present value, the following formula is used:

(1) $$NPV\, {\equals}\, \mathop{\sum}\nolimits_{t\, {\equals}\, 1}^n {{{NCF_{t} } \over {\left( {1{\plus}i} \right)^{t} }}{\minus}NCF_{0} } $$

where,

NCF_t=Net Cash Flow at time t

NCF₀=Net Cash Flow at time 0 or the initial investment in the precision technology

i=interest rate.

Unlike the net present value, IRR cannot be calculated easily by hand. However, with computer spreadsheets, calculating IRR can be relatively straightforward. If the IRR of the precision agriculture technology is greater than the cost of capital (i.e. interest rate or hurdle rate), then it is a sound investment. If comparing multiple alternative precision agriculture technologies to invest in, the one with the greatest IRR is the best investment (as long as it is still higher than the interest rate). If the precision agriculture technology being considered is automatic section control or auto-guidance systems, Kansas State University has a profit calculator that will determine the ROI automatically with the correct information (Dhuyvetter et al., 2016).

Other economic tools include partial budgeting or whole farm planning. Partial budgeting is relatively easy to use, requires minimal data and is readily adaptable to many types of management changes. Partial budgets reflect the expected average annual changes in economic revenues and expenses. Any change in management requiring substantial investments and income over time can be analyzed using the measures above. Unlike partial budgeting, whole farm planning can examine the impact of precision technologies across all enterprises in the farming operation. This method would be used to capture the impacts of the precision technology on scarce resources. Whole farm planning requires the most information and is a complex economic modeling process. Therefore, seek expert advice if whole farm planning is the preferred tool.

Example analysis using high-speed planting

A producer is interested in investing in a new planter in the USA and is deciding between a new traditional planter or upgrading the new traditional planter with high-speed planting capabilities. The additional cost for high-speed planting technology would require an initial investment of $2 200 (median price reported by Scott, Reference Scott2015) per row to equip a 12-row planter and have an economic life of 8 years and salvage value of 45% (Dillion et al., Reference Dillon, Shockley and Mark2017). While unknown, high speed planting is anticipated to increase repairs and maintenance (R&M) on the planter compared to planting without the technology so an additional $1500 per year was assumed. However, the producer expects to save money on operating costs in the amount of $3 000 per year due to labor savings from conducting planting operations faster than with the new traditional planter. In addition to operating savings, high speed planting allows for planting more acres than possible with a traditional planter when constrained by weather events. This result in a yield benefit valued at $5 700 per year (Dillion et al., Reference Dillon, Shockley and Mark2017). Table 1 illustrates the information above within a cash flow.

Table 1

Example cash flow for investing in high-speed planting.

Using the net cash flow in Table 1 and Equation 1, the net present value can be determined. If the interest rate for this example is 6.75%, the net present value calculation is as follows:

(2) $$\eqalignno{ & {\rm NPV}\, {\equals}\, {{\,\$\,7,\!200} \over {1.0675}}{\plus}{{\,\$\,7,\!200} \over {1.0675^{2} }}{\plus}{{\,\$\,7,\!200} \over {1.0675^{3} }}{\plus}{{\,\$\,7,\!200} \over {1.0675^{4} }} \cr & {\plus}{{\,\$\,7,\!200} \over {1.0675^{5} }}{\plus}{{\,\$\,7,\!200} \over {1.0675^{6} }}{\plus}{{\,\$\,7,\!200} \over {1.0675^{7} }}{\plus}{{\,\$\,19,\!080} \over {1.0675^{8} }}{\minus}\,\$\,26,\! 400 $$

(3) $${\rm NPV}\, {\equals}\, \,\$\,50,\!458\,{\minus}\,\$\,26,\!400$$

(4) $${\rm NPV}\, {\equals}\, \,\$\,24,\!058$$

Since the NPV is greater than $0, the present value of benefits exceeds the cost today so a high-speed planter would be a good economic investment for this producer. If a percentage is preferred to reflect a return on investment, the IRR can be calculated using computer spreadsheets or a financial calculator. Using the cash flow in Table 1 and a computer spreadsheet, the IRR for high-speed planting is 24%. Since the IRR is greater than the interest rate, or 6.75% for this example, high-speed planting would be a good economic investment based on IRR. On the other hand, if the simple rate of return was used instead of the preferred IRR method, it would have resulted in a return on investment of 33%. Therefore, the simple rate of return method overstates the actual return on investment. The magnitude of inflation represented by utilizing the simple rate of return method is dependent on the specific net cash flows of the investment and the length of time the investment is elevated. If the above example indicated an IRR of 4.5% and the simple rate of return was 8.5%, the resulting investment decision would be (accept the investment if greater than the interest rate of 6.75%) different and incorrect if only using the simple rate of return method. This also becomes an issue when comparing and having to choose between two different investments. Therefore, NPV and IRR are the preferred methods for determine the return on investment of precision agriculture technologies.