Using a partial budget to analyze the adoption of technology.
By Greg Steele, AgStar Financial Services
Editor’s note: This is Part II of Steele’s look at how to determine if Precision Dairy Farming justifies its cost. Part I can be found here.
When considering investing in a new technology for your dairy business, the first step is to figure out how the change will affect your operation’s profitability.
A good method to determine the impact on the profitability of your business is a partial budget. This simple and efficient tool can help you define the financial impact of incremental changes. A partial budget helps you segment and analyze the costs that will change and assume other costs such as feed costs or crop production costs will remain unaffected.
Partial budgets are built on the theory that small changes can have meaningful results. Done correctly, a partial budget will help you see how your proposed technology may influence your income and/or expenses. Will your income increase or decrease? Will your expenses rise or fall? A partial budget can provide the answers.
When beginning this exercise, it’s vital to include all income and expense items that will be affected by the change. For example, if milk production is expected to increase, then revenues will increase. If you use less feed, feed costs will likely go down. A partial budget analysis provides you with an easy-to-see, side-by-side comparison.
Let’s examine the following theoretical situation: A new technology that is gaining acceptance quickly is a cow sensor monitoring system that provides data via your mobile phone. For this example, we’ll compare the technology’s claimed benefit of improving reproductive efficiency with improved conception and pregnancy rate while simultaneously reducing drug and hormone therapy costs in the dairy herd.
Let’s assume the herd size in question is 500 head and the cost to install and implement is $200/cow for a total of $100,000. The herd presently has a pregnancy rate of 20% and a heat detection rate of 55%. In addition, the herd currently is using a timed AI program for breeding.
The projected annual savings are as follows: drugs costs will be reduced $12/cow and labor costs will go down $60/cow. It is also anticipated that heat detection will increase to 65% with a pregnancy rate increase to 24%. This improvement is expected to lower the days in milk from 185 to 175. We will assume the economic value of this change is $5/cow/day change in days in milk or $25,000 in added income.
OK, let’s run the numbers as we should have all the information we need to create a partial budget on this.
The above analysis assumes reducing days in milk will add an estimated $25,000 in added milk revenue. Additional changes to net income occur from reduced drug and labor costs by $36,000, for a total net income increase of $61,000. In this situation, there would be no decrease in net income to account for. The cost of the sensors, however, would be a consideration. We can reasonably spread the $100,000 cost of these devices over a three-year useful life and, as such, include one-third of the investment cost, $33,333, plus interest costs of $3,300 in the budget.
The analysis illustrates that adopting the technology will result in an annual net benefit of $24,367. Additionally, the entire investment is paid for in less than 24 months, bringing future year’s potential benefits even higher.
Key to this analysis is using realistic assumptions on economic benefits of the expected changes. Remember, this budgeting process can only estimate the potential financial results, not guarantee them. A good practice is to repeat the analysis by using different assumptions as this will provide an idea about the degree of risk involved when considering a change. Keep in mind management practices and unplanned circumstances can alter the outcome.
All in all, partial budgeting can be a very helpful method when analyzing the benefits of investing in new technology. This systematic approach can assist the dairy manager in making informed financial decisions.
Greg Steele is vice president, dairy industry, for AgStar Financial Services. He can be reached