A REVIEW OF THE FARM MACHINERY throughout most of the last decade. More AND EQUIPMENT INDUSTRY recently, International Harvester, one of the two largest firms, has acknowledged It probably comes as no surprise to most financial difficulties and the need for American farmers when I say that restructuring. This action, alone, suggests machinery and equipment purchases now the need for a review of the industry, both constitute the single largest expenditures past and present. for total agricultural production inputs. According to the U.S. Department of Market Considerations Commerce, 1980 sales for farm machinery There is little doubt that farming has and equipment totaled over $13 billion in dramatically increased its level of the U.S. Such production inputs have mechanization since World War II. Given contributed immeasurably towards my age, I personally experienced the increasing our productivity as American transition from horsepower of the hay- farmers are the most efficient producers burning variety to horsepower of the fuel- of food and fiber in the world. Yet the burning variety. My own children look at price of these inputs has risen abruptly me in a state of bewilderment as I within the past decade. Using a price attempt to describe my youthful index based upon 1967, farm machinery experiences with a team of mules, a two- and equipment prices reached 337 (from a row cultivator, and a corn field in southern base of 100) by September of 1980. By Illinois. The current array of production comparison, the price index for other farm equipment is mind boggling. Tractors, of production inputs had reached 256 and course, now account for more than 25 the well-known Consumer Price Index percent of all farm equipment sales and stood at 249. In a recent study by the most firms which manufacture tractors Office of Policy Planning of the Federal also produce a full line of tractor-powered Trade Commission1, it was suggested that machinery, self-propelled equipment and some of this price rise may be attributable miscellaneous attachments and to increased concentration amongst implements. As such, they are often manufacturers, distributors, and retailers. characterized as "full-line" producers. The contents of this study and other Other manufacturers known as "long-line" related documents examine closely the producers are generally smaller and more changing structure, conduct, and specialized. They produce machinery for performance of the nation's largest a sub-sector of the total agricultural agribusiness sector. Such changes impact market. Still others known as "short-line" directly the entire agribusiness sector and producers concentrate their production on warrant further review. Of this nation's machinery or equipment used selectively seven major manufacturers of farm in the production of particular crops or machinery and equipment, two have animals. Long- and short-line firms hovered on the brink of financial collapse generally compete in less concentrated markets where the barriers to the entry of 1 Leibenluft, Robert F. “Competition in Farm new competitors are relatively low. For Inputs: An Examination of Farm Industries.” these reasons, most attention has been O.P.P., F.T.C., February 1981. focused upon those full-line producers,

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WASHINGTON STATE UNIVERSITY & U.S. DEPARTMENT OF AGRICULTURE COOPERATING particularly those operating in the all- number of tractors used dropped almost 9 important tractor and harvesting percent during this period, the total machinery sub-markets. tractor horsepower employed rose just over 38 percent and the value of that The demand for farm machinery has equipment increased by 65 percent. certainly changed since my days in the Some leveling off of this trend is expected cornfields of southern Illinois. Such as we approach limits in the amount of changes have doubtless had their effect arable land and as the growth in average on the structure of the industry. For farm size tapers off. Those manufacturers example, it can be shown that the seeking to expand their production have demand for farm machinery is now highly sought to expand into non-farm volatile, peaking in 1974-75 as commodity equipment areas. To the extent that new prices rose, and then dropping off manufacturers have been able to enter precipitously as economic conditions the market, they have done so through weakened and interest rates rose. the development of very specialized Additional instability in the demand equipment normally based upon a new situation can even result from seasonal technology. variations. Like the purchase of most durable products, the purchase of As our agricultural machinery and machinery is more easily postponed equipment has grown larger, during hard times than is the case for technologically more complex, and more other agricultural inputs such as fuel, costly, an additional demand factor has feed, chemicals, etc. The farmer has entered the market, i.e., interest rates always shown himself to be a very and financing. If one is to manufacture, adaptable creature, extending the life of distribute, and retail farm machinery older equipment during periods of successfully today, the ability to provide depressed commodity prices and then buyer financing is now critical. Last year, aggressively purchasing new machinery for example, the typical U.S. following the year of the bumper crop. manufactured farm tractor sold for While some input industries (e.g., between $35,000 and $80,000. At this fertilizer) have attempted to lengthen price level, dealers must not only compete their season of peak business activity, it is with regards to the product they offer, interesting to note that 17 percent of new they must also offer a competitive farm equipment sales occur between the financing program. Hence, major period of April to October. For some manufacturers have established large specialized types of machinery, this sales credit divisions to serve both their period is even more concentrated. This dealerships and their farmer customers. factor, alone, creates a formidable burden for smaller companies and dealerships as The useful life of most new farm they are less able to carry a year-round machinery or equipment is tied to a 5-10 labor force. year period. Replacement parts and related services become, therefore, an In addition to the volatility in demand, it is integral part of the marketing strategy. surprising to note that the overall demand Hence, in addition to financing and credit for farm machinery has grown only slowly provisions, machine reliability and services in recent years. U.S.D.A. data show that and repair facilities are crucial concerns. during the 15-year period ending in 1978, In fact, one industry survey2 revealed that there was actually a decline in the number the most important considerations in of tractors employed in U.S. agriculture. buying new farm equipment, in order of Yet this statistic is clouded by the importance, were: (1) dealer proximity knowledge that our tractors in use have grown larger, more powerful, and much 2 Angus Research Corp. “The Farm Equipment more costly. For example, while the Industry.” March 1979.

2 and reputation, (2) product capability, (3) difficulty is attributed to their earlier loss product reliability, and (4) price. of market share, as John Deere and Co.'s reputation for dependability and its Current Market Structure exploration of a growing market for 4- wheel drive tractors pushed I.H. into a When Cyrus McCormick invented the defensive mode. reaper and John Deere developed the steel moldboard plow, little was known Larger Tractors and Foreign Imports about the giant agribusiness firms these actions were to foster. By the beginning The trend towards larger tractors is a well of the 20th century, substantial documented one. Several U.S. consolidation at the manufacturing level manufacturers have totally discontinued had already occurred. Needs at the their production of tractors with less than distribution and retail levels were such 40 horsepower (excluding garden that this was necessary for survival. By tractors). Yet some demand for smaller 1977, there remained only about a dozen tractors remained and by the 1970s, companies still operating within the Japanese firms began to fill the gap. No industry. Based on a 1979 study, 95 less than eight Japanese firms now export percent of all farm tractor sales were small tractors to the U.S., and by the late accounted for by John Deere, 1970’s, it was estimated that 43,000 such International Harvester, J. I. Case, White units valued at $201 million were sold Farm Equipment, Allis-Chalmers, Ford, here. These companies have not, and Massey Ferguson. Steiger (an however, expressed an interest in the affiliate of I.H.) and Versatile had large tractor market and appear reluctant achieved a significant share of the market to take on the major U.S. manufacturer in for larger 4-wheel drive units. Perhaps as this area.3 a result of competitive pressures, some of these companies have recently elected to The Distribution System specialize in a selected segment of the At the retail level most farm machinery farm equipment market, while actively and equipment is sold through a network expanding into the production of non-farm of independent franchised dealers. As equipment. J.I. Case, for example, has shown in Figure 1, U.S. manufacturers use acquired six construction equipment a system of "branch houses" which serve manufacturers since 1967, while at the as regional sales offices and warehouses same time reducing its farm machinery for products and parts. Only in rare cases line to the production of tractors alone. where manufacturers have been unable to Ford has also reduced its line of find suitable dealers, do they actually own equipment and trade news has suggested retail facilities. Experience has shown that they may exit the tractor market most manufacturers that independent also. operators are more strongly motivated

and tend to propagate and maintain Allis-Chalmers remains a full-line stronger customer loyalties. manufacturer, but has greatly expanded its involvement in the processing An attempt by a manufacturer to integrate equipment market. Recent financial forward into retailing is often met with the difficulties for both Massey Ferguson Ltd. defection of affected salesmen and service of Canada and the White Motor Corp. have personnel. In fact, as early as 1914, an been chronicled in the Wall Street Journal antitrust consent decree prevented (November and September 1980). In International Harvester from establishing addition, of the two companies remaining, a retail unit in a community already International Harvester is reported to be "on the brink of bankruptcy" (Newsweek, 3 November 23, 1981). Much of their “Tractors from Japan.” Implement and Tractor, November 7, 1980.

3 Figure 1 Distribution System for Major Farm Machines in North America

NATIONAL JURISDICTION

FARMER

RETAIL LEVEL

FRANCHISED DEALER • New, Used Machine Sales • Parts Sales • Repairs • Service Under Warranty

WHOLESALE LEVEL

AFFILIATED BRANCH HOUSE COMPANY • Blockmen • Technical Specialists FINANCE SUBSIDIARY • Inventory Handling & Control • Floor Planning Dealer • Dealer Supervision Inventory (New & Used MARKETING DIVISION Equipment) • Inventory Handling Control • Financing Farmer Purchases • Advertising & Promotion • Pricing • Financial Control

EXPORT MANUFACTURING PLANT(S) AFFILIATED Production MANUFACTURING Production Control COMPANY Shipping

FLOW OF GOODS FINANCIAL TRANSACTIONS

OWNED AND CONTROLLED BY MANUFACTURER

Source: Council on Wage and Price Stability, Report on Prices for Agricultural Machinery and Equipment (May 1976)

4 served by an independent dealer. It is no volume manufacturers, declining unit great surprise to learn that such sales since 1970 suggest one major factor dealerships are growing larger and fewer underlying the current financial difficulties in number. According to the National of the large companies. As existing Farm and Power Equipment Dealer manufacturers are now operating well Association, the average dealership had, below that economically most attractive in 1979, an annual gross sales of $2.3 level of production, there exists little million and a net worth of $324,000. Just incentive for new manufacturers to enter nine years earlier they reported sales at the market. Further, the capital $600,000 and a net worth of $115,000. requirements for the construction of new The economies of such retail operations manufacturing facilities and for the provide ample incentive for such growth. establishment of a commensurate A study at the University of California dealership network has reached an indicated that average dealer cost per astronomical level. dollar of sales declined from $1.025 at $500,000 of annual sales to $.892 at Even more cogent is the knowledge that it $3,750,000 of sales. Such economies of would he extremely difficult for a new scale resulted from a better utilization of a manufacturer to achieve a sales volume dealer's fixed investment and the more commensurate with an economic level of efficient use of the labor force. production. While product differentiation in the tractor market is not that "real," Structure, Conduct, and Performance farmers do place a tremendous In the FTC study of R. F. Leibenluft, it was importance on a perceived difference in concluded that substantial barriers to the dependability, durability, and entry characterized the farm machinery serviceability of their particular choice of and equipment industry. The importance product line. Such brand associations, of an established dealer network was cited when coupled with a long-established as a major deterrent to new competitive dealership loyalty, make for formidable entries into the market. High product barriers to new entrants. To be sure, loyalty amongst farm-users is somewhat foreign producers of smaller tractors have more difficult to quantify, but was also a good knowledge of the U.S. market and credited with discouraging major new a growing brand loyalty of their own. Yet competition entries. No doubt the major it would seem obvious that what has deterrent, however, rests with the happened to the U.S. automobile market extensive economies of scale in the will most likely not occur in the machinery manufacturing process. An attempt was and equipment industry. Unlike small made in 1969 to synthesize the costs of compact cars, small tractors are not a manufacturing tractors at varying levels of reasonable substitute for the larger U.S. production. These data are now over a products. Moreover, foreign decade old but they did show that the manufacturers are not providing a full line manufacturer's return on investment rose of tillage and harvesting equipment from 11.8 percent to 44.8 percent as needed in the U.S. farming sector. annual production was increased from 20,000 to 90,000 units.4 It is interesting In search of measures of market conduct to note that at the time of this Canadian and performances, one is confronted with study, tractor production had reached an a lack of valid data and established all-time record output of 275,000 units criteria. Looking first at some measure of and has declined since. While substantial profitability, one is confronted by the savings appeared possible for the high knowledge that many major U.S. manufacturers are now faced with adverse 4 McDonald, N. “Farm Tractor Production Costs: financial conditions. This somewhat A Study in Economies of Scale.” Royal contradicts an earlier Canadian study Commission on Farm Machinery, 1969-1971. which suggested that retail prices are

5 higher than might be expected had the reached 6 percent of sales.5 Looking market been more competitively beyond profit on sales, however, we find structured. According to data published in that in 1979, the average dealer realized a Moody's Industrial Manual (1980), the 7.78 percent return on total assets major U.S. manufacturers reported after employed and a 26.6 percent return on tax returns on equity of 12-17 percent owners' equity. During the decade of the during 1977-79. After tax returns on 1970’s, after adjusting for inflation, sales reached 3-7 percent during this Leibenluft reported that while the dealer's same period. owner-equity increased by only 57 percent, his net profits grew by 163 The Leibenluft study reports the following percent. He further asserts that the observations: (1) prices may have been industry: (1) has failed to operate at placed at higher levels to help retain the lowest achievable costs, (2) reflects a lack viability of those financially stressed U.S. of modernization, (3) was slow at moving manufacturers, hence preventing the into more basic kinds of product research, foreign acquisition of their facilities, (2) (4) has been slow in making safety U.S. and Canadian prices for tractors up improvements, and (5) unnecessarily ties to 75 horsepower were priced 30 to 45 up excessive amounts of capital in percent above their European- inventory. manufactured competitors, while the costs of the inputs and distribution expenses Summary accounted for only half of this differential, (3) arbitrage, as practiced through dealer In the total market for all agricultural restrictions, reduced the level of foreign production inputs, farm machinery and price competition, (4) there existed an equipment constitutes the single largest apparent lack of interest on the part of sector. The importance of this U.S. farmer organizations about farm agribusiness sector has taken on an even machinery prices, (5) the price impact of greater significance as prices have risen major technological breakthroughs (rotary most rapidly since 1967. For this and combines) has been muted by an industry other reasons, the industry came under practice of licensing these improvements some institutional scrutiny. The market to competing companies after having been for farm machinery and equipment has exploited by the originating firm for only changed much since the early 1970’s, one or two years, and (6) despite some reflecting to a large degree, adjustments recent changes in models and styling, which have occurred in the food and fiber advertising expenditures generally used to producing sector. A half dozen "full-line" exploit such changes remain at less than manufacturers remain as a dominant force 1.5 percent of sales revenue. in the production, distribution, and retailing of farm tractors and combines, As noted above, overall profits for farm although foreign manufacturers now fulfill machinery manufacturers do not appear an important role in providing low- to be excessive and many are operating horsepower tractors. The industry, and under conditions of financial stress. A the market for their products, remain survey by the Farm and Industrial volatile and susceptible to seasonal Equipment Dealers Association in 1979 variations. The level of demand for major showed that at the dealer level overall net products, tractors especially, has operating margins averaged 15.5 percent, diminished in recent years and despite the yielding a net profit on sales of 1.29 fact that gross sales have increased, many percent. This represented quite a manufacturers are financially stressed. decrease in level of profitability from the The industry remains heavily dependent mid-1970’s when the agricultural economy was booming and dealers' net profit 5 “How Dealers’ are Picked Clean by Inflation.” Implement and Tractor,

6 upon a franchised retail-dealership system decade, profit levels appear modest for where dealer reputation, financial the major manufacturers, and all but one arrangements, repair services, and major company seems to have customer brand loyalty fulfill as important experienced financial difficulties. a role as does product differentiation. Given the importance of this agribusiness A recent investigation by the F.T.C. sector, it would seem that we must all regarding industry structure, conduct, and focus more attention on the fortunes and performance raises numerous questions future of our farm machinery and and produces some anomalies. The equipment industry. findings suggest that prices are unnecessarily high relative to competitive expectations. Contradicting these assertions are the facts that market structure has changed little in the past Ken D. Duft Extension Marketing Economist

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