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Re-leasing The Deere

Deere can drive profits by launching a rental and driver service in India.

Deere & Co. has had a rough year.deere quote The company is one of the world’s largest agriculture equipment manufacturers, with its Agriculture and Turf division accounting for 80% of its sales in 2014. It is unsurprising then, that the global crop oversupply and subsequent decrease in farmer cash receipts resulted in a 5% decrease in revenue in 2014, and is expected to fall a further 21% in 2015. However, Deere has experienced these sorts of fluctuations before and will experience them again since crop prices rise and fall with market cycles. With world-wide brand recognition and billions of cash on hand, Deere will survive this storm. Ultimately, this is a short-term challenge which disguises the true problem facing the company.

Deere’s investor presentation raises some red flags. The company is planning to hit $50B in revenue by 2018 mid-cycle, nearly double of its 2015 outlook. This goal is not new, as CEO Samuel

R. Allen had set it back in 2011 when sales were close to current levels. Deere suggests that agricultural output must double by 2050 to meet food demand, suggesting that the company will grow with this expectation. But that does not address the reality that the company needs to hit a 24% annual revenue growth into 2018 to achieve its target. Despite double-digit growth in equipment sales between 2007 and 2014 in Latin America, Africa, and Southern Asia, their historic growth is not enough to meet its goal.

It is also easy to see that there is a significant imbalance in the company’s revenue by geography; 61% of the company’s equipment revenue comes from the US and Canada,  which has 14% of global arable land. By comparison, its Asia Pacific equipment segment boasts 2% of sales despite being home to 30% of global arable land – over 60% of which is in India and China. If Deere is going to achieve the high rate of growth it is expecting, it needs to take a proactive approach to be more competitive in emerging markets rather than relying on riding commodity cycles.

India Bound

To achieve long-term sustainable growth,deere quote 3 Deere needs to look to expand in regions that will see large gains in food production efficiency. Arable land provides a proxy to assess ideal expansion locations. According to the World Bank, the top five countries by arable land are India, the US, Russia, China, and Brazil. This matches the original growth destination outlined by the CEO when the $50B sales target was set in 2011. Deere’s ability to grow its customer base in the US is limited by its strong existing presence. Deere has subsequently made investments in factories in India, China, and Brazil in the hopes of growing within those markets. Despite these investments, it is alarming to see that Deere has such a poor representation in India, as it not only has the world’s largest share of arable land, but is also the largest market in the world by units for tractor sales.

Deere_InfographicIndia’s need for improved agriculture efficiencies is expected to drive an already large market. While its yield of wheat crops has hovered around the global average for the last 25 years, rice, cotton, corn, and soybean yields are all well below the average global yields. Inefficiencies persist despite generally good quality soil, seasonal yet ample rainfall, the  largest  irrigated area in the world, and growing government outlays on input subsidies, such as fertilizers. India’s small farm sizes, which have an average area of 1.15 hectares and meagre resulting cash flow, is the ultimate hindrance of current tractor adoption. Average income for an Indian farmer is $1,200 USD.  Deere tractors cost between $4,000 and  $10,000 USD in India, far out of the reach of the average farmer. Only the wealthiest farmers purchase equipment; even then, 80 to 90% of all tractor sales were purchased on bank credit.

The logical solution to gain deere quote 2market share would be to offer lower credit terms, both to capture new customers and to steal market share. However, this already happened in the early 2000s when multiple consecutive years with monsoons forced    a price war to salvage market share as sales plummeted. While local players like Punjab Tractors saw market share decline, Mahindra & Mahindra (M&M) came out on top. M&M now owns approximately 40% of the Indian market, whereas Deere’s share has dropped from 10% in 2011 to 7% in 2014.

Opportunity in Debt

India is currently already the largest tractor market globally by unit sales, such that for Deere to increase its revenue in this market, it will need to steal market share from competitors to meet its growth goals. Deere needs to adopt an innovative method for undercutting M&M and other players in the market in order to gain market share.

Given the high burden of debt often deere quote 4used to finance a tractor, finding a cheaper solution presents an opportunity. If a farmer is significantly over-levered in order to own a tractor, that farmer would be better off paying for someone else to seed and harvest his or her crops if the fee was less than the cost of capital of the loan. Tractor rental and driver services are not a prevalent business in the world, considering that most farmers in an area are confined to crops that follow a similar growing season. In India however, 50 crops are grown across three growing seasons, implying that a tractor and driver would experience demand throughout the year, as opposed to a spike at certain points in time. This could allow the service to operate for more days of the year than if it were in a cold climate with a single growing season. Regardless, Deere could likely never own a business like this due to dealership laws, which leaves an additional barrier to starting such a business excess capital expenditure.

Deere-lerships Evolved

Deere should approach existing authorized dealers to develop and operate this tractor rental and driving service. As Deere is a manufacturer, a local dealer would be better at successfully managing this kind of venture. The benefit to a dealer includes adding a different revenue stream, while also increasing reach and positive brand value. Considering the typically high debt required to purchase a tractor, there is likely a negative association that farmers make to these dealerships.

Deere should attempt to expand this operation in Indian states with a breadth of different crops to ensure a wider spread of demand throughout the year. These states should also have larger farm sizes and a substantial tractor density, proving that they are viable markets for Deere to attempt to steal market share. Uttar Pradesh, Rajasthan, and Maharashtra are all states that fall within this category, and in total account for 36% of the Indian tractor market.

While Deere would deere quote 5be providing the initial fleet, the daily rate would be set based on the associated labor and equipment costs for the service. This rate would ideally be cost-effective to the farmers with the smallest land size allowable to get a tractor loan (4 acres) in order to allow for maximum market share potential. To cover depreciation, labor, fuel, and allow for a 20% mark up for the use of a 35 HP tractor and a driver, the cost would be $405 USD to an Indian farmer to come three times a year to the field. For a similar farmer to have a $7,000 35 HP tractor at 80% over the required 9 year term and 12.5% interest rate set by NABARD norms, the cost of capital would come close to

$1,072 per year. Even if the farmer sells the tractor prior to the end of the loan’s term, the cost of interest and the potential loss on the asset due to amortization would not result in a lower cost than the $405 rate. This range in cost would allow the tractor rental and driver service significant room to expand margins to ensure longevity of the business.

Smaller Farm Appeal

This change in business model also allows this new entity to offer its services to farmers who were not able to afford a tractor in past. The average farm size in Uttar Pradesh, Rajasthan, and Maharashtra are 0.76, 3.07, and 1.78 hectares, respectively. Applying the same costs and margins as above, the rate to plow a field once would amount to $51, $207, and $120, respectively. This would provide Deere access to a large array of lower income farmers within the area. While this segment is likely not as profitable and does not have room for increasing margins to match the cost of capital, Deere can use this as a way to gain recognition within smaller farms and ensure long-term growth as smaller farms merge in the distant future.

A Deere in the Crosshairs

This strategy could potentially cannibalize Deere’s existing sales at the start. The farmers who are already happy with Deere’s products have no reason not to shift to a cheaper alternative, ultimately switching Deere’s sales from the farmer to the rental service. Additionally, one rental tractor could work on multiple farms, whereas previously, each farm would have bought its own tractor at a high credit risk.

deere2However, Deere acting as a cost leader encourages its competitors to switch over to the rental service as well. Considering how heavy the burden of debt is on Indian farmers, it is probable that farmers who had originally planned on purchasing a competitor’s tractor will shift to Deere’s lower cost option. Players with similar sized market shares may follow suit, but M&M, Deere’s largest competitor, might be hard-pressed to compete in this price range if it means significantly shrinking its own margins and dominance in the market. Even if it does decide to mimic the business, the projected start-up time will provide Deere with a first mover advantage to steal considerable market share. This will have to be communicated to the partnering dealership that there is a long-term upside to ensure buy-in.

If Deere is to meet its sales targets, the company will have to make some aggressive attempts to steal market share in the developing world. The company will never hit the 24% growth targets with such small market shares in developing areas that either are or are expecting to become global food production powerhouses. A similar rental and driver service could be scaled to other economies with low income farmers in order to access new customers and further increase the reach of the company. While Deere is unlikely to see significant gains in the short- term, an increased presence in the market by offering high quality equipment at a low cost will give Deere the foothold it needs in high growth markets, and continue growing even during down cycles in crop prices.