July 2018
The Business of Farming

Risk in Agriculture: Friend or Foe?

One of my favorite sayings of my grandparents (who are corn and soybean farmers in Iowa) is, "We don’t need to go to the casino for fun, we’re farmers."

Agriculture is an inherently risky business to be in, making it both challenging and exciting.

I spent most of April traveling across the United States to conferences held by economists and Extension professionals discussing risk management issues in agriculture. In this article, I’ll share with you some of the thoughts and concepts I found interesting.

First, it is important to highlight the difference between risk and uncertainty. (Yes, there is a difference and I often ignore it, too.)

Risks in agriculture deal with unknown events in which there is some knowledge of the probability of outcomes. For example, there is a 60 percent chance the September 2018 corn will be $4 per bushel and a 40 percent chance it will be $3.50 per bushel. (This is an example and not my prediction!)

An uncertainty in agriculture is an unknown event in which there is no knowledge of the probability of outcomes. Can one calculate the probability of outcomes if a new disease affecting broilers is discovered in Alabama? Probably not.

By gathering information, one can make educated guesses about possible risks and manage them, but uncertainties are uncontrollable and really cannot be planned for.

USDA defines five risks in agriculture: production (i.e., weather, diseases, pests), market (i.e., fertilizer and crop prices), financial (i.e., interest rates, credit availability, debt and equity ratios), legal or institutional (i.e., chemical regulations, tax laws, land rental agreements) and human or personal (i.e., health, injury liability, divorce).

Typically, farmers concentrate on production and market risks. What will the price of cotton be at harvest? Will there be a drought this year? These are the kinds of questions most likely to keep you awake at night. Oftentimes price and production risks are what government-subsidized insurance products focus on.

Farm operations often neglect thinking about and planning for financial, legal and personal risks. If the primary farm operator ends up in the hospital for an extended period of time, will the farm still be operational?

Asking questions like these in advance can make or break a farm operation during tough times.

So, what can farm operations do about risk? As with almost everything, the first step is acknowledgement. Identifying potential risks enables farmers to determine their risk management strategies. The United States Department of Agriculture has a Risk Management Checklist on their website, https://www.rma. usda.gov/pubs/2011/risk_management_checklist. pdf, that farm owners and managers can access to help identify risks in their operations.

Once risks are identified, farm operations can determine the best way to manage them. The following are five general strategies for risk management: accept, avoid, transfer, mitigate and exploit.

Accepting is the knowledge that the risk is there, but allowing it to happen. This is ideal for small risks that won’t cost your operation too much money by ignoring them.

Avoiding means changing plans to steer clear of a risk altogether. For example, if you are planning to get into the agritourism business and are concerned about lawsuits caused by injury to visitors on your farm, you can decide not to hold farm tours or to not allow visitors near machinery or risky animals.

Transferring usually involves paying someone else to take on the risk, in other words, insurance. In the agritourism example, you could decide to pay for liability insurance to protect yourself against lawsuits from injury on a farm tour. Also, many farmers transfer price and production risk through the purchase of crop insurance.

Mitigation refers to limiting the impact of the risk. Diversification is one way for farm operations to mitigate risk for a given crop enterprise. Not putting all of your eggs in one basket limits the impact of a disease, pest, market or weather event that would affect a specific crop. An example of risk mitigation is holding safety trainings for employees to decrease the likelihood of one of them being seriously injured.

The previous four risk management strategies referred to managing risks with negative consequences. However, we often forget that risks can create opportunities, as well.

Exploiting involves trying to increase the impact of or likelihood the risk happens. Risk exploitation likely requires some strategic planning to set your farm operation up to take advantage of the risk. For example, if it is likely a nearby city is going to expand in population, many nearby farm operations may view this as a risk of development encroaching on farmland. Instead, could you view this risk positively and take advantage of demand from new consumers by offering or expanding fresh fruit or vegetable production?

A publication by USDA that I believe helps, particularly with this risk management strategy, is the SWOT Analysis; you can find information at https://www.rma.usda.gov/pubs/2011/swot_brochure.pdf. SWOT stands for Strengths, Weaknesses, Opportunities and Threats. It helps businesses identify existing or potential problems or opportunities. SWOT analyses are helpful for identifying ways your operation can strategically plan to take advantage of favorable circumstances.

Which risk management strategy you choose will depend on your level of tolerance to risk and the amount of risk. Risk and returns are usually positively related. In other words, if you want high expected returns, you will likely have to take on a relatively high level of risk.

In the real world, farmers must compromise between risks and returns. When making these compromises, it’s important to remember, sometimes, a little risk can be a good thing.

 

Brittney Goodrich is an assistant professor and Extension specialist at Auburn University.