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Managing risk on the farm: tools and strategies

Risk management is an important component of any business.


November 19, 2007
By Donna Fleury

Risk management is an important component of any business. In agricultural
businesses, producers face multitudes of risks every day, from weather, to international
markets, to increasingly complex business relationships. Addressing and managing
risks will help improve business success and profitability.

"Managing risk on the farm means taking a broader look at your whole business
and your entire farming world," explains Ted Darling, agricultural risk
specialist with Alberta Agriculture, Food and Rural Development (AAFRD) at Airdrie.
"Risk doesn't stop once you've selected your crops or decided how much
fertilizer to apply or how to run your cropping enterprise."

To help farm managers make better risk management decisions, Darling and his
AAFRD colleagues have developed two easy-to-use risk tools that are designed
to cover the spectrum of risk and risk management: CropChoice$ and RiskChoices.
The risk management mantra and the foundation of both of these tools, is 'identify,
measure and manage'.

CropChoice$
CropChoice$ is a computer software tool that is designed specifically for planning
a crop. It is very specific and quantitative, and requires numbers for doing
various calculations. On the other end of the spectrum is RiskChoices, which
is more strategic and qualitative, requiring words and descriptors rather than
numbers. AAFRD is also developing a Cattle Marketing Risk Tool, a tool similar
to CropChoice$.

"The key to CropChoice$ is that it adds the whole idea of risk management
to crop budgetting, forecasting and planning cropping alternatives," explains
Darling. "We've been doing crop budgets for a long time, but they tend
to be flat budgets or single point estimates, resulting in one final number
estimate." The benefit of CropChoice$ is it takes the variability in yields
and prices into account, and uses that information to calculate the expected
value and variability of the enterprise margin.

"We recognize that yields and prices will vary from what you expect, so
CropChoice$ helps determine the range from worst to best case scenario,"
explains Darling. Once you have developed your base plan and considered its
risk profile, then you can go through and develop scenarios involving various
risk management strategies to mitigate the risk.

There are three risk management strategies built into the CropChoice$ program:
crop insurance, changing rental agreements and crop diversification. "Once
you have completed your plan, then you can choose an option such as crop insurance
and run the program again," says Darling. "The program will show the
options and help you judge which strategy is more risky and what steps you need
to take." Darling reminds producers that although the CropChoice$ program
could be used by producers anywhere in western Canada, it has been specifically
developed using only Alberta Crop Insurance and other Alberta information. Therefore,
it should not be used to make actual cropping decisions elsewhere.

Another risk management option may be to consider changing rental agreements,
for example, from a cash rental to a share crop of some kind. The program also
allows the opportunity for diversification and to assess the risk of choosing
different crops or combination of crops. The key is to try to make sure your
cost profile is as accurate as you can make it. Lowering your costs means you
can also lower your risk.

"We're really pleased with the CropChoice$ program, and as far as we know
it is the only program of its kind developed in Canada," says Darling.
There are a few similar programs in the US. "CropChoice$ is the only program
that actually looks at risk in this way, and allows you to compare scenarios
and see the effects of selected risk management strategies." AAFRD has
been updating the information in CropChoice$ every year, working in co-operation
with Agriculture Financial Services Corporation (AFSC) and a major industry
partner.

RiskChoices
The second important tool that works well alongside CropChoice$ is a new easy-to-use
risk matrix tool called RiskChoices. This tool is a strategic planning tool
and works well for producers, processors or any agriculture business. "RiskChoices
helps producers work through a process to identify, measure and manage risk,
which is really the possibility of unexpected outcomes or the chance of a loss
or a gain," explains Darling. Drawing from a process known as enterprise
risk management (ERM), this tool uses words and ideas instead of numbers, math
and statistics.

"In the past, we've done a pretty good job of identifying risks, but then
we usually jump right to trying to manage them without really measuring the
risk or assessing how important it really is," says Darling. With RiskChoices,
the first step is to identify the risks, then assess the risks to determine
the likelihood and impact of each one. "The next step is to take the risk
ranking, and determine which risks are acceptable, which may require action
and which require immediate action," explains Darling. Risk strategies
can be developed to manage each of the risks.

"The final step is to reassess the risks identified to determine whether
or not the impact or likelihood is improved, now that risk management strategies
are in place," explains Darling. "At this point you can assess whether
the risks are acceptable, or do they require further action to become acceptable."
The real benefit is having an easy way to keep track of the strategies developed.
It also helps the whole management team deal with risks in an organized manner.
Some operations may choose to work through RiskChoices on their own, while others
may prefer to have a facilitator or consultant help them work through the process.

"Some of the biggest risks producers are facing in the future concern
strategic issues such as the move away from more public markets to more complex,
specific value chains and captive supply markets," says Darling. "Other
issues include unstable energy costs and the potential impact they may have
on the whole market supply chain system we're used to." It may be useful
to consider the chance of unexpected major world events into your risk plan,
for example the devastating hurricanes in the US in the fall of 2005 and the
impact on fuel and fertilizer prices. Consider other world events that may affect
the ability to ship products or get inputs to your farm. "Although this
may sound crazy, there are people including these kinds of what-if questions
in their planning."

These two risk management tools, CropChoice$ and RiskChoices, help farm managers
do a broader risk assessment of their cropping plan and whole farm operation
by identifying, measuring and managing risk. "These tools help mitigate
risk, or determine how to reduce risks, get rid of risks or avoid them,"
says Darling. "Remember that risk is not always a bad thing, it's really
about variability and determining both good and bad risks." Risk goes both
ways, as insurance companies know.

CropChoice$ and RiskChoices are both available on AAFRD's Ropin' the Web and
have downloadable user guides. Printed copies of RiskChoices are also available.
"Remember the risk management mantra: Identify, measure and manage,"
adds Darling. -30-

 


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