Risk can be defined as an uncertain event that will have a positive or negative effect on business objectives.
Most people are averse to risk because they see only the threatening side and ignore the potential opportunities.
A basic assumption in business is that investment leads to profit and that there should be a positive relationship between risk and return. If an investor perceives that the return may not be adequate to compensate for the risk exposure, then the investor is unlikely to make an additional investment in the business.
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Farmers typically accept far more risk relative to return on investment than other entrepreneurs. They must constantly deal with unique risk scenarios due to the structure of their business and have become more comfortable with higher risk thresholds. As a result, investments continue to be made even when rate of return is lower and relative risk is higher.
Historically, farmers have been advised to manage production and market risk by using production insurance and market risk management tools such as hedging and options.
When some farmers faced a negative return on investments, the government introduced programs designed to offset the effects of market risk. Farmers should not consider these government programs to be their total risk management strategy.
Managing risk in a margin of profit is clearly different than managing risk associated with the farm’s total investment. Investment in inputs and assets has steadily increased over the past 30 years, while profit margins have remained relatively flat, resulting in a widening gap that is correlated to risk.
Adding to risk is the fact that farming tends to be moving away from long, well-understood and more traditional practices. More farmers are investing in off-farm businesses, large scale farms and value-added or highly specialized farms with little or no experience on how to manage risk associated with these ventures.
An example is a potato grower who wanted to better manage the risk in finding a market for his product. Over time, he was able to obtain qualified supplier status with a large potato chip company.
The company established a specific number of growers it would retain so that it was able to achieve better standardization of product.
This meant the potato grower was able to manage the risk in finding a market, but in doing so he took on a new risk within the qualified supplier arrangement. If he did not maintain standards of quality set by the processor, he would lose his qualified supplier status to other growers waiting to move up the list.
Farmers face a lengthy list of risk exposures on a daily basis, and the broader domain of risk management is a relatively new issue for most farms. However, it will increasingly become an important management function.
Having risk associated with every aspect of business can be daunting. The reality is that risk doesn’t have to be avoided if producers have a sound method for evaluating it.
Given the volatility and change underway in the marketplace, it is important that farmers proactively manage risks associated with their livelihood.
Understanding the risks that can potentially affect a farm and where and how these risks present themselves is critical so that producers can minimize exposure but steadily expand their business. Remember, there is risk in not understanding the importance of managing risk.
Terry Betker is a partner with Meyers Norris Penny LLP, working out of the Winnipeg office. He is director of practice development in agriculture, government and industry. He can be reached at 204-782-8200.
