Creative Risk-Management Strategies in Agriculture
Agriculture is a risky business. Weather is a gamble. Yields are a gamble. Commodity prices are a gamble. Even starting up your PTO in the morning is a gamble. But since you’re going to roll the dice, you might as well hedge your bets.
Fortunately, there are several ways to go about managing the inevitable risks in agriculture. Dr. Jay Parsons, professor and farm and ranch management specialist at the University of Nebraska–Lincoln, explains:
“Risk in general is the effect of uncertainty on the objectives you’re trying to achieve, so risk management is essentially trying to account for the uncertainty and increase the probability and magnitude at which you achieve your objective. In some sense, you’re trying to control the uncertainty.”
Why manage risk?
Risk management sounds like one of those classes everyone would opt out of if it weren’t required – but for farmers and ranchers, it can mean the difference between success and failure.
For South Dakota rancher Wacey Kirkpatrick, proactive risk management is the thing that kept him in the black in 2016 when the cattle market crashed:
“Had we not been using our risk management, I think it would have put us under right off the bat, so I became a believer.”
Parsons agrees. “In agriculture – you produce in the elements,” but also — “You have basically a fixed amount of food that people can eat, so if you produce a lot, your markets tumble; if you produce little, your markets rise considerably…so we have some very inelastic demand.”
On top of that, says Parsons, things can be complicated by government involvement and changing programs as well as multigenerational family operations that have a lot of complexities.
“It just makes it a very dynamic and uncertain environment… I can’t think of a business that’s full of more risk than agriculture.”
Risk management mistakes
Despite this, many producers aren’t managing their risk well. According to Parsons, the biggest mistake people make is trying to manage risk too late.
“People tend to pay attention to risk when things go bad,” says Parsons. “So we have a drought, and we have a lot of people asking about drought risk management at this point. Your options are few when you’re in the middle of a crisis…the time to prepare for these things is ahead of time.”
Another big mistake producers make is an over-reliance on government programs, says Parsons.
“A lot of mistakes in ag sometimes get covered up, I guess, by our government programs, well-intentioned or not. One of the bad things about the government doing that is that people tend to be less encouraged to be proactive in managing risk,” says Parsons.
“Producers that are happy, thriving—operations that tend to be at the head of the pack—they are being proactive. They are managing their market risk, they are managing their human resource risk, they’re doing lots of different things on the production side, diversification and otherwise, to make the system work independently of the programs. They are aware of programs, utilize the programs in their operation, but they’re not making themselves dependent upon somebody else to bail them out in hard times.”
How should producers approach risk management?
The first step to good risk management, according to South Dakota rancher and ag lender Dave Koupal, is education.
The next step is to explore the many risk management options.
With any risk, Parsons says, “We can accept it, decide not to do it, or manage it in one of two ways. Transfer is a big one that everybody knows about because of insurance and marketing contracts. Either one of those mechanisms, you’re basically transferring the risk off to somebody else. The other main route, other than transferring it, is to control it within your operation.”
Most producers are somewhat familiar with insurance coverage like Pasture, Rangeland, Forage and Livestock Risk Protection. But even with that, you’ve got to be strategic, says Koupal. “When we do risk management, I want to protect whatever product we are marketing. If it’s grain, or cattle, or what – that’s my first priority. If you think you have extra money, and you want to do the rainfall – great. But my opinion is, I want to protect whatever commodity is being sold first.”
More than insurance
The experts agree, there’s a lot you can do besides crop insurance. The way we think about risk management must get broader.
Simply diversifying your operation minimizes risk, says Koupal. Sometimes, that means raising a few different crops or types of livestock with the understanding that if the price for one goes down, the price for the other might go up.
Diversification can also mean spreading the risk across one industry and into the next through off-farm employment or investment opportunities.
Another way to reduce risk is through contracts or locking in prices, as well as marketing at different times.
For example, Parsons says, “Right now we have high cattle prices, so right now’s a good time for people to be looking to price risk management tools.”
It was contracts like these that saved Kirkpatrick and his family from losing everything.
“It was 2016 when the cattle market fell from those all-time highs. We had bought calves in the fall, and we protected them right away – we try to get protection on the calves as soon as possible,” says Kirkpatrick.
“And then the market fell, but because of our risk management – the protection we had – we actually made money on that, so the cattle ended up making money in the end and kept us afloat.”
Nevertheless, Kirkpatrick says that working with risk management tools like contracts can have a learning curve.
“We have had wrecks with it,” says Kirkpatrick. “In 2017 we droughted out. And so all of a sudden we had contracts on weight that we didn’t think we were going to have, so we had to get out of them…that cost us quite a bit of money, but it was a good learning lesson.”
More than contracts
Contracts and insurance are certainly part of it, but Koupal says, “Risk management is really a bigger thing than any of us think about.”
Dr. Parsons agrees, “You’ve got two different components to the risk: the probability of something happening, and then the magnitude, or the impact, if it does. It’s difficult to control probability but you can in some cases.”
For example, good machine maintenance decreases the probability of a breakdown when it counts. Things like vaccinations and quarantining decrease the probability of introducing disease into your herd.
Another thing people don’t put as much thought into, says Parsons, is keeping your labor force happy. Workers who feel valued and well cared-for are less likely to leave in the middle of harvest.
Probability is difficult to influence, though, so most people try to control the impact with things like extra storage capacity and more flexibility.
If you’ve got extra storage bins when the grain market crashes, you can hold onto it until the prices go back up, for example. Similarly, having hay or an alternative feed source on hand in case of drought – that flexibility is going to minimize the impact of a negative event.
Look outside the bubble
Producers can get really creative when it comes to risk management, says Koupal.
“How can you take your talents and capitalize on that, or resources you have? It might be a tractor or a snow plow, or if you have a talent in leatherwork, it might be making leatherwork and saddles in the off-season. What can you generate with what resources you have?”
“In the future, we’re going to really look outside the bubble as far as what opportunities are out there to help cash-flow the ranch. It could be easements, it could be wind power, it could be solar power.”
Even a simple thing like knowing your numbers is a risk management strategy, says Koupal.
“Part of risk management is knowing your cost of production compared to the average cost of production of your peers, knowledge of your financing.”
In addition, says Koupal, you’ve got to have a good team to succeed. “A rancher cannot, nowadays, do it on his own. They need to have a team.”
At the bigger ranches, especially, delegating responsibilities is important. People don’t realize it, says Koupal, but that’s a form of risk management – making sure your team is well-oiled and running well, and nobody’s spread too thin.
Similarly, estate planning and transition planning are important for risk management, says Koupal. Anything that keeps things flowing smoothly is going to bring down your risk.
Parsons and a team of ag econ experts put together some tools to help producers design and implement the risk management strategies that best fit their needs. Rightrisk.org features educational materials, including Risk Navigator – a 10-step risk management program designed to help farmers and ranchers understand and explore risk management options. Agsurvivor.com, a risk simulator program, allows producers to compare risk management strategies in real-world farm and ranch settings. Rightrisk.org also offers workshops and online courses.
What does successful risk management look like?
An operation that’s managing risk well is a diverse one, says Parsons.
But most of all, people have taken the time to learn things and be proactive. It’s a mindset, says Parsons.
North Dakota farmer James Steinberger is one producer who has educated himself and is taking a well-rounded approach to risk management.
“I roll with the concept of ‘six out of ten to win,’” says Steinberger.
“My dad was in Vietnam. He met a guy from North Dakota talking about 145 Versatiles to a guy from New York City on the plane. Mike was trying to explain 145s to this dude and dad came up and said, ‘Are you talking about tractors – 145s?’ Mike said ‘yes.’ Dad exchanged seats with this New York City dude and Mike and Dad have been friends since 1972,” says Steinberger.
“Mike coined the phrase ‘six out of ten to win,’ meaning: farming is a gamble, but you need to take risks – it’s an inherit part of the business. But don’t be crazy or stupid. It also means you don’t need to retire on every deal you make but you need to make a profit.
“You’ve got to be willing to take some chance, but you have to be cognizant of the ever-changing environments, you have to be nimble enough to take advantage of what the market gets you, as far as taking advantage of programs, or buying fuel ahead.”
Steinberger tries to break the cyclical trade pattern by buying things like fertilizer and fuel ahead as well as utilizing more on-farm storage.
“That also safeguards you against supply chain interruptions – having things on hand.”
Like most risk-management gurus, Steinberger promotes diversification. He even diversifies his insurance portfolio.
“I buy my insurances from different insurance companies, just to safeguard against any pitfalls with the insurance companies. It might cost a little more not having everything bundled, but it diversifies your risk.”
In addition, Steinberger recommends being intentional with your purchases.
Part of long-term risk management, says Steinberger, is “being willing to buy locally to keep your local business in place so that you can have parts on time and in-hand quickly.”
“Buy quality, not necessarily quantity. Buying oversized machinery for the acres you farm reduces your strain on the machinery and the operator.” It also allows you some flexibility in your operation – you can always diversify your income by doing some custom work, and before too long, you’ll probably grow into your bigger machinery anyway.
Steinberger is definitely “looking outside the bubble” when it comes to risk management.
He promotes good health and wellness practices – after all, you are the one asset you can’t replace.
“Make sure that you’re taking adequate care of yourself,” says Steinberger, whether that’s nutritionally or otherwise. “What we do in agriculture is pretty stressful.”
Another surprising take on risk management: marry well, says Steinberger.
If you don’t and it doesn’t work out, “You give away half your assets to someone else – it’s expensive and it takes about ten years to rebound from that.”
Living with risk
“The risk isn’t going away,” says Parsons. “Risk leads to reward. It’s a matter of living with it, what kind of level of risk are you comfortable with, and then, what’s your strategy for staying in that zone of comfort you have and realize that you’re always stretching yourself in taking a little bit of risk. The people who tackle the uncertainties the best are the ones who get ahead.”
Steinberger agrees. “Dream big, and don’t be scared to fail. I mean, as scientists, that’s one thing we are – you have to go out and be willing to fail but try to work through that so that you’re not failing. That’s part of agriculture and that’s part of what makes us special as Americans.”
“Be willing to take a risk and see what the economy and the system provides and take advantage of those opportunities,” says Steinberger. “Too often, we are a bit conservative, and we miss out on those opportunities because of our own fear or lack of understanding.”
“There’s a lot of global uncertainty going on,” says Steinberger, “but in times of uncertainty, there’s fortunes to be made.”