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Risks in Agriculture

A Key Binding Constraint

In a Nutshell

December 2006
In a Nutshell is designed to stimulate interest and
inform on issues and topics of importance to sustainable
agricultural development in Caribbean countries.

This is the age where knowledge and information are critical for success.
Information is central to our decisions, social interactions and economic
actions. It informs and educates us to those attributes that will empower
and enable us to sustain ourselves and flourish, instead of merely existing.

It is the general opinion that farmers and other 'agripreneurs' know their
risks and practice some form of risk management in their operations.
However, the annual impacts of such 'known' and expected risks,
especially natural events, are usually severe, impacting the agripreneur in
much the same manner. This implies that risk management and mitigation
systems are either not in place or addressed on an ad-hoc basis. In most
cases, the issue of 'risk' is not linked to the issue of 'opportunity' and risk
management, especially on the farm, is based on traditional knowledge and
practices, and treated more as a defensive response.

This issue discusses risk in agriculture, with special focus on the farm. It
synthesises the wide body of literature and information on this critical
topic into a simple form that can be more readily understood by students
and young farmers. It also seeks to stimulate thinking and more
concerted and collective actions among the more experienced
agripreneurs and policy makers.

An internet search will yield an almost in-exhaustive list of links to the


topic. The following publications provide useful introductions:
- Introduction to Risk Management, United States Department of
Agriculture on (http://www.rma.usda.gov/
pubs/1997/riskmgmt.pdf)
- Managing Hazards, Reducing Risks and Increasing Investments in
Agriculture: Some Perspective IICA-CTA 2006.
In a Nutshell 1

Risk- Understanding the Concept


In essence, “…there are things we know we know - known
knowns; we know there are some things we do not know -
known unknowns; there are the ones we don’t know we don’t
know - unknown unknowns.” Donald Rumsfeld
Risk means the possibility of loss or injury”
(Websters’ Dictionary) and is “present when
future events occur with measurable
probability” (Frank H. Knight “Risk, Uncertainty and
Profit, 1921)

Risks arise from uncertainty, the inability to


foresee the future and from the possibility
that alternative and even undesirable
outcomes might occur.
An outcome is a consequence, result, or
impact of some event, eg. a weather
event such as rainfall, unusually hot
weather, or high humidity can result in
various outcomes for banana production.

Risk begins when “something happens”, an


occurrence or event. Events can be external
(outside of the entrepreneur’s control) or
internal (from decisions made by the
entrepreneur).

Risk increases when the probability of


events occurring, all their potential
outcomes and the cost of their negative
outcomes are unknown.
Probability is the likelihood that any
outcome will occur, eg., there is a 15,
30, or 60% probability that rain would
fall. Probability is central to the
definition of risk. As humans and
especially as agricultural producers, we
deal with and make daily decisions based
on the probability, for example, of rain,
disease, or achieving high yields.
In a Nutshell 2

Risk is not ‘uncertainty’. Uncertainty


exists when the likelihood of future
events is indefinite or incalculable”
[F.Knight, 1921]. Since situations of
uncertainty are either too irregular or
too unique, uncertainty is not
measurable and cannot be quantified or
addressed through protective
mechanisms. Faced with uncertainty, an
entrepreneur must rely on his/her own
experience and judgement. That
decision can either bring profits or
losses.

Risks are unavoidable, but they are


manageable. There are risks involved in
any investment: risks that the return
will be lower than expected and risks
that some or all of the money invested
will not come back. Risk may not be
completely eliminated, but it could be
substantially reduced.

Risk can be quantified, either before an


event occurs, (a priori), or by empirical
observation. When enough instances of a
given situation of uncertainty have
occurred, enough time would have
passed to convince people that the
entrepreneur’s judgement is sound.
Hence the uncertainty will have been
transformed into a risk and can be
measured. Measuring risk makes it
possible to establish the institutions and
protective mechanisms for mitigation.

It is impossible to realise a return on any


investment without facing a certain degree of risk. Each
Agricultural entrepreneur (Agripreneur) must determine the
‘acceptable’ risk, based on personal levels of tolerance.
In a Nutshell 3

Tolerating Risks
The Agripeneur’s risk management choices reflect his/her
level of risk tolerance. Understanding these choices is
important in making risk management decisions that match or
closely reflect the tolerance for risk.

..on a Scale of 1-5:


1. Retain – take the risk - push the envelope;
make no protective arrangements (as in
holding an un-priced commodity);
2. Shift – sell if off - make protective
contractual arrangements, where someone
else takes on some of the chance of a
negative occurrence in exchange for a
premium - insurance. The more of the risk
that is shifted, the higher the premium.
3. Reduce – prevention is better- using good
practices, such as, intercropping, irrigation
(eg. instead of rain-fed production), selecting
resistant varieties (eg. drought, pest, disease,)
or securing marketing contracts to assure
some guarantee of sales.
4. Self-insure – save for the rainy day – by
keeping emergency reserves from funded
from previous years’ profits to mitigate
losses without burden a high premium.
5. Avoid – play it safe – by not selecting a
particular enterprise; not pushing either end
of planting windows; not increasing debt-to-
asset ratio beyond your comfort level.

Understanding risk tolerance and risk


management responses allows the Agripreneur to (a)
identify and exclude those options that increase exposure
to unacceptable risks, (b) select risk management services
that best suits risk tolerance levels, (c) get value for
money from insurance premiums and thus select the best
combination of risk management strategies.
In a Nutshell 4

Risk and the Agriculture Business


The business of agriculture is the cumulative result of
decisions made independently by several individuals. They all
face risks in investing time, effort and resources in any
aspect of the agriculture business.

All business starts and expands to make


and increase profits. Faced with the
absolute unpredictability of things, the
entrepreneur’s judgement of risks in
the operating environment will
determine whether the outcome is
profit or loss.

Risk has always been a part of the


agriculture business. It is present along
the entire farm-to-table chain. But
Agripreneurs now operate in an entirely
new environment:

 factors affecting production, supply


and trade are substantially different.
They go beyond raw materials and
prices to technologies, information,
product regulations etc;
 the substantial flows of ‘free’ donor
funds have receded and are
increasingly difficult to attract;
 information and capital are ‘flowing’
faster around the globe, removing
geographic constraints and increasing
competition for financing;
 chain consolidation, new product
development and new global entrants
characterise today’s competitive and
integrated world markets.

Agriculture today is already fundamentally


different than a decade ago. The agriculture business now has
new rules, new stakes. The Agripreneur now has new
opportunities and most of all, new risks!
In a Nutshell 5

Agriculture’s Risks
Production Risks:
These risks are known and present
in production along the entire
supply chain. They affect expected
yields and actual output and
impact on income gains or losses.
These include natural events
(hurricanes, drought, pests and
diseases), prices (land, labour,
equipment, machinery and capital),
standards and regulations
(production and process methods,
quality and safety), equipment and
technology efficiencies, market
dynamics (increasing scale, specialisation
and chain consolidation) and strategic
risks (choosing inappropriate technology).
Production risks cannot be completely
eliminated, but could be reduced.

Marketing Risks:
These are known and present,
especially in handling and
distribution. These include poor
market information, marketing
strategies and skills, poor
implementation and process
problems in distribution, weather
conditions in export markets,
disruptions in transportation,
rising costs of business, stringent
standards and regulations. The
shift of power to the consumer and a
demand-driven chain has escalated
these risks. They cannot be completely
eliminated, but could be managed.
Strategic marketing can create and
sustain consumer loyalty to a product
and transform production activities into
financial success.
In a Nutshell 6

Institutional Risks:
These relate to changes in government
policies and interventions. The structural
adjustment programmes of the 1970s
and 1980s were serious national
institutional risks which adversely
impacted agriculture in a direct and
significant manner in affected Caribbean
countries. Other such risks include the
adequacy and efficiency of business
development support for agriculture,
including enforcement of safety, quality
and environmental regulations and risk
mitigation. These risks have legal and
social consequences that affect all
investments and operations along the
entire production-marketing chain.
Institutional risks greatly affect the
Agripreneur’s decision-making.

Personal Risks:
These risks relate to the impact on
health and physical well-being in the
process of carrying out the business of
agriculture. Such risks are relatively
high on the farm and can arise from
improper use of machinery and
chemicals, lack of awareness of safe
practices and unavailability or
inappropriateness of protective
equipment. Other human sources of
risk are associated with labour and
management dis-functions, such as,
health problems and industrial
disputes, which disrupt the
production cycle and can lead to
losses.

This ranks farm agriculture as among


the three most hazardous occupations,
alongside mining and construction.
In a Nutshell 7

Financial Risks:
These risks relate to the ability to
meet cash flow needs in a timely
manner and to grow equity. They
also include the rising costs and
increasing unavailability of
financing, investment and capital
and the possibility of partial or full
loss from natural or man-made
events. Cash flows are especially
important given the variety of ongoing
farm obligations (eg. cash input costs,
rentals, tax payments, debt
repayment and family living expenses.
Since the substantial contraction of
Caribbean traditional agricultural
export industries and slow pace of
agricultural diversification, it has
become increasingly difficult to
obtain adequate financing, at
reasonable rates and terms,
particularly for primary production.
Financial risks increase in the absence of
adequate mitigating mechanisms and
protective arrangements for the other major
risk categories, particularly production risks.

As Agripreneurs diversify their


portfolio, introduce new product lines, enter new markets
and lose the protection of traditional industry barriers,
managing risks, averting and reducing financial losses have
become an important part of managing an agricultural
business and reducing the risk impact.

Agricultural risks have a significant


impact on investment worthiness and level and stability of
earnings. All categories of agricultural risks affect the cost of
production and marketing, the price of the product and
income derived from its sale. In all cases, the seriousness of
the risk depends on the nature and magnitude of the possible
end consequences and their probabilities.
In a Nutshell 8

Risk - Understanding the Impact


Risks exist in all activities, at all levels of the agriculture value and
supply chain. But the nature of the risk and the impact on the
chain can lead to variable consequences and outcomes.

Who?
▪ The Individual. Such risks are isolated
to an individual business. They will have
adverse consequences on the enterprise,
they may not necessarily affect the
entire industry, chain or sector.
When?
▪ Everyday. Business faces normal risks on
a regular basis. These risks may be
short-lasting, such as, bad weather, fire,
disease, poor equipment, industrial disputes,
price spikes, loss of markets, product recalls,
disruptions in export transportation, etc.
However, over time, frequent and/or repeated
occurrences will affect the profitability
of a business.
Where?
 The Industry/Chain. These risks can
have an adverse impact on an individual
farm/firm, an entire industry and in
extreme cases, an entire chain and sub-
sector (if a major industry eg. bananas).
Such risks (pests, free trade agreement)
may originate from an external source (other
country), with widespread and longer-
lasting negative effects.
How?
▪ Unexpected and Extreme. These risks
can occur suddenly (Avain flu influenza,
hurricane or volcano). They effects on the
entire industry or sub-sector can be
rapid and destructive, requiring an
extreme response (such as total
destruction of Avian Flu infected flock),
with long-term impacts on economic viability.
These risks are, however, are generally rare.
In a Nutshell 9

Managing Agriculture’s Risks


In today’s environment, opportunities have increased, but so
have the risks. Risk management must become a key element
of the ‘new’ agriculture. Risk management means engaging in
agriculture with confidence in a rapidly changing world.

Agripreneurs make decisions in a risky,


ever changing environment. The
consequences of their decisions are
generally not known when these
decisions are made, and outcomes may
be better or worse than expected.

Risky situations of concern are


typically those in which there is a high
possibility of adverse consequences,
which, if they occur, would cause
significant disruptions.

Agripreneurs generally do not get into


risky situations unless there is a
probability of making profits. Higher
profits are typically associated with
higher risks. It is to their advantage
that these risky, but potentially
profitable situations be managed as
carefully as possible.

The two primary aspects of risk


management are:
1) anticipating that an unfavourable
event may occur and acting to
reduce the probability of its
occurrence; and
2) taking actions which will reduce
the adverse consequences should
the unfavourable event occur.

Effective risk management involves


anticipating possible difficulties and planning to reduce their
consequences. Effective risk management is not about
reacting to unfavourable events after they occur.
In a Nutshell 10

Risk Management – on the Farm


Farmers, as managers, have the primary responsibility for
managing the risks associated with their business. The typical
farmer worldwide engages in a range of risk reduction
activities but the choices and mix of options will depend on
the specific situation.

Diversification
Diversification - the combining of
different production options - is by
its nature, a defensive strategy. It is
an effective way to reduce large
year-to-year fluctuations in income
and financial risks. It can ensure
adequate cash flow for meeting
production costs, debt obligations
and family living expenses. However,
diversification is becoming
increasingly costly, as capital
investment requirements become
greater.

Insurance
Management of yield or price risk,
through crop insurance, shifts the
Agripreneur’s risk to others for a price,
i.e., the insurance premium. Crop
insurance is a risk management tool
that reduces the direct losses to the
producer and offers the opportunity for
more consistent gains. Its benefits
include ensuring a reliable level of cash
flow and allowing more flexibility in
business and marketing plans.
If some part of the expected
production can be insured, then that
part can be forward-priced with
greater certainty, creating a more
predictable level of revenue.
In a Nutshell 11

>>Risk Management – on the Farm

Contract Production
Contract production is normally
associated with vertical integration,
i.e., to coordinate all aspects of
production from farm to table. This is
common in the poultry and livestock
industries. A major advantage for the
farm producer is that a market for the
output and, often, a favorable price is
guaranteed. It also protects against
future price reductions. A disadvantage
is that the producer loses the
opportunity of benefiting from the
potential for future price increases,
since the sale of the product is fixed by
the contract. The loss of flexibility and
potential profit opportunities is the cost
of receiving a predictable market for
sale of product and cash flow.

Innovation and New Technologies


The science of crop and livestock
production has evolved, offering
unprecedented possibilities, through
innovation and new technologies.
Among these, agro-biotechnologies are
seen as instruments for raising
productivity/yields and achieving
competitiveness. For farmers who are
innovative and adopt new
technologies, the potential benefits
include lower input costs, higher yields
due to improved pest and disease
control and varieties, more cost-
effective use of inputs and enhanced
environmental quality. However, new
technologies must be evaluated to
determine their appropriateness before
are they adopted.
In a Nutshell 12

>>Risk Management – on the Farm

Management Plans
Risk management risk begins with
sound integrated farm management
planning which must define the goals
and objectives of the enterprise and
develop business and marketing plans.
A good understanding of production
costs and marketing strategies are a
critical part of a sound farm
management. Management decisions
should consider the impacts they will
have on the production, financial, legal
and human resource aspects of the
business. A strong business and marketing plan
can significantly improve the possibilities for
accessing financing and investment.

Associations and Cooperatives


Forming and participating in
associations and cooperatives
provide members the opportunity to
benefit from collective actions, such
as, joint input purchasing and
marketing, obtaining financing and
risk-sharing. Benefits may be in the
form of enhanced stability of prices
and incomes or reduced costs of risk
management. There has been an
increased interest in cooperatives in
all aspects of the agriculture
business as a risk management
strategy.

Risk in agriculture, especially on the farm, is more profound


in the food chain. But risks are also linked to opportunities.
In an environment of less government interventions (support)
and more product regulations, effective risk management
strategies are an essential condition for successful and
competitive enterprises, firms and industries in agriculture.
In a Nutshell
In agriculture, risks are unavoidable and are
present along the entire farm-to-table value
chain.

Farmers, food processors, wholesalers, retailers,


exporters, distributors, restaurants and any
entrepreneur involved in the agriculture business
has a responsibility to manage these risks.

In managing risks in agriculture, Agripreneurs


must clearly:
- establish goals and priorities for their business
in the face of risk and uncertainty;
- identify the sources and characteristics of
their major risks;
- determine their levels of acceptable risks and
tolerance to these risks;
- understand the potential impacts of these
risks on the comparative advantage and
competitive potential of their business;
- decide on the mix of management options that
can be taken to substantially reduce these
risks;
- identify actions needed by others, such as, the
specific industry, government, private
financial institutions (eg. insurance, farmer
pensions) etc, to complement the
agripreneurs' risk tolerance levels and
personal risk management plans.

By taking these and other complementary


actions, risks can be quantified and although
they are unavoidable, risks can be managed.

Since risk and opportunities are linked,


thinking about risk can provide useful
insight into where opportunities for
agriculture maybe found.
In a Nutshell 2

Issue #12
December 2006
ISSN-0245-4746 A2/TT/05/06

Prepared by the
Trade Policy and Negotiations Programme
IICA Caribbean

Diana Francis
Regional Specialist
and
Richard Rampersaud
Research Assistant
Caribbean Regional Agricultural Policy Network (CaRAPN)

Printing:
CTP Services & Supplies

This issue is printed with financing from the


Technical Centre for Agricultural and Rural Cooperation

For more information, please contact:

INTER-AMERICAN INSTITUTE FOR COOPERATION ON


AGRICULTURE
OFFICE IN TRINIDAD AND TOBAGO
#3 Herbert Street, Newtown, P.O.Box, 1318
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