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Production Risks:
Alive and Well!
by Dr. Laurence Crane, NCIS
For decades, agricultural risk has been synonymous with production risk. Reducing variability in expected yields has been a major focus of farm managers. Over time, improvements in technology and production practices have helped decrease agronomic risks and increase yields. For example, genetic engineering has produced new seed varieties that are disease and drought resistant; commercial petroleum-based fertilizers were manufactured increasing yields; effective herbicides and insecticides were developed controlling weeds and bugs; and a whole host of improved production and management practices have been written about. Credit is due to the Land Grant University System for the lion’s share of these developments, their distribution and for educating farmers in their use and practice.
Coincident to these production improvements, the economic climate has changed accompanied by increasing non-production risks—marketing, financial, environmental, legal, etc. For instance, increased disposable income has changed consumer demands. Communications and transportation developments have revolutionized supply systems, inventory controls and marketing opportunities. Increased production costs associated with expansion has increased demand for debt capital as a means of leveraging growth. And shifting societal goals have placed an increased emphasis on environmental protection, food quality and recreational pursuits.
The same underlying changes that are driving the increase in economic risks are also changing the nature of production risks. Not only is yield variability still a formidable production risk, but the industrialization of agriculture is impacting the entire agricultural production sector. Changes that initially started in the livestock sector are now starting to revolutionize the grain industry. These structural shifts mean that farmers are vulnerable not only to the vagaries of weather and Mother Nature, but are vulnerable to economic forces that exacerbate traditional production risks. Some view these risks as potentially more threatening than bad weather.
Litany of Production Risks
Most farm management textbooks identify the major production risks as weather, pests, disease, the availability of critical inputs and the interaction of technology with other farm and management characteristics. In practice, any event or action that causes variability in production is considered a production risk. In general risk can be is defined as any sort of uncertainty caused by an unfavorable event. Adverse weather is arguably the greatest production risk. It is truly a risk for all seasons because it can strike at any time, in numerous forms, day or night. Even with sophisticated forecasting methodologies, the impact of the vagaries of weather still exists—even worsening by some measures. Some assert that global warming, El Nino, etc., are combining to cause an increase in weather uncertainties. Significant data seem to support this line of thought.
Disease and pests are especially devastating because frequently they go undetected until major damage has been done. Moreover, chemical control is often cost prohibitive. Fortunately, proper cultural practices and attention to detail can prevent major losses over a sustained period.
Technological advances are a two-edged sword - cutting both ways. Improved transportation and communication allows producers almost immediate access to new marketing opportunities. However, yield shortfalls in the immediate area are no longer accompanied by price increases because these technological advances enable others to effectively meet demand and keep prices low.
Improved technology affects the returns to production in another important way. Not only does it help stabilize prices at a lower level by increasing production, it reduces the proportion of inputs contributed by the farmer. Increased technology inputs in the production process reduces the amount of farmer owned and supplied inputs. As a producer’s share of labor and other inputs decline, so does their share of the earnings. The profit earned (economic rent) is returned to the provider of the input. Thus, profit margins are narrowed and the importance of controlling the risk associated with the other inputs is enhanced.
Input availability and quality can occur in many different ways. Poor quality seed, inferior genetics, costly chemicals, ineffective herbicides and insecticides, unskilled labor, machinery down time, electrical outages and other power shortages, poor timing of activities, etc., are examples of input induced production risks.
Agricultural industrialization is a production risk that is not listed in most farm management textbooks. It is included here (rather than as part of the technological category) because of the belief that the process of adapting technology, and responding to other economic pressures, is creating a host of production related risks. Industrialization has been defined as adopting business strategies to shift the business away from perfect competition. Imperfect competition is desirable because of the opportunity to earn higher rates of return when potential competitors are in some manner blocked from entering the market. Some key concepts here are vertical coordination, contractual arrangements and adding value.
Vertical coordination is usually thought of as a marketing risk consideration; however, it impacts production practices as well. When a producer coordinates vertically through a strategic alliance with a processor for example, they no longer produce what they can and then sell it. Instead, they produce a specific product to meet a predetermined consumer demand. Meeting the processor requirements in terms of quantity, quality and timing are significant production risks.
Risk Responses
The key to effectively dealing with any risk, including production, is management. Effective management has been defined as "paying attention to details." As agricultural production becomes more specialized and industrialized, the risks associated with this type of production increase. Obviously anytime risk is increased, the opportunities for profits and losses also increase. Management ability and decision making determine whether it is profit that is enjoyed or loss that is suffered.
The first step in risk management is risk identification. Knowing and appreciating the risks one faces is critical to designing effective management responses. The majority of this article has been focused on risk identification.
A second step is to measure the likelihood the risk will occur and the potential negative impact by assigning probabilities and outcomes. This is a particularly difficult step because of the subjective nature of many of these measurements. However, this only underscores the importance of accurately measuring those variables for which reliable, objective measures are available. The need for and value of record keeping in risk management was discussed in detail in the article: "Record Keeping: Essential to Risk Management", Crop Insurance TODAY, Vol.30, No. 4, November 1997, pg. 9-12.
The third step is to identify risk goals; i.e., what do I want/need to accomplish? Numerous resources are available to identify appropriate goals. A particularly useful aid is the Guide to Crop Insurance entitled "Risk Management: The Checkup." This publication posses numerous questions that, when answered, will help a producer identify risk goals.
The final step is to identify risk management tools and products that can be used to meet the risk goals. For obvious reasons, crop insurance is a major management tool that can be used to address the production risks described above. To understand fully which crop insurance product(s) to use under any given circumstance, a producer needs to sit down with a licensed agent and outline their risk needs and goals. The agent can then help identify which crop insurance products are available and will most effectively meet the producers management needs.
Crop insurance has a bright future as the premiere tool to manage production risk. The primary societal goal of an affordable, sustainable and safe food supply essentially has been achieved and society is now pursuing important secondary goals of environmental and resource protection, social integration, health maintenance and recreational pursuits. Just as astute decision-making was critical to reaching this primary goal of "cheap food", management’s role will be equally as important in successfully achieving these additional goals and remaining profitable.
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