So you understand risk do you? I used to think so too. After all, we met with our broker annually to review our insurance portfolio. Admittedly it was a pretty casual affair – he was a nice guy with a great array of the latest jokes – but we always updated the insured value of the policies.
I shudder when I think about it. We hadn’t a clue, and in the risky business of farming we were lucky to get away with such bad management. We, and coincidentally our broker, almost completely misunderstood the concept of risk. It’s a complex subject, and ever since the concept emerged in the Middle Ages, students of risk have struggled to find a clear definition of it. There are many, and each depends on the specific application and situation. However, an obvious underlying principle runs through all these definitions: The level of risk is proportional to both (a) the expected losses and (b) the probability of the event which triggers these losses occurring.
Put another way: Risk = (probability of event occurring) X (negative impact of event occurring).
Quite obviously greater loss and the greater likelihood of the event mean greater overall risk. But not so obviously, and here’s the rub, it’s very difficult to reliably estimate the loss potential, and even more difficult to measure the probability of the loss-making event taking place. Another problem was our confusion between uncertainty and risk. Douglas Hubbard, the author of How to Measure Anything: Finding the Value of Intangibles in Business, cleared it up for me. “One may have uncertainty without risk, but not risk without uncertainty,” he wrote “You may be uncertain about the outcome of a contest, but unless you have a stake in it, you have no risk.”
As a manager, a large amount of our management effort needs to be directed at managing risk. We are surrounded by it – personally and professionally – and how successfully we manage it will to a very large extent determine our future.
We must remove or limit those risks which threaten personal and business survival, but we also don’t want to waste time, energy and money fighting off misidentified risks. That’s why it’s so important to understand where our risks lie, and to have a clear measure of them.
As a farmer I always felt, and often loudly told my friends in other fields of business, that we operate in one of the highest-risk environments. We have to cope with the usual financial, government and human risk, but also face production loss to pests, diseases and weather and extremely unpredictable, variable product prices.
I was brought down to earth recently when I was asked whether farmers’ risk was greater than the risk in the nuclear energy industry or the oil business, where the price has fluctuated between US/barrel and US0/barrel in a matter of weeks. Okay, so farmers might not be worse off than everyone, but of one thing I’m certain – unless you really understand what risk is, there’s a very high risk you’ll do a bad job of managing it. – Peter Hughes ([email protected], or call (013) 745 7303). |fw