Risk surrounds us. RISK IS BIG business. The global shift from socialism to capitalism, which is inherently more risky for citizens and business, has provided a rapidly expanding market for products which deal with risk. A scientific approach to risk is also a relatively new phenomenon, having only entered finance in the 1980s when financial derivatives grew. The power of personal computing in the 1990s, which has enabled widespread data collection and analysis, has also enabled a more scientific approach to risk management.
Farming risks are often grouped together as follows:
- Production risk – the risk of loss of production due to pests and diseases and weather.
- Market risk – the unpredictability and variability of product prices.
- Financial risk – the availability of debt capital and interest rates.
- Government risk – tax, land claims and minimum wages.
- Human risk – bad management, poor security, death or disablement of key people.
A crucial part of any manager’s job is to recognise risk in each of these areas and to manage it. Here’s how it should be done:
Step 1 – Identify the risks. Build a risk register and quantify it. For example, don’t identify a risk as “hail”, instead “hail causing 25% crop loss”. And you might also need to add “hail causing 50% crop loss”. If the risk is present, but so remote not to justify consideration, leave it off the list.
Step 2 – Measure. Risk = (probability of event occurring) X (impact of event). If you’ve got some statistical skill and historical data, calculate the probability. Otherwise make a judgment call. Using our example above, you might allocate “25% crop loss to hail” which happens on average once every five years, a 20% probability. The “50% crop loss” risk might get a 5% probability. Next, do an estimate of what a 25% and 50% crop loss will cost you. Let’s call it figures of R100 000 and R200 000. Draw up a table like the one on this page and calculate a risk index. It’s a process of determining priorities.
Debating and analysing risk in this way with your colleagues and perhaps an expert in the field, will lead you to a better understanding of the risks and the priorities you should give them.
Step 3 – Manage the risks. You have five options – avoidance, reduction, transference or retention.
- Avoidance is the eliminating of the risk entirely. For example, cease producing a crop prone to hail, or sell a high-risk farm. Sometimes a good business decision is to stay away from activities which carry too high a risk.
- Reduction – With hail risk, it might be erecting hail netting or introducing a weather modification programme.
- Transfer the risk to someone else – insurance falls into this category. Or pass market risk to your market agent by requiring a minimum guaranteed price or hedging to manage financial risk.
- Retention – Self-insurance falls into this category. This might well be a viable strategy, but take care to ensure you have the reserves set aside to cope with the loss.
Risk management needs to become part of your DNA. You need to be sensitive to it, constantly on the prowl for it and always finding ways to minimise or remove it.
Peter Hughes ([email protected], or call (013) 745 7303)).