In our previous post, we highlighted that risk occurs whenever the consequences of a decision are not entirely known at the time a decision is made. Just like other sectors, there are a number of risks associated with farming and strategies have been developed to manage all these risks.
Production risk stems from the uncertainty regarding the factors that affect the quantity and quality of farm produce (e.g. weather, disease, pests). It also arises with the introduction of new technologies. Several strategies can be used to reduce production risk.
Risk-reducing inputs are production inputs that improve the chances of better quantity or quality of farm products. Fertilizers and compost are used to reduce the risk of low yields. Pesticides and Integrated Pest Management (IPM) practices are used to reduce the risk of crop damage. Irrigation is used to reduce the risk of low rainfall. Not all inputs necessarily reduce risk. For example, even if fertilizer is used, the crop still depends on rainfall, which may or may not be favourable. When soil moisture levels are low, using a fertilizer can still result in low yields.
Farmers can reduce risk by learning about and applying new technologies and practices designed to address specific risks common to their area of production. For example, new varieties of seed are being developed and livestock is being bred with certain characteristics, including the following:
• drought-resistant seed for maize
• bird-resistant seed for sorghum
• disease- and pest-resistant seed species
• disease-resistant livestock species
• livestock bred to provide better productivity
• irrigation for high-value crops
• crops and livestock bred specifically to improve marketability
Selecting low-risk activities
One way to reduce production risk is to choose a farm enterprise that has a lower risk. In these situations, farmers choose reliability over potential profitability. A farmer may forego an enterprise that has a high potential for income but also carries a high risk for loss, and choose instead an enterprise that is less profitable but also less risky. For example, some smallholder farmers may prefer a drought-resistant variety of sorghum or millet to high-yielding varieties that could fail in a drought.
Marketing risk exists because of the variability of product prices and the uncertainty of future market prices that the farmer faces when making the decision to produce a commodity. Several methods can be used to reduce price variability or to set a satisfactory price before the crops or livestock are ready for sale. These are discussed below.
If the farmer is producing a crop that can be easily stored after harvest, parts of the crop can be sold at different times during the year. The farmer can watch for changes in the market and sell when prices are most favourable. This particularly applies to food grains and for seasonal produce that can be stored (e.g. apples, potatoes and onions). This strategy may or may not increase income for the farmer but it reduces risk and provides the added benefit of ensuring a regular cash flow throughout the year.
For some farmers, selling directly to final consumers may be a way to enhance profitability and reduce risk. Smallscale farmers near population centres may especially benefit from direct sales to final consumers. However, the farmers need to be sure that they can sell everything taken to market. Otherwise, they may end up worse off than selling to traders. They also need to be sure that the higher prices they will get from retail sales will cover the extra costs they will incur
Contractual agreements to sell produce and buy inputs
Price uncertainty could be greatly reduced if farmers could make advance contracts with buyers of products. Contractual agreements can be made with a private individual or company. The farmer often knows in advance the prices that will be received. For example, a livestock feed mill may contract to buy a farmer’s grain at an agreed price or a tobacco company may do the same for the tobacco crop. Some companies that buy produce from farmers at harvest time also sell inputs to farmers.
Forward pricing is a practice where the buyer and producer agree on a price for the sale of crops or livestock in advance of delivery. An agreement is reached to deliver the crop at an agreed price, quantity, quality and time. This practice enables farmers to reduce the risk that the price they receive for their output might not cover production costs.
Financial risk occurs when money is borrowed to finance the operation of the farm business. This risk is caused by uncertainty about future interest rates and repayment schedules, changes in the loan collateral, and the ability of the farm to generate the cash flow necessary for credit repayments.
The three aspects that need to be considered in managing financial risk are as follows.
The availability and cost of credit and the repayment schedule.
The farmer’s liquidity or ability to generate cash flow.
The farmer’s ability to maintain and increase capital.
Many factors influence a farmer’s decision to borrow money, including attitude toward risk; the size and type of farm operation; the farmer’s relationship with input suppliers and output purchasers; the willingness of lenders to provide loans at conditions acceptable to the farmer. Increasing the capital available to farmers through lending enables them to expand their farm businesses but this, in turn, obliges them to repay outstanding debts and creates the risk of loan default. Increased debt raises the likelihood that farmers would be unable to meet their financial obligations in a year of low returns. Highly indebted farmers operate in an environment of greater financial risk.
Liquidity is the ability of the farmer to raise cash. What can a farmer do if an unfavourable event happens? Does the farmer have ready cash or other assets that can be easily converted to cash to cover his or her financial obligations? Assets tied up in land and machinery are the most difficult to convert to cash, while stored inputs or products are easier to convert. Cash held at home or in a bank provides the best protection. As a risk management strategy, the farmer should start by selling assets that are most easily converted to cash. Less liquid assets should be sold only if and when additional cash is needed.
Some farmers, usually the “better off” more commercial farmers, can insure their farms against major risks, which have a low chance of occurrence but may have very adverse consequences. Such events include:
• the death of a farmer or a family member
• sickness and accidents that disable the farmer
• fires or other hazards that destroy capital items
• loss of crops by hail, storms and floods
Institutional risk refers to unpredictable changes in the provision of services, such as the supply of credit and purchased inputs, and information from both formal and non-formal institutions. It also refers to uncertainties concerning government policies that affect farming. There are a number of strategies to manage institutional risk.
Traditional institutions and social arrangements
The customs and organization of traditional societies tend to provide the individual family with a measure of security against risk. As part of a survival strategy, the close bonds between community members have resulted in mutual assistance and self-help when required. Generally, the more fortunate and able members of the community are obliged to help their kinsmen or neighbours in times of need. This may relieve the situation in cases of sickness, injury or death of an individual member; however, it is less effective in situations where the entire community suffers. For instance, failure of rainfall or an attack of crop pests may affect all community members in the same way.
Producer groups / Cooperatives
When farmers have sufficient trust in each other there is scope for them to work together informally as a producer group in order to reduce some of the risks associated with credit mobilization, the purchase of inputs and marketing. Groups for credit and marketing purposes can produce:
• economies of scale in input procurement, loan administration and marketing of produce
• capital accumulation through savings and credit mobilization
• timely delivery of services.
HUMAN AND PERSONAL RISK
Human risk refers to the risks to a farm business caused by illness and the personal situation of the farm family. It also covers issues that relate to hired workers.
Human resource management
An aspect of managing risk for larger farmers is good human resource management. This includes:
• selecting casual workers with suitable skills and experience
• regular communication
• ensuring the safety of workers
• providing adequate supervision and discipline.
Another aspect of human risk management involves strategies to guard against unexpected changes in the availability and productivity of labour. Careful labour planning, such as using a seasonal labour calendar, ensures that farmers know exactly what and how much labour is needed at various times during the production season. Labour productivity To address labour productivity risks larger farmers may replace hand labour with animal power, tractors or motorized implements. Different production programmes including changing farm enterprises and enterprise mixes may also be looked at. Intercropping, improving farm layout, the introduction of labour-saving technologies and similar actions can all contribute to a risk management strategy
Fleisher, B.1990. Agricultural Risk Management, Lynne Rienner Publishers, Boulder, Colorado, USA.
FAO,2008 Farm Management Extension Guide by David Kahan, Managing Risk in farming