"One must bear in mind that whatever strategy is chosen to manage risk, it will come at a price. The price could be direct or indirect. A good farmer will try to find a balance between managing risk and making profits."
Farming is risky. Farmers live with risk and make decisions every day that affect their farming operations. Many of the factors that affect the decisions that farmers make cannot be predicted with 100 percent accuracy: weather conditions change; prices at the time of harvest could drop; hired labour may not be available at peak times; machinery and equipment could break down when most needed; draught animals might die, and government policy can change overnight. All of these changes are examples of the risks that farmers face in managing their farm as a business. All of these risks affect their farm profitability.
While farmers have always faced risk, farming has over the years, as a result of market liberalization and globalization, become increasingly risky. Smallholder farmers have become especially vulnerable. A casual approach to farming, even if it is for household food consumption, is no longer viable. Farmers need to acquire more professional skills, not only in basic production but also in farm business management. Among these are risk management skills.
The most common sources of risk in farming can be divided into five areas:
- production and Technical risk
- Marketing risk
- Financial risk
- Institutional risk
- Human and personal risk
Crop and livestock performance depend on biological processes that are affected by the weather, and by pests and diseases. Low rainfall or drought may lead to low yields. Heavy rains could damage or even wipe crops out. Outbreaks of pests or diseases could also cause major yield losses in crops and livestock.
When farmers plant seeds and fertilize their land they do not know for certain how much rain will fall, or whether there will be a hail storm. They do not know if there will be a problem with pests or diseases. But still, they must decide whether they are going to plant their crops or raise their livestock. The resources they spend to plough, plant and fertilize their crops or to care for their livestock may not be recovered. This is why there is a risk. Farmers produce without complete certainty about what will happen to their production.
Another source of production risk is equipment. A farmer’s tractor may break down during the production season resulting in an inability to harvest in time, thus affecting yields. Similarly, if the farmer uses shared or hired traction or other equipment, will it be available when needed? If the farmer is using new technology, will it perform as expected? Will it actually reduce costs and/ or increase yields? If seeds don't germinate and day-old chicks die what will be the impact on production and farm family income? The farmer can never be completely certain.
Marketing risk – prices and costs
Changes in prices are beyond the control of any individual farmer. The price of farm products is affected by the supply of a product, demand for the product, and the cost of production.
The supply of a product is affected by a combination of production decisions made by farmers as a group and by the weather and other factors that influence yields.
Demand for a product is affected by consumer preference, consumers’ level of income, the strength of the general economy, and the supply and price of competing products.
The cost of production of a unit of a product depends on both input costs and yield. This makes it highly variable. Although input costs tend to be less variable than output prices, when combined with yield variations the cost of production becomes a serious source of risk.
Sometimes price movements follow seasonal or cyclical trends that can be predicted. Many times, however, supply or demand will change unexpectedly and, in turn, affect the market price. When farmers plant crops or commit resources to raise livestock, they do not know for certain what prices they will obtain for their products. In situations of low rainfall, the production of crops is often reduced and, as a result, prices rise.
Financial risk occurs when money is borrowed to finance the farm business. This risk can be caused by uncertainty about future interest rates, a lender’s willingness and ability to continue to provide funds when needed, and the ability of the farmer to generate the income necessary for loan repayment. Smallholder farmers who borrow money at high-interest rates may have particular difficulty making debt repayments. Lower than expected prices, combined with low yields, can make debt repayment difficult and even lead to the sale of the farm.
Institutional risk refers to unpredictable changes in the provision of services from institutions that support farming. Such institutions can be both formal and informal and include banks, cooperatives, marketing organizations, input dealers and government extension services. Part of the institutional risk is the uncertainty of government policy affecting farming, such as price support and subsidies. The risks farmers face are often a result of decisions taken by policy-makers and managers. Subsidies, food quality regulations for export crops, rules for animal waste disposal and the level of price or income support payments are examples of decisions taken by the government that can have a major impact on the farm business.
Human and personal risk
Human risk refers to the risks to the farm business caused by illness or death and the personal situation of the farm family. Accidents, illness and death can disrupt farm performance. In many countries, labour migration away from rural areas is a common occurrence. Migration can cause labour shortages for the farm. Political and social unrest can also limit labour availability. When farmers plant their crop or commit resources to raise livestock they cannot be certain whether they will have enough labour to manage the farm enterprises.
Finally, in order to succeed, farmers need to generate more profit and become competitive. It is imperative that they have a good understanding of the farming environment and be skilled at managing risk. By dealing with risk more effectively, better farming opportunities arise. Extension workers can also help farmers improve their risk management skills. They can help farmers recognize and understand their problems and assist them in making better farm management decisions.