Whether we know it or not, we take risks daily, sometimes even multiple times a day. Think about it; have you ever weighed the consequences of snoozing your alarm and getting those precious five extra minutes of sleep? What about taking a shortcut to work that you have not fully planned out? While these may seem like not big issues, they are still examples of taking risk. Agriculture is one of the riskiest industries and professions due to the various sources of risk that can impact a farm or even whole sector of the industry. There are strategies that producers utilize to manage and mitigate the impacts of risk on their operations. A recently published USDA report analyzed data from 1996-2020 to evaluate how producers across the U.S. utilize on-farm risk management strategies and market-based tools, as well as how they manage strategic risk across all farm types. A previous Farm Focus blog discussed the USDA’s farm typology, which is also used in for this report.
What is risk in agribusiness?
Before getting into the post, it is important to understand what risk is and the types of risks present in agribusiness. University of Wisconsin Extension outlines the three main components of risk: an event, the probability of that event occurring, and the potential outcome of that event. The more uncertainty of an event occurring, the more difficult it becomes to plan for and the greater the risk. Events can be external to the operation (such as weather, government policies, or global events) or internal to the operation (such as planting decisions, purchasing equipment, or applying an herbicide). In the context of agribusiness, there are five sources of risk: production (pests, diseases, weather), financial (debt, access to capital, equity), legal (contracts, laws and regulations, business structures), human (employees, family relations, personal health), and price/market (commodity prices, input costs, market access). An event or factor can be in multiple different sources of risk.
On-Farm Risk Management Strategies
The report begins by analyzing four main types of on-farm risk management strategies: diversification, commodity storage, using savings, and accessing credit. Diversification in the report is further categorized by producing a variety of commodities, utilizing multiple sales outlets, spreading production across different geographies, and entering other farm-related enterprises. The report shows that most farms are not diversified, and even the most diverse operations specify in only a small number of commodities. Approximately 27% of all farms had diversified commodity production, with midsize family farms (77%) and large family farms (78%) having the highest share. Only 5.6% of all farms used multiple sales outlets, with 36% of very large family farms and 35% of large family farms being the highest. Roughly 10% of farms spread their production across different geographies, with both very large and large family farms having the highest shares. Finally, 68% of all farms engaged in another farm-related enterprise, with off-farm occupation farms (79%) having the highest share.
Storing commodities is further separated in the report by use of unpriced storage either on or off farm, and use of on-farm storage. Approximately 14% of all farms used unpriced storage, and 18% of all farms used on-farm storage. Large family farms and midsize family farms had the highest shares of farms that used these storage strategies. Large family farms had the highest share for both strategies, with 50% using unpriced storage and 55% using on-farm storage.
Usings savings and access to credit are the final on-farm risk management strategies analyzed in the report. These two methods are used to supplement negative impacts to farm incomes, but the use of both varies based on farm size. Around 85% of all farms utilize savings, with off-farm occupation farms (94%) and small family farms (85%) using this strategy the most. Only 17% of farms access credit, with large (61%) and very large (55%) of family farms using this strategy.
Market-Based Risk Management Tools
Managing risk using on-farm strategies can be effective in situations with small losses, transferring risk to markets can be important for larger losses. The market-based risk management tools analyzed in this report are insurance programs, futures contracts, and production contracts. The insurance programs in the report include the Federal Crop Insurance Program (FCIP) for crops and livestock, building and machinery insurance, and insurance for stored commodities. Only 14% of all farms has insurance through the FCIP, with large family farms (71%) and midsized family farms (60%) using these programs the most. More farms used other types of insurance, 57.5% in total, with all types of family farms reporting high usage of insurance. Specifically, 61% of small family farms, 92% of midsize family farms, 95% of large family farms, and 94% very large family farms using additional insurance programs. Around 26% of all farms use insurance for stored commodities, with only very-large family farms (59%) reporting a majority that use this type of insurance.
Commodity futures and options can be used to establish a set price for a commodity, which eliminates some risk before harvest time. However, using futures and options can be difficult, with many different types of contracts and many technicalities. The report found only 2.3% of all farms used futures and options, with no type of farm reporting use above 20%. Production and marketing contracts are made between a producer and buyer that specify quantity, quality, and even type of commodity to be produced or marketed. Like with futures and options, production/marketing contracts are not commonly used across farms, with only 2% of farms using production contracts and 6% of farms using marketing contracts.
Strategic Risk Management
The on-farm and market-based risk management strategies are designed to respond to more immediate and short-term risks that could threaten a farm operation. However, risks could be long-term and not become fully evident for years down the road. The report looked at three strategic risk management strategies: capital improvements, soil health investments, and succession planning. Capital improvements are typical management decisions operators make, especially in times with strong financial health. These usually include adding additional acres to the operation or putting up new buildings. However, these decisions can affect operations in years where the financial position becomes weaker. The report shows only 15% of farms making these capital investments on a yearly basis, with the share of farms making these improvements increasing as the size of the farm increases. These capital investments can help ensure the farm remains efficient with the current state of production, but investing in soil health can help the farm maintain its level of productivity for years to come. These practices can take years to see the full benefits but can help reduce risk in the long-term. Around 21% of farms use soil health practices, with large family farms (61%) and midsize family farms (55%) having the highest share.
Capital investments and soil health practices can help an operation keep producing efficiently in the future, but one thing is important to keep the operation itself going: succession planning. Succession planning can be a long, multi-faceted process that involves difficult decisions and discussions among family members. These discussions often involve emotion and nostalgia, while trying to balance the financial and production decisions for the operation. The report found 32% of farms engaged in succession planning of some kind, with larger family farms having higher shares of those engaged in the process.
Risk is present in our everyday lives and can come in many different forms. In agriculture, risk is something that can threaten the very livelihood and future of farm families. This USDA report looked at how farms of all sizes use risk management strategies on their operations. While the use of a particular risk management strategy varies across all farms, the report does make one thing clear. Risk management is not a one-size-fits-all approach, nor can any single strategy protect against all risks. Proper risk management requires an analysis of the current state of a farm operation, then implementing the strategies that align with the strengths and weaknesses of the operation.