The sources of risk in agriculture are numerous and diverse. The markets for agricultural inputs and outputs have a direct impact on farming risk, particularly through prices. A diversity of hazards related to weather, pests, diseases, or personal circumstances determine production in ways that are outside the control of the farmer.
Unexpected changes may occur in access to credit or other sources of income that affect the financial viability of the farm. To combat these myriad risks in agriculture, there is a need for farmers and farm managers to understand the meaning and scope of risk management.
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Meaning of Risk Management
There are several definitions of risk management; some of them are presented here. Risk management is a mechanism for managing exposure to risk that enables the recognition of events that may result in unfortunate or damaging consequences in the future, their severity, and how they can be controlled.
Risk management is a discipline for identifying risks, assessing how serious or severe the risks are, and determining ways to address that uncertain future with the goal of avoiding or minimizing harm and financial losses.
Risk management is the continuing process to identify, analyze, evaluate, and treat loss exposures and monitor risk control and financial resources to mitigate the adverse effects of loss.
A working definition of risk management that applies generally and not specifically to agriculture could be: the identification, analysis, and economic control of those risks that can threaten the assets or earning capacity of an enterprise. Several important points emerge from these definitions:
i. The threefold approach to risk management is quite evident. Risks must be identified before they can be measured, and only after their impact has been assessed can a decision be made on how to address them.
ii. The eventual control mechanism, whatever it is, must be economic. There is no point in spending ₦100,000 to control a risk that can only ever cost ₦50,000. There will always be a point where spending on risk control has to stop.
iii. The definition mentions assets and earning capacity. These assets can be physical or human. Both are important, and risk management must be seen to play a part in both. However, risks do not only strike at assets directly, and for this reason, the definition mentions the earning capacity of an enterprise.
iv. The definition uses the word “enterprise” rather than a more restrictive term such as “company” or “manufacturer.”
Risk management has its origins in manufacturing or process industries, but the principles are just as applicable in the agricultural sector as in the manufacturing sector and are of equal importance in the public and private sectors of the economy. Reference to “earning capacity” does not automatically imply the private sector and the profit motive.
v. Finally, the definition is couched in terms that support the expected objectives of the enterprise. Risk management should be viewed as a positive way of helping operational managers achieve their objectives. By identifying, measuring, and controlling risk, the earning capabilities of assets, and hence the objectives of the enterprise, will be secured.
In ideal risk management, a prioritization process is followed whereby the risks with the greatest loss (or impact) and the greatest probability of occurring are handled first, and risks with a lower probability of occurrence and lower loss are handled in descending order.
In practice, the process of assessing overall risk can be difficult, and balancing resources used to mitigate between risks with a high probability of occurrence but lower loss versus a risk with high loss but lower probability of occurrence can often be mishandled.
Risk management also faces difficulties in allocating resources. This is the idea of opportunity cost. Resources spent on risk management could have been spent on more profitable activities. Again, ideal risk management minimizes spending (or manpower or other resources) and also minimizes the negative effects of risks.
Intangible risk management identifies a new type of risk that has a 100% probability of occurring but is ignored by the organization due to a lack of identification ability. For example, when deficient knowledge is applied to a situation, a knowledge risk materializes.
Relationship risk appears when ineffective collaboration occurs. Farmers who do not interact and collaborate with other farmers in the neighborhood will not have access to helpful information at the right time, if at all, and hence will be exposed to relationship risks.
Process-engagement risk may be an issue when ineffective operational procedures are applied. These risks directly reduce the productivity of farmers, family, and hired labor, decrease cost-effectiveness, profitability, service, quality, reputation, brand value, and earnings quality.
Intangible risk management allows risk management to create immediate value from the identification and reduction of risks that reduce productivity.
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Principles of Risk Management
The following are the principles of risk management:
1. Risk management should create value for the farmers.
This implies that the resources expended to mitigate risk should be less than the consequence of inaction. In other words, the gain of risk management should exceed the pain.
A farmer should not spend ₦100,000 to control pests on a farm where the net farm income is ₦50,000. Risk managers are measured and judged on several dimensions, but the only dimension that matters is how it impacts the value of the business. Good risk management increases value, whereas bad risk management destroys value.
2. Risk management must be an integral part of organizational processes.
This principle signifies that risk management must be part of the processes involved in crop production or livestock enterprises.
3. It must be part of the decision-making process.
Farmers, as entrepreneurs, are decision-makers. In the course of making decisions on or before investment in planting seasons or livestock production, the management of expected risks must be planned for, and appropriate strategies must be put in place to mitigate or avoid the risk.
For instance, when a poultry farmer decides to acquire or purchase day-old chicks, part of the decision process should include how to avoid disease outbreaks. To achieve this, the farmer plans to vaccinate the chicks at regular intervals.
Some risks could be avoided if farmers have access to information. Hence, farmers should seek information from co-farmers and, more importantly, from extension agents. Farmers should utilize the acquired information by carrying out risk management based on the best available information.
It must take human factors into account. Two out of the four factors of production (labor and entrepreneur) are human factors. The actions or inactions of these two factors constitute a major source of risk in any business enterprise.
It is therefore imperative for the risk management process to take human factors into consideration. The death of a farmer or farm manager of an agribusiness enterprise or the withdrawal of services by farm workers are human-based risks that must be planned for in risk management strategies.
4. Risk is a threat and an opportunity.
Risk is the combination of danger and opportunity. Market volatility can ruin a farmer or make them wealthy. Changing customer tastes can lay an entire market to waste or allow a farmer to dominate a market. Business failures and large losses come from exposures to large risks, but so do large profits and lasting successes.
The trouble with risk management is that people see one side or the other of risk and respond accordingly. Those who see the bad side of risk, i.e., the danger side, either argue that it should be avoided or push for protection (through hedging and insurance) against it.
On the other side are those who see risk as an upside and argue for more risk-taking, not less. Risk is a mix of upside and downside. Good risk management is not about seeking out or avoiding risk but about maintaining the right balance between the two.
Risk is a combination of potential upside with significant downside and requires a more nuanced approach. If the proposition that one cannot have upside without downside is accepted, a more realistic approach to dealing with risk can be adopted.
This approach can also move toward a consensus on which risks should be sought out because the upside exceeds the downside and which risks are imprudent, not because risk-taking is disliked but because the downside exceeds the upside.
5. It must be dynamic, iterative, and responsive to change.
Risk management must not be static; rather, it should be dynamic. A farmer who is rigid and traditional in their approach, unwilling to adopt innovations such as new crop varieties resistant to certain pests, might suffer losses. Farmers should therefore be responsive to changes taking place in the agricultural industry.
6. Risk management portfolios must be capable of continual improvement and enhancement.
7. Risk management must be continually or periodically reassessed.
The risk management process includes monitoring and evaluation. Farmers are expected to assess risk management strategies continually in terms of quality and cost by weighing the cost of risk management against the value created in terms of net farm income.
The outcome of the assessment or evaluation will indicate the next line of action, which could be adhering to the existing risk management portfolios or adopting new and better risk management strategies.
Risk management is the identification, analysis, and economic control of those risks that can threaten the assets or earning capacity of an enterprise.
Risks must be identified before they can be measured, and only after their impact has been assessed can a decision be made on how to address them.
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