Types of Risk Most Important to Producers

Sources of Risk in Farming

Some risks are unique to agriculture, such as the risk of bad weather significantly reducing yields within a given year. Other risks, such as the price or institutional risks discussed below, while common to all businesses, reflect an added economic cost to producers.

Production or yield risk occurs because agriculture is affected by many uncontrollable events that are often related to weather, including excessive or insufficient rainfall, extreme temperatures, hail, insects, and diseases. Technology plays a key role in production risk for farmers. The rapid introduction of new crop varieties and production techniques often offers the potential for improved efficiency, but may at times yield poor results, particularly in the short term. In contrast, the threat of obsolescence exists with certain practices (for example, using machinery for which parts are no longer available), which creates another, and different, kind of risk.

Price or market risk reflects risks associated with changes in the price of output or of inputs that may occur after the commitment to production has begun. In agriculture, production generally is a lengthy process. Livestock production, for example, typically requires ongoing investments in feed and equipment that may not produce returns for several months or years. Because markets are generally complex and involve both domestic and international considerations, producer returns may be dramatically affected by events in far-removed regions of the world.

Institutional risk results from changes in policies and regulations that affect agriculture. This type of risk is generally seen as unanticipated production constraints or price changes for inputs or for output. For example, changes in government rules regarding the use of pesticides (for crops) or drugs (for livestock) may alter the cost of production or a foreign country's decision to limit imports of a certain crop may reduce that crop's price. Other institutional risks may arise from changes in policies on the disposal of animal manure, restrictions in conservation practices or land use, or changes in income tax policy or credit policy.

Farmers are also subject to the human or personal risks that are common to all business operators. Disruptive changes may result from such events as death, divorce, injury, or the poor health of a principal in the firm. In addition, the changing objectives of individuals involved in the farming enterprise may have significant effects on the long term health of the operation.

Asset risk is also common to all businesses and involves theft, fire, or other loss or damage to equipment, buildings, and livestock. A type of risk that appears to be of growing importance is contracting risk, which involves the reliability of contracting partners.

Financial risk results from the way the firm's capital is obtained and financed. A farmer may be subject to fluctuations in interest rates on borrowed capital, or face cash flow difficulties if there are insufficient funds to repay creditors. The use of borrowed funds means that a share of the returns from the business must be allocated to meeting debt payments. Even when a farm is 100-percent owner financed, the operator's capital is still exposed to the probability of losing equity or net worth.

Survey results!

Several surveys have asked farmers about the most important types of risk that they confront in their farming operations. USDA's Agricultural Resource Management Study, (ARMS), a nationwide survey of farm operators, questioned farmers as to their degree of concern about factors affecting the operation of their farms. The concerns cited in the survey varied from "uncertainty in commodity prices" to "ability to adopt new technology".

Wheat, corn, soybean and wheat producers answering the survey were more concerned about yield and price variability than any of the other categories.

What can we do?

Commodity markets offer many challenges as well as opportunities. As you consider your involvement in these markets, it is important that your decision be based on sound business factors. You must also be comfortable with your decision once implemented.

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