In business, the higher the risk the higher the reward. We as farmers are exposed to much the same risks as other businesses, like price risk, theft and political uncertainty. Farmers, however, have the added complication of weather. In South Africa we are either in the middle of a drought or waiting for the next one! This makes controlling and managing risk critical.
By Claude Cloete, veteran Merino farmer
All businesses must take calculated risks, otherwise they would never make any money. The emphasis is, of course, always on “calculated”, because you are after all in business, not in the business of gambling!
The cost of managing risk
There are many methods of reducing risk, and they all have an associated cost. This cost by definition reduces profit. All sound businesses, however, regard risk management as simply part of the cost of doing business. Very few people can survive a situation where they have a record crop one year and no crop the next year, hence the need for some form of risk management.
The most common way of spreading risk is to take out insurance. Crop farmers can insure their crops for virtually every peril imaginable: drought, hail, fire, theft… The problem is that such insurance is very expensive. When planting with borrowed money, the banks and agribusinesses insist on some form of insurance. Remember that they, too, must manage their risk. This makes insurance a fixed cost and, as such, it does not affect yield.
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Spreading risk with crops
Crop farmers spread risk by planting a combination of crops, like maize, soya beans and sunflowers. Planting these crops at different times spreads both price risk and the problem of something like a midsummer drought or localised hailstorm. Such mixed crop systems of course also have an added cost because additional expertise and machines are needed.
A relatively new innovation in crop farming is minimum tillage, which increases water infiltration in soil and the soil’s water-storage capacity – in other words, making the soil more sponge like. Cover crops are then planted, and crop residues are left on the land to reduce runoff. Minimum till has costs, of course, like the new equipment it requires, but its greatest advantage is the management of drought risk, and this reduction in risk must be offset against the cost of having to buy new equipment.
Spreading risk with animals
For stock farmers, a fodder bank is probably the most obvious strategy, but it’s also the least employed due to cost. A fodder bank can either be stored hay or spared veld, and many farmers, especially in drier areas, farm at 80% of their carrying capacity. You can run out of money, but it is never a good idea to run out of veld or hay, because in the middle of a drought, no matter how much money you have, there simply is never grazing or hay available because everyone is looking for the same thing!
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Farming with wethers (hamels) or oxen also reduces risk, as you don’t need to get them pregnant when a drought comes along, and they simply can go into survival mode. Remember, every farm can only calve a certain number of cows, or lamb so many ewes. Productive females will always be more profitable than hamels or oxen, but only until a drought comes along.
The greatest risk stock farmers expose themselves to is selecting for maximum production. Yes, it is possible to run 12 cows of 500kg where you can have 10 cows of 600kg. The 500kg cows also have a lower associated risk.
Productive females like ewes and cows will always be more profitable than hamels or oxen, but only until a drought comes along!
A dairy cow producing 30 litres of milk per day carries more risk than one producing 20 litres. A sheep shearing 6kg of wool has a higher risk than one shearing 4kg when they have to produce in the same environment, because that sheep giving 6kg of wool often doesn’t lamb. Yet farmers continue to select for production without understanding the associated risks.
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Getting risk management right
Managing risk has become incredibly important for South African farmers. First, because the government doesn’t have the money to bail out farmers. Second, farming isn’t always the most urgent political problem, and government doesn’t feel drought has much to do with them. That makes drought a cost of doing business, and a very important cost at that.
In the same way, it is not your neighbours’ job to look after you during a drought. He simply wants to buy your farm, and if he manages his risk and profit better than you do, he most likely will!
If you have all your eggs in one basket, your risks are simply too high. If you have too many irons in the fire, your fixed costs and management pressures are too high. Everyone must balance those two concepts to the best of their ability and talents. Every farm and person is different. Some people panic when they have R1 million in debt, whereas others are unfazed even at R10 million!
Yes, the best way to avoid risk is not to plant, but then you must have enough cash reserves to carry you for a year. For many farmers this is not an option. And if there were no risk, there would also be no reward.
I hear many farmers complain about how tough farming is and how unfair it is. Farming is not meant to be easy. If it were easy, there would be no money in it!
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