MANAGING RISK In Farming - Home Food And Agriculture .

3Farm management extension guideMANAGING RISKin farmingbyDavid KahanFOOD AND AGRICULTURE ORGANIZATION OF THE UNITED NATIONSRome 2008

First Printed: 2008Reprint: 2013The designations employed and the presentation of material in this informationproduct do not imply the expression of any opinion whatsoever on the part of theFood and Agriculture Organization of the United Nations (FAO) concerning thelegal or development status of any country, territory, city or area or of its authorities,or concerning the delimitation of its frontiers or boundaries. The mention ofspecific companies or products of manufacturers, whether or not these have beenpatented, does not imply that these have been endorsed or recommended by FAO inpreference to others of a similar nature that are not mentioned.The views expressed in this information product are those of the author(s) and donot necessarily reflect the views or policies of FAO.ISBN 978-92-5-107543-2 (print)E-ISBN 978-92-5-107544-9 (PDF) FAO 2013FAO encourages the use, reproduction and dissemination of material in thisinformation product. Except where otherwise indicated, material may be copied,downloaded and printed for private study, research and teaching purposes,or for use in non-commercial products or services, provided that appropriateacknowledgement of FAO as the source and copyright holder is given and thatFAO’s endorsement of users’ views, products or services is not implied in any way.All requests for translation and adaptation rights, and for resale and othercommercial use rights should be made via www.fao.org/contact-us/licence-requestor addressed to copyright@fao.org.FAO information products are available on the FAO website (www.fao.org/publications) and can be purchased through publications-sales@fao.org.

iiiPrefaceFarmers in developing countries are frequently exposedto the uncertainties of weather, prices and disease.Many farmers live on the edge of extreme uncertainty,sometimes falling just below, and sometimes rising justabove the threshold of survival. Farmers do not knowwhether rainfall will be good or bad over a season; theydo not know the prices they will receive for producesold; and they do not know whether their crops will beinfected by disease. These risks are not under the controlof farmers but some farmers have developed ways ofcoping and managing themHow do you as an extension worker help farmersdeal with risk and reduce variability in productivity andprofitability? How can you assist farmers by advisingthem on good risk management?

vContentsPreface . iiiAcknowledgements . viChapter 1RISK, RISK MANAGEMENTAND INFORMATION REQUIREMENTS .1Chapter 2APPROACHESTO RISK MANAGEMENT . 29Chapter 3ASSISTING FARMERSIN MANAGING RISK . 87Further reading . 107

viAcknowledgementsThe author would like to acknowledge the assistance ofcolleagues and friends. Thanks are due to Steve Worthfor his review of the draft guide and to Andrew Shepherdwho reviewed and edited the final version, as well asto Tom Laughlin, who managed the production process,Michael Breece, for the design and final layout forpublication, and to Francesca Cabre-Aguilar and MartinHilmi for their contributions. Errors and omissions do, ofcourse, remain the responsibility of the author.David Kahan

Chapter 1Risk, risk managementand information requirements

2Managing risk in farmingMAIN POINTS IN CHAPTER 1The risks of farmingFarmers make decisions every day that affectfarming operations. Many of the factors thataffect the decisions they make cannot be predictedwith complete accuracy; this is risk. Farming hasbecome increasingly risky as farmers becomemore commercial. Farmers need to understandrisk and have risk management skills to betteranticipate problems and reduce consequences.Sources of riskRisk affects production such as changes in theweather and the incidence of pests and diseases.Equipment breakdown can be a risk as canmarket price fluctuations. Borrowing money canalso be risky with sudden changes in interestrates. Risk also occurs as a result of changesin government policies. Such risks often have amajor impact on farm income. Finally, there arerisks related to the health and wellbeing of thefarmer and his family and the supply of labourfor the farm.Risk managementDecision-making is the principal activity ofmanagement. All decisions have outcomes orconsequences. However, in most situations the

Risk, risk management and information requirementsRisk management, continuedoutcome of a decision cannot be predicted.The more complex the risk, the more difficultit becomes for farmers to make aninformed decision. For effective decisionsto be taken, farmers need information onmany aspects of the farming business. Farmershave to find ways of dealing with risk andprotecting themselves from the uncertainties ofthe future.Farmers’ attitudes toward riskFarmers differ in the degree to which theyaccept risk. Some farmers are willing to acceptmore risk than others. Attitudes to risk are oftenrelated to the financial ability of the farmer toaccept a small gain or loss. Farmers’ attitudesmay be classified as: risk-averse those who tryto avoid taking risks; risk-takers those who areopen to more risky business options; and riskneutral farmers who lie between the risk-averseand risk-taking position.Information for decision makingGood risk management decisions depend onaccurate information which requires reliabledata. Good information can help a farmermake rational risk management decisions. Thesources of information available include farmrecords, off-farm statistics, information frominput dealers, traders, extension workers andother farmers and market price data.3

4Managing risk in farmingINTRODUCTIONExtension workerscan help farmersto improve theirrisk managementskills . help them torecognize andunderstand theirproblems . and assist themin making betterfarm managementdecisions.Farming is risky. Farmers live with risk and make decisionsevery day that affect their farming operations. Many ofthe factors that affect the decisions that farmers makecannot be predicted with 100 percent accuracy: weatherconditions change; prices at the time of harvest coulddrop; hired labour may not be available at peak times;machinery and equipment could break down when mostneeded; draught animals might die; and governmentpolicy can change overnight. All of these changes areexamples of the risks that farmers face in managing theirfarm as a business. All of these risks affect their farmprofitability.While farmers have always faced risk, farming hasover the years, as a result of market liberalization andglobalization, become increasingly risky. Smallholderfarmers have become especially vulnerable. A casualapproach to farming, even if it is for household foodconsumption, is no longer viable. Farmers need to acquiremore professional skills, not only in basic production butalso in farm business management. Among these arerisk management skills.Skillful farmers and other business peoplegenerally do not become involved in risky situationsunless there is a chance of making money. Higher profitsare usually linked with higher risks. These risky butpotentially profitable situations need to be managed ascarefully as possible. Good risk management involvesanticipating potential problems and planning to reducetheir detrimental effects. Simply reacting to unfavourableevents after they occur is not good risk management.

Risk, risk management and information requirementsIn order to succeed, farmers need to generatemore profit and become competitive. They must havea good understanding of the farming environment andbe skilled at managing risk. By dealing with risk moreeffectively, better farming opportunities arise.Extension workers can help farmers improve theirrisk management skills. They can help farmers recognizeand understand their problems and assist them in makingbetter farm management decisions.At the start of a season, farmersdecide to grow different crops. Theydecide what to plant, how muchto plant and when to plant. Thesedecisions may appear simple, butfor each decision there are manypossible consequences. There willbe only one outcome; only oneresult. But at the time the decisionis made, the outcome is uncertain.When the chance or probability ofan outcome is known in advancethis is called risk. When the chanceof an outcome is not known inadvance this is called uncertainty.Note: For the purpose of this guide we will assume thatrisk and uncertainty refer to the same thing.5

6Managing risk in farmingSOURCE OF RISKThe most common sources of risk in farming can bedivided into five areas:production marketing financialinstitutional humanRisks includelow rainfall,drought, hailor heavy rains,pests and disease,breakdown orunavailabilityof equipmentand spare partsProduction and technical riskCrop and livestock performance depend on biologicalprocesses that are affected by the weather, and by pestsand diseases. Low rainfall or drought may lead to lowyields. Hail or heavy rains could damage or even wipeout crops. Outbreaks of pests or diseases could alsocause major yield losses in crops and livestock.When farmers plant seeds and fertilize their landthey do not know for certain how much rain will fall, orwhether there will be a hail storm. They do not know ifthere will be a problem with pests or diseases. But stillthey must decide whether they are going to plant theircrops or raise their livestock. The resources they spendto plough, plant and fertilize their crops or to care for theirlivestock may not be recovered. This is why there is risk.Farmers produce without complete certainty about whatwill happen to their production.Another source of production risk is equipment. Afarmer’s tractor may break down during the productionseason resulting in an inability to harvest in time, thusaffecting yields. Similarly, if the farmer uses shared orhired traction or other equipment, will it be available whenneeded? If the farmer is using a new technology, will itperform as expected? Will it actually reduce costs and/or increase yields? If seeds do not germinate and dayold chicks die what will be the impact on production andfarm family income? The farmer can never be completelycertain.