November 20, 2012 | By Drs. Joan Fulton & John Foltz

Uncertainty and Risk: How Are You Planning for It?

Seize the opportunities presented by the unknown

The weather is always a major source of uncertainty for all agricultural businesses and as a manager in the feed and grain industry, you know this very well. Certainly those of you operating in the Midwest did not expect the drought to be as long and devastating  as it was during the summer of 2012. Yet, there were some regions where there was ample rain and agricultural production was very good to excellent. Still others of you in places like Texas are dealing with drought conditions extending beyond a single season. In the feed and grain business these dramatic weather conditions greatly affect your volume of business and your bottom line.

Risk and uncertainty are a reality for your business — so what are you doing about it? How are you planning for it? Three common ways of dealing with risk are: ignore it; extrapolate from current trends; and raise the hurdle rate (the minimum rate of return on a project or investment) on all new projects. While there are instances where any one of these reactions may be appropriate, a systematic plan for dealing with risk and uncertainty can help put your business in a better position.

Uncertainty creates both opportunities and challenges. When the discussion of risk and uncertainty comes up usually the negative or downside aspect of uncertainty is what is considered — but there can be opportunities as well. A systematic approach to evaluating, planning for, and implementing a strategy to deal with uncertainty is needed. In this article we discuss some of the different sources of uncertainty and then lay out a plan for developing a strategic response to uncertainty and the risks created. Sources of Risk and Uncertainty

Uncertainties can be broad-based, like the weather example noted above or they can also be more local and specific. Have you ever seen prices make rapid movements when you have been concerned about your exposure in the market (having bought grain and not yet sold it, or having sold it but not yet bought it)? Even with the best hedging policy you may find your business exposed if price fluctuations happened quickly — before you got your original decision hedged. All businesses, at one time or another, face the unexpected departure of a key employee, another source of business risk. On the upside, uncertainty can bring about positive events. The important thing is to plan for risk and uncertainty.

Sometimes events happen that are totally unexpected. It is generally not the case that no one ever imagined that something might happen — rather, when the idea was raised, the reaction was “no that could never happen.” With the news of Hurricane Sandy fresh in our minds as we write this column we see one such example. While there were many who talked about the possibility that a major hurricane could hit New York City, many dismissed those calls of concern, noting one reason or another as to why such a catastrophic event would not actually happen. Still further, the possibility that just days after a major hurricane hits New York City and the east coast the chance that a second storm would bring ice cold temperatures and snow was yet further outside of the realm of possibilities.

The purpose of this article is not to scare you into running out there to put a plan in place for every remotely possible event that could happen. While it is important to be prepared in business, you also have to pay attention to your use of scarce resources. Being fully prepared for that once in every 200 year event will most likely cost your firm more than its worth. However, systematically developing your plan for dealing with risk and uncertainty is what is needed.

A Six Step Approach

We borrow the planning framework from Elizabeth Teisberg (Harvard Business Review, 9-391-192) as a step by step approach for developing your plan for dealing with risk and uncertainty.

1. Brainstorm a list of uncertainties

The purpose in this first step is to come up with a complete and comprehensive list of the uncertain events that could happen to your firm.  When thinking of the uncertainties it is helpful to think of those things that the world can throw at you. At this stage you are not thinking about the decisions that you make, but rather the “events” that can happen. These can relate to: weather, government policies, employees and human resources, and competitor actions.

Start broad and then get more specific. The broad examples might reflect events like large-scale weather events or changes in government policy that impact how you do business and what that costs your feed and grain business. More specific events could be very local in nature, such as an action by a key competitor, the decision by one of your major long-term customers to take business to another firm, a member of your management team getting injured or taking sick such that they are unable to work and carry out the decisions that the business depends on from that person. Local weather events can also be an example of something at the micro level. These are all uncertain events that your business could face, and if they happen, would have a significant impact on your bottom line.

2. Identify Strategic Choices for the Firm and Consider the Inter-relationships Between Uncertainties and the Choices

At this stage you want to identify for each of the uncertainties that you noted in number 1, strategic responses that you and your firm could make. This is the stage where you identify potential decisions or actions. These are the things that you can “do.” You might think about mapping this out as a decision tree. Start off with several initial branches of your tree, one for each of the uncertainties that you identified in #1 above. Then from each of the first round of branches insert another set of branches. On each of these new branches identify a possible strategic response that you and your firm could take to that uncertain event. By the time that you have finished, you will have a very comprehensive diagram with possible events and a whole set of strategic choices.

3. Develop Internally Consistent Visions of the Future

At this stage you can take your comprehensive diagram from #2, and consolidate it into something more useful. Examine the comprehensive diagram and using your judgment and expertise as a manager, develop a set of internally consistent visions of the future for your firm.  So, how many of these visions should you develop? Teisburg specifically indicates that it is not appropriate for an outsider to dictate how many different visions to formulate – rather that will depend on your industry and what works best for you. The idea here is to develop a set of plausible paths that the future could hold for your business. We suggest something greater than 2 or 3 but fewer than 10.

For example, say that one of your risks is that a key competitor is purchased by a new owner, who appears to have a relatively aggressive competitive streak. Plausible responses might be:  

  • Do nothing
  • Seek out a buyer for your business: an outside buyer, or sell to the expanding competitor
  • Expand your business on your own: slightly, moderately, aggressively
  • Merge with a different competitor 
  • Purchase one of your regional competitors.

These are eight plausible paths, each of which would require a different plan to execute. While our example is generic, if it were to occur in your marketplace — you could fill in the names of the players and make determinations as to an appropriate strategy.

4. Check Whether Uncertainty is Critical to Decisions

Now consider each of the uncertainties and the responses that you have laid out. Ask yourself if there is really anything that you can do associated with this uncertainty. If there are actions that you can take ahead of time such that the impact of the event will be different for your business then these are uncertainties for you to pay attention to. For all of those uncertainties where there is nothing with respect to your actions that you would do differently irrespective of the event — then these are uncertainties for you to “put on the back burner.” In other words, pay attention to those uncertainties that are critical to the decisions that you would make.

5. Formulate Strategic Responses to Uncertainty

Now that you have done all of the background work you can lay out your strategic responses to uncertainty. In other words, develop your plan. For example, you may modify and update your hedging strategy for addressing commodity price risk. You may examine your various insurance policies to see if your level of coverage is adequate to cover risks or uncertainties you have identified. Do you have someone in your business responsible for regularly monitoring changes in the Farm Bill and other government policies and evaluating the implications for your business? Have you considered the diversification of your business and whether you have the appropriate level of diversification to handle unexpected events?

Evaluate different strategies, make your action decision          

In this sixth stage you implement your plan and as you implement your plan evaluate how it is working and make adjustments accordingly. Once you have updated your hedging strategy an important step in implementation might be in-service training for you and your employees so that everyone is on-board to implement the new strategy. Follow through with your insurance agent(s) and update your insurance policies. Sometimes updating insurance policies may even result in lower premiums. Even in those cases where you have higher premiums, remember that your analysis has shown that these premiums are worth it because your risk of exposure is now much less.  Set up a time to meet with the employee responsible for monitoring changes in government policy to go over upcoming changes. Arrange to have one of the agenda items for an upcoming board meeting be the consideration of the appropriate level of diversification for the business to address marketplace uncertainties.

Implement strategy for risk mitigation

In the feed and grain business you face many risks and uncertainties. We identified some earlier in this article and you may also face: storage and transportation challenges; feed contamination that results in sick or dead animals; changing market demands for new services such as identity preservation or special measurement of quality traits; loss of grain quality during storage in your facility; and technological risk related to new feed formulations or new grain handling equipment. 

As you implement your strategy for risk management keep in mind that many of these uncertainties represent opportunities as well as challenges. If you have back up plans in place for these unexpected events you may well find yourself with a competitive edge over your rivals in the marketplace. Some strategic steps on your part might be to consider things like how much grain storage you have; what capacity you have for unloading deliveries and loading outbound product; safety training for all employees to minimize the risk of workforce accidents and a deliberate employee retention plan to avoid having your key employees recruited away by your competition.

The take home message of our column is that we can never reduce all the risk and uncertainties in the industry, and that it pays to think deeply and broadly about potential risks and how your feed and grain business might respond.  While we don’t want to keep you up at night — some of those dreams can be sweet ones — that come with opportunities that are presented by the risks and uncertainties in the marketplace.

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