Everything we do has some risk. Walking down the street you could get hit by a car, or an asteroid for that matter; eating an ice cream cone you could choke on the cone or get sick from bacteria in the ice cream. There are risks in investing in a new feed mill — the technology may change, sales may drop such that your payback period lengthens, or the crane installing new bins for the feed mill could fall over and destroy some of your existing grain storage — but some risks can have a bigger impact on your business, and the prudent feed and grain manager analyzes risk appropriately and manages accordingly.
All risks don’t have to be all bad. For example, what is the risk of significantly increased demand for a newly developed horse feed you are selling (which is a good problem to have) but are these risks lost sales or erosion of goodwill if you can’t meet demand, and how would this affect your business? Probabilities come into play here also: in other words what are the chances “so and so” will happen? Do you have historical data which can help you determine how often a certain event or occurrence happens in your business? Do you need to check with your insurance agent to help you assess risk? In fact, that is exactly why actuarial tables were developed historically — to give businesses the chance to better understand what might happen in given situations and the probability associated with certain events.
Methods to reduce, mitigate risk
Our purpose in covering risk in this column is not to make you an expert on everything involving risk and how to handle it, but rather to ask some important questions and provide some management ideas on a topic we don’t often dwell on. Risk makes most people uncomfortable, and the uncertainty associated with it causes people to worry. As such, the (mostly) rational nature of the general population and business managers generally leads them to do something to mitigate and minimize risks (though we do have to be careful about making broad generalizations as there are always the thrill-seeking adrenaline junkies that thrive on risky activities such as sky diving or bull riding).
Basically, people deal with risk in five basic ways: avoiding risk, retaining risk, transferring risk, sharing risk and reducing risk.
Avoiding Risk
As an individual or as a manager, you can avoid some risks altogether by refusing to accept a particular risk, though this may not possible for all choices. Risk avoidance can be accomplished simply by not engaging in the action that gives rise to the risk. If you want to avoid the risks associated with the ownership of property or a piece of equipment — do not purchase the asset, but lease or rent it instead; however, it is generally well understood in economics that the greater the risk taken, the greater the potential for return — thus if total risk avoidance were utilized extensively, both individuals and society would suffer.
Retaining risk
Risk retention may be the most common method of dealing with risk. As we mentioned at the beginning of this column, individuals and businesses face an almost unlimited array of risks, and in most cases nothing is done about them because we may see the probability of an event occurring to be very small. Thus, when an individual or firm does not take a positive action to avoid, reduce, or transfer a risk — then that risk is retained. This risk retention may also be conscious or unconscious. Conscious risk retention takes place when the risk is recognized but not transferred or reduced. When the risk is not recognized, it is unconsciously retained. The result in both cases is the same — the risk is retained. Risk retention is a reasonable strategy — firms must decide which risks to retain and which to avoid or transfer based on their margin for contingencies and ability to bear loss.
Transferring Risk
Risk may be transferred from one entity to another, where the other entity is more willing to bear the risk. A great example in the grain industry is the process of hedging, where a farmer or elevator guards against the risk of price changes in one asset by buying or selling another asset whose price changes in an offsetting direction. Risk may also be transferred or shifted through contracts. A “Hold-Harmless” agreement in which an entity assumes another entity’s possibility of loss is an example of such a transfer. For example, a tenant may agree under the terms of a lease to pay any judgments against the landlord which may arise out of the use of the premises. Insurance is a means of shifting or transferring risk (insurance is also an example of “sharing risk” as described below). In consideration of a specific payment (a premium) by one party, a second party contracts to indemnify (pay for hurt, loss or damage) the first party up to a certain limit for the specified loss that may or may not occur.
Sharing risk
Believe it or not, the corporation is one method/tool of sharing risk. In this form of business, the investments of a large number of people are pooled — thus each bears only a portion of the risk that the enterprise may fail. Insurance is another method for dealing with risk through sharing — and in fact it only works if a group of people participate and due to the laws of averages/probabilities that certain events will occur.
Reducing risk
Risk may be reduced in two ways — the first is in preventing or managing loss and the second is in controlling loss should it occur. There are almost no sources of loss where some efforts are not made to avert the loss — these include safety practices and other strategies we will touch on below. Unfortunately, no matter how hard we try, it is impossible to prevent all losses. In addition, in some cases the loss prevention may cost more than the losses themselves. The second method of reducing risk is controlling the severity of loss once it occurs. Examples here are sprinkler or alarm systems.
A Risk Management System
Risk management involves five basic steps:
Identifying risk: Brainstorming sessions initially amongst management and then involving your staff and other employees can allow you to develop lists of possible risks your feed mill or elevator faces.
Measuring the risk: This can involve developing a risk analysis matrix — further discussed below, where you take the risks you have identified in step one above, and simply rate the probability of their occurrence in a “high, medium, low” fashion.
Formulating strategies to limit your risk: As we will discuss in more detail below, management must determine how to address the risks your firm faces. Insurance, contingency plans and education such as safety training are useful tools here.
Carrying out specific tactics to implement your strategies: This step of your risk management plan involves carrying out your plans and putting them to work.
Continuously monitoring your efforts: As with any aspect of management (i.e. strategic planning, human resource management, financial management) — constant monitoring of performance is needed to insure that your strategies are appropriate and are accomplishing the intended goals. This can be especially important with risk management — for example, it is one thing to develop a set of safety protocols/standard operating procedures, it is another thing entirely to make sure these are utilized properly and consistently by your employees.
Risks specific to the feed and grain industry
As with any industry, there are certain risks specific to the grain and feed industry. We cannot list all of the risks you face, but hope to highlight some of the key ones and suggest some possible management strategies. Market risk is faced by firms in any industry, and grain markets face volatility due to weather and associated supply shocks, exchange rates, the vagaries of transportation (fuel prices, etc.) and in recent years the effects of swings in demand for energy as a result of government ethanol legislation as well as other policy interventions. Hedging in the futures market is one strategy for dealing with grain price risk. Effective utilization of numerous and varied information sources is another strategy to deal with market risk, as information helps you manage this type of risk.
Grain quality and/or feed spoilage is another source of risk faced by our industry. Good management here means proper aeration of stocks, grain turns as appropriate, and fumigation for mold or insects (see sidebar). Dust explosions — we all know that grain dust can be dangerous due to its potential for explosion. Thus, good dust suppression practices are a great risk management strategy.
Falls and grain bin suffocation are definite hazards of the grain and feed business. Safety training and enforcement of confined space rules are very important approaches to risk mitigation. Al Tweeten with Berkley Agribusiness Risk Specialists, states in a recent presentation on insurance risk control in the grain industry that focus on safety is perhaps one of the easiest approaches to managing risk and must be a priority. He feels that training should never have a day off and is everybody’s responsibility. As manager, you should give appropriate rewards for following the rules and you should dispense appropriate discipline for breaking them. Creating a culture around safety is important and in general having rules and training is not enough — it just takes a constant effort. OSHA has a reasonably informative page regarding safety in the grain and feed industry, located at: http://www.osha.gov/SLTC/grainhandling
Another risk management topic of current interest and concern is the recently enacted Food Safety Modernization Act signed into law by President Obama on January 4, 2011, which includes some coverage for feed manufacturers (see http://www.fda.gov/Food/FoodSafety/FSMA ), and for which the Food and Drug Administration (FDA) has oversight. Our intent is to devote a future Manager’s Notebook column specifically to dealing with this new law.
Insurance and contingency planning
The most common tool used to manage risk is insurance. Individuals and firms can purchase insurance for almost any situation. Pretty much anything that has a potential risk for loss or damage can be insured. Insurance works as we have mentioned above — funds from policy holders’ premiums are combined into an insurance pool. Insurance companies use statistics to predict what percentage of those insured will actually suffer a loss and file a claim. Claims are then paid from the insurance pool — with the balance accruing to the insurance company as profit.
Contingency plans are strategies your feed or grain business draws up in anticipation of certain events. They can cover any of the risks or possibilities that might occur to your firm: a competitor going out of business, a fire or flood, a product recall or contamination problem, the death or departure of an owner or key employee. How or whether you engage in developing these sorts of plans depends on your view of the severity of the impact of a particular event and the probability of it happening. The important point here is the conversation: it is far better to have considered a potential risk and decided that no action is required, than to not have the conversation and suffer the consequences when something unexpected happens with no contingency plan in place.
Key components of a contingency plan include a response phase focused on a quick and immediate response to an incident, a resumption phase which targets “getting back to work,” a recovery phase which allows for rebuilding critical infrastructure if destroyed by a disaster and finally a restoration phase which implements procedures for normalized operations. A very detailed contingency plan template (meant for Federal Agencies — so some of the parts of the plan will not apply to the grain and feed industry) can be found at: www.csrc.nist.gov/groups/SMA/fasp/documents/contingency_planning/contingencyplan-template.doc.
This plan is worth looking at because it has some good, thought provoking elements such as a “risk analysis matrix,” discussion of contingency plan contact information, an outline of “team staffing and taskings” — who is responsible for what in the event of an emergency — and suggests developing a succinct listing of all vendors and contractors that currently provide support or will provide support in a post-disaster environment, among other components.
Your insurance and your contingency plans are part of your risk management system. Don't just put them in a ‘safe place’ and forget about them however. Make it an annual commitment to review your risk management system and strategy and update it as necessary. No business is a static venture. Involve your employees as much as possible. They, more than anyone, can spot the flaws/gaps in your operation that can be tomorrow's disaster.
Unavoidable yet manageable
There are lots of things that can happen in life and business and while we may not want to think about these negative outcomes and occurrences, it makes good business sense to carefully consider risks and prepare for contingencies. It may be instructive to engage professionals such as an insurance agent or a risk management specialist to assist with your strategies. A well-thought out plan can definitely make your life easier should an unexpected disaster strike. Risk is unavoidable but is manageable.
