To truly manage risk you must work on the "buy side" and the "sell side" of your beef business.
The "sell" side is the traditional marketing side most producers think of when they hear the term "risk management." It is the stuff you use futures and options and forward contracts and other marketing agreements to manage.
The "buy" side is all the inputs you use to run your operation. Wise management on that side requires good analysis and budgeting and smart asset allocation, says Jeffery "Jeff" Geider, director of the Institute of Ranch Management at Texas Christian University.
Geider tells of a TCU graduate who operates a feedyard with well-aged feed trucks. He decided older trucks with better maintenance would allow him less risk in cash outlay.
Is it more profitable? Maybe.
Is it financially safer? Yes.
In fact, Geider says they teach their students at the TCU Ranching School that if you can take a 20% hit by way of reduction in the price of your product your risk is probably well managed and you are sustainable.
That's a big hit, comparable to what happened in the markets after the BSE panic in December 2003. Fed cattle opened that month at a board price of $99.70 and closed the month at $78.92 after the Texas BSE case was reported.
This has become more important than ever, says Geider, who also operates a family ranch. Everything costs more these days. You're not just getting higher prices for calves. All your inputs cost more too.
Randy Blach of CattleFax recently said that since 2010 the weekly corn price change has been $20 or more 39% of the time.
In that vein Geider says, "Higher prices for livestock will not guarantee profitability. We're margin operators, and there's risk associated with managing the margin."
"There's a lot less margin for error," Geider continues. "Take cattle feeding, for example. Once you could take a couple pretty big hits and come out of it. Not anymore."
Cow-calf records in the Standardized Performance Analysis southwestern data base show costs per beef cow have gone from the mid to upper $300 price range in the mid 1990s to nearly $600 today -- an input cost increase of nearly $250 per cow or 60-65%.
Of course, feeder-calf prices have climbed more than that, running from cyclical lows in the $70s per hundred to about $150 today.
But there's more to the story.
Bruce Schneier, an international security technologist and author, wrote a good blog on risk management not long ago. He says the term "risk management" is just a fancy term for the cost-benefit tradeoff associated with any security decision.
He says, "It's what we do when we react to fear or try to make ourselves feel secure. It's the fight-or-flight reflex that evolved in primitive fish and remains in all vertebrates. It's instinctual, intuitive and fundamental to life, and one of the brain's primary functions."
The problems with using that primitive "risk management" system of ours in modern decision making are:
- We miscalculate the probability of rare events.
- We react more to stories than data.
- We respond to the feeling of security rather than reality.
- We make decisions based on irrelevant context.
Therefore Schneier says in modern terms that "risk cockpit" we operate from is not nearly as finely tuned as we might think.
He says you can't completely remove emotion from risk management decisions and best way to keep risk management focused on the data is to formalize the methodology.
This is exactly what Geider is getting at with his talk and the TCU ranching school's curriculum.
Geider says you must list, analyze and then manage the major risk factors in your operation.
He says the major risk factors in beef production include market risk, production risk, basis risk, inventory risk, liquidity risk and principal risk.
Analyzing and managing risk not only gives you survivability in these volatile times, it can let you capture bigger profits than ever before, say Geider and others.
Write down and evaluate all your risks
Your entire operation should have regular risk analysis, according to Texas Christian University ranching school curriculum.
Jeffery Geider, director of the college's Institute of Ranch Management, says they teach students to make a checklist like this one for evaluating an investment in the livestock industry and weighing the risk/reward ratio.
____ What are the measurable risks associated with the enterprise?
____ How much capital is required?
____ How much personal or business equity is subject to market exposure?
____ What is a reasonable expected return?
____ What are the opportunity costs associated with this enterprise?
____ Are there tools or management techniques available to mitigate or transfer risk?
____ Can the business afford the possibility of a loss?
____ Is the enterprise utilizing all of its resources efficiently?