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Executing a Dairy Margin Management Plan

Aug 15, 2011

Successful dairy margin managers should focus on these points to help drive consistency in executing their margin management program.

By Will Babler, First Capitol Risk Management, LLC
In prior articles in this Dairy Margin Management series, we have reviewed strategic issues such as hedging philosophy, selecting the right hedging tool and developing a commodity risk management plan. We have also discussed tactical issues such as understanding milk basis risk and hedging complex feed rations. Maximizing the potential benefit of these various topics requires discipline and consistency in execution.
With volatile markets and a distracting operating environment, it is one thing to have a plan. It is an entirely different thing to follow through with it. Successful dairy margin managers should focus on the following points to help drive consistency in the execution of their margin management program:
·         Written Policy – Having a written document that outlines the agreed upon hedging tools, budgets and targets allows for decisiveness and time savings. It also prevents second guessing since all stakeholders in the operation have come together and made a final decision on the policy. This written game plan allows for a consistent approach in execution since expectations and constraints aren’t a shifting target.
 
·         Regular Schedule – Dairy managers have no shortage of pressing issues vying for their attention. Unfortunately, markets don’t have a pause button. Fast markets can result in drastic changes in profitability. Setting aside regularly scheduled times for review of the risk management program keeps opportunities and risks from slipping through the cracks. These scheduled times can be used for either internal review or discussions with outside advisors. Many managers set aside a short amount of time each day or each week for a quick review of positions, prices and margins. A more in-depth review is often scheduled biweekly or monthly.
 
·         Actionable Information – To consistently execute a hedging program requires turning a huge quantity of market and operational data into good information. It is important that a dairy margin manager have their vital numbers in front of them before making any hedging decisions. Actionable reports should include details of milk and feed prices and price trends, option hedging costs, coverage and exposure and forward profit opportunities. Having a means to assemble this information in a consistent format allows for time savings as well as the ability to view opportunities and risks through the same lens as time passes.
 
·         Stick with the Plan – When forward profit margins are in historically high percentiles, it should be easy to take steps to lock in this opportunity. Yet the typical dairy producer may have trouble pulling the trigger. These are times to reflect back on the policy, which should direct a less emotionally conflicted course of action – scaling into hedge positions that lock in margins as they reach historically favorable levels. In a perfect world, a hedger would spend his or her time only making decisions on how to go about locking in these types of opportunities. In reality, hedgers must also focus on playing defense. When margins become less than ideal, the tendency is for producers to pull back and decide they no longer want to hedge. This ignores the fact that margins could erode further. Consistently managing risk requires maintaining hedge coverage in good times and bad. This approach requires discipline that is rewarded over the long term by smoothing out the peaks and valleys in margins.
 
Will Babler is a principal partner at First Capitol Risk Management, LLC. Contact him at 815-777-1129 or at wbabler@firstcapitolrm.com. Visit the company’s website at www.firstcapitolrm.com.
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