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Know Your Market

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Dairy trading experts offer strategies and practical perspectives to optimize market performance.

How to Make a Risk Management Decision as a Team

Dec 19, 2011

Here are a few simple steps to help make the process a little easier for everyone.


Katie Krupa photoBy Katie Krupa, Rice Dairy

Many individuals struggle with making risk management decisions for themselves or their own personal business. The process frequently becomes even more difficult when multiple business partners are involved in making risk management decisions.

Here are a few simple steps to help make the process a little easier for everyone.

1. Set a goal. It is very important to set a goal for your risk management strategies. For any business, the goals should be driven by the business objectives and financial situation. Many farms set a goal to return a profit or protect their break-even. When utilizing a risk management strategy, there will inevitably be times when your farm price is above the actual cash price, and times when it is below the actual cash price. When the actual cash price is higher than the hedged price and some upside opportunity is missed, many people start to question and regret their strategy. Setting a clear, logical goal relative to your farm’s financials will help keep everyone on board with the strategy, regardless of the actual cash price. It is important to write down your goals and review them periodically.
 
2. Get the right people involved. Is your wife the one who receives the milk checks and manages the books? If she is, she should be part of the goal-setting discussion and the decision. Many farms I work with have a management team meeting, which includes the on-farm management staff and frequently the key consultants or agribusiness professionals, such as the lender, the accountant, nutritionist, etc. Agribusiness professionals can frequently offer unbiased advice and help make sure the decisions being made are truly in the best interest of the dairy.   
 
3. Walk through several scenarios. Many times dairies will enter into a contract because they think they know what the market will do. They tend to say things like, “The milk price won’t move any higher,” or “No way we’ll see prices that low again.” Unfortunately, no one knows what tomorrow will bring and where the milk price will end up. That is why we have risk management – to protect against the unknown. A simple exercise is to walk through the desired risk management strategy at various cash prices. For example: With this strategy, what happens if the milk price goes to $10, and what happens if the milk price goes to $25? 
 
4. Review your results. The results from your risk management strategy should meet the established goals. If they do not, analyze and find the problem. If they do, but you are not satisfied, look for alternative strategies that can meet your goals but have different attributes and potential outcomes. It may be necessary to work with an agribusiness professional to help complete the review. 
 
5. Repeat. Your goals and strategies will most likely change over time, but you should be consistent in your use of risk management. Repeat steps 1-4 annually or several times per year depending on your situation. It is important to keep in mind that there may be a time when your risk management strategy is to be on the cash market. What I mean by that is, you are actively not placing any hedges but just taking the cash price that is announced each month. Either way, it is important to consistently review your goals and strategies and make sure you are protecting your business.

If your operation struggles to make risk management decisions, I suggest following these steps and working with a professional to help keep the team on track and make sure the decisions being made are in the best interest of the dairy. Make good, long-term financial decisions, try your best to avoid fear and greed, and your risk management strategies (and your business) will be successful.
 
Katie Krupa is the Director of Producer Services with Chicago-based Rice Dairy, a boutique brokerage firm offering guidance, analysis, and execution services on futures, options, spot and forward markets. If you are interested in learning more, Katie offers monthly webinars on the basics of risk management. You can reach Katie at klk@ricedairy.com.Visitwww.ricedairy.com.

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