In the real world, anything can happen. If you aren’t convinced of that, consider events such as Chernobyl, Mount St. Helens or even the fall of communism. Adopting the military planning strategy known as “scenario planning” can take some of the emotion out of unexpected events and put you in a position to profit from them or at least deal with them.
An obvious use for scenario planning is in pricing your production or inputs. If USDA projects a 2010 crop average cash price of $9.15 to $10.65, you would include plans for say, $5 and $15 beans as well as prices within the range. However, scenario planning can also be used for other aspects of your business: Suppose a key employee is disabled, your daughter surprises you by wanting to farm or your bank goes out of business.
“It takes a mindset that gets you out of predicting the future or focusing on outlook and being prepared for whatever might happen,” explains Scott Stewart of Stewart-Peterson, which developed a practice it calls Market Scenario Planning (MSP). “Scenario planning is all about embracing uncertainty. It is designed to deal with major, uncertain shifts in your environment.”
In MSP, outlook accounts for 20% of the planning process and strategies represent the other 80%, Stewart says. “We define where the market is most likely to go, then explore what other price scenarios are possible. Then we come up with strategies to capitalize on each of the possible scenarios, taking into consideration the financial position, business goals, risk tolerance and lender relationship of the operation,” he explains. The result: much less uncertainty regarding what to do under various scenarios. “Through planning and preparation, you aren’t blinded by outlook.”
Kent Kalcevic is part of a fourth-generation, multifamily farm that grows wheat, proso millet, sunflowers, corn and forage in eastern Colorado. “Scenario planning aligns with our business goals. It removes the emotional yo-yo effect you can feel when you focus on rapidly changing outlook,” says Kalcevic, a client of Stewart-Peterson. “We develop scenarios and strategies for various yields and prices. It’s especially important because our dryland, summer-fallow rotation production variation is huge. For example, on July 1, 2010, we thought we were 100% hedged. It turned out we had a great crop and it turned to a 50% hedge. It can just as easily go in the other direction—$3 wheat or $10 wheat may not be likely, but we are prepared if either happens.”
Outlook as Influencer. Kalcevic and his partners—his father, wife, uncle and two cousins—review where their sales stand versus the market at least weekly. “It is difficult to ignore outlook completely, but we view it as an influencer, not the foundation of our marketing plan,” he says. “How often we revise our plan depends upon volatility. We may make several changes a year or once a year, but much less than if we relied on outlook. In 2008, we implemented defensive scenarios for about 18 months. We just shifted to more neutral scenarios in August.”
Kalcevic began 2010 wheat sales during the bull market in 2008 because the market provided opportunities. “We also had the ability to lock in some input costs two years ahead of the crop,” he says. Because they are in a summer-fallow rotation, the partners use a 24- to 30-month
planning window for their crops as opposed to the more common 18-month window for corn, he adds.
Stewart urges farmers to consider scenarios for a wide range of possible market movements and measure their impact on the value of total production frequently. “We always model them on 100% of the crop. The more you make marketing about math and the less about outlook, the better off you are. We focus on the balance of positions rather than where the market is headed,” he says. “If you are 75% sold at good prices and the market falls, you don’t need to panic; the impact on your bottom line won’t be devastating. We ask, ‘At what point does the current sales price look bad?’ We try to identify decision points where you might buy puts to protect the downside or you might want to reown grain. Then when prices hit triggers, you know what to do.”
The ultimate position to reach is the one at which, no matter where the market goes, you don’t care because your overall position is satisfactory. This takes recognizing that no market strategy will capture every penny. “Let that fantasy go,” Stewart urges. “It is too costly to manage to every cent move in the market. In today’s environment, you can’t market for 20¢ moves. You have to worry more about 50¢ to $3 moves.”
It’s not much different from the contingency planning farmers do for field work at planting or harvest, he adds. “You have spare parts in case of a breakdown. If it rains, you know how you’ll adjust.
“The key to successful scenario planning is remembering that it is not a tool for predicting
the future,” Stewart emphasizes. “Rather, it is an attempt to describe and plan for possibilities.”
Not Easy. It takes a lot of intestinal fortitude to execute a plan developed some time ago, and it definitely requires a change of focus, Kalcevic says. “Distancing your business from market noise is hard to do and it means a long-term commitment to maintaining a focus for multiple years. But that’s where most businesses need to be: planning weeks, months and years ahead.”
The payoff? More sleep, Kalcevic quips. “We have more consistent marketing year in and year out. We may not sell the highs, but we avoid the lows. And because we are better prepared for the market to do the unthinkable, we can make good, informed business decisions.”
Practice these Key Steps in Market Scenario Planning
A good way to experiment with scenario planning, says Scott Stewart of Stewart-Peterson, is to create a group of distinct and plausible price possibilities, then test the impact of various marketing strategies. As you become more comfortable, you might apply the process to other aspects of your business or incorporate more factors. Here are the key steps to begin:
> Define the scope of your planning and the time frame (old crop, new crop and next year’s crop).
> Use fundamental and technical analysis to develop likely scenarios of where the market could go (for example, up a little, up a lot, down a little, down a lot).
> Identify triggers or signs to serve as indicators that a certain scenario is unfolding.
> Make up a matrix that reflects ranges in the variables (an example for 2010 corn is on the preceding page) and do similar matrices for old and new crop.
> Test the various marketing strategies you use for each box in the matrix.
> Develop the discipline to act when triggers are hit.
> Continuously create new scenarios and trigger points as each scenario unfolds.
Learn More at the 2011 Top Producer Seminar
Scott Stewart will be speaking on Market Scenario Planning at the Top Producer Seminar in January. To register, click here.
Top Producer, Mid-November 2010