MITIGATING POTENTIAL MARKET AND ECONOMIC RISKS

Risk is a term that has been thrown around a lot recently. It is, however, something that those in farm management have been working with since when humankind first started farming. Risk is still about farm management and not about creating new ‘financial tools’. The following is another answer to the Food Strategy 2025 and in it I have taken the opportunity to express a few thoughts about risk mitigation.

Question – What measures should be taken to mitigate or better manage potential market and economic risks?

Given the current talk about risk and price volatility one could be forgiven for thinking that these are something new to the agricultural and food industries. Far from it, farming has a very long history of risk management. It may well be as a result of greater ‘investor’ involvement from other business sectors or enhanced interest from ‘city’ financiers, but there appears to be much more talk about risk management in agriculture that there ever has been. It may also be that those selling risk management tools may be more active in promoting the idea that they have products that are relevant to and should be employed widely within the agri-food and farming sectors.

One could start by saying that the oldest guiding principle of farm management is to diversify one’s food producing activities so as to minimise the risk to the food supply to the farm household. It probably goes back thousands of years. It is also a principle that was well known to our immediate forebears and was widely implemented until at the least the 1970s. It is almost certainly still a guiding principle for many in the industry today. It is encapsulated in the saying that ‘when hoof is up corn is down and vice versa’. It is about having a diversity of farm enterprises so as to reduce the risk of being exposed to adverse trading conditions relating to one particular farm product.

A similar principle applies to marketing. A diversity of market outlets [and or supply-chain trading partners] used to be considered a good idea. The diversity provided an element of guarantee that you were not exposed to one specific market or, easily forgotten, that you were not exposed to the failings of one primary supply-chain trading partner. The latter is a point that Irish beef farmers are certainly aware of given the problems that have faced due to them being locked into a very few routes to markets with few or no alternatives. For the Irish dairy farmer, just how many are locked in [by catchment area] to the success of their local processing co-operative?

For those brought up in the rarefied atmosphere of the modern business school, a multi-enterprise, multi-market business is an anathema. It is all about specialisation. Vertical integration whereby the producer seeks to have greater control of what happens up or downstream within the supply chain they operate in is just yet another anathema. It is simply far better to specialise and to benefit from thus derived supply-chain efficiencies. Somehow one suspects that this is the kind of thinking that dominates the formation of Irish agri-food industry strategy.

So what can Ireland do to mitigate against market risk?

a) Ensure that your entire supply-chain is competitive within the targeted market

This is probably the most fundamental of issues within the Irish agri-food system. From an outsiders perspective it appears that markets are being targeted without due regard for whether the primary producer within the supply chains is able to compete with their counterparts elsewhere. When prices are high this issue is well disguised. As they fall it becomes highly problematic; not least when there is a massive imbalance in trading weight within the supply chains [as in Ireland] as this transmits the price falls to the primary level. Elsewhere, farmers may own a greater proportion of the supply-chain [and the margins there within] or be of a far greater operational scale [thus benefiting from economies of scale]. In Ireland in some sectors [beef] there is little protection for the small-scale Irish farmers whilst in others the farmer may own a part of the supply-chain [but it is a part that is in itself being squeezed by more powerful, supply-chain partners who control the secondary processing and the brands].

b) Ensure that there are more not less supply-chain options for primary processors

There is a fixation in Ireland with consolidating the processing sector in the belief that this will generate economies of scale that will make the entire supply-chain more competitive. Indeed the beef processors [at least they do in the UK] like to cite this need so that they can pass on the benefits of their lower costs to the primary producer. It is, however, a low-margin-per-processed-head business so the potential gains for the primary producer may only be minimal and certainly insufficient to offset the massive scale disadvantages that Irish beef farmers have when compared to other producers supplying the global market [another example of a) above]. The question is, will even a fully consolidated processing entity in Ireland ever be able to compete on the global markets? Probably not.

If consolidation is not an option, should one be asking whether a fresh look should be taken at the structure of the processing sector? Is it time to consign the consolidation idea into history? A major problem with too few entities operating within the supply chain is that dynamism can be lost, both in terms of competition and in terms of the development of new products and markets and the evolution of new routes-to-markets. There is also an inherent risk in having too few players making the decisions for a combined processing and farming sector [not least when the farmers are locked in to supplying them by there being too few selling options available to them].

The author would suggest that the point has now been reached where [although the current structure has been successful in moving Ireland from a basic commodity producer-exporter] one has to ask if the agri-processing model has to be re-thought so as to help refocus Irish farming at the top of the international food markets.

With respect to creating new routes to market Annex B includes a recommendation that consolidation should still be sought but not at the processing level. The recommendation is that consolidation happens further downstream and with the distribution and sales activities; thus facilitating market access for more, not less, local processors.

One has mentioned on numerous occasions above that Ireland needs to first develop a strategy for rural Ireland first that includes farming, local food processing, employment and community development and environmental measures. The globalisation versus localisation argument also suggests that Ireland needs to focus on developing local products that can add value to farm produce and create local employment; thus focusing activity in the local economy [as opposed to a very sweeping focus on increasing national exports]. It is an approach that balances the family farming structure and the needs of rural Ireland with the [real] premium food markets. It does, however, need an alternative means for products to move from rural Ireland to premium international market and this is unlikely to happen by following the idea of further consolidating the processing component of the supply chains.

So what can Ireland do to mitigate against economic risk?

a) Limiting routes to market means limiting options for farm diversification

Operating a diverse farming business that sells various products is a classic risk reduction strategy. In Ireland it is, however, limited by the lack of available routes to markets. With its small population [especially in rural areas] the options for income from local sales is limited. The problem is that agri-food strategy is too focused on expanding the single enterprise farm and in a way that it is a raw material supplier to a major processor. In such a scenario the farm business is fully exposed to the risks associated with the marketing decisions of their supply-chain partner. If the latter decides to compete in the global markets and to expose its suppliers to competition from far stronger farming entities elsewhere in the World there is nothing the individual farmer can do about it. They are fully exposed to the vagaries, speculations and volatilities of global markets. This is what has and is happening in Ireland and there is very little that the individual farmer can do to reduce this imposed risk exposure. They need options in terms of different routes to markets but they are not being offered them [indeed the agri-food strategy is to limit them] and this is going to have serious consequences in the coming months for Ireland’s dairy farmers [as has happened to the country’s beef farmers]. It is simply a result of placing too many eggs in too few baskets.

b) Shorten and control supply-chains to get closer to the final retail consumer

Another way to reduce economic risk is to shorten supply chains and to get closer to the final consumer. It works even better if one can retain ownership of the supply-chain itself [either directly or as a socially-owned entity]. Apart from the potential for enhancing the proportion of the supply-chain margins being received by the primary producer, it also distances the business from exposure to global markets. The development of farm shops is an example of how farms can mitigate against economic risk. As a solution it is, however, limited in Ireland due to the size of the rural population and the scarcity of rural towns. There are nevertheless alternative solutions to more closely connect Irish farmers with [preferably issues-aware, premium paying] consumers. These need to be more fully explored so as to enable farmers and local processors to access far wider markets. Yes, there are initiatives in place but they are too often constrained by support being limited to food businesses that can [or want to] scale up significantly. Again, it is too much about increasing exports and too little about local, rural economic development.

c) Committing farm expenditure in ways to mitigating against economic risk

There is a school of thought that suggests that economic risk can be mitigated against by using financial ‘tools’ that can hedge against market downturns. In the current times of falling milk prices much is being said about how the volatility on prices [that is apparently a characteristic of global markets] can be minimized for the farmer. This is, of course, happening at a point in time that coincides with the end of EU milk quotas but, in part, that is coincidental, although one would expect that the market is factoring in an expected milk supply increase in the spring of 2015.

The author has spent a lot of time in countries where, farm income fluctuations are great due to drought-created crop failures. This may not equate to price volatility but it has the same impact on farm incomes. Invariable the government is called upon to mitigate the impact and, nearly as invariably, someone starts talking about creating a crop assurance package so the farmers pay a premium and the financial markets then pay income compensation.

Hence, is the creation of financial instruments the way to go? Firstly, money cannot compensate for a food supply loss [or a fodder supply loss in times of a widespread supply failure]. Secondly, someone has to pay for the creation of the financial tool and for the cost of running the risk mitigation programme. The cost will include administration costs plus whatever the market will require to provide what is, in effect, income protection. It will probably not be cheap and will likely eat significantly into dairy farm incomes and, more so, profits. The use of financial tools to support what is volatility within normal trading conditions is not common in the EU and that is for a reason. It is more common with crop assurance in the USA but one hears varying comments on its success.

Using farm expenditure to mitigate against risks created by a dairy farm being placed in a competitive position against farm more powerful ‘rivals’ and in a situation where they are the primary producers in a supply-chain that places products into a highly volatile global market is questionable. One would suggest that there are other ways to mitigate against such market risk but that will means some change in strategic focus in the Irish dairy sector.

In the drought conditions mentioned above, the long-term solution is to focus investment on irrigation rather than crop assurance. What is irrigation other than a risk mitigation tool? Within the EU there is the use of, say, hail insurance in the high-value cropping sectors, but otherwise risk mitigation is about capital investment and employing husbandry practices that reduce risk. Simple examples are land drainage on the capital side and the regularised use of pesticides on the annual cost side. Making silage instead of hay has its origins in risk mitigation.

In an environment where farm management is already playing a major risk management role, is there the need to take on the further costs of financial risk management tools? And one should remember that even forward selling and long-term price fixing contracts are such; and they will all have a significant cost that transfers funds from the farming industry to the financial industry. The author for one would certainly prefer to see the industry in Ireland develop other market and economic risk mitigation tools first; not least because the scale of the typical Irish farm is already competitively weak when it comes to the crucial activity or creating an income for the farming family. It is unlikely that it will also be able to sustain the costs of what would, de facto, be an income protection policy.

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