Risk and Uncertainty in Agriculture: What are the Sources?
An article for publication in
Seed World
February 27, 2004
Dr. MichaelBoehlje,Dr. Allan Gray, Brian Briggeman, and Josh Detre*
Change and the uncertainty that results are not new to agriculture. However, the rate of change appears to be accelerating which is creating uncertainties that agribusiness have little experience in managing. For example, biotechnology and genetic engineering have reduced the time lapse from trait identification to commercialization in corn genetics from about 12 years to almost 7 years. There has been rapid consolidation and restructuring of the food retailing, chemical manufacturing and theretail input supply industries. The rate of adoption and diffusion ofnew technologiessuch as biotechnology is much more rapid than in the past. These dramatic changes are creating new and different risks than traditional operational and financial risks (price, cost, financing, legal, etc.) agribusinesses have faced in the past. As agriculture becomes more industrialized, strategic risk and uncertainty is likely to become increasingly more important, and as we will note this uncertainty is typically more difficult to manage.
Strategic vs. Tactical Risk with Uncertainty
Strategic risk and uncertainty is the sensitivity of the company’s value to inappropriate strategic choices, ineffective strategy implementations, or uncertainties in the business climate. These uncertainties include: 1) political, government policy, macro-economic, social and natural contingencies, and 2) industry dynamics involving input markets, product markets, competitive and technological uncertainties. Strategic risk and uncertainty might be characterized as having a low or even unknown probability of loss, but if a loss does occur the consequence could be catastrophic – maybe even threatening the survival of the business. Tactical or operational risk is easier to manage than strategic risk and uncertainty, in part because most strategic risks cannot be managed or transferred through conventional futures or insurance instruments. Strategic risk is multidimensional while tactical risk has an identifiable one-to-one exposure such as price risk to futures contract (i.e. hedging). Therefore firms must manage strategic risk through proactive strategies.
To illustrate; one of the strategic uncertaintiesagribusiness managers are facing because of the industrialization of agriculture is contractual or relationship risk. The expanding use of contractual agreements and other forms of negotiation-based linkages between the various stages contained in the agricultural production and distribution system, combined with the decline in market-based transactions, results in price risk being replaced by relationship or contractual risk for many businesses. A seed company may have a contract that guarantees access to enhanced genetic traits at a set price, but what happens if the biotech firm goes bankrupt or leaves the market? What happens to the status of the contract if the biotech firm finds other seed companies who can satisfy their need for market access at a lower price? This risk is not unlike that of losing a distributor or retailer in a particular area, but losing access to key suppliers is becoming a significant risk in the seed industry.
The Domain of Risk and Uncertainty
When viewed from the broader perspective of both strategic and tactical/operational risks, the total risk that agribusiness firms face is much more complex and more pervasive than is often perceived. In fact, as the agricultural sector increasingly exhibits the characteristics of an industrial model, the types of riskit faces will change and so must the strategies that firms use to manage risks. A taxonomy of the broader dimensions of risk that agribusiness firms will be facing in the future is presented in Figure 1. As seen in Figure 1 a risk category can have a tactical and strategic risk aspect, an indication that the ability to manage the interdependencies of the two risks will be of the utmost importance when developing risk management strategies. Recognition of these interdependencies is essential, for example if an agribusiness firm is facing competition risk it must develop a strategy that addresses market share risk while at the same time taking into account how this strategy might impact antitrust risk.
From both an analytical and managerial perspective, a major challenge in the future will be to quantify both the frequency or probability of occurrence and the magnitude of exposure from each of these potential sources of risk. Managing these risks requires not only new assessment tools such as scorecarding and mapping, but also more systematic decision frameworks that capture the total domain of risk and uncertainty.
*Boehlje and Gray are professors and Detre and Briggeman are graduate students with the Center for Food and Agricultural Business at PurdueUniversity. Additional information on this topic can be obtained by contacting Mike Boehlje at .
Table 1. Dimensions of Risk and Uncertainty in Agribusiness
Categories of Risk / Sources of RiskTactical Risk / Strategic Risk
Business /Operational / Operations and Business Practices / Natural hazards, facilities, disease outbreaks / Contractual risk, internal processes and controls, management transitions
People and Human Resources / Health, contract terms, turnover / Recruiting, training, retention, organizational culture
Strategic Positioning and Flexibility / Mergers and acquisitions, joint ventures, resource allocation and planning, organizational agility, information access
Financial / Financing and Financial Structure / Debt servicing, leverage, liquidity, solvency, profitability / Debt structure, non-equity financing,
Financial Markets / Cash, interest rates, foreign exchange / Portfolio misalignment
Business Relationships / Business Partners and Partnerships / information asymmetries, adverse selection / Interdependency, confidentiality, cultural conflict, information sharing
Distribution Systems and Channels / Cost, transportation, service availability, hold-up / Access, dependence on distributors
Market Conditions / Market Prices and Terms of Trade / Product price volatility, input price volatility / Contract terms, market outlets, market access
Competitors and Competition / Market share, price wars / Antitrust, industrial espionage
Customers and Customer Relationships / Product liability, credit risk, food recalls / Poor market timing, inadequate customer support
Reputation and Image / Product recalls, defective products, rating agencies / Corporate image, brand image, reputation of key employees, community relationships
Policy and Regulation / Political / War, terrorism, civil unrest, law, governing agencies / Enforcement of intellectual property rights, change in leadership, revised economic policies, budget shortfalls
Regulatory and Legislative / Reporting and compliance, environmental, food safety, traceability / Government trade negotiations, Government farm subsidies
Technology / Technological / Asset specificity, research and development / Complexity, obsolescence, workforce skill-sets, adoption rate, diffusion rate
1