Dairy Initiatives

Dairy

Department of Animal Science

D A I R Y   I n i t i a t i v e s   N E W S L E T T E R
V o l u m e   9      I s s u e   1     Winter   2 0 0 0

Risk Management: The First Steps

MARGOT RUDSTROM
West Central Research and Outreach Center, University of Minnesota

Risk management tools such as crop insurance, life insurance, futures and options, and contracts can help you manage the risks in dairy farming. But before you choose risk management tools, it's important to identify the risks you need to manage. Many times identifying the key risks is the first step in reducing the risk. Understanding the risks lets you choose the best tools for the job.

First, some definitions:

EVENT:   An event is something that happens. It can be external to the operation (something you don't control, such as a weather event) or internal (something you control, such as a decision you make regarding herd health). The key is to think about events that could affect the ability of your business to operate. Events can range from a drop in milk price, to divorce, to hiring new employees, to bringing a son or daughter into the farm business, to hailstorms--and the list goes on.

OUTCOME:   What could happen if an event occurs? An event can have more than one outcome. The key to successful risk management is identifying all potential outcomes, both positive and negative.

An example of an event and outcomes: You treat a cow for mastitis (event). Two possible outcomes are:

1. Milk from the treated cow is dumped.

2. Milk from the treated cow is not dumped and ends up in the tank.

PROBABILITY:   Because an event can have more than one outcome, we need to rank how likely each outcome is. Probabilities are most often used for this. In the above example, the likelihood of dumping the milk from a treated cow could be 95%. That means there would be a 5% chance that milk containing antibiotics would show up in your tank.

What Is Risk?

Risk occurs when an event has more than one potential outcome, you don't know for sure which outcome will happen, and one of those outcomes could be costly to your business. If you have not identified the alternative outcomes, risk increases.

The following diagram shows how to map out risk. Mapping out your risks gives you a clearer picture of the tools you might use to manage risk.

Identifying and Prioritizing Risks

Identifying and prioritizing risks is a three-step process.

STEP 1:   Identify all potential outcomes of an event.

STEP 2:   Assign a probability for each potential outcome.

STEP 3:   Prioritize the risks of negative outcomes. Start by determining which outcomes would cause your farm to cease operating. For other negative outcomes, determine the cost.

After you have identified and prioritized risks, you can begin to identify which risks need attention, how you might protect your farm business against potential negative outcomes, and who can help you manage your risks (veterinarian, nutritionist, financial planner, tax consultant, lawyer, etc.).

The following table, developed by Geoff Benson of North Carolina State University, can help you determine which risks need immediate attention. If an outcome has a high probability of happening and the potential impact on your business would be catastrophic, it requires immediate attention. You need to have a plan in place for when this outcome occurs. If an outcome has a low probability of occurring and would have a small impact on your business, no action is required.

Once you have identified the risks needing immediate attention, those not so urgent, and the risks that don't have the potential to disrupt your business, you are in the position to identify the resources and tools you will need to manage risk on your farm.

D A I R Y    I n i t i a t i v e s    N E W S L E T T E R
Volume 9     Issue 1    Winter 2000

Dairy Initiatives

Dairy

Department of Animal Science