Learning to Manage a Risky Business

Transcription

1 Department of Agriculture Western Australia CRC for Plant Based Management of Dryland Salinity Abstract Paper Presented at Managing Climate Risk in Agriculture Workshop of The Australian Agricultural and Resource Economics Society Conference held at The Esplanade Hotel Tuesday, February 11th 2003 An interactive group-based simulation game has been developed for learning about managing a farm business under risky and uncertain circumstances. It is a facilitated workshop, named Risky Business, which incorporates a computer-aided game. The game and the workshop are designed to enhance learning in the area of planning and management of a farm where climatic and marketing risks create inter-seasonal variations in business profit. Responses of game players are collated to reveal their perceptions and experiences of the game. Player feedback indicates that they find the game challenging, entertaining and effective in conveying a range of risk management issues. The Australian experience shows it is possible to design a game package that harnesses the beneficial elements of group activity, facilitation, computer simulation and peer competition; with the outcome of stimulating and facilitating people's learning about managing a risky business. Climatic and Marketing Risks in Farming In agricultural industries, decision makers, be they a grain or livestock producer, a processor, a merchandiser or a credit provider can not ignore the impact of the variability in weather and prices, both within seasons and between seasons, that is the source of much of the risk observed in the production of agricultural commodities. An adverse change in markets or weather can result in substantial reduced profits, or worse still, significant economic losses. Managing weather and market risk is a key element in farm management. It is increasing in importance as agriculture moves further into a global economy and government agricultural support programs are constrained as to what formal level of assistance is permissible. Risk can take on different forms, in varying degrees, depending on the individual or firm s financial position, cash flow position and need to avert risk. Not all risks can be controlled or transferred through traditional insurance schemes. Commodity price risk and production risk associated with variability in seasonal conditions are among such risks. Significant fluctuations in the price of commodities and in the yields of crops and livestock carrying capacity of pastures can have dramatic financial impacts on agribusiness. Global climate change; reduced governmental control of markets and gradual withdrawal of subsidy programs demand that more attention be paid to risk management for improved sustainability and wealth creation in farm businesses. Strategies for Managing Yield and Price Risk To make sound risk management decisions farmers need to have more than a working knowledge of the available strategies and risk management instruments. They need a practical and robust decision-making framework for their risk management decisions. Such a framework should allow them to account for their experience, personal preferences, their financial circumstances and their farming system. The framework should allow a manager to evaluate the impact, on the whole farm, of their alternative courses of action in managing risk. A grower needs to be able to choose the course of action that is her own best interest.

2 In the context of climate and market risks associated with the production of agricultural commodities the most relevant risk management strategies available to farm managers include: Diversification strategies that may involve on-farm and off-farm enterprises or investment; Benchmarking and evaluating the risk/return trade offs; Understanding the concept of probability and its use; Understanding and using climate and market forecasts; Assessing the risk characteristics of production alternatives; Budgeting and activity planning using different scenarios; The use of futures hedging and other risk management instruments; The use of climatic and technical information in planning for risk. Experience has shown that reading and understanding the impact of risk and the alternative management strategies available to a decision maker does not empower her to implement the relevant strategies appropriately. Practical managerial knowledge, spanning several business cycles, helps the decision maker select the best alternatives where there is both uncertainty and variability about the impending season and the unfolding market conditions. This is a life long undertaking accomplished with various degrees of success by business managers. Learning From Participation In Simulated Scenarios Simulating decision making environments is a method of experiential learning that offers the opportunity to practise the strategies learnt through reading the theory and application of risk management or through observing the choices made by decision makers. When placed in a simulated farm business environment, the learner can begin to visualise, experience and utilise concepts that previously were mere descriptions. In this environment the participant can be provided with the opportunity to control or experience, often vicariously, various events and choose the responses that may offer the most rewarding payoffs. Using a business simulation environment as a teaching tool enables the teacher to create a learning environment in which the learners are responsible for the decisions they make and the outcomes and consequences of their choices. To be successful in this simulated environment, as in real life situations, the decision maker must use their analytical and critical thinking skills to identify a suitable solution or response to a problem or an opportunity. In simulated environments the students learning is stimulated and they are motivated to actively participate and are given responsibility for making the decisions. The interpersonal communication between the participants, the natural tendency of students to cooperate when placed in teams and the challenge of competition between teams can create an excellent learning opportunity and a fun teaching environment. A rich source of data and information is created in such learning environments when the strategies adopted by the students in response to unfolding situations and their consequences are recorded. This data when analysed produces valuable information that is then offered for discussion by the participants. These discussions then give the instructors the opportunity to seize the teachable moments and draw on the students reactions and experiences with the situations facing them, to illustrate particular concepts of risk management and decision-making under uncertainty. Decisions that were made by teams in a simulated risky business can be discussed and reviewed in a workshop style environment to reveal the influence of individual attitudes and the social as well as the cultural dynamics that often underpin key business decisions (Stewart et al. 2000). The Risky Business Workshops Risky Business is a training workshop that simulates a business environment. It offers participatory action learning opportunities by putting its participants in charge of a hypothetical farm business. It incorporates a computer-aided game designed to achieve specific educational goals related to planning farm enterprises and managing the production and marketing that are subject to seasonal variability. A Risky Business farm business needs to be operated as a partnership. Two or three participants of the workshop must make decisions jointly. In every season the farm managers have to consider and put in place several strategies and make tactical adjustments where necessary. 2

3 In Risky Business there are many opportunities for learning from trial and error. The game allows the presenter to create an atmosphere in which participants take responsibility for managing a hypothetical farm. Participants find it an enjoyable way to learn complex concepts in management decision-making. Through a series of short lectures participants at the workshop are exposed throughout the game to the key theoretical principles and concepts of decision making under uncertainty, farmers management response to price and climatic risk and adoption and diffusion of rural innovations. The course integrates colour projections, music, entertaining caricatures, graphics and fun games and quizzes. Participants are also given copies of the lecture content and notes. After a brief introduction to their farm, the participants put on their farming hats and are shown how to play the game. Throughout the day the facilitators make reference to the principles learnt in the lectures. All participants are given the same hypothetical farm to manage. All farms face the same climatic and market conditions. It is their responses to these conditions that distinguish them from one another. There are constraints under which the decision makers must plan their farm to maximise their financial well being over several seasons. The key constraints include land, finance and the type of enterprises. The partners in this virtual business become engrossed in the following activities and have to consider several managerial issues: Analysis of historical yields and prices to help with the choice of enterprises and grain sales; Analysing the variability associated with the price and yield of alternative enterprises; Assessing the profitability of each of the several production options - benefits of budgeting; Benchmarking and evaluating the risk/return trade offs between alternative enterprises; Choosing the best mix of enterprises and the best diversification strategies under different scenarios; Deciding what level of inputs will result in the highest profits; Understanding and using climate and market forecasts for strategic planning Learning to make tactical adjustments to enterprise mix and commodities sales within each season; Comparing actual with estimated farm budgets; The importance of knowing the gross margin of enterprises; Consequences of adjusting inputs versus changing the scale of operations; Assessing the profitability of additional inputs Learning the importance of marginal analysis; Constrains and opportunity cost of land and other resources such as credit, labour and manager s time; Strategies in adopting new technology and expansion of the farm; Tactical management versus strategic management; Differences between forward planning versus accounting processes in helping make decisions; Break-even price, target price and target profit as aids to grain price management; Timing and amount of physical sale of grain Choice of forward contracts versus harvest deliveries Learning about the main forces that shape the climate and market and create variability in them; Differences between risk transfer and speculation; Understanding of the derivatives markets; Trading with commodity derivative instruments - Futures and Options contracts; Timing of trading contracts Opportunities in trading versus climate/production in a any given season Trading psychology Setting up and trading according to well-defined personal rules. Myths of trading Slippages and commissions in trading; Temperaments of market traders Bulls, Bears, Hogs and Sheep. Learning Outcomes of Risky Business The simulation game provides opportunity for many teachable moments. As the day progresses participants are stopped on several occasions to discuss progress, highlight observations and to draw their thoughts back to relevant decision making theory. The workshop organisers feel that it is important to take advantage of these moments, to pose questions and highlight points to increase the comprehension of the principles by the learner and to draw out relevant lessons. This course facilitates a fair amount of learning from peers and other participants. 3

4 The farm management environment created by the simulation game highlights to the participants the importance that decisions and current actions have on the ability to carry out future plans. During the course some participants find that due to their earlier management decisions they can not implement desired farm plans. This is largely due to financial constraints. The participants find that sometimes (depending on how they manage) they have insufficient funds and equity to cover the costs of their proposed farm plan. To many participants understanding this dynamic nature of running a business is an eye opener. There are also several key lessons purposefully imbedded in the structure and content of Risky Business. Among the key lessons are the following: There can be a substantial difference between a planned and actual outcome. In short, farming is a risky business. Farmers have to make large and small decisions often under conditions of imperfect knowledge and with important ingredients of farm profitability being outside the control of the farmer. The decision environment can be highly variable and unforgiving. Time and income pressures along with a range of uncertainties can make farm decision-making frustrating and at times very stressful. A good decision is not necessarily the correct decision. Farm managers almost always operate under conditions of imperfect knowledge and so have to be content with making good decisions based on the information they have. With the benefit of hindsight, good decisions may not turn out to be the correct decisions. Adoption of innovations may offer the opportunity for diversification. Trialing an innovation provides information about the innovation and may lead to improved decision making about the innovation. However, not all innovations can be readily trialed. Determining the profitability of an innovation is often a non-trivial exercise (Abadi Ghadim, 2000). Not all information is reliable or valuable. Also, lack of time and opportunity can limit acquisition of key information needed to make informed decisions. However, in general, information and experience reduce uncertainty about a situation, so relevant and timely information can be very valuable. Enterprise diversification can reduce risk and occasionally diversification can also increase profit, but it does not necessarily achieve either of these outcomes. Sometimes there is no profitable technological solution for a problem. At times, past decisions and limited liquidity can heavily constrain a farmer s current decision options. Land use in previous years can restrict or influence enterprise selection in a current year. Further, current use of the land should account for planned uses of the land in the future. Individual management of farms can vary substantially because of a range of factors related to each individual: management style, attitudes to risk, competence with different enterprises, perceptions and beliefs and the time taken to revise them. Utilizing simulation modelling in a group-based game setting does mean a change from the traditional lecturing role of the educator. In a game setting the educator takes on the role of a collaborator, a facilitator, and a commentator; rather than simply the didatic lecturer. Experience of Participants Risky Business has been used to train an estimated 1200 individuals around Australia. Participants have come from a variety of backgrounds such as farming, banking, agribusiness, agricultural education, technology transfer and research. Workshop organisers have found that a diversity of backgrounds among 4

5 players provides for rich discussions among players and gives opportunity to hear a wide array of management views. Farming groups in WA, SA and NSW as well as rural bank mangers, agronomists and farm consultants, students of agricultural colleges and universities have all found that the game helps them experience the practical ramifications of the principles and theories of risk management. Corporations such as Westpac bank use the game to help their employees view situations from their farmer clients' perspective. Empathy with real farmers is promoted through enabling participants who are inexperienced with a farming business to develop an appreciation of the general difficulties and complexities of farm management faced by farmers. A farmer participant of Risky Business made the following remark at the completion of the workshop: I have been attending sessions over many years where experts have tried to impart their knowledge on [commodity] marketing but with little success Finally, today was the one I have been waiting for, and am so please that I accepted your invitation and was privileged to have been invited. I believe this is a great tool to learn more about risk. I enjoyed today s really interesting, informative and hands-on workshop. Mr Dennis Wise, a commodity marketing advisor, made the following remarks about Risky Business after he was asked to review its educational value to the agricultural industries. "Risky Business" advances farm risk management to a level never before seen in Australia. The practical "hands-on" approach developed by this program offers Australian farmers and agribusiness the opportunity to experience realistic seasonal, price and production scenarios and examine the outcomes in a safe learning environment. I am not aware of any Canadian or US farm risk management training programs, which even approach the benchmark set by "Risky Business". A great strength of "Risky Business" is the whole-of-farm approach. No other workshop in my experience offers such a comprehensive integration of the farm business impacts of risk management on capital and financial resources. No other workshop so clearly illustrates the real profitability drivers of farm businesses. A good feature is that the program encourages participants to get a feel for risk/reward ratios, or how to handle farm business risk according to their own needs and preferences. I especially like the emphasis on hedging or protecting farm prices rather than speculation. "Risky Business" is a very timely training tool for Australian grain industry. Whilst many innovative grain farmers now have some knowledge of derivative and other pricing instruments this program should help farmers understand the best use of pricing tools by training people in the development of better farm market tactics and strategies. This program is the logical extension of many other marketing and risk management training programs which have been offered to the industry over the past decade. While it could be made even more sophisticated in the future I believe that "Risky Business" strikes a good sensible balance between ease of use and practical farm situations to provide an excellent training tool for the Australian grains industry. To further understanding of risk management ProFarmer Australia hopes that all our clients have the opportunity to undertake "Risky Business" in the future. 5

6 Development and Future Prospects Risky Business was developed by a team of agricultural and resource economists at the University of Western Australia and the Department of Agriculture in Western Australia. It is designed to enable participants to gain a greater understanding of the principles and processes of decision making under risky and uncertain conditions from a business manager s point of view. The framework and contents are designed with the aim of teaching participants from all levels of student learning and from a variety of discipline backgrounds relating to the rural sector. The government of Western Australia and several other private and public corporations recognize Risky Business as a worthwhile training program and provide ongoing assistance to farmers who wish to attend this course. GRDC funding has been made available for a commodity price risk management version of this game. Conclusions The case study of the Risky Business training workshop shows that enjoyable educational programs based on simulation of scenarios aided by computers can facilitate learning about managing risk in farming systems. Interactive simulation games of farming systems that are easy and fun to use have the potential to be a powerful educational tool in effectively conveying many lessons about farming systems and their management. Experience with Risky Business shows the power of training workshops based on simulated business scenarios aided by computer applications that are specifically designed to help deliver the learning outcomes of the workshop. Group-based activities within the game format can ensure that the incentives of collaboration and competition stimulate learning. Experiences with the Risky Business workshop indicate that it is possible to design a farming system simulation game that stimulates and facilitates the learning of participants in a professional, engaging environment. Feedback from players verifies their enjoyment of the game and its effectiveness in generating learning outcomes. In a game setting the role of the educator becomes one of facilitator, entertainer and commentator; rather than simply the didatic lecturer. References Abadi Ghadim, A.K. (2000), Risk, Uncertainty and Learning in Farmer Adoption of a Crop Innovation. PhD Thesis, Faculty of Agriculture, University of Western Australia. Stewart, V., Marsh, S., Kingwell, R.S., Pannell, D., Abadi, A. and Schilizzi, S. (2000). Computer games and fun in farming system education? A case study. The Journal of Agricultural Education and Extension 7: Acknowledgments The author gratefully acknowledges funding from the Grains Research and Development Corporation. 6